June 18, 2014 6:55 pm

Fashion: A better business model

Inditex has become the world’s largest fashion retailer. But how long can its dizzying expansion last?

A few weeks from now, young women all over the world will decide that what they really want to wear this summer is a long, flowing trenchcoat with a buckle belt and soft shoulders. They don’t know it yet. But Manuel Ruyman Santos knows, and Inditex knows, and €17bn in sales says they will be right once again.

For the moment, the trenchcoat is a prototype, hanging on a clothes rack at Inditex´s sprawling headquarters in Arteixo, northern Spain. But Mr Ruyman Santos, one of the designers of the new garment, is confident it will be a success. Soft trenchcoats have sold well in recent months, so he knows the new creation will tap into a broader trend.

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For Inditex, the biggest fashion retailer in the world, the success or failure of one trenchcoat is of marginal importance. It is just one of 18,000 individual designs made every year for its chain of Zara shops alone. Add in the group’s seven other brands – from upmarket Massimo Dutti to casual Pull & Bear – and the number rises to more than 30,000. The new coat is nothing but a tiny thread in a much bigger story – but one that illustrates how a small family-owned clothes manufacturer on the edge of Spain turned into one of the most striking corporate success stories of recent years.

The rise of Inditex holds valuable lessons for business leaders, highlighting how important it is to challenge industry conventions and turn entrenched practices upside down. “Our business model is the opposite of the traditional model,” says Pablo Isla, the group’s chairman and chief executive. “Instead of designing a collection long before the season, and then working out whether clients like it or not, we try to understand what our customers like, and then we design it and produce it.”

If that sounds simple enough, it is because the company’s basic philosophy is not so different now than it was in 1975, when Inditex founder Amancio Ortega opened his first Zara shop in the nearby town of La Coruña. The idea was to sell well-made, relatively cheap pieces of clothing, always cut according to the latest fashion, designed and produced by Inditex itself.

What has changed since then is the scale of the business – and the scale of the challenge facing Inditex management. After decades of dizzying growth, some are asking whether Inditex is approaching the limit of its long expansion drive. With close to 6,400 stores in 88 countries, 900m items of clothing sold last year, and an increasingly important presence in online sales, how much more of Inditex’s ever-growing output can the global consumer absorb?

The expansion so far has been relentless. For more than a decade, the group has opened at least one new store every day. In 2010, it overtook Gap to become the world’s largest fashion retailer by sales. A year later, it usurped Banco Santander as the biggest company in Spain. Inditex shares have risen sevenfold since the group went public in 2001, turning its reclusive founder into the third-richest man on the planet. Today, it is the undisputed industry leader, a company studied in business schools and management books, hailed at home and abroad as a rare European success story in a continent scarred by stagnation and unemployment.

Speed is of vital importance to Inditex. Industry analysts say no other company reacts to fashion trends as quickly as the Spanish group, and none is faster when it comes to turning sketches into products ready for shipment. “The essence of the Inditex model is to push the moment of production as close as possible to the moment of sale,” says José Luis Nueno, a professor of marketing at Iese business school. Many of the items you see in Zara stores today will have been designed back in Arteixo as little as two weeks before.

This rapid response time has prompted analysts to describe Inditex as the leading exponent of “fast fashion”. But top managers at the Spanish group wince when they hear the term. “I don’t identify with the concept of fast fashion,” Mr Isla says. “We are not about selling a million striped T-shirts as fast as possible.” He insists that Inditex’s success is based not on speed but on accuracy, on understanding exactly what customers want, week by week, and store by store.

Take the new trenchcoat. Once it goes on sale, Mr Ruyman Santos and his colleagues will know almost immediately how it is faring with shoppers around the world. Every day, tens of thousands of customer reactions are fed back to the design teams. Is the sleeve too tight? Are the fringes too long? Does your bottom look big in this? The answers are analysed and swiftly incorporated into new designs, creating a never-ending cycle of iteration and innovation. Even successful designs will never get a second run. “You need to evolve, and you must never repeat,” says the designer.

Inditex is able to turn around so many new designs so quickly because most of its manufacturing is still done close to home. More than 60 per cent of production takes place in Spain, Portugal and other nearby countries such as Morocco and Turkey. Only clothes that require little tinkering, such as simple shirts and basic chinos, are made in low-cost factories in Asia.

At the group’s Arteixo headquarters, there is almost no physical distance between the operations: To get from Mr Isla´s office to Zara´s design team takes just two elevator rides and a short walk. On the same floor are the workshops where prototype models are cut, ready for a last inspection by the creative team. Deep in the bowels of the same building is a mock-up Zara store, where stylists decide how every dress, shirt and hat must be presented later in the shops.

Another short walk away is the vast on-site manufacturing plant, where textiles are cut, stitched and ironed. From there, another elevator takes you to the packaging floor, where conveyor belts race along at dizzying speed to drop the right T-shirt into the right cardboard box ready for dispatch to Shanghai or Seattle. Every Inditex store receives fresh deliveries twice a week – a feat of logistics that helps encourage customers to return to the store as often as possible.

According to Prof Nueno, Zara customers typically visit the shop four or five times more often than clients of a more traditional fashion store. “They sell in small batches and they are producing what they already know will sell,” he adds. This means, crucially, that Inditex has much lower inventories than its rivals, and less need to discount unsold goods. According to research by Société Générale, the investment bank, only 15-20 per cent of Inditex stock is marked down, as opposed to 45 per cent for a competitor like H&M.

Another point of contrast is advertising: the Spanish group simply does not do it – no television spots, no street posters, no sponsorships and no pages in glossy fashion magazines. “It’s not a philosophical thing. We would just rather spend the money on our stores and products,” says Mr Isla. The lack of publicity is compensated, up to a point, by the group’s flagship stores, which are often located in fancy shopping streets, side-by-side with the luxury brands whose styles Zara designers and shoppers hope to emulate.

A third difference, and the most obvious reason why Inditex has been able to stand apart from the crowd, concerns the group’s location itself. To this day, every item of Zara clothing is designed in a faceless string of concrete buildings on an industrial estate in provincial Galicia, six hours by car from Madrid. The only other large business in the vicinity is a plant that processes frozen fish.

In the early years, says José María Castellano, who served as Inditex’s chief executive until 2005, the company’s location made it hard to attract talented managers and designers. In fact, the decision to open a store in New York as early as 1989 was partly motivated by the need to make Inditex more attractive for new employees by adding a dash of glamour, he recalls.

Attracting designers is no longer a problem (Zara alone employs 350 in Arteixo). The challenge facing management today is how long Inditex can keep on growing, and at what pace. Fears that the group’s expansion would run out of steam have been around for a long time. When the group listed on the stock exchange in 2001, one analyst warned bluntly that “highly complex supply and distribution models tend not to be scaleable”.

At the time, Inditex had just over a 1,000 stores. Thirteen years and more than 5,000 store openings later, the model clearly still works. But it is also hard to dispute that the group’s financial performance of late has been lacklustre. Last year, earnings growth was negligible and Inditex opened significantly fewer shops than in previous years – a sign, some believe, of things to come.

Over the past few years, 50 to 60 per cent of new store openings were in China, Russia, Poland, Mexico and a few other markets

“No model stays brilliant forever in business, and Inditex is no exception to the rule,” says Simon Irwin, retail analyst at Credit Suisse. Some elements of the group’s approach no longer make sense, he argues, not least a logistics network that forces Inditex to ship vast amounts of clothing from China to Spain and then back to China again. But Mr Irwin also warns that the group is now facing much tougher competition in emerging economies – the very markets that have been the focus of the group’s recent expansion drive.

“Over the past few years, 50 to 60 per cent of new store openings were in China, Russia, Poland, Mexico and a few other markets. Every business slows eventually, but especially so when you are so reliant on a relatively small number of countries for such a large share of your growth,” he says.

Other analysts take a more upbeat view. Anne Critchlow of Société Générale points out that Inditex still only controls a fraction of the global clothing market. “Inditex is present in 88 countries, and in the vast majority of those it has a market share of 1 per cent or less. I think it is capable of getting to at least 7 per cent in any market. In Spain it already has around double that.”

Store openings have indeed slowed down markedly in recent years. But Ms Critchlow argues that this reflects a shift in company policy towards fewer but bigger outlets, as well as the new focus on selling Inditex products over the internet. Far from dying, she sees the Inditex model as the one that will set the standard for the whole industry: “Inditex is already where the rest of the industry will eventually end up.”

The argument is certain to rage for years to come. For Mr Isla, talk that Inditex is running out of room to grow is premature. The group has never come up with a fixed number of stores they believe can be sustained by shoppers around the world. “Our company is perfectly used to growing at a gradual and sustainable pace,” he says. “It is very difficult to see where the limit is.”

Amancio Ortega: The reclusive founder who knew his limits

Amancio Ortega is the third-richest man on the planet, with a fortune larger than Warren Buffett’s. Yet even in his native Spain, few would recognise him in the street.

He rarely appears in public, and Inditex agreed to release a picture of its reclusive founder only in 2001, when the group listed on the stock market. Mr Ortega has never given a formal interview to the media.

Estimated by Forbes to have a fortune of $64bn, Mr Ortega has been richly rewarded for his vision and perseverance. He was born in the northern region of Leon in 1936, the year the Spanish civil war broke out, to a railway worker father and housemaid mother. He left school in his teens to work in a tailor’s shop, later becoming a clothes manufacturer in his home province of Galicia with his first wife and brother.

Mr Ortega was quick to spot the importance of technology, hiring a local professor in the early 1970s to boost the company’s computing expertise

The first Zara shop was opened in 1975, after Mr Ortega noticed that the designs his factories were asked to produce never seemed to match what people on the street wanted to wear.

Current and former Inditex executives describe him as a humble, hands-on manager, who continued having lunch in the Inditex canteen most days, long after joining the club of the super-rich.

Crucially, Mr Ortega always knew what he was good at and where he needed help. He was, for example, quick to spot the importance of technology, hiring a local professor in the early 1970s to boost the company’s computing expertise.

The professor, José María Castellano, went on to serve as Inditex’s chief executive until 2005. “[Ortega] is a charismatic man, but with a very down-to-earth management style. He was always talking to the staff, asking what they need and what needs to be done,” he recalls. Although still a board member, Mr Ortega no longer takes an active role in managing the company, after handing over the chairmanship to Pablo Isla, the chief executive, in 2011.

The founder lives with his second wife in a discreet apartment in La Coruña, a short drive from Inditex headquarters.

His main pastime is equestrian sports, a passion he shares with his 30-year old daughter, Marta.

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