By: Ignacio Barros
Zara’s flagship Paris store at 92 Av. des Champs-Elysées was closed on and off for much of 2020. Now, signs in exterior windows announce that it will not reopen even after pass the Covid-19. Disappointed fashionistas are now redirected to the company’s website.
Or, alternatively, they can walk two blocks down the same avenue, where a smaller store of the brand still exists.
Dotting city centers and malls with outlets was the natural strategy for clothing retailers. Inditex, owner of Zara and the world’s largest provider of fast fashion, went from less than 750 stores at the beginning of the century to around 7,500 at the end of 2019. But trends in the business world, at just like on the catwalks, they come and go. In 2020, for the first time in its two-decade history as a listed company, Inditex ended the year with fewer stores than a year earlier, and suffered its first quarterly loss. 1,200 points of sale were eliminated, compared to the 300 openings planned at the beginning of the year. But it is not that Inditex has lost ambition. Quite the contrary. He’s going after his young clientele where they spend the most time: on their phones, between Instagram and TikTok. The ever-increasing migration to online sales, which has been accelerated by the pandemic, will require a nimble realignment of the way fashion brands do business.
Much of what it takes logistically to sell, say, a $27 Zara women’s dress (the average selling price of the Inditex family of brands, which also includes the cheaper Bershka and the fancier Massimo Dutti) is the same in the physical store or online: the product must be desirable and available at the right time, the right size and the right price. But from a cost point of view the story is very different. Physical stores are much less efficient, mostly because of rent and staff, who only become profitable once enough product is transferred through them. Websites and stores, on the other hand, cost less. Now, it is also true that the shipping costs of each package have increased, so that the variable costs have also risen, but after adding and subtracting, the online world is undoubtedly more efficient from an economic point of view.
In short, at least superficially, migrating to online sales would seem attractive: gross margins are lower than in stores, where shoppers find it more difficult to compare prices than on Google, but at the same time, an exclusive retailer Online does not have any of the expenses associated with stores, such as clerk wages and rent payments. However, the migration to e-commerce is more difficult to execute than many retailers want to admit. It would seem to be something psychological: the apparent control that having the physical store and the potential customer standing in front of them gives them. But the problem is that if brick-and-mortar stores don’t close as online sales increase, retailers risk having to pay higher variable costs for online fulfillment while continuing to incur the fixed costs of the physical world. . That is to say, they are stuck in the middle (stuck in the middle, as they say in English), with the worst of both worlds.
For this reason, the signal sent to the market by Inditex that it is reducing the number of stores in a significant way is a wake-up call. CEOs in this industry don’t like to close their shops. Layoffs irritate politicians. Redemptions and canceled sales may upset investors. But where Inditex goes, others follow. The Spanish group has grown faster and faster than its rivals, such as H&M or Gap. It got ahead by outsourcing a good part of its production close to its main European market, which allowed it to respond faster to fashion trends and keep a smaller stock. Fresher inventory led to fewer end-of-season sales and higher profits. Despite the fact that its rivals have tried to imitate it, Inditex has managed to maintain operating margins at a high 17%. To put this into perspective, the margins of Fast Retailing, Uniqlo’s Japanese parent, and the only rival to match Inditex’s sales growth in recent years, are a third lower.
Few doubt then that Inditex will meet its goal, set in June 2020, of raising its share of online sales from the 14% they had in 2019 to no less than 25% by 2022. Pablo Isla, the company’s boss, has announced a huge investment: more than $3 billion will be spent through 2022 to boost online capabilities and make sure its stores and website run seamlessly in parallel. A new technology, RFID chips, traces almost to the millimeter where the items are, which allows Inditex to have very high levels of compliance in its dispatches to stores or warehouses. On the other hand, he is testing a new app to tell shoppers if a particular item, of a particular size, is available at a given point of sale, and even which of the point-of-sale shelves to find it on.
All of these investments should be easy for Inditex to finance, given its healthy balance sheet and earnings; certainly easier than for other retailers, who have their backs against the wall after a terrible year. The Zara brand is strong enough to attract shoppers to its own app; smaller brands rely on middlemen like Zalando or Amazon, limiting their margins. Inditex has short leases on its stores, giving it more room to haggle over rents or make rent payments more flexible by linking them to store sales. That is to say, it wins everywhere.
Some challenges.-
But being an online champion inevitably brings its own headaches. Amazon is a much more fearsome competitor than, say, H&M. Barriers to entry are low. On average, one in three garments sold online is returned, a much higher proportion than in stores, as the customer can try them on. Zara, which spends next to nothing on advertising, may have to start doing so if people aren’t reminded of its existence by walking past its billboard-like outlets.
Over time, sales per square foot at the remaining brick-and-mortar stores will likely continue to fall, threatening their viability. Unlike banks, which have been downsizing their branches for years but have a more mature and stable business, clothing retailers deal with much more fickle shoppers, given that fashion itself is fickle. Zara, the industry’s supermodel, will likely walk online catwalks more successfully than her rivals. But you’d better watch her step anyway.
Sources:
- How Inditex is refashioning its business model (The Economist, Jan 2021)
- E-commerce worldwide – stratistics & facts (statista.com, Oct 2020)
- Zara owner to close up to 1,200 fashion stores around the world (theguardian.com, Jun 2020)