Memorandum
To: Board
From: Alex Moret, 75960138
Subject: Zara
Date: 2001

Root Problems
International Expansion
New expansion in other continents and countries trends may not match with a consistent similar global market. New stores can be franchised, partnered or own. Shipping from one centralized manufacturer and distribution centre has increased shipping costs and is harder to coordinate, especially with 10,000 products per year and re-stocked monthly. When a new store is opening, it can sit vacant until all the staff is properly trained. When they do marketing they only do it for bi-yearly sales, which can leave the stores empty as a result of getting rid of stock.

Manufacturing
While vertical integration is not a normally practiced with in the clothing retail business, Zara has set up an effective and extensive in house manufacturing. However, this model does have some root problems. Their 50% of in-house manufacturing requires large investment and intensive logistics and smooth operation to ensure proper distribution. There is also increase labour and R&D costs associated with vertical integration that other companies do not have. The increased yearly growth of 20-30% will put pressure on the integrated system and may not be able to adjust fast enough with the growing international sales.

Pricing
Pricing is put on the clothes right when it leaves the factory in spain and could not properly represent pricing in the country it is intended for. Exchange rates change daily and it needs to align with all costs associated with the manufacturing process. Individual stores have their hands tied as to specific regional pricing and cannot pick from a specific catalogue, they sell what they get from head office. Import duties differ from country to country and raises price when clothes are manufactured overseas. This in turn increases the cost and they may no longer be competitive in pricing.

Analysis
International Expansion
Costs to produce goods in Europe is high and coupled with increased in shipping costs will decrease profits to stay competitive with pricing. When expanding stores Inditex prefers leases over owning retail space. While this is good to keep liabilities down, are they operating or capital leases and are they being shown in the books. Since Zara relies on expensive areas to act as marketing for them, this increases costs especially when buying property. With no marketing or customers this is not a good determination of how the new market will actually pan out.

Manufacturing
Inditex has a low Dupont and Asset turnover ratio compared to GAP and H&M. (See attached exhibits) This shows that Inditex has more liabilities, most likely due to the extensive manufacturing equipment capital cost in their process. While GAP and H&M out source their manufacturing, then do not incur the capital cost that Inditex does. Inditex current ratio is quite low as well and we can infer that they have higher fixed costs from manufacturing and a high inventory turnover rate, which is confirmed in the attached exhibit.

Pricing
With production in one central location, importing the majority of raw goods overseas, and 52% of sales in other countries, Inditex is highly susceptible to changes in currency rates between countries. As the European union is developing, a common European currency is around the corner and this uncertainty could increase manufacturing costs and decrease profits.

Recommendations
International Expansion - Use store Franchise model in smaller and riskier countries. Partner in more established countries like Italy and Germany. Own/lease stores when a market is known to be secure and successful. - To reduce shipping costs, have smaller distribution and manufacturer centres in cheap labour countries closer to the market and in the same time zones. Such as Mexico for North America, Argentina or brazil for South America and China or India for Asia. - While major design will still completed in Europe, allow inventory and stocking to be determined by the markets and style in the individually country by a “trend team” looking at sales and trend in specific regions not globally. - When opening a new store have other store employees and managers that can fill their positions until training is completed and the store is opened when ready. - When a new store is opened, have some marketing to attract people the store. - For southern hemisphere countries use the previous season designs. As sales volumes will be known and can determine which items were successful, inventory can easily be predicted and then outsourced to other manufactures, lowering costs and liabilities. - When having the bi-annual sales, have some new stock coming in the stores to ensure the store is not empty.
Manufacturing
- Since %50 of the product lines Zara knows it will manufacture and the remainder is determined throughout the season by sales and trends, 20-50% of known production lines could be outsourced. This will reduce the overhead and capital costs required for the 20-30% increase of yearly new emerging markets. This will lower the Dupont, asset turnover and current ratio with continuation of growth. It will decrease costs (labour and fixed) associated with the hi tech production. - This will diversify their manufacturing and allow to maintain good characteristics of vertical integration, while lowering risks of it by having room to handle more production of goods if needed.
Pricing
- Needs to follow pricing with all markets and allow mangers to change pricing to reduce stock and allow more sales that will have less inventory build up during biyearly sales. - With the smaller distribution and manufactures in new markets can target countries with high import duties therefore reducing this cost and keeping prices low. EG, one in Argentina.

Alternative solutions. - Instead of having a large sale twice a year from leftover stock that often results in empty stores, ship to the southern hemisphere to sell in their approaching season. As sales and fashion trends are know from the previous season, then you can predict what will sell and have little remaining inventory at the end of the season in the souther hemisphere.

Worked with project with Brett Hannigan, Bradley Fossen and Adrian Hay.

Word Count: 1000

Exhibits:

| | | | |Return on Assets |Asset Turnover |

|2000 |1999 |1998 |2000 |1999 |1998 |2000 |1999 |1998 |2000 |1999 |1998 |2000 |1999 |1998 | |Inditex S.A. |0.23 |0.23 |0.24 |0.10 |0.10 |0.10 |1.24 |1.15 |1.22 |1.80 |1.98 |1.97 |0.90 |0.87 |0.88 | |GAP Inc. |0.30 |0.50 |0.52 |0.06 |0.10 |0.09 |1.95 |2.24 |2.28 |2.39 |2.32 |2.52 |0.95 |1.25 |1.21 | |H&M |0.46 |0.30 | |0.18 |0.11 | |1.94 |1.96 | |1.32 |1.38 | |3.51 |3.43 | | |Benetton Group | |0.17 |0.13 | |0.10 |0.08 | |0.75 |0.74 | |2.36 |2.33 | |1.78 |2.06 | |

|ZARA | |H&M | |BEN | |GAP | |Invetory Turnover Ratio |5.28 |5.26 |5.39 | |3.38 |3.64 | |3.25 |3.38 | |4.52 |4.63 |5.03 | |Days to sell inventory |69.14 |69.40 |67.69 | |107.85 |100.16 | |112.39 |107.95 | |80.82 |78.76 |72.51 | |