Following Zara - Increase Profits by Reducing Markdowns

Click to Skip Ahead:

• Highlights
• Jim's Story
• The E-commerce Savings Trap
• Lessons From Li & Fung
• Zara's Method
• How E-commerce Retailers Can Reduce Markdowns

Highlights

• Only 60% of retail products are sold at full price; the rest become markdowns or deadstock
• Logistics company Li & Fung use dispersed manufacturing to reduce lead time and gain a better view of the market
• Retailer Zara’s vertical integration of their full supply chain allows them to reduce lead time and start the season with manufacturing space available to adapt to the market
• Other retailers can also reduce their markdowns and dead stock with enhanced data insights that make performance-based promotion possible

Jim's Story

Jim realized he was spending an average of $562 every month on gas. Every month! He resolved to fix the issue by only getting gas at stations he knew sold it for 10-20 cents less than the average. Over the next month, that’s exactly what he did. 

Every time Jim needed to fill his tank, even if it was out of his way, he made sure to only visit the cheaper gas stations. At the end of the month, he totaled his gas spending: $624. 

Jim saved money by buying cheaper gas, but he used more gas in order to save the money in the first place! And man was his wife angry when she found out.

Jim was so focused on one area of saving money that he ignored the other areas that would be affected. Jim’s mistake seems obvious, yet this is what nearly every retailer does.

The E-Commerce Savings Trap

In order to ensure enough products are in stock for the season, we buy too much. We overspend to prevent shortages, and on average, only 60% of those products are sold at full price. The other 40% experience heavy markdowns (even below their production cost), or sit in a warehouse as deadstock.

We try to make up for the losses by trimming the fat. Lower production costs, cutting corners. When in reality, the real savings come from reducing the amount of items needing markdown. 

Logistics company Li & Fung accomplished this reduction through their dispersed manufacturing process; Zara accomplishes it with their vertically-integrated supply chain; and other e-commerce retailers can accomplish it using product-level performance insights.

Lessons From Li & Fung

Li & Fung, an international logistics company from Hong Kong, started picking up major steam back in the 1980s and 1990s with their innovative method of dispersed manufacturing - breaking the manufacturing phase of value chain into pieces and optimizing the sections with the greatest potential impact. 

Here’s an example of Li & Fung’s process, from an interview with Victor Fung:

1. An order comes in for 10k garments for a European retailer
2. L&F source the yarn they want from Korea, where they found the best price
3. They find the best zippers/buttons come from Japanese manufacturer YKK (who mostly manufacture in China), so they order directly from the Chinese factory
4. They find that, due to quotas and labor conditions, Thailand is the best spot to manufacture for this project, and so ship all materials there for dying and assembly
5. Since the customer needs fast delivery, the order is split between five Thai factory partners
6. The 10k garments are stocked on European shelves five weeks after the order was received

Breaking the manufacturing process apart and spreading it across several countries created a far more flexible system. Beyond the extra speed, it brought retailers into the design process, making them more active when dealing with their suppliers and their suppliers’ suppliers as they started seeking their best options.

Where did the big savings for retailers come from? Dispersed manufacturing shaved down the cost of materials and assembly, but the real savings came from fewer items needing to be marked down at the end of the cycle; something made possible through a shortened buying cycle.

“If you can shorten your buying cycle from three months to five weeks, for example, what you are gaining is eight weeks to develop a better sense of where the market is heading. And so you will end up with substantial savings in inventory markdowns at the end of the selling season.”
Victor Fung

For industries like fashion, shaving a twelve week manufacturing period down to just five weeks is an incredible advantage. 

A report from McKinsey found that the average hybrid fashion retailer (e.g. retailers who take part in more than one area of the supply chain) has a full go-to-market process length of 44 weeks. Taking seven weeks out of the manufacturing phase means speeding the overall process up by 16%.

Zara's Method

If Li & Fung proved that you can reduce markdowns by optimizing lead time in manufacturing, Zara proved you can accomplish the same goal by owning your full supply chain, (known as “vertical integration”). The McKinsey study mentioned previously found that, on average, vertically integrated retailers move 36% faster than their hybrid counterparts, with an average go-to-market speed of 28 weeks.

There’s a reason Zara is dominant in fashion. While the average fashion retailer changes their designs every 2-3 months, Zara’s designs change every two weeks. While most fashion retailers turn over their inventory 3-4 times a year, Zara does it 12 times. While the average fashion retailer only sells 60% of their stock at full price, Zara sells 85%. 

How does Zara do it? Rather than splitting the supply chain between multiple countries/companies like Li & Fung, Zara built their own optimized supply chain over the course of 30 years. This complete control gives Zara the flexibility to start a new season with only 50-60% of their line locked in; meaning Zara is able to design and manufacture about half their stock right in the middle of the season.

This is an example of how an order might go through Zara’s supply chain:

1. Zara sees the potential of a new dress on a fashion catwalk
2. Raw materials are purchased from local suppliers and sent to Zara’s distribution center, “the Cube,” where they are designed and cut in-house.
3. Materials ready for dyeing and assembly are sent directly to the 11 Zara factories surrounding the Cube via high-speed underground railway.
4. With only 50-60% of manufacturing being used for advance orders, the factories have the flexibility to immediately create a limited run of the new dress.
5. The finished garments are sent back to the Cube via the railways.
6. The garments are sent from the Cube to Zara’s logistics hub, and shipped worldwide. Trucks are used to supply Europe, while air freight is used for the rest of the world to speed the process up, allowing for a lead time of just 2 - 6 weeks.

Zara isn’t just faster - compared to the rest of the industry, they’re essentially acting in real-time. In terms of gathering product-level data, they are acting in real-time: Zara employees continually collect feedback straight from customers in the store. And because of their speed, they’re able to line their offerings up with what the market wants- at the time the market wants it. 

Zara spends more than the average retailer on shipping costs. They even spend more on manufacturing by hiring local employees at a decent wage. But they make up for all of it by selling more clothing at full price. With their dramatically reduced lead time and powerful product-level data, Zara barely has to markdown any items at all.

Zara can make a number of safer, short-term production bets rather than one high-risk long-term production bet on what will sell best this season.

How E-Commerce Retailers Can Reduce Markdowns

Product-Level Insights

“Cool, but what if I don’t have an international logistics company or a complete manufacturing process at my disposal?”

Not everyone has the capability to own their supply like Zara does, or the infrastructure to disperse their manufacturing like Li & Fung did. But keep in mind, these were two different strategies toward reaching the same goal: fewer markdowns.

Marketers can reach the same goal of fewer markdowns with a different strategy: by enabling accessible, product-level data for every department. This is the idea behind a Product Performance Management (PPM) platform, a tool built to help retailers catch up to giants like Zara.

A PPM platform enables category managers to see, not just the number of purchases for each product, but also how difficult each individual product is to sell (through an analysis of the spend beyond each product, chance of it being returned, number of users that visit the product page before a sale happens, and numerous other product-level factors).

Automatic Promotion Based on Performance

Using a PPM platform or similar tool gives you the option to choose which products you promote based on performance and company strategy, rather than based on Facebook or Google’s algorithms. 

It may seem logical to think those algorithms are optimized to show top-performing products, but remember, the most important factor for both Facebook and Google is user experience. 

Therefore, their algorithms are designed to find the items likeliest to provide a good experience: products with a proven track record. 

Unfortunately, this can lead the algorithm to select discounted items (due to their higher sales) and ignore newer items, which lack previous success. Meaning more markdown will be needed to sell incoming items by the end of the season.

By promoting products with high profit potential for their company rather than products selected by an algorithm with its own goals, retailers can sell more items at full price, and be less affected by the amount of markdowns required at the end of the season.

Final Thoughts

The process of bringing a product to market has been refined and adapted for centuries. The milestone innovations detailed here (Li & Fung, Zara) are part of a long line of improvements, but their improvements caused a noticeable effect because they increased profits through focusing on inefficient parts of the supply chain, rather than continuing to nickel and dime their way to cheaper manufacturing.

Today’s retailers have a similar opportunity to fix the inefficiency between the number of products ordered, and the number sold at full price (or at all).