8 Proven Ways to Cut Massive Inventory Dragging Your Profit Down

You know the fast-fashion retail. Zara is the king of low inventory possession. Their inventory turnover is a staggering 12 times per year, meaning they sell out all their inventory in just one month on average. That is an insane speed. Normally it takes retailers more than 5 months to turn over their entire inventory.

Zara achieves this by having a negative cash conversion cycle (CCC). If you don’t know what CCC is please read my article. They have an extremely low level of inventory on hand, operate as a cash business with almost no receivables, and pay their outsourcers on a normal schedule.

This allows them to run their business without operation cash. In fact, when Zara increases sales, they don’t need to invest additional cash into operations like a normal company does. On the contrary, higher sales generate more cash for Zara.

This means they can expand the business without needing capital while accumulating a debt-free cash stockpile to invest in future growth. This is the hallmark of a winning business model.

But how exactly does Zara keep their inventory amounts so remarkably small? The answer is they turn over a very small amount of inventory at an insanely fast speed through rapid design, production, shipment, and customer purchase cycles. All of those processes are very fast.

1. Air transportation enables “very in now” fashions that sell fast. Zara uses air freight to get the latest trendy clothing styles into stores just 2 weeks after fashion shows, allowing them to sell the hot fashions of the moment rather than last season’s looks.

2. Factories close to stores mean very short lead times. Many of Zara’s European suppliers are located in close geographic proximity in Spain and Portugal. Zara exploits this proximity to ensure a rapid response in filling orders for time-sensitive fashion products where being first to market is critical.  For basics and other less time-sensitive categories where cost is paramount, Zara sources from Asia where they capture that region’s pricing advantage.

3. Limited product runs with no restocking induce scarcity and spur impulse buying. Zara intentionally produces extremely limited quantity product runs. There is no warehouse inventory – the limited items on store shelves are all that’s available. If an item sells out, customers lose the opportunity to purchase it forever, creating a fear of missing out that incentivizes them to buy quickly at full price rather than waiting for potential discounts that may never come.

4. Frequent small shipments reduce cash tied up and risk of unsold items. By increasing the frequency of shipments to stores with small batch deliveries, Zara can reduce the amount of merchandise on shelves at any given time. This reduces cash tied up to inventory. Also, this reduces the possibility of having large amounts of unsold items staying on the sales floor.

For example, it is more risky to receive 200 items all at once, where all 200 could potentially go unsold and sit for a long time. Whereas by receiving 50 items 4 separate times, at most only 50 units could be unsold. If it doesn’t sell well, just don’t order the next time.

Additionally, receiving 200 items requires more capital. Getting only 50 items requires far less capital investment. A company can purchase 50 units, sell them, collect that cash, and then reuse that money to purchase the next 50-unit shipment – tying up only 1/4 of the capital needed for a 200-unit buy at once.

5. Using just 5 core materials reduces dead stock write-offs. Although Zara offers a diverse range of clothing designs, they simplify their sourcing by using only 5 core fabric materials across all products. This drastically reduces potential dead stock from excess raw material overages. Very low writes-offs of raw material as a result.

6. 85% sold at full price by never marking down hot sellers. Zara bucks industry norms by avoiding discounting entirely on their most popular, fast-selling lines that sell out at full retail price. For their few true underperformers, they simply ship any residual units back to Spain rather than mark them down, deterring customers from deferring purchases in hopes of discounts.

7. Short-term forecasting is far more accurate. For example, which one do you think is more accurate, the forecast of weather tomorrow or 300 days from now? Of course, short-term forecasting is more accurate. And more accurate sales forecasting leads to less unsold products.

Because Zara’s design-to-delivery cycle is so rapid, they only need to forecast demand over a very short 1-month horizon, unlike other retailers who must attempt projections 5-8 months out when predictions are far less accurate.

For example, if it takes 2 months to design and produce an item, plus 1 month for shipping from Vietnam by ship, and the industry’s normal shelf life standard is 4 months, retailers need to forecast consumer demand 7 months out (2+1+4). For Zara, it’s just 2 weeks for design/production + 2 weeks for air shipping = only a 1-month forecast needed.

8. Strategic mix of outsourcing and automated in-house production. While outsourcing labor-intensive production, Zara has heavily invested in automating their own machine-intensive manufacturing facilities. This enables crazy-fast production speeds.

Zara demonstrates that less can truly be more when it comes to inventory.

Reference
Md Afzalul Aftab, Qin Yuanjian, Nadia Kabir & Zapan Barua (2018) Super Responsive Supply Chain: The Case of Spanish Fast Fashion Retailer Inditex-Zara Published by Canadian Center of Science and Education