M

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MS vs ZARA

• Market Mediation Costs
• The Zara Process SC Design for Speed
• Process Technology S-curves and Disruptive
  Innovation

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MS vs ZARA

• Market Mediation Costs

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Why is profitability in apparel so low, when
margins are so high?
ExpectedDemand
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Classic Apparel Business Process
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Demand is Difficult to ForecastPredictions are
usually difficult, especially about the future.

Yogi Berra
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Newsboy ProblemHow much to order?
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Expected Costs and Benefits of Adding a Unit of
Inventory to Meet Future Demand
ith unit is sold at V
Add ith unit of inventory
pi PD?i
C cost of adding inv.
ith unit is not sold
1 - pi
Expected Value of Adding ith Unit piV - C
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Optimal Inventory Levelat zero marginal value
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Analysis Market Mediation Costs

• In the 1998/1999 Season, MS was hit hard by
  inventory write-offs when it was convinced that
  the Fall/Winter season would be dominated by
  black and gray colors. As indicated in the case,
  this turned out to be a poor bet, and the
  resulting excess inventories had to be disposed
  of at a significant loss to the company.
• To illustrate this problem consider the
  production decision for a hypothetical garment,
  which can be produced, in gray and blue colors.
  Costs of production are 20, sale price is 50,
  and any unsold items are salvaged on an
  end-of-season sale at 10. The above economic
  figures are identical for either color.
• Early in the planning process, MS forecast
  indicates that demand for the gray garment is
  Normally distributed with a mean of 3,000 and a
  standard deviation of 500, while demand for the
  blue garment is Normally distributed with a mean
  of 600 units and a standard deviation of 100
  units.

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Expected Costs and Benefits for MS Example
V 50 - 10 40
C 20 - 10 10
PD?i C/V 10/40 0.25
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Optimal Inventory Level
0.75
0.25
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Marginal Value of Last Unit Produced

• After adjusting for minimum lot sizes and other
  considerations MS production planners order
  3,300 gray and 700 blue garments. What is the
  marginal value of the last unit produced of each
  color?

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The Day of Reckoning

• As the selling season nears, it becomes apparent
  to MS forecasters that they anticipated the
  wrong colors for the season, and they revise
  their forecasts to a mean of 3,000 and a standard
  deviation of 500 for blue garments, and a mean of
  600 units and a standard deviation of 100 units
  for gray (exactly the mirror image of the initial
  forecast).
• What are now the expected marginal values implied
  by the production decisions?

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Marginal Value of Inventory

• To increase marginal value
• Decrease money at risk C
• Reduce costs
• Increase salvage value
• Increase value from selling V
• Increase price
• Increase probability of selling pi
• Marginal value of inventory decreases with
  inventory level (for likelihood of sale decreases)

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Post-Mortem Analysis

• An analysis of demand after the selling season
  reveals that the actual demand was 3,600 units
  for the blue garment and 600 for the gray. Any
  excess inventory was sold on clearance at
  10/unit

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Profit Margin Analysis
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Market Mediation CostsPost-Mortem Analysis

• Using the definition of market mediation costs
  as losses associated with markdowns plus lost
  sales opportunities, what are the market
  mediation costs for each garment color in this
  example?

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Market Mediation Costs
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Market Mediation Costs

• Even under optimal inventory policies
• Market Mediation costs often amount to 15 to 20
  of profits
• How to reduce Market Mediation Costs?
• Improve the balance between stock-out costs and
  excess inventory costs
• Improve forecasts
• Play a different game!

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MS vs ZARA

• The Zara Process

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Zara Business Concept
Integrated fashion delivery Fashion at low cost

• Store experience
• Copy fashion
• Involve the customers and her group/cohort
• Create a network/brand

• Focus on getting it approximately correct
• Define a fast process
• Solve the material constraint
• Constrain designers
• Optimize the offer
• Offer follow-up (next batch) and create customer
  flows

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Zara Customer Experience
Fresh
Quality
Cost

• Fast copying
• Of leading styles
• Fast delivery
• in own stores
• Limited editions

• Raw material poor/OK
• Knit poor
• Look grand!
• Customer satisfaction
• fashion at low price!

• Low monetary cost
• Low time cost
• the Zara experience

Flexibility

• Limited variety
• only what is on display
• Every customer is participating
• in the process
• Customer defines next batch

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ZARA Business Process 5 to 7 day lead time!!!
Step 5 Designers  pull  next RM batch
Step 4 Shoppers (and store mgers)  pull  next
design (shape) designers  adapt 
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Classic Apparel Business Process
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Breaking Away from Market Mediation Costs
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MS vs ZARA

• Process Technology S-curves and
• Disruptive Innovation

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Disruptive Technological Change The Classic
Scene 1
Disk Drive Performance  Megabits/
14 inch technology
Mainframe demand (IBM)
Script by C. Christensen  The Innovators
Dilemma 
Time
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Disruptive Technological Change The Classic
Scene 2
Disk Drive Performance  Megabits/
14 inch technology
Mainframe demand (IBM)
Minicomputers (DEC)
8 inch technology
Time
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Disruptive Technological Change The Classic
Scene 3
Disk Drive Performance  Megabits/
14 inch technology
Mainframe demand (IBM)
Minicomputers (DEC)
PCs (Apple, )
8 inch technology
5.25 inch
Time
30
Disruptive Technological Change The Classic
Scene 4
Disk Drive Performance  Megabits/
14 inch technology
Mainframe demand (IBM)
Minicomputers (DEC)
PCs (Apple, )
Laptops
8 inch technology
3.5 inch
5.25 inch
Time
31
Industrial Process Life Cycleor Technology
S-curve

• Phase 1 Many years of experience
• LEARNING and PROBING with an innovative formula
• Phase 2 DEFINING the process
• IMPROVING process performance
• Phase 3 Process improvement becomes more
• difficult LIMITS TO IMPROVEMENT APPEAR
• Phase 4 Innovation then continues at the
  INTERFACES (shopping experience, internet, )
• Phase 5 Process eventually OVERTAKEN (but
  when?)

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Technology S-curve
Performance
Time
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Disruptive Technological Change 1 setup
Performance MS quality (RM, cut, fit, variety
)
ZARA quality as perceived by ? MS or  50 
? ?  16/24  ?
Time
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Disruptive Technological Change 2 disruption
Performance  ZARA quality ( freshness )
ZARA
MS
MS is overtaken by a technology they consider
 inferior  to theirs!!!
Time
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Disruptive and Sustaining Technologies

• Sustaining Technology
• Improves the performance of a product/service as
  judged by current metrics that evaluate
  satisfaction of mainstream customers
• Disruptive Technology
• Product/service actually perceived as worse,
  initially, as judged by current metrics that
  evaluate satisfaction of mainstream customers
  but actually perceived as better according to
  non-mainstream customers