FelipeCaro

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The Fast-Fashion Business Model: O d h C An Overview Based on the Zara Case Felipe Caro UCLA Anderson School of Management & Depto de Ingeniería Industrial U de Chile Depto. de Ingeniería Industrial, U. de Chile [email protected] Taller "Rocket Science" en Retail 2008, Santiago, 19 de Junio The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro Presentation Outline • Motivation Recent brand value data Recent brand value data How fast is Fast Fashion? What is Fast Fashion? Business strategy/Operations strategy T F t F hi l Two Fast Fashion examples Fast Fashion open questions Research Collaboration with Zara Inventory allocation model Clearance pricing optimization • Conclusions The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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The Fast-Fashion Business Model: O d h CAn Overview Based on the Zara Case

Felipe CaroUCLA Anderson School of Management &

Depto de Ingeniería Industrial U de ChileDepto. de Ingeniería Industrial, U. de [email protected]

Taller "Rocket Science" en Retail 2008,Santiago, 19 de Junio

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

g ,

Presentation Outline

• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?

• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions

• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization

• Conclusions

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Motivation: Recent Brand Value Data

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: BusinessWeek / Interbrand (2007)

Zara and the Fast-Fashion Strategy

2007

Bra

nds

2p G

lobal

To

p

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: BusinessWeek / Interbrand (2007)

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Zara and the Fast-Fashion Strategy

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: BusinessWeek / Interbrand (2007)

Zara and the Fast-Fashion Strategy

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: BusinessWeek / Interbrand (2007)

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Zara and the Fast-Fashion Strategy

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The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: Interbrand (2008)

Motivation: Fast-Fashion Assortment Rotation

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The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Presentation Outline

• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?

• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions

• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization

• Conclusions

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

What is Fast-Fashion?

• Business Strategy:gy

“Cutting-edge fashion at affordable prices”

• Operations Strategy: builds on Quick • Operations Strategy: builds on Quick Response

Quick Response: similar to what just-in-time manufacturing has meant to the auto a u actu g as ea t to t e autoindustry (Hammond and Kelly 1990)

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Fast Fashion Operations Strategy

• Structural choices (tangible, “hardware”)– High level of vertical integration (includes store ownership)g o a g a o ( ud o o p)– Tight control of production (either through ownership or

permanent monitoring)– Dual supply chain (SC):pp y ( )

Basic items: efficient SC (minimize cost)Fashion items: responsive SC (minimize lead time)

– Simple but effective IT systems p y– Modern distribution centers

• Infrastructural choices (intangible “software”)• Infrastructural choices (intangible, software )– Cross-functional decision making highly centralized– Fashion items produced in small batches

Frequent assortment changes trying to follow fashion trends– Frequent assortment changes trying to follow fashion trends– Daily information exchange with store mangers– Strong operations-driven organizational culture

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Two Examples of Fast-FashionZara (Spain) H&M (Sweden) The Gap (U.S.A.)

Vertical Integration (2007)

Fully integrated. Subcontracts cutting, sewing, and shipping

Controls of every link in the chain but does not own factories

From design to store but outsources production

No. of stores worldwide(2007)

1,361 1,522 >1,572

No. of Countries(2007)

68 28 21

Distribution of Stores - Main Locations

(2007)

13% North Europe60% South Europe

7% East Europe8% Latin America5% Asia Pacific

63.5% North Europe19% South Europe

5% East Europe12% North America

9% United Kingdom79% North America

7% Japan

Sourcing - Main Suppliers(2006)

34% Asia50% Spain & Prox. 14% Rest of Europe

>60% Asia<40% Europe

97% outside U.S.A.

Assortment Composition 40% Basic >70% Basic 99% Basicp(2006) 60% Fashion <30% Fashion

Lead Times - Dual SC(2006)

Efficient SC: 6 MonthsResponsive SC: 2-5 Weeks

Efficient SC: 6 MonthsResponsive SC: 3-6 Weeks

Efficient SC: 9 Months

Refresh Fashion Items Twice a week Daily Occasionally (2006)

y y

Pricing (2002)

Overall, higher than H&M (especially out of Spain)

Lowest among Fast Fashion Comparable to Zara, if not higher

Marketing Expenditure 0.3% of Revenues 3-4% of Revenues Comparable to H&M

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

g p(2002)

p

Source: Annual Reports and Public Press

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Two Examples of Fast-Fashion

Inditex (Euro) H&M (SEK) Gap Inc. (US$)

Revenue (Net Sales) 9 435 78 346 15 763 2007Revenue (Net Sales) 9,4358,196

78,34668,400

15,76315,923

Gross Margin 56.7%56.2%

61.1%59.5%

36.1%35.5%

Operating (EBIT) Margin 17.5% 23.5% 8.3%

002006

Operating (EBIT) Margin 17.5%16.6%

23.5%22.4%

8.3%7.7%

Net Margin (ROS) 13.3%12.3%

17.3%15.8%

5.3%4.9%

Working Capital /Sales -6.1% 9.7% 10.5%Working Capital /Sales 6.1%-6.1%

9.7%10.2%

10.5%17.3%

Inventory Turns 4.064.36

3.833.84

6.395.72

Asset Turnover 1.33 1.88 2.01Asset Turnover 1.331.43

1.881.92

2.011.86

ROA 17.7%17.6%

32.6%30.4%

10.6%9.1%

Leverage 1.69 1.30 1.83Leverage 1.691.67

1.301.28

1.831.65

ROE 30.0%29.3%

42.3%38.9%

19.5%15.0%

Source: Annual Reports 1 SEK = 0.107 €

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

p

1 US$ = 0.65 €

Vertical Integration

Manufacturing Design Distribution Retailing

ZaraWorld Co.

H&MH&M The Gap

Benetton MMango

• H&M does not own factories but has production offices next to the main suppliersmain suppliers.

• Benetton subcontracts labor-intensive activities but has invested heavily in controlling other production activities. On the other end, y g p ,most stores are franchised

• Mango does not own the stock at the stores (same as Benetton) but d ll h d

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

does allow merchandise returns

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Achieving Shorter Lead Times

Source: “Zara: Fast Fashion” HBS Case 2003.

Sh t l d ti bl i k t f hi t dShort lead times enable quick response to fashion trends

…but short lead times are (usually) achieved at a higher cost

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Selling at an Affordable Price

• If procurement costs are higher, how can a Fast Fashion retailer still sell at an “affordable price”?Fashion retailer still sell at an affordable price ?

Frequent assortment

Short lead times / Small batches

Increase visits to stores Sales increase

qchanges

Revenues increase

Two-way information flows

Better forecastsMinimize underage & overage costs

Less and smaller markdowns

(POS, store managers)

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Fast Fashion, Retailing Panacea?

• Does quick response guarantee superior performance?

World Co. Zara

Time to Market 2-5 weeks 2-5 weeks

Net margins 2% 10%

Overhead (% Revenue) 40% 20%

I F t F hi db ki i ti ?

( )Source: “Zara: Fast Fashion” HBS Case 2003.

• Is Fast Fashion a groundbreaking innovation?Debatable, but for sure it is a self-reinforcing system based on:1) closed loop communications1) closed loop communications2) rapid timing and synchronicity3) appropriate capital investments to increase supply chain flexibility

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Fast Fashion Open Questions

• Is Fast Fashion a retailing fad? Remember Benetton?Benetton?

• Should every retailer adopt the Fast Fashion b i d l?business model?

• Zara-H&M rivalry. What is the right balance y gbetween basic and fashion items?

• How much can a Fast Fashion grow?• How much can a Fast Fashion grow?Mature marketWill it work in the U.S. and China?Are the operations scalable?

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Presentation Outline

• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?

• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions

• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization

• Conclusions

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Inventory Management of Zara’s Retail Network

Objective Develop and measure the impact of an optimization model that supports the optimization model that supports the inventory allocation decisions in a large retail network

Timeline August 2005 June 2007

Results - 3–4% sales increase- Less stock outs

M ti di l- More time on display- Less transshipments

Deployment Used to ship all items to all stores worldwideStatus

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Zara’s Supply Chain (2006)

Supplierspp2 shipments/wk24 - 48h transit

backroom display

70% Europe30% Asia

900 Stores:45.4% Spain37.3% R. Europe

2 warehouses:Arteixo andZaragoza

10.5% America6.7% R. World

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: “Zara,” Columbia Business School Case, 2002. Caro and Gallien (2007)

Former Inventory Allocation Process

assortment decisionsstore inventory assortment decisions

store

store inventoryIssues:

Storei timanagers

requested shipment quantitiesinventory warehouse

• incentives• information• resources

q p qfor each reference and size

warehouse

yin stores,past sales

inventory

Warehousewarehouseallocation team

Warehouse• resources• decision rules

shipments

(a) Former Process

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

( )

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Brief Literature Review

• Inventory management in distribution systems w/random demand (1 warehouse, N retailers):( , )– Eppen and Schrage (1981): depot does not hold inventory– Federgruen and Zipkin (1984): several approximations

Erkip et al (1990): correlated demand– Erkip et al (1990): correlated demand– McGavin et al (1999): impact of balancing retailer

inventories

• Salient features or Zara’s problem:– Lost sales and holding cost is irrelevant– Finite horizon with no re-ordering (only allocation)– Dependencies across sizes

• Literature on fast-fashion retailing:– Cases: HBS (3), Columbia, Georgetown/Warwick/Sevilla– Caro and Gallien (2007)

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Caro and Gallien (2007)

Proposed Allocation Process

assortment decisionsstore inventory past sales datastore managers

assortment decisions

assortment decisions

store

store inventory past sales datastore managers input

forecastingd lmanagers

requested shipment quantitiesinventory warehouse demandinventory warehouse

model

q p qfor each reference and size

warehouse

yin stores,past sales

inventory forecasts

optimization

yin stores inventory

warehouseallocation team

optimizationmodel

shipments shipments

(a) Former Process (b) New Process Envisioned

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

( ) ( )

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Proposed Allocation Process

past sales datastore managers

assortment decisions

past sales datastore managers input

forecastingd l

Maximize: Global Revenues

By Changing: Shipments

demandinventory warehouse

modelBy Changing: Shipments

Subject to: InventoryAvailability

forecasts

optimization

yin stores inventory

y

optimizationmodel

shipments

(b) New Process Envisioned

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

( )

Inventory To Sales Function

Expected store salesf f th t kfor reference that week

Expected Demandpor

Max Sales Capacity

Stock of reference in store at beginning

of week

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

of week

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Store Level Display Policy

• Not all combinations of sizes are displayed:– Sales vs brand perceptionSales vs. brand perception– Key to inventory distribution

S M L Keep on display

remainingsizes action

S M L Keep on displayS M L Keep on display

M L Keep on displayS M Keep on display

M Keep on displayS L Move to backroomS Move to backroom

L Move to backroomL Move to backroom

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Store Level Display Policy: Validation

Adh t M j Si Di l P liAdherence to Major Size Display Policy

45%

50%

30%

35%

40%

45%

Sto

res

15%

20%

25%

30%

Fra

ctio

n of

0%

5%

10%

F

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

DPF/DPA (%)

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Final MIP Formulation

warehouse inventory constraints

approximateinventory-to-sales

function

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Implementation

• Forecast development p

• Model development and integration with IT systemsy

• Pilot test

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Pilot Test: Objectives

• Prove concept feasibility through actual i l t tiimplementation

fi f i f d d l f• Refine software interface and model features based on feedback from real users

• Estimate the model’s specific impact on the inventory distribution inventory distribution

How to measure improvements?

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Pilot Test: Metrics

• Back to basics: newsvendor framework

Sales = min{ Shipments, Demand }

• Sales / Shipments (S/S):Shipments success ratio– Shipments success ratio

– Less overstock ↔ S/S closer to 1

• Sales / Demand (S/D):– Demand cover ratio– Less understock ↔ S/D closer to 1

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Pilot Test: Distribution Performance Matrix

Highnot enough inventory

everywhere

idealsituation

Sales / Shipments=

ShipmentsS R i

Low

Success Ratio too much inventory

in low-selling stores, not enough

too much inventory

in high-selling stores

everywhere

Low High

Sales / Demand Demand Cover Ratio

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Sales / Demand = Demand Cover Ratio

Pilot Test: Estimating Demand

• Censored information: sales are observed, not demandE l• Example:– Weekly replenishments– Initial stock = 8 units– Item stocks out before next order is placed

Mon Tue Wed Thu Fri Sat Sun

day

unitsDemand

7

8≈

Mon Tue Wed Thu Fri Sat Sun

unitsD d

8

Mon Tue Wed Thu Fri Sat Sun

dayDemand

3≈

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Mon Tue Wed Thu Fri Sat Sun

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Pilot Test: Estimating Demand

• For each size/store/week, we calculate:

– Days when stock is not exposed (DSE) = days in which that size stocks out, or one of the major sizes stocked out and no sales were observed

– If Sales > 0 and DSE < 7:

Demand = Sales x (7/(7 DSE))Demand = Sales x (7/(7-DSE))

– If Sales = 0 or DSE = 7:

Demand = most recent demand (otherwise, zero)

• Finally, we aggregate demand across all stores and references

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Pilot Test: Design• The model was only implemented at warehouse in Arteixo

• The warehouse in Zaragoza was used to validate the • The warehouse in Zaragoza was used to validate the methodology

• We collected sales and shipment data before and after the • We collected sales and shipment data, before and after the model was introduced

• The analysis is based on 10 references, 4 basics y 6 y , yfashionable (for the rest there was not enough data)

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Pilot Test: Methodology to Asses Impact

ObjectiveEstimate the impact of the model on the distribution performance metrics

W t b th Problem

We cannot observe the counterfactual (what if the model had not been used)

SolutionControl Group +Difference-in-differences

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Slide courtesy of Shanna Rose

Pilot Test: Control Group

• For each reference in the pilot, we identify a control f i h f ll i hi i ireference using the following matching criteria:

– Basic with basic, fashion with fashion

– The dates when both references were introduced differ at most in one week

– We minimize the difference in performance (measured by the S/S and S/D ratios) the week before the allocation model was int od ced (i e the sta ting point m st be the same) introduced (i.e. the starting point must be the same)

W t th f th 10 f i • We repeat the process for the same 10 references in Zaragoza

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Pilot Test: Difference-in-Differences

Pilot Start Pilot EndPilot Start Pilot End

Pilot Reference PS PE

C t l R f C C

S ifi M d l P f I t

Control Reference CS CE

Specific Model Performance Impact:

Removes anything that happened before the pilot

(PE - PS ) - ( CE - CS )

Removes anything that happened during the pilot but is not due to the model

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Pilot Test: Example, Reference XXX/YYY/250

Metric S/SPilot Start: Pilot End:

Metric S/Sweek 33 week 46

XXX/YYY/250 (pilot) 37.4% 78.3%

XXX/YYY/800 (control) 30.1% 65.2%

Specific Model Performance Impact:

Removes anything that happened before the pilot

( ) ( )

Removes anything that happened during the pilot but is not due to the model

(78.3% - 37.4% ) - ( 65.2% - 30.1% ) = 5.8%

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Removes anything that happened during the pilot but is not due to the model

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Pilot Test: Arteixo vs. Zaragoza

•A larger fraction of what is sent is actually sold

•A better match between supply and demand

•Overall, total sales increase by 3-4%!

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

, y

Pilot Test: Increase in Sales

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Pilot Test: Other Metrics

• Returns / Shipments (R/S): returns & transshipments ratio

• Store Cover (SC): proportion of sizes x days x stores with stock

• Display Cover (DC): proportion of sizes x days x stores on display

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Pilot Test: Additional Results

•Less returns and transshipments

•Less stock outs

•More time on display

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Full Scale Implementation: Estimated Impact

• Full scale model implementation: 1st half 2007

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Full Scale Implementation: Impact on Net Margin

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Source: Inditex Annual Reports

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What’s Next… Clearance Pricing Optimization

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

What’s Next… Clearance Pricing Optimization

• Zara avoids price promotions during the regular selling season.

• New challenge: how to estimate price sensibilities?

ParametersParameters

Parameters

ParametersParameters

Parameters

Historic Data

Parameters Parameters

Predicted

Current Season

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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What’s Next… Clearance Pricing Optimization

• Optimization model: “apparent temperature is more important than the actual one”more important than the actual one

• Most relevant metric:

($)%

StockInitial

SalesClearanceenueRevMarkdown =

Valued at regular

• Current project status:

($)StockInitial Valued at regular season prices

• Current project status:Prototype implementation readyPilot test: 3 countries, 4 categories, gFirst pricing decisions are being implemented today!

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

Presentation Outline

• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?

• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions

• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization

• Conclusions

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro

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Conclusions

• Key lessons from Academia-Industry collaborationMain obstacles: lack of data & internal barriersMain obstacles: lack of data & internal barriersNeed project champion and clear metricsInitially, expect results to confirm intuition up to 90%t a y, e pect esu ts to co tu t o up to 90%Retail is detail: behavioral aspects matter (e.g. store level dynamics), but remain focused

• High impact application of Operations ResearchDirect impact on profitsp pScalable system that enables growth

• Fast fashion is successful because it competes with(and not in spite of) operations

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro