Table of contents
1.2 Definitions & Problem statement
1.3 Preview of the paper
2.1 Fast fashion market
2.4 Model: Measure sourcing performance
3.1 Data collection
3.2 Unit of analysis
4. Analysis and Results
4.1 Costs of goods sold
4.2 Salary expenses
4.3 Overall expenses
7. Asset utilization
8.2 Future recommendations
In this article a comparison is made between the H&M Group and Inditex to measure the differences in overall performance of outsourcing and in-house production in the apparel industry. Outsourcing is often discussed in the literature as the perfect solution to cost reductions however the literature lacks results on the actual performance; this article measures the performance obtained through outsourcing and in-house production. H&M is studied because it has a fully outsourced production, where Inditex mostly produces its products in-house. Performance is measured by the follow variables: costs, agility, asset utilization and product quality. Costs and asset utilization were measured using an independent samples t-test; comparing costs of goods sold salary expenses and overall expenses as a percentage of the revenue, asset utilization is measured by comparing the return on assets ratio. Agility is studied by an in-depth analysis and product quality based on a survey on consumer perception. The results show that H&M has significantly reduced its costs by outsourcing, while Inditex with higher costs is able to keep a very short lead-time. H&M has been successful in increasing return on assets and product quality is perceived equal for both companies. This article contributes to the field of research by showing that outsourcing does lead to cost reduction, however in-house production leads to better performance in agility.
In the last few decades the world has seen an increased globalized economy, creating opportunities for businesses able to exploit the changing dynamics of the global market. One of the considerable changes is the relocation of supply chains to international locations in the apparel industry (Taylor, 1997). The textile industry has shown a visible trend of companies relocating their production facilities and outsourcing to low-cost countries. (Navaretti Soloaga & Takacs, 2001) Especially since the removal of all quotas in the apparel industry coming with the General Agreement on Tariffs and Trade applied by the World trade organization in 2005. Thus, clothing retailers are free to source their textiles from any country with an unlimited quantity. Due to fierce competition in the global market companies are searching for strategies to create a competitive advantage. (Christopher, M., 1998). With continuous price pressure from competition, clothing retailers are reducing costs by outsourcing their production to low-wage countries. However with the concept of back sourcing introduced after many failing outsourcing strategies the question is whether outsourcing is as efficient as assumed. Back sourcing is defined in many different ways but this paper defines it as: “Business processes that were previously outsourced brought back to the in-house production” (Chapman & Andrade, 1997). Deloitte found in their research on outsourcing that 70 percent of the companies had some kind of negative experience related to outsourcing, moreover 25 percent of the companies back sourced their outsourced processes. (Veltri, Saunders & Kavan, 2008) This indicates that for many companies outsourcing isn’t performing as well as initially thought by the management. A lot of theoretical information can be found on outsourcing, however there is limited research done on the actual results and performance obtained through the use of sourcing.
1.2 Definitions & Problem statement:
In this thesis a comparison is made between two different strategies for the relocation of the supply chain, namely outsourcing and insourcing. To make a clear distinction between outsourcing and insourcing, outsourcing is defined as: “reliance on external sources for manufacturing components and other value‐adding activities.” (Lei & Hitt, 1995: 836) In this case companies do not own the production facilities and have low control, they are depending on third parties usually positioned in low-wage countries. “Insourcing is when an organization uses especially internal labor and personnel, but other resources as well, to supply the operational needs of its enterprise.” (Sikulu, Chong, Braun & Sikula, 2010: 3) insourcing refers to production done inside the company structure, maintaining full control over the production plants, either internationally produced or in the home country. According to Gereffi (2005) international retailers are the driving force behind globalization in the apparel industry. Therefore a comparison is made between two of the largest globally active retail groups, namely H&M group and Inditex. H&M does not own any production facilities and therefore operates, using a fully vertically disintegrated supply chain. Meaning they outsource the production of all their clothing produced. Where on the other hand Inditex is known for its vertically integrated supply chain, focusing on in-house production controlling every step of the supply chain. They only outsource the production of simple clothing ordered in large batches like sweaters. (Göransson Jönsson & Persson, 2007) by comparing the two opposite business models of Inditex and the H&M group, both active in the clothing industry, a first indication and measurement of the performance of outsourcing and insourcing in the clothing industry can be done. To measure the performance of outsourcing and insourcing the “house of sourcing” model of David Jacoby president of the Boston logistics Group is presented. A comparison on costs, quality, service, agility and asset utilization will be made. Through measurement and comparison of the results of the costs, quality, service, agility and asset utilization, findings will be derived to answer the main research question: “To what extent does performance differ between the vertical disintegration strategy (outsourcing) of the H&M group and the vertical integration strategy (insourcing) of Inditex ? Followed by the following sub questions:
- To what extent do costs differ between the vertical disintegration strategy of the H&M group and the vertical integration strategy of Inditex?
- Measuring: Costs of goods sold, salaries, overall expenses as a ratio to sales.
- To what extent does quality differ between the vertical disintegration strategy of the H&M group and the vertical integration strategy of Inditex?
- Measuring: Aesthetics, Intangible Elements, Conformance, Features, Reliability, Durability
- To what extent does agility differ between the vertical disintegration strategy of the H&M group and the vertical integration strategy of Inditex and which benefits are gained?
- Measuring: The lead-time for new products.
- To what extent does the asset utilization differ between the vertical integration strategy of the H&M group and the vertical disintegration strategy of Inditex?
- Measuring: Return on Assets.
By not just comparing costs but also including other indicators of performance, the results will give an overall indication of the performance of outsourcing and insourcing.
1.3 Preview of the paper :
This report begins with a literature review on the background and important facts of the company; followed by the methodology discussing the sample, timeframe and methods used to measure costs, quality, service, agility and asset utilization. Next, we analyze the results; here we present all the findings regarding the performance of outsourcing. The report concludes with an overall conclusion where all findings are summarized and the research question will be answered.
2.1 Fast fashion market
In the past the fashion industry was known for ”haute couture” where the focus was laid on unique design for its customers usually only available for customers with a lot of money. Since the 1980’s the fashion industry has seen changing dynamics in the market, and is now referred to as the “fast fashion industry” (Tokatli, 2007). Instead of putting large investments into design, trends are copied from promising clothing lines in fashion shows, merged with information gathered from consumers (Reinach, 2005). The trends are converted into clothing lines ready for production, set to the market with the lowest possible lead-time (Ferdows, Lewis & Machuca., 2004; Reinach, 2005). The fast fashion market is marked by short-life cycles, high volatility ( unstable demand) , low predictability and high impulse purchasing. (Christopher, 2004) To be competitive, clothing retailers should have stores all over the world to sell on a global scale and obtain the demand for economies of scale (Tokatli, 2007). An effective information system to match the costumers demand with their production and distribution ( Thomassey, 2010). A short development cycle for new clothes combined with short lead times enable to produce different sets of cloths, combined with a highly responsive supply chain which can be easily adjusted to produce different types of clothes (Bhardwaj & Fairhurst, 2010) and with continuous price pressures from competition, production costs should be kept at a minimum level, this is often done by relocating production facilities to low cost labor countries. Where relocation of the production usually succeeds in reducing costs, it does decrease the responsiveness of the supply chain and increases the time-to-market. (Christopher, 2004). In the fast fashion industry global retailers must be able to produce a variety of clothing in small batches combined with a short time-to-the-market, to brand the clothing as exclusive, while still minimize the costs. For example Bershka and Zara, two clothing retailers owned by Inditex, provide a new collection of clothing for their costumers every two weeks. A trade-off is made by the global retailers between costs reduction, or a short lead time.
The Inditex Group is one of the leading global fashion retailers, with ownership of brands like Zara, Pull & Beer, Massimo Duthi, Bershka, Stradivarus, Oysho, Ulterque. According to the Annual report of Inditex (2013) The supply chain of Inditex consists of 1592 suppliers of which 648 located in Europe, 738 in Asia, 82 in America and 124 in Africa. Even though the suppliers are widely dispersed over the globe, 51% of the total production is still produced near the headquarters in Spain. Since Zara is the flagship of Inditex, accounting for 65% of the total sales and 68% of the total earnings before income taxes (EBIT) in 2013, the focus will lay on the business model of Zara.
Zara is known for its vertical integration strategy (in-house production), from the development of a new clothing line till the in-store presentation takes around 10 to 15 days (Emerald insight, 2003; Mukherjee, 2015; Inditex Strategy report). Due to Zara’s short lead-time they can immediately respond to the changing demand of the consumer. Therefore Zara’s stores are always filled with a wide range of new products, however only a limited amount of the same cloths are displayed in a spacious store to give the impression that the clothes are exclusive (Ferdows et al., 2005) According to Ferdows et al. (2005) Zara uses an advanced IT system that enables the exchange of information from the level of design and production all the way op to the retail stores. Moreover, Zara’s main production facility is located in its headquarter in Spain, together with the teams of designers. “Zara's cadre of 200 designers sits right in the midst of the production process.” (Ferdows et al., 2005: 1). The headquarters operates in three separate channels, one for men, woman and children clothing. “Accordingly, separate design, sales, and procurement and production-planning staffs are dedicated to each clothing line.” (Ferdows et al., 2005: 1). Since the designers, producers and market specialists (who are in contact with the local stores) for all three clothing lines are located in the same building, information and feedback can be exchanged with colleagues without barriers created by a bureaucratic system. “The physical and organizational proximity of the three groups increases both the speed and the quality of the design process.” (Ferdows et al., 2005: 1-2). Thus, because designers, producers and market specialists can communicate frequently, without experiencing barriers to communication, Zara is able to produce its clothing lines within 10 to 15 days. According to Carugati, Liao & Smith. (2008) 18 out of the 20 internally operating production facilities of Zara are located close to the headquarters. “Approximately 50% of products are manufactured internally. Two-thirds of the remaining items are outsourced to Europe and North Africa and one-third to Asia.” (Carugati, 2008: 3). Zara outsources products that are not sensitive to the quickly changing demands of the fashion industry and can be ordered in large amounts; like plain shirts and sweaters.
Where Zara is known for producing many of its products internally using their vertically integrated supply chain, H&M follows another strategy. According to the Annual report of H&M (2013), H&M does not own any production facilities and is depending on 900 different independent suppliers for the production of their products. Thus, H&M has outsourced its entire production to third parties, and therefore operates a fully vertically disintegrated supply chain (Santos, 2009). H&M runs local production offices to communicate with their 900 different suppliers; the local production offices have an intermediate function between H&M’s headquarters and the suppliers and are responsible for placing orders at the right suppliers, for the right price and control the quality of the delivered clothing (Annual report H&M, 2013). Just like Zara, H&M has its own integrated team of designers, preparing the designs for new clothing collections. When the designs are finished, the local production office will divide the production of the right products to right suppliers and communicate the orders with the suppliers (Annual report H&M, 2013). H&M is outsourcing its production to reduce the production costs; this can be managed by choosing suppliers that produce for a lower price than H&M could produce itself. However by outsourcing production to independent suppliers, different companies are involved in the supply chain, with more information that has to be exchanged, increasing the lead-time.
2.4 Model: Measure sourcing performance
The “House of Sourcing Model” written by Jacoby (2005), the president of Boston Logistics Group, defines five key metrics to measure the success of sourcing. The first key metric defined is costs; purchasing materials generate most of the revenue of manufacturing companies. Sourcing is used to effectively reduce material costs. The second key metric defined is quality; the model focuses on the defective returns, however this thesis will measure the overall quality of the clothing produced by both companies. Followed by agility, Sourcing often reduces the lead-time to the market; therefore cycle times should be measured and compared, especially in the fast fashion market where a short time to the market is key to success. Next, asset utilization will be assessed, asset intensive companies use outsourcing to reduce their assets increasing their return on assets. Service is defined as the last key metric, with a focus on the percentage of perfect orders. However neither of the companies provide information on the percentage of perfect orders, and therefore this metric is excluded from the analysis. (Appendix A, figure 1)
3.1 Data collection
All data included in this research is secondary data, using secondary data has several advantages; first, the data is already readily available and thoroughly researched, moreover all financial indicators were deducted from the financial reports of the companies themselves, and therefore are internal sources of data and do not include errors. Other secondary data like: Journals, articles, case studies and books were used to define the strategy and background of Inditex and H&M Group and to answer the research question concerning agility (lead-time) and quality. To measure performance this report includes financial indicators like costs of goods sold, salary expenses, overall expenses, sales and return on assets (ROA), obtained from the annual reports of the H&M Group and Inditex. All variables are included following a time frame of 10 years, from 2004 until 2013. Inditex and the H&M group use different currencies in their financial statements, the variables costs of goods sold, salary expenses and overall expenses are divided by sales to transform the variables into ratios. Using ratios removes the bias that would incur because of different currencies. In the analysis we compare the vertical disintegration strategy of H&M and the vertical integration strategy of Zara, however there is no financial data available for Zara as an isolated company. The financial results of Zara are included in the consolidated financial statement of Inditex; therefore this is the closest data to measure performance of Zara’s vertical integration strategy.
3.2 Unit of analysis
Since there is limited time for the research, the units of analysis include Inditex; the global retailer that includes Zara is one of its main brands and the H&M Group.
A multiple case study is performed on Inditex and the H&M Group to indicate whether the vertical integration strategy of Inditex and the vertical disintegration strategy of the H&M group differ in performance. Performance will be measured using four key metrics derived from the Model of “Sourcing performance”: Costs, quality, asset utilization and agility. (Jacoby, 2005) To measure costs, descriptive statistics will be provided for the ratios of Costs of goods sold to sales, salary expenses to sales and overall expenses to sales. Moreover an independent paired t-test will be performed to analyze, whether the ratios of costs of goods sold, salary expenses and overall expenses to sales significantly differ between Inditex and the H&M Group. Costs will be measured because outsourcing is performed to reduce costs; H&M does not own any production facilities and is outsourcing the production of all their products to reduce the production costs (Annual report H&M Group, 2013) Costs will be compared to indicate whether the H&M group is producing for a significantly lower price than Inditex. To measure asset utilization, descriptive statistics will be provided for the variable return on assets (ROA) and an independent paired t-test will be performed to analyze whether the H&M Group has a significantly higher return on assets compared to Inditex. This is based on the theory of Jacoby (2005) who claims that outsourcing is used to create a more favorable return on assets for asset intensive companies. Agility, more specifically defined as the lead-time or time-to-the-market will be compared using secondary data like articles, books and case studies. From the theory the lead-times for both companies will be derived. Moreover, the implications and advantages for the fast fashion industry that are posed by the differing lead-times of Inditex and the H&M Group will be discussed. The lead-time is compared, because short-lead times are mentioned as one of the key factors to success in the fast fashion market, where demand is unstable and new clothes should be introduced on a regular basis (Bhardwaj & Fairhurst, 2010). Moreover Inditex has integrated its production to use short-lead times to compete in the fast fashion market (Ferdows et al., 2005). Lastly, a comparison for quality will be made using results obtained from the bachelor thesis written by Ying (2010). Ying (2010) measured the perceived quality for Zara, H&M and Uniqlo their products; using a questionnaire containing questions to measure quality on eight indicated variables: Aesthetics, serviceability, conformance, features, reliability, durability and intangible elements (further information will be discussed in the analysis on quality). The questionnaire had 200 respondents in total, following convenience sampling. For this report we will use the results found for Zara and H&M to compare the overall quality of Zara and H&M their products. The results for Uniqlo will be excluded from the analysis, because the analysis on quality only considers Zara and H&M.
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- outsourcing offshoring Zara H&M Sourcing performance measurement costs lead time quality asset utilization in house prod