This analysis of two well-known global retailers suggests not, since the cost-cutter fared much worse. But what can you do instead?
The one who focused on minimising unit prices had a hard time, with profits flat over 10 years – even though in 2002 it had three times more sales than its competitor (the red line on the graph). By 2012 David had overtaken Goliath, and now sold 30% more, and their 2012 profit was almost the size of their sales in 2002 – a 700% increase (blue line).
And it didn’t do this by cutting its supply costs.
This article was first written in 2013, and published on my previous – now closed – website. I also posted a version on LinkedIn in 2016.
Whilst cost has a key role in business, and good businesses pay as little as they need to for what they need, that by itself is not enough. Your supply base needs to help you achieve your objectives, and I don’t know any organisation whose overarching goal is to reduce spend. If it was, close everything down, spend minimised, goal achieved!
Back to the case. The two companies I studied were the UK retail bellwether Marks & Spencer (M&S) who in 2002 had sales of £8 billion making a profit of £500 million. The rival is Spain’s Inditex – best known for the brand Zara. In 2002 it had sales of £2.5 billion and made £300 million in profit. By 2012 M&S achieved £10 billion of sales, with an average profit of £550 million across the decade. Inditex/Zara’s sales were now £13 billion and had averaged £1 billion in profits each year over the decade. In the graph M&S’s profit is the red line, Inditex’s the blue dotted line.
Imagine you work in the global retail industry. If you focus on functional savings or PPV (purchase price variance), and want the lowest price per garment, you might consider sourcing tactics such as:
By the early 2000’s M&S had done just this – moving its suppliers from mainly the UK to Eastern Europe, North Africa, and Asia in search of lower unit prices.
Although this is tempting logic, how is it that Zara – whose clothes are not designer-label expensive – managed to grow and make higher profits, with what seems such a high cost operation? During the period studied
So how has it managed to grow sales and profits every year for 20 years, and to deliver a return on assets of over twice the industry norm….when it didn’t focus on minimising the purchase cost of everything?
Tradition fashion follows a well-trodden path.
Design – Buy/Manufacture to Forecast – Deliver to Store – Sell during Season – Discount Sales of unsold items
Design might take place 12-15 months before the season, in order to allow the required volumes to be purchased at the best prices. Buying a season’s quantity at a time helps reduce unit-prices and transportation costs to a minimum.
But once garments hit the shop floor things do not always go to plan. Customers love some items…and they sell out within a few weeks. Lost opportunity. However others did not seem to sell at all, leading to the rise of the Outlet Mall and end-of-season sales. Which in turn makes things worse – “I like that, I’ll come back when the sales are on”…or “I’ll pick it up in the Outlet Mall in 6 months”. What to do? Get better at predicting the future?….
A dilemma: Keep high stock to ensure you get every sale possible…whilst at the same time keep as little stock as possible so you have fewer unsold items and so you can carry a wider range (assuming you have limited space & cash).
Zara broke that dilemma with a different approach, which its founder Amancio Ortega called “Fast Fashion“. If you speed up the supply chain, the need to forecast almost disappears. With Zara it takes around 4-5 weeks from first design to a garment in the store. A minor modification, or making more of a popular garment, is less than 2 weeks from factory to store.
Fast Fashion brings many benefits which help grow the top line and increase the profit. It does reduce cost, not at a detailed unit-price level but at a more strategic level.
I would be surprised if the price Zara pays for a shirt is lower than M&S, and very surprised if the freight cost per item is not higher. It is easy to imagine a keen but naïve buyer suggesting that Inditex should buy in bulk, ship full containers by sea, and have fewer products, so that it could reduce its costs. And I’m sure if it did this then there would be a noticeable increase in profit in the short term. But this would be the wrong thing to do. Very soon sales would fall too. Inventories would rise, tying up money, and leading to heavily discounted sales. Profits would plummet, CEO’s would get sacked, and a great company destroyed.
I’m sure Inditex doesn’t pay more than it needs to for its locally-produced garments, or for its air freight, and gets a great deal when building its offices and warehouses. However I don’t believe it spends much time considering moving back to designing a year ahead of sales and ordering all its stock 6 months before the sales season, just to lower its unit item price.
Fast Fashion doesn’t just rely on traditional suppliers. It needs suppliers who are flexible and adaptable and can produce small batches quickly and cost-effectively. This is quite possible, but not if the manufacturer has a traditional (large order well in advance) mind-set. I would be surprised if Zara, like Toyota, has not helped their suppliers to improve during its journey – there is no way they could have grown if manufacturers had said “Sorry, 4 months lead time is the best we can do”.
As a Brit I love the idea of M&S, and wish them every success.
If you read this and know someone who works there, please send them a link to this article, or suggest they buy a copy of Eli Goldratt’s book “Isnt In Obvious“. For less than $20 it will show them how to run a fast retail or distribution supply chain – better than just copying Zara without understanding the fundamentals.
Goldratt’s book is an easy to read novel, that explains the overall approach to applying a pull supply strategy in a retail environment, and is very accessible.
For a few dollars more you can get a fully detailed text book on DDMRP by Ptak & Smith. DDMRP in my view is the best way to design and manage your supply chain available today. This book will tell you exactly how to implement the kind of approaches Zara intuitively developed for themselves.
No army of consultants, no need for a $multi-million computer system to “forecast better”. Another fantastic “saving” for the company, but another one that you might not be allowed to claim!
Ian is a consultant who helps clients to improve the performance of their capital projects and programmes. Before becoming an independent consultant, his experience included 15 years working as a project manager on capex projects, 10 years in procurement, including being chief procurement officer for a large construction company, and 10 years management consulting with niche consultancies in supply chain and procurement.