Zara appears to embody the SCM model of the future
Spanish retailer Zara has already discovered that the biggest opportunity in the supply chain lies not in reducing transaction costs but in recapturing margins lost due to markdowns and stockouts. New contracts in softgoods supply are likely to follow a similar approach, focusing on flexible partnerships with trusted suppliers. John S Thorbeck, co-founder, president and CEO and Manas C Fuloria, co-founder, chief technology officer at SupplyChainge present their vision for the future.

The fevered predictions of instant IT-driven revolutions across the supply chain have moderated. Hype and experience, however, are contributing a new intensity to the search for retail profit potential. Today, the focus is on the following questions: Where is the source of the highest returns in apparel supply chain management? What does the future of apparel supply chains look like? What role does IT play in this future?

The future: Zara?
For many softgoods retailers today, the Spanish store group Zara appears to embody the model of the future. This company claims a mere 15-day cycle from factory to in-store, an advantage linked to astonishing results: 15 per cent EBIT (earnings before interest and taxes), 20 per cent revenue growth and 25 per cent return on capital.

Zara, which is found in only seven New York area stores, is now on the minds and agendas of every major US retailer and brand, thanks to the recent highly successful IPO of its parent company, Inditex. The financial community is asking how this globalising retailer so outperforms its better known US and European rivals. And the premium price of the Inditex stock suggests this murmur is now rising to the level of a shout.

More than 24,000 people work for the Inditex Group in 34 countries.
With a logic characteristic of the dot.com bubble days, supply chain management (SCM) system vendors have rushed to "adopt" Zara and to proclaim that it exemplifies the new IT-driven world. This is far from true. Zara does not credit its success to any specific SCM systems. Further, while supply chain optimisation vendors mainly "optimise" distribution networks, Zara services all of its 449 stores around the world from a single logistics centre. And a key tool in the information system of store managers feeding fashion trends to the designers is the humble telephone!

Stranger still, the focus across today's industry is on "core" competencies, where brand marketers and merchandisers diminish the status of sourcing and procurement as "non-value added." Yet half the apparel sold in Inditex stores - across its four brands including Zara - is actually manufactured in factories owned by Inditex, and an additional percentage is made in factories with which the group has close ties. What is happening here?

Zara knows a secret that has not yet been declared elsewhere: the largest value in the supply chain is in the management of inbound components of raw materials, capacities and production. Conventional retail business models focus on finished goods, prices and margins.


"The biggest opportunity in the supply chain lies not in reducing transaction costs but in recapturing margins lost due to markdowns and stockouts"

Thus, Zara's success points towards two striking facts:

First, the biggest opportunity in the supply chain lies not in reducing transaction costs but in recapturing margins lost due to markdowns and stockouts. These two cost elements alone are today worth more than 30 per cent of sales in an industry that struggles for low single digit percentages of net profit. New point-of-sale and merchandising software systems are indeed valuable, but none explicitly link to Zara-like advantages for fast, lean and flexible supply that drives full price sales.

Second, significant SCM opportunity can be tapped only by attention to the detail of real-world processes throughout the supply chain - particularly on the inbound side. Financial opportunity is hardly touched by merely retrofitting IT solutions to inbound supply chains that pretty much operate the same way as they did, say, in 1980, when markdowns were just a third of their current levels.

Zara comes to retailing with a valuable fabric and production perspective; its parent company Inditex had its origins in textile manufacturing and many of the group companies are still focused on manufacturing.

Softgoods supply chain models
Any successful model for the apparel industry will need to incorporate the above two facts: the screaming importance of markdowns and stockouts, and the linkage to their drivers in the inbound supply chain. This latter point has hitherto been ignored…except for the purpose of squeezing more gross margin by beating down FOB's.

Yet, it is clear that the Zara model need not be the only successful one, or even the best one. Ownership or large equity participation in manufacturing entities has its own strategic risk for a brand, including increased exposure to demand risk and dilution of focus. Both of these risks are particularly high for fashion-driven companies, which often have volatile sales volumes and may require different manufacturing capabilities from season to season.

So what solution provides the benefits of essentially "in house" capacities, and provides the means to accomplish this in a purely outsourced model?

The new strategic goal in softgoods is that of short-term flexible partnerships. In such a scenario, a brand relies heavily on trusted suppliers with whom it has long-term relationships based on time and resources invested in understanding each other. Formal supply contracts with flexibility built into them will take the place of the current rigid purchase orders for finished goods that are typically placed months in advance of the selling season.


"The new strategic goal in softgoods is that of short-term flexible partnerships"

This new form of flexible supply contracts will be based on the benefits that can be gained by transferring risk from finished goods to raw materials and capacity; in other words, as far back in the "inbound" chain as possible. Brands, currently focused on finished goods, will sponsor such new partnership models not only to their immediate vendors, but to fabric and trim suppliers as well. Once such business architecture is in place, IT will play a critical role in making it hum by providing new intuitive tools to streamline the complexity of the added flexibility.

Just how big is this opportunity? From benchmarking studies carried out in our company's engagements, this opportunity is at least a 50 per cent increase in profit for wholesalers and a doubling of profit for retailers. In cases where the large parts of the retailer's sales come from a private label brand - as in the case of one customer, one of the world's largest shoe retailers - the potential is even higher.

Benefits for the entire chain
Reduced markdowns, stockouts and inventory risk definitely benefit consumer brands and retailers. However, supply chain solutions have been charged with putting pressure on the suppliers; that is, "buyer power" aggregation masquerading as collaboration. Does that hold true for this strategy as well?

Unlike other B2B structures such as e-marketplaces, this new strategy in fact takes the focus off price and onto the more collaborative area of flexibility. It encourages vendors to distinguish themselves in a positive way by adding "flexibility services" to their offering. Thus, the vendor contributes further up in the value chain, and its employees are worth more and earn more. Potential financial incentives to reward factories for collaborative services beyond production volumes and unit prices include reduced finished goods, less required working capital, and more frequent shipments.

The entire chain benefits by flexibility, adjusting product ranges and volumes to market preferences, and speed-to-market. When the inbound capabilities - raw materials, capacities and production process - are linked to what consumers buy, then retailers, brands and manufacturers will incorporate the fact that the greatest gain is not in reduced FOB costs alone.

Based in Portland, Oregon SupplyChainge (www.supplychainge.com) is a provider of integrated process and software solutions in supply chain management for the softgoods industry. Its software and process services help reduce worldwide order/delivery lead times to 10 days for apparel, footwear, sporting goods and other short life cycle products. This dramatic result directly addresses the risk and costs of product markdowns and stockouts. The impact is measured by higher full price sales, driving improved margins and return on investment.