Increasing competition and the economic downturn have fuelled a shift to value, increased the emphasis on lowering prices and undercutting the competition. Faced with such a situation what can and should managers and organizations do? Research on the fashion industry provides valuable lessons for fighting commoditization.
The fashion industry is being transformed, as once-valuable brands find themselves being increasingly commoditized. Leading the charge is the Spanish retailer Zara, owned by Inditex. In Europe, Zara uses new mass-production processes and sourcing strategies to offer imitations of designer products at a low price shortly after their release. In contrast, in the United States, Zara is positioned as a mid-priced retailer, reflecting the costs of exporting goods from Spain. Zara now has 1,341 stores in 73 countries. Korea, Ukraine and Montenegro are recent additions to Zara’s seemingly endless expansion.
On European Main Streets, the arrival of Zara, with its combination of high fashion and low prices, first puts pressure on mass-market and mid-priced competitors. They have to compete directly. But as the middle-price-point brands change their strategies, the effect cascades to the very top designers, forcing everyone in the industry to shape a response.
Zarafication is an example of a commoditization phenomenon I label deterioration. The deterioration is caused by a competitor at the low end of the market who creates a dominant low- price-and-benefit position that expands the market share of the low-end of the market. Like a stellar black hole, the low-end competitor creates such a dominant price-benefit position that it literally swallows up the positions around it. We have seen this with the emergence of value retailers such as Wal-Mart and no-frills airlines such as Southwest or Ryanair. They are such a force to be reckoned with that everyone else has to compete on their terms.
Zara’s initiative represents the latest disruptive move in an industry where business models are constantly being innovated. To fully understand the world of fashion you need to go back to the 1960s, when French and Italian haute couture houses transformed what was a local boutique industry into a global market. Seeking a broader market, these houses created ready-to-wear fashions at high prices, positioned slightly lower than their haute couture lines. Fashion shifted from being a fine art to an industrial activity—usually producing merchandise in small batches in job shops. Later, they addressed the opportunities created by ready-to-wear for the growing upper-middle market. Haute couture designers rolled up their silk sleeves, and created upper-middle price range “diffusion brands” that extended their high-end images to broader markets. Dolce & Gabbana launched D&G, Calvin Klein launched CK, and Georgio Armani launched Emporio Armani and Armani Exchange to capture different upper mid-market segments. Likewise, Versace created Versus, while Prada spawned Miu Miu.
By the early 1990s, some of the mass marketers were moving up to the lower-middle price range market. H&M (from Sweden) and Benetton (from Italy) extended some of their lines to push a number of their products up to the lower-middle price range. Retailers such as Replay and Diesel emerged in Europe using “bridge” brands, which were characterized by brand names with distinctive and fashionable images that were not marketed with any attachment to a specific designer. The brand, not the designer, was the identity of the company. And their products were produced in large numbers.
And then came fast fashion, as exemplified by Zara, which opened its first store in La Coruna, Spain back in 1975. This threatened mass-and middle-market brands. Zara uses superior production technologies and supply-chain management to imitate ready-to-wear fashion. This competes with the mass bridge and diffusion brands of better quality and style but at lower prices. Zara created a time-compressed production process that became the subject of business school case studies. Zara stores receive two deliveries a week and each delivery includes new models to ensure that what the stores offer is constantly changing. With over 200 designers of its own, Zara identifies the trends of haute couture and ready-to-wear. It can then move these fashions to the middle market in about four weeks, compared to the six months it took using old technology and processes.
Such quick-delivery imitation within four weeks forced the bridge and diffusion brands off their stride. Previously, the fashion firms issued fall and spring collections, but now Zara had imitations available in mid-season. This forced the fashion firms to issue new, mid-season designs to differentiate themselves from Zara, leaving them with more excess inventory mid-season. Consequently, they were forced to dump this inventory on discount channels. In the past, buyers got last season’s designs in the discount channels, but today they can buy current-season designs at lower prices than originally intended. This further blurred their image at a time when they needed to distinguish themselves from Zara.
Consumer responses to these trends also have brought different parts of the market into closer competition. In their book Trading Up, Michael Silverstein and Neil Fiske note that consumers are accessorizing low-priced items such as Zara pants with high quality (diffusion-level) tops or jewelry from a high-end designer. The mass and luxury markets are more and more in competition with each other, as fashion trends allow more freedom to mix and match not just colours and style but also prestige levels.
Zara has experienced tremendous growth and rising market power. By 2007, it was the biggest fashion company in Europe, outpacing H&M as the queen of cheap chic. With annual sales of 6,264 million euros (2007), it is committed to continuing international expansion. In 2009, Zara announced a joint venture with Tata Group to open stores in India starting in 2010.
More to come
Why does this matter? Research by McKinsey & Co. shows that as long ago as 2002 bargain-value retailers already accounted for more than 21 percent of the U.S. apparel market. This market share can only increase both in the U.S. and abroad. Importantly, companies like Zara are going to emerge in a host of other industries. With global competition, the advent of new business models, new manufacturing processes, and the rise of off shoring, more opportunities will be created for low-end competitors to appear and take over markets. Today, half of all consumers in the United States and Europe shop at value retailers such as Wal-Mart (up from one quarter in 1996). Many other industries are experiencing a “shift to value” – something that is being exacerbated by the global downturn.
Managers face a conundrum: They cannot compete head-to-head with these competitors and hope to win; but if they stand still they will certainly lose share. Imitation of the imitator is not an option, and escape seems nearly impossible. Movement away from the low-end rival tends to move firms into smaller and smaller niches, while movement toward the rival (based on imitating and benchmarking it) leads to a no-win game. Often the firm can’t match the low-end rival’s economies of scale, cost structure and experience curve, so it loses the race. Even if it could match the position of the low-end rival, this would only serve to accelerate the deterioration.
How can companies respond to deterioration? What should you do if the entire market is moving towards the low-end? There are three strategies:
Escape the trap: Sidestep the discounter
In a battle with a dominant, low-end discounter, discretion is sometimes the better part of valor. Some companies can shift their positions to sidestep the market power of the low-end discounter, by making its power irrelevant or even by avoiding it.
For instance, some fashion firms have conceded the low and mid ends of the market and are moving upscale or away from the parts of the market where Zara has the most power. In this way, the haute couture and ready-to-wear companies hope to perform a neat sidestep by moving into other high-end areas to retain their exclusivity. Some companies, such as Hermes, avoided the low-end threat by focusing entirely on high-end luxury goods that are classics, not seasonal or annual fashion statements. To increase its exclusivity, Hermes reduced the number of its licensees and the stores carrying its goods. Diesel and Chanel pursued a similar strategy.
Others are choosing unique materials to sidestep Zara, For example, Diesel is focusing on building expertise and dominance in denim products. Some high-end brands are also using rare fibers such as “baby cashmere,” which comes from the first combing of a young goat and requires about 20 goats to make a single sweater. This is a niche that mass-production, low-end players cannot enter.
The demand for luxury goods remains solid – due to the stability of the distribution of wealth among the rich—so staying focused on this segment can keep high-end brands outside Zara’s reach. Brands using this strategy emphasize exclusivity to clearly separate themselves from the low-end. In some rare instances, the move can be so successful that it actually reverses the deterioration by drawing the market upscale, away from the discounter.
The silk industry in Italy – responsible for over 90 percent of European silk production — successfully competed against low-cost Chinese rivals by concentrating on high, value-added positions. As a result, during one eight-month period, exports of Italian silk to China increased by 155 percent, despite the availability of low-cost silk from China.
Part of the secret of success in Italian silk making has been several initiatives to move upscale and redefine benefits for customers. Small Italian silk makers in the northern Italian city of Como, for example, joined together to create a new brand that gave them the scale and marketing clout to compete more effectively in global markets. These companies also co-invested in new technologies to produce higher-quality fabrics that don’t tear, irritate skin or stain. They are changing how quality is defined for certain segments of the market, allowing them to effectively meet the challenge of Chinese. The Italians also were able to add convenience, innovation and flexibility to their services. This allowed them, at least in the short term, to utilize the side-step strategy — move away from the pull of the market power of low-end players. Instead of trying to beat the low-end rivals – a competition that Italian silk makers were ill prepared for – they moved out of the line of fire.
Many haute couture companies are sidestepping Zara’s market power by moving out of fashion clothes altogether, mainly to avoid the deterioration there. Companies are investing more of their attention on very high-end products other than clothing. They are designing everything from hotels and restaurants (Armani, Bulgari, Versace and others); consumer electronics and appliances (Armani is working with Samsung); cell phones (Prada is in partnership with LG); automobiles (Versace is designing the interiors of Lamborghinis); helicopters (Armani and Versace are designing the interior of helicopters created by Augusta); furniture (Armani Casa); and even flower arranging (Armani Fiori). Armani, in particular, is attempting to create a unique “life style” and “customer experience” called the “Armani Lifestyle.” It is appealing to the very wealthy, using products so high end and unique that they do not compete with Zara. Nor can they be imitated by Zara’s new mass-production-and-sourcing system.
Destroy the trap: Undermine the discounter
The second way to beat a deterioration trap is to attack it. Undermining the market power of the low-end discounter can be achieved by eroding its power from below by offering even lower costs and benefits, through a reinvented value chain that generates profits at the same time. Alternatively, this can be achieved by redefining the way customers see price.
In the fashion industry, some companies are using celebrities and advertising to raise their image and directly undermine the value proposition of discount players. European mass retailer H&M is trying to neutralize Zara’s model of designer-less fast fashion imitations by offering equally low-priced products while using stars such as Madonna and guest designers such as Karl Lagerfeld, Stella McCartney, and Roberto Cavalli to raise H&M’s image. The goal is to undermine Zara by offering more for a lower price or the same price. In addition, H&M store formats are being recreated to look more attractive than Zara’s stores in Europe. H&M uses smarter presentation and shiny steel racks to look more upscale, rather than place merchandise in boxes and bins where you have to search for the clothes, as you often find in European Zara stores. So, H&M is trying to undermine Zara’s value proposition of offering a cool, in-store experience by providing a more upscale atmosphere (as well as designer clothes) for about the same price as Zara, or at H&M’s typical lower price level.
Fashion forward players such as Gucci and Dior use innovation and speed to undermine or match Zara’s advantage in imitation, with half their sales from new products each year, compared to about 20 percent on average for less fashion forward firms. By rapidly introducing products and repositioning brands to have clearer positions and better defined customer segments, these players are finding that customers are buying the intangible brand image, uniqueness, and emotional content of Gucci and Dior products. This strategy makes Zara’s emphasis on imitating the physical product less effective.
Firms using this approach don’t run away from Zara. They try to make themselves fast enough to partially neutralize Zara’s advantage by making imitation more difficult. They now issue eight collections per year compared to one every two seasons. Gucci Groupe (owned by PPR, a French conglomerate) is repositioning its collection of brands (Gucci, YSL, Bottega Veneta, Alexander McQueen, Stella McCartney, and Balenciaga) to get more consistency and to clarify each brand’s image and target market.
Armani and other major designers like Dolce & Gabbana now release their collections much earlier than before in private showings of portions of their collections. As a result, they sell most of their designs secretly, well before they hit the runway, and so undermine Zara’s ability to imitate their designs after they become publicly released. Some 60 to 70 percent of Armani revenues are attributable to such “pre-collection” sales.
Another potential way to undermine Zara’s value proposition is to sell used clothing. While high fashion houses are fighting for new clothing, there has been a rapid expansion of the market for used clothing. In the U.S., the small, unorganized stores in this sector are being replaced with more organized chains. For example, “pre-owned” clothing chain Buffalo Exchange, with 34 stores nationally, did $56 million in revenue in 2008. Is this the CarMax of the clothing industry? Is there an opportunity for the high-end brands to create their own “pre-owned” fashion business in Europe, similar to what Toyota did with certified pre-owned Lexus cars? Note that in many cases the haute couture and ready to wear dresses have been worn only once, and are discarded quickly by the wealthy, so these stores would not be vintage stores. Such stores would offer trade-in credits for an old dress toward the purchase of another used dress or even a new high-end dress. And since there is no wear and tear to speak of, customers can purchase a relatively new dress at a low price. This would attack discounters such as Zara from below.
Turn the trap to your advantage: Contain and control the discounter
The third way to beat the deterioration trap is to turn it to your advantage. In this strategy, companies work to confine the power of the discounter to a limited part of the market.
Some companies can use geographic confinement. For example, D&G is expanding the number of its company-owned boutiques around the world to compete better against companies such as Zara. By taking back control from licensees, D&G hopes to be able to execute its strategies against the discounter more quickly and forcefully. United Colors of Benetton expanded its network of 5,500 stores and increased its fashion cycles to four per year, while reworking its image through advertising and new store design to try to confine the threat of Zara to the low end. At the same time, H&M is also beginning to confine Zara to its customer niche by introducing a series of specialized stores targeting different segments, such as children’s, accessories, and lingerie, to surround Zara.
Some diffusion brands such as Roberto Cavalli’s Just Cavalli and Gianfranco Ferre’s GF Ferre are reducing their prices to contain Zara as well. At the same time, Chloe offered lower prices through its new C brand.
Legal maneuvering is another strategy for confinement. Chloe, for example, is defending its diffusion designs against imitators by using lawsuits, such as the one filed against UK-based Top Shop (the UK chain was forced to destroy over 1,000 of its dresses which copied the £185 Chloe design) and another against Kookai for selling copycat versions of its snakeskin Silverado handbags.
Fight or flight? You choose
Ultimately, the key decision about market-power management strategies is whether to fight or to take flight. Like any schoolyard fight-or-flight decision, the choice is based on the relative strengths of the rivals (whether you think you can win the fight) and the opportunities for flight (if there is an escape route). Winning the fight depends on the amount of resources you have available to throw at the battle relative to the low-end competitor. If you are hopelessly outmatched, then the choice may be to flee, as long as a sidestepping move is feasible. If you are evenly matched or have an advantage, then containing or undermining the discounter become more possible. It is not just your own resources that count, but the resources of partners that you can pull into the fray.
As Zara gained market power, it became harder for rivals to stop it or even to keep up. Fear of retaliation may also affect whether rivals choose to confront or confine the low-end player. In brief, companies caught in the deterioration trap need to assess the balance of power between themselves and the low-end discounter.
Fighting the market power of a large and growing low-end discounter causing the entire market to deteriorate often feels like the classical David versus Goliath story. Yet, we can find hope in a saying of Napoleon Bonaparte, who reminds us that, “the essence of strategy is, with a weaker force, always to have more force at the crucial point than the enemy.” And if we recognize a rising power, we can undermine or contain it before it can gather too much market power. One wonders why Sears did not imitate or buy discounter Home Depot before it ruined Sears’ home improvement business. Or why one of the large retailers did not imitate or buy discounter Wal-Mart before it gathered steam. As Leonardo Da Vinci observed: “It is easier to resist at the beginning than at the end.”