Should Zara replicate the integrated store and online DC model in other markets? Why or why not?? 2 pages. Attached case. No references need it.0d1b1ff4-0875-40cb-8ab3-33279188ce

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Professor Antonio Moreno prepared this case with the assistance of Assistant Director Elena Corsi (Europe Research Center). Professor Moreno thanks Professor Jan Hammond (Harvard Business School) and Executive Director Vincent Dessain (Europe Research Center) for their help in the development of this case. It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2020, 2021 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

A N T O N I O M O R E N O

Zara: An Integrated Store and Online Model (A)

This fully-integrated approach is much more than stock integration. It's everything. It’s our real estate strategy. It's the way we show the product in the stores. So it has a lot to do with all the different aspects of the management of the company. That is why it is so strategic.

— Pablo Isla, Chairman and CEO of the Inditex Group

In the fall of 2018, a group of senior managers of the fashion group Inditex were heading to a meeting with Group Chairman and CEO Pablo Isla to discuss how to advance Zara’s “integrated model” in light of the growth of online orders. Isla, who had been Group Chairman and CEO since 2005, had topped the Harvard Business Review ranking of best performing CEOs in 2017 and 2018, and had ambitious plans for the future.1

Zara was the Group’s oldest and largest brand, representing around 69% of sales, or €18 billion in 2018 (see Exhibit 1). At the core of Zara’s success was an innovative business model based on a very responsive supply chain and quick merchandise turnaround. Zara designed, produced and delivered new items to stores in less than three weeks, allowing it to constantly update its collections and adapt to changing customer tastes. Stores worldwide received shipments from Spain twice a week of both new and replenishment products. The stores maintained low inventories; customers visited them frequently to see the new arrivals. Zara management viewed its more than 2,200 stores as the brands’ main marketing tool and used the stores to capture quantitative and qualitative feedback on new looks and trends.

In 2010, amidst the growth of ecommerce and the emergence of new, purely online, fashion players, Zara launched its first online store, Zara.com. Since then, Zara’s online business had grown at a fast pace. The rest of the brands of the Inditex Group followed a similar path. By 2018, 12% of Inditex Group’s total sales came from the online channel. For those countries where Inditex had online sales, online sales were 14% of the sales in those countries. Since the inception of the first online store, Inditex leadership wanted its online and offline businesses to be integrated. However, the increase of online orders challenged some of its operations. For example, online orders had higher return rates (see Exhibit 2 for industry-level figures), which required more attention to “reverse logistics” activities such as receiving, evaluating, and storing returned goods. “Click-and-collect” orders, for which customers ordered online and picked up their ordered products at a store, represented about one third of online

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orders.1 F 2 Although these orders allowed Zara to contain product delivery costs, they increased in-store congestion and required stores to allocate labor to the related operational tasks.

In parallel to growing its online channel, the group had launched a “store optimization” initiative that involved opening new, large flagship stores in prime locations that “absorbed” smaller stores. Isla provided an example, “[I]n May, in Bilbao we opened a big flagship which has absorbed the four Zara stores we had in the city center. In terms of space, the new store is bigger than the four others combined. And we are selling more with this big flagship than what we used to with these four small stores.”

Zara had implemented several technological innovations to improve operations. For example, all Zara items were equipped with Radio-frequency identification (RFID) tags, which allowed real-time inventory tracking. Zara’s systems enabled its ability to fulfill online orders by shipping items to customers directly from a store, instead of from a distribution center. In some stores, Zara had installed robots that stored and sorted orders that customers had placed online for “click-and-collect”. The technology allowed customers to pick up their orders without interacting with store associates.

Inditex was committed to the vision of becoming fully-integrated, fully-digital, and fully- sustainable by 2020 and to implement that vision had committed €1.8 billion in 2017 and €1.4 billion in 2018 for IT, logistics and stores (see Exhibit 3 for a summary of the vision). As its largest brand, Zara often pioneered innovations that were later rolled out to the other brands. How could stores continue to be relevant in a world with increasing presence of online touchpoints? What should the store portfolio look like in the medium term? How should Zara use and advance the integrated model going forward? What other challenges and opportunities would arise with the increase of online sales?

The Inditex Group and Zara A subsidiary of the Spanish Inditex group, Zara was a clothes and accessories brand and retailer

that operated over 2,200 stores in 96 markets.2 F 3 Zara’s story began in the Spanish coastal city of A Coruna in 1963, when founder Amancio Ortega started Confecciones GOA, a modest workshop making dresses and quilt dressing gowns for distribution. In 1975, the first Zara store opened in A Coruna. By 1983, Zara had nine stores in Spain. In the 1980s, Ortega changed Zara’s design, manufacturing, and distribution processes to reduce lead times and quickly react to new trends. The changes included the use of information technologies and using groups of designers instead of individuals. In 1985, Ortega launched Industria de Diseno Textil SA (Inditex), the holding company of Zara and its manufacturing plants. In 1988, Zara began its international expansion by opening a store in Porto (Portugal) and subsequently, stores in New York (USA), Paris (France), Mexico City (Mexico), Athens (Greece), and many more. In the 1990s, Inditex broadened its brand portfolio by launching and acquiring new brands (described below).3F 4 In 2001, Inditex had its initial public offering on the Bolsa de Madrid.4F 5

By 2018, the Inditex Group had 174,386 employees, operated 7,490 stores in 96 markets, and had e- commerce stores in 156 countries (see Exhibit 4 for the Group’s financials). About 45% of the Group’s sales took place in Europe (excluding Spain), about 16% in Spain, 16% in the Americas, and 23% in Asia and the rest of the world. (See Exhibit 5 for a breakdown of brands and regions). 5 F6

The Group owned eight fashion chains: Massimo Dutti (higher end), Berhska (latest fashion for young customers), Oysho (women loungewear and lingerie), Pull & Bear (casual fashion), Stradivarius (urban fashion), Uterque (premium clothes and accessories), Zara, and Zara Home (see Exhibit 6 for details). Although the founder, Ortega, was still a member of the board, the company was managed by Pablo Isla, Deputy Chairman and CEO since 2005, and Chairman and CEO since 2011.

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José María Álvarez, Director of Corporate Development of the group, described Zara’s approach, “Our business model is to provide to fashion-oriented customers the latest fashion trends at the right time and at affordable prices. It does not focus on selling clothing, shoes, or apparel. We focus more on an intangible part than on a functional part of the garment.”

Zara’s business model was built on its ability to quickly produce and deliver new products. It produced over 20,000 new designs each year. The brand kept a significant amount of its production in proximity, which gave the organization flexibility in the amount, frequency, and variety of new products launched. The design team was based in Spain. Most clothes were manufactured in Spain or in neighboring countries and then quickly shipped to stores worldwide. Items that did not change with fashion trends, such as basic T-shirts, were often manufactured in other more distant countries to save costs. (See Exhibit 7 for an illustration). Zara made production commitments six months in advance for only 15% to 25% of a season’s line, and committed to 50% to 60% by the season’s start, meaning that a large fraction of its clothes were manufactured during a season. 7

Zara’s brick-and-mortar stores were a key pillar of its business model. Because the stores were the brand’s main marketing tool, Zara was careful to launch stores in high-traffic locations, usually next to high-end fashion brands, and spent a very small fraction of revenue on advertising. Zara believed that its products would “speak for themselves.”

Its ability to quickly fill store orders allowed Zara to operate with small, fast-moving store inventories (see Exhibit 8 for a comparison of key metrics with other retailers). Stores transmitted information to headquarters about products, including order and sales data, customer reactions, and outlooks on upcoming trends.8 Based on the data and anecdotal evidence, store managers sent orders to headquarters twice a week and received the products in-store within two days. The store would then display products on the shop floor. When a product was out of stock in certain sizes, the remaining inventory would be relocated from the shop floor to the backroom and replaced with new product.9 Stores changed their offerings every few weeks, prompting customers to visit stores often to see what was new. 10 Zara’s inventory management resulted in customers perceiving scarcity and feeling compelled to buy the items they liked immediately, because those items could be gone soon. 11

Zara’s model was different from other traditional fashion giants such as the Gap, which offered iconic American styles in brick-and-mortar stores and online. The Gap offered wardrobe basics such as denim and T-shirts, and also accessories and personal care products. The Gap had an average production cycle of 10 months, which caused long lead-times, distances and hand-offs in the supply chain.12, 13As a result, the Gap could not respond to new trends and consumer demands as quickly. Excess inventory accumulated when sales expectations were not met, causing steep markdowns.14

Zara Online

Launch

By the time Zara launched its online operations in 2010, some of its competitors had been selling online for years. Prior to its online launch, the Zara website was essentially a catalogue with no transactional capabilities.0 F a Zara management was initially hesitant to launch online due to concerns about being able to recreate online the store experience, which management thought was central to its value proposition. Álvarez argued:

a Zara Home had launched a transactional online store in 2007.

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The reason we did not launch Zara online earlier was because we had a clear commercial proposition in our stores and that was something we did not know whether we would be able to replicate through our PC or our laptop. When you enter a store, you can navigate freely without staff interacting with you until you need help. But in a very clean and comfortable way. We needed the internet purchase path to be as comfortable as possible. You don’t want a customer to go through 20 clicks to purchase a pair of trousers. Only when technology was agile enough and the smartphones started to reach consumers in a significant scale were we able to replicate in some way what we were expecting. So once we reached that point, we launched Zara online.

Zara did not conceive the online channel as a separate, independent initiative. From the initial launch of online operations, Zara followed an integrated approach. Isla noted,

From the very beginning, I wanted online to be totally integrated with the rest of the company. Not a separate business but totally integrated. We launched online with a strong connection with the physical store, allowing customers to return products at physical stores and to ‘click and collect.’ This is Zara online since day one.

Zara created new infrastructure and processes to launch its online operations. For example, Zara.com established a network of “online” distribution centers (“DCs”) to fulfill online orders, and built logistics teams and processes to allocate inventory to online operations. It also created customer service operations to support customers using the online channel and stores. And it assembled teams to create the website content. Zara management stressed that, from a philosophical standpoint, the online store operated very similar to the way physical stores operated. The commercial proposition was intentionally the same online and in stores since the beginning: the same new garments, the same price, the same marketing image. In coordination with stores, online products were changed quickly, which drove frequent customer revisits. As in the stores, new products were introduced online twice a week. As a result, twice a week the online content team had to update the site’s content, which included photographing new products on human models, retouching images and creating layouts and text. New products and replenishment would be shipped twice a week to the DCs, as they were to stores. And, like store managers, online team managers made new product and replenishment requests.

Zara followed a structured approach to launch online in new markets. The process started with a sales forecast to evaluate whether it needed a local DC for online product. When possible, management preferred to concentrate inventory. For example, in Europe, several markets were initially served from the DC in Madrid. As volumes grew, Zara opened additional DCs in other countries to allow faster delivery to customers. Zara’s DCs for online products were typically operated by third party logistics providers.

To launch online sales in a new region, the Zara.com team worked with local Zara teams to better understand the market and benchmark customer expectations for the online channel, which could vary considerably by market. For example, in Russia customers expected to be able to pay by cash on delivery. The Zara.com teams would set up customer service, which could involve adding a new language or local dialect. The team would also adjust online content by market. One to two months before online launch, the teams trained local store associates on new processes such as “click and collect.” To test that the online processes were working properly, Zara usually had a two- to three- week pre-launch period when online orders were open to employees but not the general public. The entire launch process took between three to six months, depending on whether a local online DC was added. Inditex’s other brands used a similar approach to establish their online operations (see Exhibit 9 for each brands’ timeline and market coverage).

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Online Operations in 2018

By 2018, Zara had physical stores in 96 markets and online operations in 156 markets served from 23 online DCs (see Exhibit 10 for a map of the DCs). The online stores were managed directly by Zara, with a few exceptions, such as in China, where Zara also had a store in T-Mall, the main online marketplace in the country, operated by the Alibaba Group. In 2018, Zara launched a global website that made its products available in countries where it did not have online operations, delivering the online orders from Spain. This increased the number of countries where it was possible to buy Zara products online to 202. By 2020 all the brands of the Inditex Group were expected to be selling globally online. Online sales grew steadily over time (e.g, 27% growth in 2018), reaching 12% of the Group’s net sales globally in 2018 (14% of the net sales in countries where the Group had online operations).

Zara charged a delivery fee (e.g., €3.95 in Spain) for online orders shipped to the customer, but offered free delivery for orders larger than a certain threshold (e.g., €30 in Spain, see Exhibit 11 for details). Most orders were large enough to qualify for free shipping. “Click and collect” online orders incurred no delivery fees. Overall, about one third of online orders were picked up at a store. In markets with a strong physical store presence, such as Spain, the fraction of orders picked up at a store was even larger. Zara offered returns via mail (with free shipping) or at stores. More than half of the returns of online orders were returned to stores. The costs to Zara were lower when customers picked up or returned their orders at the store, and Zara enjoyed the additional benefit of attracting traffic to the store. However, Zara did not encourage customers to use certain options. Álvarez noted:

We are not pushing. That comes back to the culture of the company since the very beginning. We don’t think we are able to build a fashion trend and then push these fashion trends and convince customers to buy these garments. We follow a pull approach. The same here. If a customer wants to buy in a physical store, we want to make it available for the customer. If a customer wants to buy one of our products online, we want to make it available for the customer. We are eclectic from that point of view. We don’t mind delivering a parcel from a stockroom or delivering a garment to a store and then selling through the physical store.

Although the growth of online retail created additional costs arising from the costs of home delivery and increased returns, Álvarez noted, “Zara’s margins were not diluted. The company remains focused on trying to maximize sales at full price.” Fernando Talín, Director of Finance of Zara.com, cited some initiatives aiming at increasing the efficiency of the process: “We are working on different projects to reduce the timing and the cost for us. We are integrating the stock that we have in the physical stores and choosing where to serve the online order from to reduce costs and increase speed.”

Use of Online Data

The Zara model was based on identifying fashion trends and being very responsive to them. The traditional Zara approach relied on quantitative and qualitative information coming from the stores to guide new product introductions and replenishment decisions. Quantitative information included sales data as well as the twice a week orders from store managers, and was complemented with frequent feedback from the store managers to the commercial teams in A Coruna.

As the online channel ramped up, the amount of available data exploded. For example, there was now information about what search words customers used on the website, how much time they spent viewing a particular item, the conversion rate of each item, and what issues customers reported in live chat. Valuable data was also being generated and shared through social media, but management reported that it was often challenging to identify the right information to pay attention to.

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The online channel presented interesting possibilities to inform the commercial teams’ decisions. For example, commercial teams could test products in the online store, evaluate their performance, and then adjust the quantities ordered from suppliers. Talín noted, “Online is now perceived as a tool for commercial departments to explore how customers might react to new arrivals. With the physical store, we need more time, and we lack space to put all the items on the floor at the same time and measure the reaction. With the website, it’s very easy.” Zara had an A/B testing platform and had been increasing the number of experiments run on the site. Talín added, “Probably we can impact more decisions in the company with that information.”

Integrated Inventory Management

Inventory Tracking

Accurate inventory tracking was critical for Zara’s success, and had been a major focus for a long time. The sales environment of Zara stores was very complex. There were many different products — just in the ladieswear section, a store might display around 2,000 products, 10,000 considering different sizes. And products changed very quickly. Zara presented items on the shop floor more like a luxury brand than a mass-market brand, with few units of the same item displayed on the shop floor, and additional inventory available in the store stock room. But unlike a luxury brand, sales volume was very high, resulting in a high rotation of the units on the shop floor. Zara was also careful to ensure that the presented items had an adequate size coverage. For example, if there was only one size left of an item, that product was often moved back to the stock room and substituted on the floor with another product that presented full size coverage.

Store associates constantly replenished the shop floor from the stock room. Before Zara implemented RFID, inventory tracking took a long time, making such replenishments extremely challenging. A store associate might know that a size was missing on the shop floor but would spend a lot of time trying to find it in the back room. The shop floor was often not well-replenished, even when the desired replenishment item was in the back room or misplaced on the shop floor. Inaccurate inventory also increased store associates’ workload.

Experimenting with RFID

In 2008, Zara started experimenting with RFID solutions to track inventory. Initially, the goal was to improve the movement of merchandise between the back room and shop floor. Management expected RFID to increase the accuracy and efficiency of operational tasks such as merchandise receiving, inventory management, and product transfers between the stockroom and shop floor. They also expected that RFID would allow them to improve customer service by maintaining a well- replenished shop floor and by redirecting some of the associates’ time to better serving customers. For example, if a customer was looking for an item that was not on the shop floor, an associate would be able to easily check if it was available in the stock room, and if so, could make the product available to the customer.

The first pilot was conducted in a group of stores over a two-year period. Associates were provided with handheld devices that indicated the real-time inventory availability and location status (backroom vs shop floor) of each item in the store. The location was identified through readings of the RFID tags that were attached to each item via antennas placed in the store. When products were moved from the stockroom to the shop floor or vice versa, the handheld device provided updated location information.

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Adapting and Scaling RFID

The pilot helped identify issues that needed to be addressed to create a scalable, cost-effective process. Initially RFID tags were embedded in the price label. This approach had been tested by other retailers and some tag vendors were already offering such solutions. However, the pilot showed that the label often fell off, resulting in noisy, inaccurate data. Also, RFID tags were expensive, making single-use tags difficult to scale. Iván Escudero, Head of RFID of Inditex, noted, “Mr. Isla´s instructions were that we wanted something that could be reusable or recycled, first to be more environmentally- friendly, and second, to save money and be more affordable.” His team’s solution was to insert the RFID tag in the hard-plastic tag that all items had for security and loss prevention purposes. These tags were recirculated, addressing both environmental and cost concerns. No other retailer had tried such integration before.

The pilot also revealed problems arising from the fact that the existing RFID inlays were directional, meaning that the inlay’s orientation determined whether (and how far) the tag could be read. Garments on the sales floor and in the stockroom were stored differently — some folded, some on hangers, etc. The inlays thus pointed in different directions and the reading perimeter (the distance the tag could be read) ranged from just a few centimeters to 10-15 meters. Zara worked with Tyco, its supplier of loss prevention tags, to create a spherically-shaped solution with a more consistent reading perimeter from all directions. By 2012, Zara had integrated the RFID inlay into its loss prevention tags. The solution was reusable and affordable (adding only a few cents to the cost of each item), and could operate in the complex environment of the Zara stores (see Exhibit 12).

Zara continually improved its RFID processes. The loss prevention tag was traditionally attached to the product by the apparel supplier before shipping the finished goods to Inditex. It proved difficult and error-prone to distribute tags with pre-recorded information to suppliers. Instead, the Inditex team decided that the suppliers would attach the loss-prevention tags without encoded product information and that Zara’s DCs would encode the information as shipments were received from suppliers. After a product was sold, the associate deleted the tag codification, removed the tag, and sent it back for recirculation. The used-tag recirculation process improved over time, and Zara became able to reuse almost 100% of the tags. Store associates processing returns could encode the tags using the store’s point of sales system, transferring a returned item’s SKU information to a new RFID tag and attaching it to the item.

RFID changed many store processes. For example, receiving new merchandise in a store was significantly simplified. An associate would simply point a handheld device to the box containing the new merchandise and records would be instantaneously updated. In addition, after implementing RFID, Zara associates no longer needed to conduct labor-intensive inventory audits. The implementation of RFID also fostered the creation of new tools and processes. For example, Inditex’s IT group developed a tool that determined what inventory should be transferred between the back room and the shop floor. Every thirty minutes, associates would receive a list of items to be moved from the stockroom to the shop floor and vice versa. Gabriel Moneo, Inditex’s Chief IT Officer, described the logic behind the algorithm:

The process does not simply replenish the sales happening on the shop floor, but it considers the ideal inventory each item in the shop floor should have. It could identify that a product does not have an adequate size coverage in the shop floor and should be sent back to the stockroom. It could also identify that some products in the stock room should be moved to the shop floor to increase the size coverage or to maximize the sales opportunities.

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By 2018, Zara had implemented RFID in all of its stores worldwide. Using RFID, Zara’s inventory accuracy levels increased above 98%. This was a significant accomplishment in the retail industry which was notorious for poor inventory accuracy, with some sources documenting accuracy levels below 70%.8 F 15 Consistent with the vision of having a fully-integrated model by 2020, all of Inditex’s brands were adopting RFID.

Integrating Online and Offline Inventory

Increased inventory accuracy had direct implications for the integration of the online and offline businesses. If Zara knew where each item was in the store network, that inventory could potentially be used to fulfill offline or online orders. This integration created both challenges and opportunities. In 2018, Isla created a new position, the Group Chief Operations Officer, to provide coordination between IT, logistics, and the commercial areas. Carlos Crespo, who had had a long career with Inditex, was appointed to the role. He noted, “My main challenge today is to implement a fully-integrated inventory model. For that, we needed RFID in all stores, so that we know the stock and if an item is available for sale.”

Inditex internally developed an order management software solution for integrating inventory visibility and allocation across the organization. The order management solution aggregated inventory information provided by the RFID tags, making that information visible and usable. For each online order, it searched the Inditex network of stores and DCs for inventory that could fulfill that order. The algorithm chose how to fulfill the order based on variables such

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