INDITEX INTERNATIONALIZATION PROCESS

Author: Rocío Sánchez Heres Supervisor: Jens Vestergaard

Aarhus School of Business MSc. in Finance & International Business

February / 2007

TABLE OF CONTENTS ABSTRACT…………………………………………………………………………..3 1. INTRODUCTION………………………………………………………………..4 1.1. BACKGROUND……………………………………………………………..6

1.1.1. Inditex brief history……….…………….…………………………...7 2. REASONS BEHIND INDITEX INTERNATIONALIZATION………………9 2.1. DEFINITION OF INTERNATIONALIZATION……………..……………..9

2.1.1. Motives for Internationalization………………………….……...…10 2.2. REVIEW OF RELEVANT THEORIES…………………………………….16

2.2.1. Traditional Internationalization Approach….……………………...17 2.2.2. Transaction Cost Approach / Internalization Theory…………..…..19 2.2.3. Eclectic Paradigm Theory…….……………………………………22 2.2.4. Product Cycle Hypothesis……………………….…………………24 2.2.5. Internationalization Process Model……………….………………..27

2.2.5.1. Uppsala Internationalization Model…………………..27 2.2.6. Network Approach…..…………………………………...………...35

3. WHY DOES INDITEX GO ABROAD..............................................................37 3.1. Spanish Retailing Industry………………………………………………….38

3.1.1. Political / Legal factors………………….…………………………39 3.1.2. Economic factors……………………………………….………….40 3.1.3. Technological factors……………………………….……………...41 3.1.4. Socio - cultural factors……………………….…………………….41

3.2. Competitive Advantage / Manufacturing Process…………………………..42 3.3. Industry Analysis……………………………………………………………44

3.3.1. Porter’s Five Forces………………………………………….…….44 3.3.2. Actual Competitors………………………………………………...50 3.3.3. Demand………………………………………………………….…52

3.3.3.1. Market Share…………………………………………52 3.3.3.2. Demand Analysis ……………………………………56

3.3.4. SWOT………………………………………………….…………...58 3.4. Why does Inditex go abroad?..........................................................................65

4. INDITEX INTERNATIONALIZATION PROCESS………………………..71 4.1. Spanish Market towards Internationalization……………………………….71 4.2. The internationalization of the Spanish companies…………………………73 4.3. Inditex international evolution………………………………………………74

4.3.1. Zara goes abroad…………….……………………………………..75 4.4. How companies enter into foreign markets?..................................................77 4.5. Factors Influencing Entry Mode Selection………………………………….79 4.6. How does Inditex enter into foreign markets?................................................86 5. CONCLUSION………………………………………………………………….98 6. REFERENCES………………………………………………………………...102 7. APPENDIX…………………………………………………………………….107

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ABSTRACT This study intends to be a useful guide for companies thinking about entering the

international arena, alternatively, constitutes an explanatory analysis of the conditions

leading firms to expand their activities to foreign markets. Through the different

sections of this paper, I have carried on an analysis of the factors influencing the

internationalization of the firms, taking as a reference the growth process of the

company Inditex, a big Spanish multinational with a high international presence,

examining its distinctive characteristics together with the most relevant

internationalization theories. In this research some questions were formulated in order

to gain insights about the international growth of the company. These questions were;

why does Inditex enter international markets? What are the internal and external

motivations faced by the company on its internationalization process? How does

Inditex select its foreign markets? And finally, how does Inditex choose its mode of

entry into foreign markets?

To be able to answer these questions, useful analysis of the existing literature were

conducted as well as the environment, like the SWOT analysis or Porter’s Five Forces

model. Once the internationalization is examined, the study focuses on the choice of

modes of entry providing not all, but the main strategies followed by the company and

its reasons to choose those strategies.

Finally, the last part of the study addresses the findings which shows that none of the

models observed in the previously exposed literature is fully suitable, but instead, the

whole set of theories provides good answers for the formulated questions. After the

conclusion, some suggestions for further research are proposed.

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1. INTRODUCTION

The present study integrates different analysis, conceptual issues and trends related

with the motivations and alternatives available for firms to expand its activities

towards foreign markets, analysing these concepts in relation with those steps

followed by the Spanish retailing company “Industria del Diseño Textil S.A.” -

Inditex- to increase its presence in the international arena. This paper reviews the

main theories of the international growth of companies, paying attention to its causes

and motivations, the influence of these factors in the company. It also provides an

explanation about the causes leading the company to choose between the different

modes to entry new markets. I consider internationalization as an especially relevant

issue for firms nowadays since domestic businesses are becoming increasingly

international as a result of trade agreements and the emergence of a borderless

workforce. There are fast advances in information technology enabling the rapid flow

of data around the world. Companies are concern about the complexity of global

environmental, political and social issues affecting businesses locally. International

markets are characterized by their complexity, diversity and interconnectedness.

The field of internationalization is extensive; consequently there are many situations

that companies face when extending their activities, some of these circumstances can

be foreseen, although there are still many which are unexpected, both kind are

numerous and complicated. Existing theories provide good explanations and

guidelines for companies aiming to expand its businesses, analyzing several factors in

order to avoid unexpected circumstances. Though these approaches are fundamentally

relevant, none of they are able to explain by themselves, isolated, the intricate nature

of the process which requires a wider perspective gathering the main theoretical

frameworks. This perspective should contain and relate both the dynamism of the

process as well as the existence of special features of the company. By reviewing

those theories this paper provides a general view of the development of Inditex. It also

aims to show further insights on the impact caused by these factors in the strategies

chosen by the firm, as well as competitive considerations of the company.

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The purpose of this thesis is not only to describe the development of the firm, but also

to analyze and explore the reasons and thus the pattern followed by Inditex, S.A. on

its internationalization and consequently, the strategies chosen by the company to

enter foreign markets, going through the most important literature published and

related to the process of internationalization. My contribution, with this paper, is a

detailed analysis of these factors, due to the importance of their impact on the

multinationals and their future performance, by using the process of Inditex. Through

the analysis of the most relevant theories I will give explanation to the following

matters.

The main research questions are,

Why does Inditex enter international markets?

What are the internal and external motivations faced by the company on its

internationalization process?

How does Inditex select its foreign markets?

How does Inditex choose its mode of entry into foreign markets?

The research method of this paper is an exhaustive review of the relevant literature;

consequently through this study I conduct an analysis to answer my questions. This

study is built combining relevant scientific articles and books. The paper focuses on

both international and domestic situations of Inditex, and the factors leading to these

situations. Those factors are important in order to understand the reasons of the

company to expand its activities, and one of the most important reasons is the

domestic situation of the Inditex Group. Thus, other international perspectives such as

timing of entry are ignored.

The Inditex Group constitutes a good opportunity to analyse relevant issues in the

international business field, topics like the reasons leading companies to their

international expansion, its motivations, the way that these firms conduct their

expansion and also the selection of the target markets. This is the reason why I have

chosen the company as it is one of the most developed Spanish companies in the

international arena constituting a complete framework for the analysis due to its fast

expansion and variety of strategies followed. Finally, an additional factor is the access

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to relevant information resources in terms of language, availability and local

environment understanding.

The paper is structured as follows, is divided into five sections or chapters. The first

section tries to give an idea or insight of the main subject of the thesis and also about

the questions that I will try to solve or explain through it, as we have said before these

questions are related to the process of Inditex as I consider important to get in touch

with the company by a brief description of its evolution through the time, I will

describe these issues through chapter One.

Chapter Two aims to be a frame of reference consisting of a review of the most

relevant theories and previous investigations that conceptualize the main aspects of

Internationalization, including its motivations and processes. Trough Chapter three

the different data related to the growth and evolution of the company, regarding its

domestic environment is analysed in order to have an idea of its local conditions. For

this purpose various analyses as the SWOT framework of the company or the five

forces model are developed. With this information together with the previous theories

we are able to explain factors affecting the company and its international evolution.

Across the fourth Chapter I analyze the situation of the Spanish companies and the

factors leading to their international performance, paying special attention to Inditex.

During this chapter I provide different explanations on the topic of the choice of

International entry modes, and I also analyze several factors influencing this choice.

By using these frameworks I will try to give an explanation about the strategies used

by the company to expand its international activities. Finally we find the last chapter,

Chapter five, where the main conclusions and findings derived from the research are

presented all together with answers to the previous research questions as well as

suggestions for further research in this field.

1.1. BACKGROUND

In this part of the paper first I will make a brief introduction of the company and its

activities so we will have a broader view, second I will describe how Inditex

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developed historically to be able to understand the development of the company to

understand its circumstances nowadays.

The Company is one of the biggest fashion retailers of the world. At the end of this

paper, Inditex shops are present in 62 countries, and the manufacturing process of its

products are distributed into several production facilities. 58.190 employees and over

one hundred companies related with design, manufacturing and distribution of textile

articles, comprise the group. These companies and processes turn Inditex into one of

the most important fashion distribution groups.

1.1.1. INDITEX HISTORY

Even though Inditex was not created until 1985, its beginnings are linked to the origin

of the managerial activity of its president, Amancio Ortega Gaona, in the decade of

the sixties (1963). In the beginning, the activity of the company was centred on the

manufacture of fashionable clothes, until 1975; during this year the first store of Zara,

of a large list, opened its doors to the public in La Coruña.

Right alter this first opening, between 1975 and 1980. The Company established more

Zara shops in different cities of its region, Galicia -La Coruña, Santiago, Vigo, Lugo,

etc...-. In the first eighties Inditex grew inside the national market and its initial

expansion followed the pattern of rings in the water, its establishments were coming

progressively to more remote points of the Spanish geography, first the company

reached the northwest and later the rest of the country. From 1983 to 1986, Inditex

inaugurated new shops in the main Spanish cities -Madrid, Barcelona, Valladolid,

Zaragoza, Seville, Malaga, Valencia and Bilbao-.

The first international opening took place in the Portuguese city of Porto and this was

in the late 1988, precisely when Zara had already reached the number of 60 shops in

Spain. One year after Porto, in 1989, Zara opened a shop in New York and another

year later; in 1990, the company inaugurated its first shop in Paris. Both shops -New

York and Paris- supposed a relevant variation in the process of expansion followed up

to the date. Beside of giving the first steps on two of the most important fashion

markets worldwide, it also gave a return to Zara in terms of brand identity and

prestige, by placing Zara in two of the world capitals of Fashion.

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Throughout the decade of the nineties, Inditex, with Zara mainly, is implanted

progressively in an increasing number of countries, up to 62, with 2.817

establishments. Inditex primary centre of manufacturing is located in Arteixo, La

Coruña, where they produce the most of the products that we can find on Zara stores,

but the company has facilities located in Catalonia, The Valencian Community,

Zaragoza and nowadays new platforms are being built in Madrid and León.

YEAR OF INDITEX's ENTRY ON ITS DIFFERENT MARKETS

YEAR COUNTRY

1.975 Spain

1.988 Portugal

1.989 United States

1.990 France

1.992 México

1.993 Greece

1.994 Belgium, Sweden

1.995 Malta

1.996 Cyprus

1.997 Norway, Israel

1.998 Argentina, United Kingdom, Venezuela, Lebanon, Arabs Emirates, Kuwait, Turkey, Japan

1.999 Netherlands, Germany, Poland, Saudi Arabian, Bahrain, Canada, Brazil, Chile, Uruguay

2.000 Andorra, Qatar, Austria and Denmark

2.001 Puerto Rico, Jordan, Ireland, Iceland, Luxembourg, Czech Republic, Italy

2.002 Finland, Switzerland, El Salvador, Dominican Republic, Singapore

2.003 Slovenia, Slovakia, Russia, Malaysia

2.004 Hong Kong, Morocco, Estonia, Latvia, Romania, Hungary, Lithuania, Panama

2.005 Monaco, Indonesia, Thailand, The Philippines, Costa Rica.

2.006 Serbia, Continental China, Tunis Figure 1. Inditex

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This evolution it has been based on a model of business characterized by the

flexibility and the capacity of adjustment, it also attends to different combinations of

entering new markets. As consequence of the incorporation of new formats, The

Group increases its activity, in a few cases by acquiring existing businesses, as it

happened with Massimo Dutti in 1991, or with Stradivarius in 1999, and in the rest of

the cases by creating the new chains; Pull & Bear in 1991, Bershka in 1998, Oysho in

2001, Kiddy’s Class in 2002, and finally the most recent format Zara Home in 2003.

2. REASONS BEHIND INDITEX INTERNATIONALIZATION At the moment, internationalization is getting more and more important. Companies

have to face transformations in their business processes as they experience

environmental changes, since the world evolves everyday. Nowadays, economies in

different countries influence to one another more than ever before. As many

companies have found domestic markets narrow and they have to look for new

chances and opportunities to keep their business update increasing its operational

fields. They have to reach broader areas following the trends in a global and changing

world.

This paper is expected to provide basic insights about the expansion process of a

multinational like Inditex, especially about the basic steps and problems of the

complete internationalization process that companies face when going international.

Those steps are essential for the future position of a growing company, because

during those steps, they must collect enough information and data to be able to make

decisions about starting their international route. To be able to do so, this paper offers

background information and a theoretical frame for this information, analyzing

different strategies and stages, comparing the ways of entry to diverse markets with

relevant theories of internationalization, in order to establish the relevant connections

between those theories that provide us different explanations of Inditex

internationalization process.

2.1. DEFINITION OF INTERNATIONALIZATION

If we take a look at the origin of international business relations, we will find out that

first economic relations between countries took the form of importing and exporting,

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and companies today start its new ventures in the international marketplace by using

the same method. Johanson and Vahlne defined internationalization of firms like a

process in which the firms gradually increase their international involvement.

Internationalization can be perceived as a part of the ongoing strategy process of most

business firms (Melin, 1992). As a way of diversifying risks (Rugman, 1981) or as a

network of relationships leading to foreign markets (Johanson and Mattson, 1988),

these are some of the views of the process. When talking about the international

progression of firms we find several theoretical points of view that provide us with

different explanations to this phenomenon. Increasing globalisation entails a higher

interdependence between economies of different countries as well as growing amount

of international operations as sources search, investment, manufacturing and

marketing activities.

2.1.1. MOTIVES FOR THE INTERNATIONALIZATION

One of the most significant issues when talking about the process of

internationalization of a company is related with the reasons or motivations which

induce it to go abroad, and with the strategic goals that are chased with the expansion.

It is important to know those motives which have a direct impact on the way

companies expand their activities to foreign countries. The next section will provide

us with different points of view about determinants of a company to go international.

As we go through the literature concerning the motivations that push a company

towards the International markets we can find several classifications arising from

previous studies. We are going to establish a relation between relevant theories and

the reasons that moves the group towards the international markets

All of the companies have goals or aims to accomplish. We can make different

classifications depending on the nature of such goals, the first goal that comes to our

heads may be related to profits, and the main motive for most companies for getting

into new markets is to make money (Hollensen, 2001). Firms make decisions taking

into account whether or not those decisions increase their profits. So here we can find

the first classification; Profit oriented goals include expansion. Companies want to

expand its presence in order to increase its returns. Nevertheless firms are also

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concern about increase their presence on the markets where they are already

developing their activities. Companies also look for stability.

Objectives that are essentially non profitable contain a desired market position. Firms

also want to reinforce their market image, as images associated with companies are

powerful purchase influencers. Increasing its market share is another reason as the

company tries to gain customers, trying to fill an available market sector or at least to

increase its presence on it. Some companies look for optimizing its products

technology. Companies can take advantage of using their techniques to enter new

markets with a less degree of development or learn from more developed ones. The

security of the management and the rest of the employees can be included between

these non-profit drivers, together with the ones described before leading firms to

convert its domestic environment into an international one.

The first step for a company to take is to be aware of the multiple business

opportunities that international markets offer in order to commit resources to this

market. Whilst the motivations can be different from one company to another, some

authors Czikota, Ronkainen & Moffet (1996) have identified a number of influential

factors and they split them into two different categories; The proactive and the

reactive motivations, this classification is similar to the one made by other authors

(Albaum et al., 1989) which classify these drivers into two different groups as a

consequence of two opposite purposes, one defensive and the other offensive.

Defensive purposes lead the company to keep its position reacting to internal and

external changes or pressures like the reactive motivations, while the offensive factors

are based on direct actions coming from the inside of the company and thus, affecting

its own position in the market.

The proactive motivations come from the inside of the company, leading it to a

strategic change. Hollensen argue that firms are likely to increase its profits; this is the

main proactive motivation. Managerial urge understood as the enthusiasm of

managers towards foreign market activities. A new market can be seen as an attractive

source of profit derived from a particular characteristic of the product that makes it

unique, a new technology, or exclusive information as a way to distinguish a company

from its competitors. Consequently, the company is eager to take advantage of that

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market that is not accessible for rivals and is likely to get more market share than

them, al least until its rivals will be able to copy its product or unique asset. This

motivation is connected with the first-mover advantage (Sternquist, 1998) concerning

to the advantage of being the first company of certain characteristics entering a market

without competitors on its category. The firm will try to raise its profits until its

competitors follow it to the new market even though the company lacks of a specific

or unique characteristic and its advantage derivates from superior resources respecting

its rivals. When a company is the first-mover it also can take advantage from its

location, since it has more possibilities of finding an attractive location or suitable

place deriving from its access to clients or sources.

The vision of the new market depends on the expectations about it, the information

available regarding its situation, and the perspective about the own company’s

capacity. According with the existing literature related with Foreign Direct

Investment, economies of scale (Hymer, 1960; Kindlerberger, 1969; Vernon, 1966,

Dunning, 1988, 1993) constitute another motivation included in the proactive

category, as the company saves costs by expanding its outputs. Firms go abroad

increasing their production volume and also searching a reduction on their production

costs domestically. Tax benefits also encourage exporting activities, allowing firms to

get higher profits.

The second kind of motivations are reactive motivations, these come from the outside

of the company and influence it to get adapted to environmental changes. A relevant

one is competitive pressure since companies are scared of losing their position in the

market because of the competitors. Firms are also pushed abroad due to saturated state

of domestic markets. Home markets can be a trigger for the local company to go

abroad, once the introduction and growth stages of the market are over and local

market is getting old (Sternquist, 1998; Vernon, 1966) companies will not continue

growing in sales and firms will tend to search for new and less developed markets in

the first stages described in Vernon’s Product Cycle Hypothesis. In these foreign

markets, the old products of domestic markets can be perceived as innovative goods.

But there is one factor motivating to go abroad which reduces fluctuations in

Vernon’s Cycle, extended sales of products with seasonal nature. This factor is a

strong incentive for companies that have specific products for different seasons when

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considering going abroad (Hollensen, 2001). Once the season is over, the demand of

certain kind of products decrease and companies can sell those products in countries

where the season is starting securing superior stability in sales (Albaum, Strandskov

and Duerr, 1998). Another factor related to the maturity of the market and its

saturation is the limitation of space on the domestic market (Dawson, 1994), since the

existence of public local regulations controlling and limiting the market share of a

company (Sternquist, 1998).

Companies can also take advantage of the overproduction redirecting it to foreign

countries and they can also benefit from the excess of capacity increasing the utility of

their excess. Finally, another strong reactive motivation is the proximity to customers

or resources, in terms of physical and psychical closeness, which can make firms,

grow internationally. The factor of the closeness to customers is discussed by some

authors (Weinstein, 1977, Dawson, 1994); it influences the company to follow their

clients to new marketplaces.

An additional classification of factors affecting companies to go abroad is the one

proposed by Crick and Chaudhry (1997), they make a difference between Internal

change agents and external change agents this categorization is similar to the one

between the factors coming out of the company and its workers, and environmental

factors pushing the company, made by Ghauri. There also exists a relation between

proactive and reactive classification of factors and Internal and External agents

(Albaum, Strandskov and Duerr, 1998).

While internal change agents include the advantages of the companies by means of

differentiation, accumulated stocks that can be reallocated abroad, available

manufacturing capacity to satisfy new markets and economies coming from additional

orders; internal factors arise from the goals or aims of the individuals inside the

company, from their perspective and capacity to recognize business opportunities.

The previous experience of the management team in international business is an

important asset to identify new chances (Hollensen, 2001). This experience and

knowledge about the market will give to the company an additional advantage

respecting its competitors. The company itself as a whole regarding strategies,

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capabilities and sources and its internal specific events such as overproduction are

also Internal Factors.

External change agents contain variables like the market demand, government

stimuli, unexpected orders coming from abroad, banks, other companies or trade

associations; economic environment conditions in both domestic and foreign markets.

Similarly environmental factors of Ghauri alternative listing refers to legal aspects,

taxes, regulations, financial elements, type of industry, investigation and research

costs and potential profit possibilities, in the internal and external market. The

increasing removal of some entry barriers (Dawson, 1994) also generates new

opportunities for the company.

INTERNAL EXTERNAL

PROACTIVE

• Managerial Urge • Marketing Advantages • Economies of scale • Unique product competence

• Foreign Market opportunities

• Change Agents

REACTIVE

• Risk Diversification • Extended sales of a seasonal

product • Excess capacity of resources

• Small or declining domestic market

Figure 2. Albaum, Strandskov and Duerr, 1998 Brewer (2000) and other authors highlight the importance of the business factors,

including the general attractiveness of a market, which is calculated as a function of

its sales potential -size and growth- and risk (Agarwal and Ramaswami, 1992) and

some strategic factors like meeting its clients demands. The so called Business Factors

are similar to the Proactive motivations mentioned above. Risk diversification

(Rugman, 1981, 1982) represents an important driver for internationalization by

means of reducing the risk associated to variations in the local regulation or derived

from changes in the politics of the country. If a firm expands its business to a number

of different foreign markets, it will also reduce considerably its risk respecting those

firms which limit their activities to the domestic marketplace (Albaum, Strandskov &

Duerr, 1998). By diversifying locations, companies balance their total results in other

markets when there turns out to be affected the sector of consumption of a specific

one, this is because the economic situation changes drastically from one country to

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another, this kind of diversification can be seen as a substitute of the company’s

internationalization, this means that the company will reduce its systematic risk

diversifying its investments through different countries to ensure its final profits.

Diversification is an evolutionary factor and is more common during the first stages of

the Internationalization process; furthermore all the motivations for the expansion of

the company are dynamic generally, following a sequential process (Vernon, 1966,

Johanson and Vahlne, 1977). Another driver for the company to go abroad arises from

the natural evolution of the industry, related to the fast expansion of the rest of

competitors of the firm. This particular way of interacting with its environment might

be included in the defensive strategies mentioned before.

According to the existing literature (Dunning, 1993) we can find a classification

which distinguishes between four different group of companies concerning their

motivations to move towards international markets; market seeking, resource seeking,

efficiency seeking and strategic asset seeking. Every company may be included in any

of the groups and in some cases in more than one.

The companies included on the market seeking group search for better alternatives

available in other markets coming from the specific situation of the country, regarding

tariff barriers, favourable variations in host regulations or other factors associated to

the foreign country like a less developed market compared to the domestic one of the

company. The firm entering this young market can take advantage of the situation,

due to its superior performance compared with the activities of the existing

companies. Comparing these motivations to the ones exposed above, we find this

determinants related with the mentioned maturity stage of the local market, although

here, the relevance of the new market gains weight. Additionally, production or

establishment costs can be also lower respecting the ones of domestic markets.

Efficiency seeking firms try to take advantage from expanding their activities to more

than one country so they can restructure their organization in order to increase

efficiency by using economies of scale and scope, this expansion also minimises the

potential risk associated to specific markets providing the company with a higher

degree of flexibility.

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The companies expanding abroad can also be included in the resource seeking

category. In this group companies search for a country where raw materials are more

accessible in terms of location conditions, regulation and price. Strategic Asset

Seeking companies are the ones looking for a location with a specific research and

development level or a more specialised labour, which can be transferred to their

home countries.

2.2. REVIEW OF INTERNATIONALIZATION THEORIES

During more than 40 years, the internationalization process of organizations has been

the subject of a broad amount of research in the frame of temporal and geographical

expansion of international activities and processes carried on by firms. Many authors

and researchers of this area have found common paths between companies going

international and by focusing on these patterns; they have developed interesting

explanations of internationalization of firms. The increasing investments in foreign

countries, as a result of different factors related to economic development, and

intensified by technological progress, telecommunications advances, and political

changes might have as a result the transformation of the strategies of goods and

services industries (Dunning, 1988), in a particular way the increasing of the

liberalization practices in the industry has contributed to accelerate business

expansion and the growth of multinational companies playing and important role in

the Internationalization of the economic activity. The following theories review is a

collection of findings of relevant researchers, written during the last decades

regarding the internationalization topic. I have had the opportunity to have access to

these approaches in different journals and books and although the most of the theories

are not new, they still constitute an obligatory reference as well as a useful tool when

writing about this subject. As independently these models are not able to explain

completely, the international process, by combining them a wider framework to

analyse the international growth of the company is created.

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2.2.1. TRADITIONAL INTERNATIONALIZATION APPROACH

Following Penrose’s (1959) line of thinking, internationalization is based on the

combination of two factors; it is focused on the core competencies of the company

concerning the opportunities available in the foreign environment. This approach

constitutes the essence of the Traditional Marketing theories. There are some theories

based on the imperfections of the market place. Traditional internationalization

models would be incomplete explaining why companies go abroad if we do not pay

attention to the fact that markets are not perfect organizations. If competitiveness was

perfect, the possibility of increasing benefits would not be available due to the lack of

chances to make the market more effective. The existence of specific advantages of

certain companies means that multinational firms are not in a competitive world

(Caves, 1971) and considering this doctrine we state that international investment

takes place in imperfect markets.

According to this thinking we find the first studies providing powerful insights about

foreign entry modes, Hymer (1976) on his thesis affirmed that the main reasons

leading organizations to look for an international presence are based on the existence

of special advantages of the companies, but he is not the only one as Kindleberger

(1969) also mention competitive advantages as a driver towards international arenas.

This means that firms might have some superior attributes that should be firm-

specific, easily transferable across national borders – within the company - and strong

enough to resist rivalry erosion through time. A firm must possess specific advantages

to compensate the cost of foreignness (Hymer, 1976), cost understood as “all

supplementary cost in which a firm operating in a foreign market incurs that a local

firm would not face” (Zaheer, 1995) of doing business abroad. These specific

advantages are used to compensate the cost of foreignness explained above,

advantages like superior technological skills, that foreign firms might have arising

from resources not available in the country in which this firms operate, or marketing

skills as core competencies, special manufacturing facilities, product differentiation or

a particular way of managing. These are some of the factors which can allow firms to

take advantage of Scale economies in order to surpass its competitors, high value

factors in textile market. Companies use these characteristics as long as they can to

raise market share respecting local competitors. Just the simple existence of the

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factors mentioned above implies oligopoly situations or not perfect markets, and it

also means a good motivation to go abroad. Hymer and Kindlerberger (1969)

maintain that firms expanding internationally compensate their handicaps in new

markets with their advantages while local competitors spend money in order to reach

those advantages. They also describe those superior characteristics as a reflection of

market structure failures which outcome on oligopolistic benefits. Kindlerberger in

addition, specifies some assets with the aim of allowing a company to compete

successfully in a foreign environment. These assets are the following; economies of

scale, managerial knowledge, brand power, commercialization ideas and technology

access. Hirsch (1976) and Horst (1972) give special attention to knowledge focused

on technological skills and also marketing knowledge acquired by using R+D as core

factors of a company going overseas.

Following this line of thoughts we have to talk about Porter’s diamond model, where

he settles the conditions that must be fulfilled to create or to promote the competitive

advantages of the companies. Those advantages might be generated by increasing

innovation in products, processes, logistics or new marketing strategies. The diamond

model allows analyzing why some industries within nations are more competitive than

others. It suggests that the national level of sophistication of an organization plays an

important role in helping a company to achieve advantages on a global scene. The

domestic market conditions of a company provide four core factors, which trigger or

not the advantages of a firm in global competition. Those determinants are -home-

demand conditions as regards of consumers’ needs, scope and growth; factor

conditions concerning a country skilled labor or infrastructures; Firm structure,

strategy and rivalry meaning management and organization of the company and its

interaction with local competitors; related and supporting industries in relation to the

existence or inexistence of internationally competitive supporting or supplying

industries. These patterns related to the competitive and intangible advantages that a

company uses successfully to compete in other countries are able to explain partially

the internationalization of the companies.

But we find a certain weakness in these theories in relation with the lack of a detailed

explanation of the factors affecting the choice of location or alternative ways of

foreign investment as well as the ownership advantage. Why not yield the know-how

- 18 -

or commercialize a differentiated product to other companies that, in turn, have the

proper information about the conditions of a certain local market? -By means of a

license for example-. The answer to this question has permitted to formulate further

models aiming to explain internationalization as an alternative way to allocate

resources overseas.

FIRM STRATEGY, STRUCTURE

AND RIVALRY

FACTOR

CONDITIONS

RELATED AND SUPPORTING INDUSTRIES

DEMAND

CONDITIONS

Figure 3. Diamond model, Porter, 1991

Towards the analysis of this type of blemishes there has gone a wide amount of later

literature. Granting a transcendent role to the costs of transaction derived from the

mobilization of intangible assets beyond the national borders. In this line it is

necessary to stand out, the so called theory of the internalization as well as the eclectic

paradigm.

2.2.2. TRANSACTION COSTS APPROACH / INTERNALIZATION

THEORY

Most of the internationalization theories revised previously are not complete to

provide us an explanation of why local companies chose to take advantage of their

monopolistic advantages by using foreign direct investment instead of exporting or

licensing their products.

Transaction cost theory presents powerful insights into the development of the

multinational company. There are a variety of contractual arrangements, including

market transacting, cartels, licenses, agencies, long-term contracts, franchises,

- 19 -

subcontracting and vertical integration of firms. When an enterprise has to choose

between alternative exporting modes, then transaction costs factors are the core

determinants of entry mode choice. To use the internalization model the transaction

costs of each contractual arrangement must be estimated. According to Coase (1937) -

A company will be likely to grow until the cost of an extra transaction inside the

company turn out equal to the cost of carrying out the same transaction on the open

market-. This approach is also known as the Theory of the Internalization (Burkley

and Carsson 1976, 1985; Rugman, 1981; Caves, 1982; Hennart, 1982; Buckley, 1988,

1990 or Carson, 1992), Internationalization of a company is a process that is based on

two basic premises; the first one is related with the localization advantages, a

company may locate its facilities where costs are lower, and the other premise is that

companies grow by “internalizing” markets until the profits of that internalization

overcome or avoid the costs, such as taxes, governmental regulations or tariffs

existing in external markets. Coase goes one step further and makes a deeper

classification of transaction costs emerging from frictions between sellers and buyers.

This classification distinguish between Ex ante costs -previous to the transaction like

the of compiling information about potential market intermediaries, contracting costs

arising from negotiation with a possible export partner or direct costs like taxes- and

Ex post costs -later costs like monitoring costs associated with the control of the

agreement to ensure that obligations from both parts are fulfilled or costs derived from

the enforcement in case of sanctioning an intermediary who does not achieve the

goals of the agreement-. Transaction costs theory assumes that firms will try to

minimize these costs when taking to the end transactions, consequently the most

efficient performance for a company is the one that allows the lowest combination of

ex-ante and ex-post costs.

Essentially, this internalization concept is based on the existence of market failures in

the transaction of intangible or specific assets facing the presence of high transaction

costs inherent to the use of this mechanism. Those imperfections in markets act as a

barrier to free commerce, as a consequence the company should perform internally

and keep control of its sources if it wants to extract the value that it grants them, while

relying on the market those activities in where other companies have a cost advantage.

Those associated costs would be learning, or establishment costs derived from the

extension of the activities of the company in a foreign market. This situation would

- 20 -

me more common as it grows the intensity of knowledge or the specificity of the

asset, Magee (1977) states that the higher the know-how, the most probable the use of

internalization as a way of increasing the benefits of the company. Derived from this

line of thinking, those companies with a high level of R+D would tend to expand its

international production internalizing its activities via Foreign Direct Investment.

But this behaviour does not depend on domestic or foreign market since if this

or Rugman (1982) the assignation of property rights to a company and the use of

o give a broader view of these issues we will pay attention to Dunning's OLI

situation was held in the foreign scene where logistics, distribution costs or

commercial barriers were favouring its local exploitation would constitute a stronger

reason for a company to implement foreign direct investment. The essence of the

transaction costs theory is to explain the reason why a company decides to exploit its

assets as a replacement for transferring them to another company.

F

those rights by the company in the internal market to supervise and control the use of

a specific advantage as the knowledge, constitute the main foundation of the

Internalization theory. When costs within the organization are lower than inside

markets, Internalization carries an increase in business benefits as well as a better use

of scale and scope economies and it also makes transaction costs -related with

opportunism, uncertainty and information- decrease, (Caves, 1982). Even if this

theory turns into a very useful tool when explaining the form in which companies go

international, is not able to describe the level of commitment with international

markets, the choice of location or the structure of international facilities.

Internalization theory, as currently specified, cannot explain the last stage in the

evolution of the multinational enterprise, the shift from a sale to a production plant.

The decision to replace a sales subsidiary with a production facility is essentially an

investment decision analyzed in terms of location theory and production theories.

T

framework or the so-called Eclectic Theory where internalization is supplemented by

location characteristics and ownership advantages to shape a wider model of the

multinational organization.

- 21 -

2.2.3. ECLECTIC PARADIGM THEORY

s its own name states an eclectic theory is a conceptual approach that does not hold

unning (1988) has combined elements of internalization of processes with another

rst condition is related to ownership, by means of a specific advantage that a

he second condition states that the firm must have internalization advantages; that

A

strongly to a single set of assumptions, but instead draws upon multiple theories, to

gain additional ideas into a subject. Surely the most known theory for its eclectic

character is Dunning’s approach.

D

factors such as location advantages into an eclectic theory of foreign direct

investment, a general framework which describes not just the reasons but also the

distribution among the different countries in which the investment takes place.

Dunning holds that the eclectic nature of his theory avoids a wider approximation as

well as an explication of the foreign direct investment -FDI-, he also advises that each

of the earlier theories explaining FDI determinants are incomplete stating that those

previous theories are partially correct and partially incorrect as regards of specific

example of FDI (Graham, 1992). The basic premise of the Dunning OLI model is that

companies will undertake FDI if three conditions are fulfilled at the same time:

ownership advantages (O), location advantages (L), and internalization incentives (I),

hence OLI.

Fi

company must possess related to any intangible asset, during some time at least,

inaccessible for local competitors of the foreign market, such as monopoly control

over particular technologies, processes or resources. Once a company possesses that

advantage, the firm might decide whether or not make of it an international advantage

by using market intermediaries or by internalizing it. To be able to decide the most

beneficial alternative, organization should combine this condition with additional

factors of location in the new market; otherwise, firms would choose the exportation

instead of the investment, as a way of entry.

T

is, once the first condition is satisfied, there must be some advantages deriving from a

decrease of the transaction costs -like taxes, governmental costs or partners’ search

costs- internalization of externalities or a reduction of uncertainty, which make more

- 22 -

beneficial for the company to exploit its ownership advantages internally, through a

subsidiary, than by leasing or selling these advantages to independent foreign firms.

The third condition, after first and second conditions are achieved, establishes that the

firm must determine where the ownership and internalization advantages can be

optimized in combination with specific advantages accessible in particular foreign

locations, that is, the location advantages. The location choice is the answer to a

maximization problem in which the ownership and internalization are involved.

Location advantages respecting domestic markets are derived from the quality,

availability or cost of inputs as well as physic distance, transportation and

communication costs. The last condition, Dunning (1988) the role of location

advantages is described as a core variable that it may “be both necessary and

sufficient to initiate the act of foreign direct investment”.

Neither Dunning's theory is exempt from critiques, although it is a complete and

popular pattern of study nowadays and a reference framework in different analysis. It

has been said that is not a suitable way of explaining joint-ventures, acquisitions or

licenses, all of them are common ways of going abroad. It is Dunning's himself who

checks his own approach and adapts it for alternative ways of international alliances.

As he states, is eclectic due to the fact that the role of each of the requirements as

determinants of FDI, can change in each specific situation. The main changes are

related to the role of innovation to keep and increase competitive advantages. He also

pays more attention to the territorial aspect of the location advantage, inside this

concept it should have been given more importance to the across-border alliances

increasing the competitiveness of the company. He considers that the traditional

concept that a company’s capacity is restricted by its ownership limits is no longer

acceptable when the quality of decisions is influenced by cooperation agreements with

other companies.

Eclectic paradigm has been also accused of being redundant when explaining the

difference between ownership advantages or company specific advantages and

advantages derived from the internalization of the firm (Buckley, 1988; Itaki, 1991).

The most widespread critique to the eclectic paradigm -and similar theories- refers

that the identified variables are so many, that their value of prediction is void and

- 23 -

generally, lacks of dynamic considerations, at the time of describing why a company

goes international, Dunning’s paradigm pays little attention to the way investments

are developed throughout time dimension. Dunning and Narula (1994) try to describe

how the constant interaction of OLI variables influence the evolution of the

international production across time, and the strategy of the company which will

determine the new combination of OLI variables for future periods.

The evolution in the internationalization theories let us consider that companies

choose the optimal strategy to follow depending on its development stage and

considering different variables and costs of getting updated facing changes in markets

and demands.

2.2.4. PRODUCT CYCLE HYPOTHESIS

In 1966, Vernon introduces the product cycle hypothesis; this theory is based on

consecutive stages of development of the product of a company, and its strong

influence in the internationalization process in which companies go through an

exporting phase before changing first, towards a foreign direct investment –FDI-, and

finally to cost orientated FDI. Vernon stands out the technological innovation role,

scale economies and uncertainty in commerce patterns between countries in this

framework. He describes how companies shift the location of production as products

go through their life cycle which consists on four sequential stages increasing the

level of commitment of market resources, those stages are; introduction, growth,

maturity and decline.

Firstly companies with a new or innovative product increase their benefits due to the

absence of substitutes, production is centred in domestic market as it is more easy and

familiar for the firm, Vernon assumes the success of the firm creating the dominant

product, the second stage is centred on the company’s privileged position, in this

situation and without the threat of loosing domestic market share, the firm is able to

export and to search for alternative markets to take advantages of location of sources,

labour costs or economies of scale, by licensing a foreign producer or establishing its

own subsidiary. Thus during the product maturity, when new competitors enter the

market and as time passes the product becomes standardized. Once this period of time

is over, the price decreases, as a result competition is based mainly in price but the

- 24 -

company has already established production cost differences respecting rivals due to

their foreign investments, cost of foreignness (Hymer, 1976).

Finally, as the production techniques become increasingly standardized and products

ernon’s basic premise is that manufacturers in developed countries are closer to the

ater on Vernon and some other authors (Knickerboker, 1973 or Graham, 1978)

nickerbocker (1973) found that oligopolistic firms tend to match their rivals’

are price sensitive, firms turn to even lower cost markets to increase their profits. As a

result, the relation between foreign direct investment and trade relies on factors as the

nature of the products or the degree of the country development. Vernon defends that

developed countries are closer to every market of the world.

V

markets than producers elsewhere, so they establish first in advanced countries, then

companies take advantage from economies of scale and then with less standardized

products, take advantage of product locations.

L

developed what is known as the theory of oligopolistic behaviour to explain those

causes of the international expansion leading to situations that product life cycle is not

able to explain. The basic hypothesis of this theory is that in oligopolistic markets, in

which exists interdependence between companies, the expansion of one of them

forces its rivals to answer with the same strategy.

K

overseas investments. The resulting concentration of entries into a country, over a

short time period, is called “oligopolistic reaction”, also known as the “bandwagon

effect.” If a firm establishes a subsidiary in a market in which there are no rivals

presence, rivals can answer the threat to their position by investing in the host market

and keeping their position respecting the first company. If rivals do not invest, the

company may increase its experience in the new market; obtain new advantages,

technological or managerial skills, unavailable to rivals. The new capabilities may

allow the company to change the competitive situation of the local and foreign

industry, leaving its competitors at a disadvantage. Therefore, rivals have a strong

incentive to follow the first company to enter into a new foreign market. In a similar

way Graham and Krugman (1989) affirm that we must change our company’s attitude

- 25 -

in order to become international market leaders, this line of thinking results on a

defensive strategy.

Similarly Graham's (1978) “exchange of threat” model, which explains the

competitive motivations of a firm to set up international operations in the way that

companies follow its competitors movements, but instead of following home rivals

abroad, in Graham’s approach companies follow the strategies of foreign competitors.

He proposes that, in response to invasion of home markets, firms would respond to

the threat by investing in a market of foreign firms, thus exchanging threats the

motive in the theory of Dunning is demand-pull, but in the model developed by

Graham, it is a competitive response.

Regarding the previous theory, Rugman (1981) wonders on the motivations leading

the first company to take the initial decision of investing abroad, forcing its rivals to

answer with a defensive reaction. He also affirms that multinational companies

generate higher benefits than companies with a similar size but based in a single

-domestic- market due to the fact that through diversification and bigger size, the

company reduces risk of benefits fluctuation. This is the basic fundament of

Rugman’s risk diversification theory. The company reduces risk because of the

possibility of diversify their sales between different markets. Companies diversify

their investments between different countries in order to decrease specific risk that

can harm the productivity of the firm.

But other authors like Cantwell (1995), in spite of considering product life theory as

an important source, still supports that is not complete and needs amplifications. In

the technological aspect, he considers that globalization concept of technology on

International markets is needed to draw a map of locations, where interrelated

investments in the main centres of technology have shaped the current location chart

of geographical specialization and the importance of this chart as an innovation

reference. As manufacturing or retailing sector is not as intensive in innovation of

technologies Cantwell approach is not totally applicable here.

- 26 -

2.2.5. INTERNATIONALIZATION PROCESS MODEL

An alternative approach is based on a more behavioural vision of the company (Cyert

and March, 1963). They collect certain situations related to the shortage of complete

information and the importance of risk or uncertainty when taking business decisions.

Essentially this approach is focus on the actual behaviour of firms.

The highly innovative nature characterising the first stages of the internationalization

process of the company, especially those which are related to the exportation

activities, leads to adopting an increasing logic in the decision making and a gradual

behaviour pattern throughout time substituting the scanty initial knowledge of the firm

about foreign markets, as well as the inherent uncertainty arising from the

internationalization. This is the main reason for the interest in the early stages of the

international process that constitute the foundations of any later advance and

exportation mechanism with multiple aspects, and is the most spread way of going

abroad, especially in early stages. Often is the most popular way of interfering on new

markets since exportation allows the company to measure its efforts as they obtain

more or less positive results. Following this strategy exportation becomes, more than

other ways, a learning experience in the international environment (Root, 1994)

2.2.5.1. Uppsala Internationalization Model

Though the number of proposals developed from the gradualist and evolutionary

approach of the exporting process it is certainly considerable, the so called model of

internationalization stands out as the most significant contribution. A large extent of

the internationalization process study has been carried out by some researchers from

the University of Uppsala, (Johanson and Wiedersheim-Paul, 1975; Johanson and

Vahlne, 1977) they have developed a model framework based on an empirical study

conducted in Sweden, to explain the progressive international expansion process of

the company. This framework has been a point of reference of multitude of empirical

demonstrations to establish the level of foreign development of organizations and this

is the main reason to consider this model as a pioneer. This approach puts emphasis

on the gradually increase of knowledge obtained across a sequence of stages; it is the

gradual achievement, incorporation and use of knowledge about foreign processes and

- 27 -

the increasing involvement of the company, in terms of commitment to foreign

markets in each of these stages, as organization increases its level of involvement in

external markets.

Johanson & Wiedersheim-Paul (1975) originally emphasized the lack of knowledge

or resources, together with the uncertainty that both factors imply for the company as

the main trigger to its international expansion. This difficulty or uncertainty would be

reduced through an increasing knowledge process related to international markets and

operations. Following this, internationalization would take place across successive

stages reflecting a growing degree of involvement of the firm on its foreign

operations. Before setting the model a basic assumption should be mentioned; Firms

want to increase their long-term income at their locations, but in other locations want

to keep a low level risk-taking investment.

The Uppsala model defines internationalization as a consequence of incremental

decisions which increase the level of commitment across different phases and thus a

sequential model; this sequence of stages is known as establishment chain. The

pattern assumes that companies first develop their activities in the domestic market -in

the same way to Vernon’s product cycle hypothesis- Through increasing activities, the

company enlarge its resources and knowledge, decreasing perceived risk, as the firm

learns about the overseas market. This international progression starts with exports to

similar countries to avoid uncertainty, then by using independent representatives as a

way to minimize resources commitment and after this step, the company establishes a

sales subsidiary and the process ends with the creation of manufacturing facilities

overseas. (Johanson and Wiedersheim-Paul, 1975). These stages of exporting are the

following:

Stage 1. No regular exports activities, no commitment or information, the

company is occasionally interested in foreign market only to complete orders

from abroad customers or as an alternative to sale remaining products.

Stage 2. Export via independent representatives. Certain market commitment

and regular information. The company continues more and more with overseas

- 28 -

sales of remaining products by using intermediaries, and is ready to adapt its

products to the needs of its customers.

Stage 3. Sales subsidiary. Higher commitment and controlled information

channel. The company allocates resources, manufactures products and develops

marketing policies for foreign subsidiaries to meet customers’ needs from other

countries.

Stage 4. Production. Larger commitment and Information. The company

manufactures new products for local and in some cases regional markets.

Eventually, the chain is completed by establishing production facilities in the

foreign country (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne,

1977).

All the way through the process the degree of commitment increases as well as the

information. Uppsala model stages are more flexible than it seems, authors

contemplate jumps in the establishment chain depending on the experience of the

company and another factors. It also pays attention to psychic distance concept, since

firms will be inclined to invest first in countries with culture, language, political

systems or level of industrial development similar to their domestic markets.

Companies will select regions that they find easier to understand and as they increase

its international experience they will move in the direction of those which are

culturally different.

STAGE 1 STAGE 2 STAGE 3 STAGE 4

NO REGULAR EXPORTS

DIRECT

EXPORTING

INDIRECT

EXPORTING

FOREIGN

PRODUCTION

Figure 4. The U-Model Stages of Internationalization, Johanson and Vahlne.

The psychical distance concept is used by these authors as the way of choosing the

new market to enter. Psychical distance involves differences between countries such

as culture, language, business environment, politic and social systems or traditions

that can hinder the learning process of the firm in a foreign market. As the psychic

- 29 -

distance grows, the uncertainty is also bigger. This means that companies, typically,

first operate in markets or countries psychologically closer since they can easier find

opportunities and threats. Expansion patterns of the companies are shaped by the

psychical distance, consequently organizations reduce their uncertainty. As firms gain

experience and increase market knowledge through the time, they acquire skills to

overcome bigger psychic distance, on the other hand, business in close physical

countries are not necessary easy to manage since assumptions of similarity can stop

managers from learning about critical differences.

Later on, Johanson & Vahlne (1977, 1990) re-formulated this dynamic vision of

organizations internationalization process as a permanent interaction between four

factors. In other words, the foundation of this model is that internationalization it is

seen as the product of a series of incremental decisions (Johanson and Vahlne, 1977)

or incremental adjustments to changing conditions of the firm and its environment

(Aharoni, 1966). They make a differentiation between state and change aspects of

internationalization variables. State aspects are market commitment and knowledge

about foreign markets and operations. Change aspects are commitment decisions and

the performance of current activities. The figure below illustrates the fundamental

mechanism of internationalization according to the model. This mechanism explains

the aspects described in the internationalization process. The state aspects -left part-

are the knowledge about foreign markets and the resource commitment to the foreign

markets. Change aspects -right part- are decisions to commit resources and the

performance of current business activities.

MARKET

KNOWLEDGE

MARKET

COMMITMENT

COMMITMENT

DECISIONS

CURRENT

ACTIVITIES

Figure 5. The Basic Mechanism of Internationalization, Johanson and Associates

- 30 -

- State aspects,

Such as market knowledge and market commitment that companies possess at a given

time. These aspects have impact on commitment decisions and current activities

which in turn also affect market knowledge and market commitment (Aharoni, 1966).

Market commitment is a crucial and constant issue throughout all literature concerning

internationalization. Johanson and Vahlne assume that is composed of two factors; the

amount of resources committed on one hand and the level of commitment on the other

hand. Understanding resources committed, as the ones located in a particular market,

including investment in human resources, marketing and other areas; if those

resources can be easily transferred to another markets, the degree of commitment is

low but “The more specialized the resources are to the specific market the greater is

the degree of commitment” (Johanson and Vahlne).

Market knowledge is another key concept as commitment decisions are made taking

into account different kinds of knowledge concerning to present and future market

and environmental conditions, and these conditions change from country to country

and through the time. Johanson and Vahlne (1977) further argue that market

knowledge is a strong power in the firm’s internationalization process as it affects the

willingness to make commitments.

Knowledge nature varies depending on the way it is acquired (Penrose, 1956). By

making this differentiation we find objective knowledge, -similarly to the explicit

knowledge described in extensive literature-, and experiential knowledge, -we can

find this under the name of tacit knowledge-. The former can be taught and transferred

while the latter is inherent to the person who has it, can not be as easily transmitted as

objective knowledge and arises under determinate circumstances, a large part of a

most valuable services of the person may be available only under these circumstances.

A major aspect of experiential knowledge is the one that gives a company the power

to identify and perceive opportunities but it is seen as critical in the

internationalization process, since the difficulty of acquiring it

- 31 -

Johanson and Vahlne (1977) distinguish between three different types of knowledge,

classify by their nature; objective knowledge, general knowledge and market-specific

knowledge. The basic difference among them is the scope, since market-specific

knowledge is useful just in a specific location and general knowledge is wider, while

objective knowledge would be more specific than the general one. Market-specific

knowledge is gained by experience and is restricted to a particular market. It is

focused on particular or specific characteristics, and thus difficult to transfer. Because

of this transfer difficulty, additional commitments to the market will be carried out as

incremental small steps. Deep knowledge about the behaviour or business culture of

individual customers constitutes an example of market-specific knowledge. Objective

knowledge refers to a king of information that can be assembled by a firm before its

entry on the target market, this kind of knowledge is easy to attain as normally

information sources are publicly available; customers’ power, market size or

government policies for instance. On the other hand general knowledge is acquired

through increasing experience on international operations, as it is the wider kind of

knowledge can be applied on several countries, it includes common characteristics of

management methods, general notions of customers or demand characteristics,

marketing strategies. (Johanson & Vahlne, 1990).

Uppsala model establish a high interdependence between the previous concepts. Thus

high market knowledge decreases uncertainty and so companies are able to commit

more resources and consequently, market commitment increase.

- Change aspects

Current business activities are the biggest source of experience of a company, the

model makes a distinction based on the nature or field of the experience, between

market experience and firm experience, both are necessary while firm experience it is

inherent to the company, the easiest way to gain market experience is by hiring

management who has already work in the market. The more the personnel have

market experience the sooner the company is able to use them profitably. But

generally this kind of experience is difficult to find through a long learning process

across the development of a company’s current activities.

- 32 -

Commitment decisions constitute the second change aspect, these decisions are made

once the company is able to perceive opportunities or problems in the market, and the

firm can take decisions based on its experience or similar situations. Both problems

and chances are associated to the current activities performed by the firm, and to the

market commitment. The chance that companies will be offered opportunities from

the market depends on its performance and commitment to it. We can distinguish

between two different kinds of commitment decisions, depending on the nature of its

motivations:

- Uncertainty-reducing commitment, these kinds of decisions arise from a

decrease of the maximum level of tolerable risk or because of an increase

of the existing market risk, like the entrance of new competitors or

alternative structural changes in the market. The company will commit

resources in order to reduce market uncertainty.

- Scale-increasing commitments, these sorts of commitments can be a

consequence of a particular situation in the market, as a political or

competitive stabilization. Under these conditions; the company can

increase its knowledge about the market and therefore, decreases the

uncertainty leading to an increase of the commitment to the market. These

commitments can also arise from a particular position of the company, as

the firm increases its returns it tolerates a higher risk and so, it is more

likely to commit a higher level of sources.

However, three circumstances are detailed by the authors, which constitute exceptions

to the incremental market commitment framework. One of these exceptions is the

degree of commitment of big companies. The size of the company influences its

inclination to the commitment. In other words, companies with plenty of sources

might feel more secure in making bigger commitments than smaller sourced firms.

Other condition for which this approach would not be suitable is based on markets

with a high degree of stability, market-specific knowledge arising from experience

would not be necessary in homogeneous markets. The last condition refers to markets

with common features, as companies which raised experience from those markets can

generalize their knowledge to the particular market

- 33 -

U-model constitutes one of the first existing contributions for the analysis of

Internalization of firms and the most mentioned source from export behaviour

perspective. Nevertheless it is not exempt from critiques, or judgements since many

times results trying to validate its main fundaments; psychic distance and

establishment chain process, were confusing. Several authors did not agree with the

Uppsala model, even Johansson and Vahlne, besides establishing some limitations to

its model, also argued that it was rather deterministic in terms of organizations’

behaviour. Because of the determinism, there is a need of raising the flexibility of the

model. Alonso (1993, 1994) describes the U-model as a simple transition across a

sequence of institutionalized formulas which are highly predefined, by adding

flexibility companies would improve companies’ commitment stages and create

alternative ways of presence on international markets.

On the other hand some critiques to the approach arise because of its lack of

references respecting the time it takes for a company to evolve from one stage to the

next one, and related with the deterministic aspect mentioned above, the authors do

not develop the case of companies skipping stages of the model (Johanson and

Mattson, 1988). Later literature also pays attention to globalization phenomenon in

the sense of the world markets becoming close, as time passes psychic distance

diminishes, in addition, some companies take as determinants to internationalization

another factors as market size, and not just because of the physic distance as

customers in different markets are becoming more alike. Some authors (Petersen,

Pedersen and Sharma) argue than while U-model assumes market-specific knowledge

as the only determinant of the firm’s internationalization behaviour even though the

authors of the U-model have stated that other potential factors exist and influence the

internationalization process. As a consequence, authors point out the partiality of the

model.

However some positive feedback arise as well, this model is complete when

explaining the initial process of companies -SMEs generally- especially en early

stages. At the beginning of its exportation activities, since rarely these activities can

be explained without the gradualism detailed in the model (Johanson and Vahlne,

1990; Alonso, 1993). This gradualism confirms the need of incremental experience to

explain the international behaviour of companies. But on the other side, the

- 34 -

descriptive character of the theory fails in explaining the dynamics of decisions

leading a company to move from one stage to the next one. This way, U-Model as

some other models proposed here, establish the road to follow along the company’s

exporting path but they are weak when explaining the causes of this progression

between different stages considered. It also lacks on considering the growing

proliferation of alternative formulas such licensing, franchising or joint-ventures.

Final ways of entry are highly specific, and they are also a result from previous

transactions (Reid, 1983, 1984). Thus structure chosen is a crucial issue to the strategy

of the company standing out the diversity of exporting behaviour of the company.

2.2.6. NETWORK APPROACH

This model emphasize that current activities of firms are highly dependent on the

individual past and present, activities and experience of the firm. Network model was

developed by some authors (Johanson and Mattson, 1988; Hollensen, 2001) based on

interdependences inside the market, between several business factors from one

company to another in order to shape the business. The basic assumption is that

companies, although they are individual organizations, depend on their competitors’

resources and actions. This approach provides a dynamic view of the companies

interacting with each other and therefore the need of coordination between their

activities. This coordination concept is set by the own market as companies put the

price of their products considering their competitors pricing strategies and thus

interrelating with them. We can find coordination also in the way firms chose its

partners, suppliers, distributors or customers and by dealing with then networks are

created, maintained or finished, as a result different processes of the companies are

cumulative. This cumulative factor, influences directly on the position of the company

in the market, limiting or reinforcing its activities and defining potential future

possibilities. According with the approach, there are several nets or parts of the total

networks depending on its nature, like geographical nets or products nets. Basically

these nets will determine the performance of the company even more than the

possession of a particular competitive advantage. These advantages constitute

important assets to establish appropriate nets with partners and have a good position.

As a result, this approach is more externalization oriented than internalized.

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Companies in the network approach develop positions with foreign counterparts and

depending on these positions they are allocated in one of the four situations defined

by the classification.

Degree of MARKET internationalization

LOW HIGH

LOW The early starter The late starter Degree of COMPANY

internationalization

HIGH The lonely international The international among others

Figure 6. Johanson and Mattson, 1988

• The early starter is the company with a low degree of market and company

internationalization, so its activities are mainly developed in the local market

with no major international commitment or activities, similar to companies in

the first stage of the Uppsala Model. Normally, companies in this position

enter new market with a foreign agent, who will have its own network;

therefore early starters must be careful with the position of the agent or

introducer in order to gain access to the foreign market.

• The lonely international is the company whose degree of internationalization

is higher than the degree of the market. The developed position of the firm

allows it to control its competitors but also acts as a stimulus to promote the

internationalization of the market. The lonely international has access to tight

nets and it might have an efficient coordination of its nets in order to keep its

privileged position.

• The late starter is the position of a company with a low degree of

internationalization compared to the one of the market, as its environment is

highly international; the company is pulled into foreign markets by its own

nets. In this situation flexibility is a relevant issue. The capacity of reaction

makes that small late-starter will perform better than big late-starter. This

position is hard for the companies as the market is already distributed between

competitors that can compete in prices. Here we can also observe how the

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critical role of time affects their position compared with the position of the

early starters.

• The international among others. The company has a high internationalization

degree in a highly internationalized market. In this position companies must be

concern about entering new markets and expanding its activities in order to

maintain its current position, taking advantage of its access to other

international networks.

Jonhanson and Mattson (1988) consider that the success of the company will depend

more on the current market relationships than on the particular culture or market

characteristics. Concerning relevant theories about the International development of

companies, the Network theory stress this process as a result of activities between the

company and its environment, is more external orientated while the Internalization

model emphasizes the internal activities of firms. Authors also compare the Network

model with the Uppsala Internationalization approach; both frameworks consider the

importance of cumulative activities for the company although companies described in

the Uppsala model could fit into the Early starters classification, but is not suitable for

companies positioned in the International among others’ group as it is too general

(Reid, 1983).

3. WHY DOES INDITEX GO ABROAD?

The analysis of the influencing factors and accordingly, the strategy of

internationalization followed by the companies, would be incomplete if we do not

take into consideration their domestic situation to be able to understand and identify

their main resources and assets. The most efficient combination between internal

resources together with external opportunities emerging from the environment, are the

essential variables defining the expansion process of companies (Durán, 1991).

Companies have resources which evolve according to their experience constituting a

source of competitive advantages or disadvantages and this is why the internal as well

as domestic situations of Inditex are important in order to understand its past, present

and future performance.

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3.1. SPANISH RETAILING INDUSTRY

The Spanish textile retailing sector has experienced big changes during the last

decades due to the globalization of the economy and the rise of new information

technologies, which have promoted the sector by increasing the interaction and

management among the different processes of the production until to the final sale of

the articles. Until the eighties, the design department of the companies established the

seasonal trends and the firms used to release their collections designed almost one

year before being placed on the market, and this is one of the reasons why many

articles failed. Besides, the division between manufacturing units and retailers was

reducing the capacity of reaction in order to face market changes deriving from new

trends.

Vertical integration constitutes a big step in the Spanish textile sector, due to the

previously mentioned division. Vertical integrated companies, assume both

manufacturing and retailing tasks, leaving the traditional market trend and increasing

their power across the distribution channel. An important motivation for

manufacturers to carry on this integration is to establish a direct relation with the

consumer, due to the constant changes in the trends.

The most eminent change of the Spanish market is the implementation of the integral

companies which arise to be able to control the entire cycle of the product, in order to

monitor costs, qualities and delivery times. This strategy, which some years ago was

limited to a few companies like El Corte Inglés or Cortefiel, has been developed in a

new way by some groups covering different segments of the market. The pioneer

company developing this new concept was Inditex, but its success induced other

retailers to improve and increase the flexibility of their logistic systems. The

consequence of these changes is the reduction of the time from the design of an article

until its sale, creating a new concept of distribution as a short cycle, with more

frequent and smaller deliveries, allowing the company to answer to its consumers’

demand in a few weeks opposite to the year mentioned before. This kind of

distribution faces the switching trends of the market with a politic of storage zero

which allows firms to have new articles during all the year. The textile companies of

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confection have verified that it is much more profitable to produce what they sell than

to accumulate produced inventory.

Traditionally, companies in the Spanish market were subcontracting the production of

the garments to other independent workshops of the local market but this situation has

been progressively changing due to costs reductions. Companies, nowadays reallocate

part of their manufacturing processes mainly to Asian countries but in Spain also to

Portugal, Morocco and some West European countries1 with lower labour cost, in two

ways. They establish their own facilities in the foreign country or subcontract these

activities with foreign workshops in order to save costs. Once companies reallocate

production stages to optimize their efficiency, cost optimization will depend on what

formerly was considered to be marginal, management expenses. Internet nowadays

constitutes an important tool to reduce the operative costs and facilitates the flow of

information between the central department of the company and its stores.

3.1.1. POLITICAL / LEGAL FACTORS

These factors concern to the restrictions affecting the volume of production as well as

the concentration of the establishments. Spanish companies must be aware of different

policies, depending on the region, which regulate these issues to avoid monopolistic

situations. Regarding the labour force market, generally Spanish companies -and

particularly Inditex-, do not have their own labour agreements, and so the conditions

of the personal of each store is regulated by the in force agreement of the Spanish

region where the store is located, which supposes taking into consideration, from a

legal point of view, very different agreements. The number of people working in the

textile market decreased 5,6 percent during the last decade2 as a consequence of the

decentralization -from Spain to developing countries where the labour costs are lower-

of some textile processes of the manufacture, since 2002 the percentage has increased

near 1,8 percent.

1 Distribución y Consumo Magazine, 2004 2 Acotex 2005 annual report, “El comercio textil en cifras”

- 39 -

3.1.2. ECONOMIC FACTORS

The inflation does not have the same consequences in all the companies, but it can

harm some more than others. The companies of those countries that have a high level

of inflation as Spain are less competitive than those of the countries without inflation.

If the type of interest grows, the price of the lending rises and as a consequence, it is

more expensive for the companies to reach capital to develop their investment plans,

in addition the savings would be stimulated by having better remuneration while the

consumption diminishes, as a result the demand of products of the companies

decreases and therefore the employment parallel diminishes. The opposite effect takes

place if the interest rates go down. In case of Spain that depends on what it says the

Central European Bank, this rate of interest has remained constant during the last

years.

As the degree of uncertainty grows, the companies find difficulties in their planning,

firms do not know how much it will cost to produce certain goods, and what will be

these goods final price to consumers, accordingly the plans of the companies in the

long run will be more affected, diminishing the investment. In case of Inditex, there is

less uncertainty in the European markets and more uncertainty worldwide, for the lack

of knowledge. Exchange rates affect us, since these rates have an effect on those

companies that buy or sell products in international markets. When the Euro currency

loses value, the goods that produce the Spanish companies are cheaper abroad and in

turn, foreign goods are more expensive on the national market; thus the amount

exports rise, diminishing the imports. This has an effect on the Spanish economy and

also affects the companies operating in the Spanish market. If the value of the Euro

currency increases, the opposite consequence will happen. The effects of the Euro are

not be the same for all the companies, these effects are clearly more noticeable in

those companies with a higher level of international activity, and especially, in those

who exercise their activities in several countries of the European Union, as Inditex

and its different formats. The list of the major textile companies’ shares in their stock

exchange comes as a result of the need of resources to grow and to expand into the

international markets, in which they have a major presence in the last years.

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3.1.3. TECNOLOGICAL FACTORS

Although the products of the company are not as sensitive to the technological

development as other kind of goods, the fast evolution of technologies and

information systems constitute a relevant factor for the communications inside the

company as these systems improve the information flow, ensuring quicker responses

to market variations. For the companies of the sector, the spread of the Internet

constitutes a good chance to increase their sales and reach new customers, since the

number of users is growing at a fast rate in the country. It means an opportunity

although during 2002, just the 3 percent of the total online orders were clothes3.

Inditex is not interested on this kind of commerce since a big extend of its activity

takes place on its stores as a result of the relation between seller and buyer, for the

company is also a critical issue the problem arising from different sizes since with the

e-commerce customers buy clothes without wearing them.

In the textile sector there is few investment allocated to R+D and therefore

manufacturing efficiency is lower than it could be expected, although Inditex invests

more than the average of the sector and is advanced regarding its competitors due to

its manufacturing technology based in the Just in time. This system, originally

designed by the Japanese company Toyota was adapted and implemented to Inditex

during 19914.

3.1.4. SOCIO-CULTURAL FACTORS

There are some socio-cultural variables affecting the situation of the company as well

as the whole market. The level of revenue and saving of consumers is a relevant factor

as depending on the economic situation of each moment, the trends of the consumers

will be influenced and accordingly will change, therefore in crisis times, customers

will spend less money in clothes, using their savings to fulfil their primary needs and

in prosperity times, they will allocate more resources to buy products as the one

offered by Inditex. Right now is tended to save less and so the textile sector will

benefit as the consumers spend more money to the above mentioned sector. Another

3 Spanish Chambers of Commerce, 2003 “Líneas de Negocio en Internet” 4 Luís Alonso Álvarez, 2000. “Vistiendo a tres continentes”

- 41 -

behavioural factor nowadays is a trend towards consumerism, following this trend

people try to reflect an image to the society in order to be accepted in a social group;

as a consequence happiness is highly related with consumption.

The increase in the national birth rate is an important demographic factor deriving

from the increasing phenomenon of the immigration in Spain, this is positive for the

retailing textile sector as these new part of the population becomes stable

professionally, increasing their resources and therefore being able to buy in order to

satisfy not only their needs but also their wishes in the clothing stores as the ones of

Inditex, meaning an increase of the potential consumers as well as in the labour force,

since the Industry companies find a new source of employees. This situation means

the incorporation to the Spanish market of a bit more of 3 million inhabitants5 , a 6,7

percent of the Spanish population The change in the familiar structure also

constitutes an influential variable as in Spain, people waits more time to have their

own home and family compared with the general tendency during the last decades, the

young people spend more money on things for themselves since they live in the at

their parents home and once they form their families, both men and women work and

consequently there are two salaries and this behaviour does that more resources are

allocated to leisure activities and clothes.

6

3.2. COMPETITIVE ADVANTAGE / MANUFACTURING PROCESS Inditex designs all its products; at the end of 2005, more than 30.000 different models

were designed. The design department is integrated by near 300 professionals design

two seasonal collections per year which constitutes almost the half of its production,

the rest is manufactured relying directly on the information received from national

and international stores, together with the trends seen in the street, and thus adapting

the manufacturing process to the current demand of consumers. Inditex obtains a large

extend of its raw materials from its own textile companies as Comditel, S.A, or

Fibracolor, S.A. -dying company-. Then the fabrics are cut following the designs and

independent workshops sew the pieces.

5 Secretaría de Estado de Inmigración y Emigración 6 Instituto Nacional de Estadística

- 42 -

The production cycles of the company constitute its main competitive advantage. The

different chains receive products twice a week, not only current products but also new

models renewing the offer constantly. The speed of change in their collections spread

a climate of shortage and opportunity, since the clients do not know if next week they

would be able to find what they like today; customers also know that they should visit

Inditex stores since their collections are constantly changing. This cycle it has been

possible, among other factors, due to the introduction of the just-in-time system

innovative and efficient in the textile and retailing industry, it has the advantage of

changing quickly the production in order to face the demand, providing the company

with the power and flexibility to answer, in a short period of time, to any change on

the fashion trends by eliminating stocks and reducing manufacturing and distribution

time. This time between the order is received in the distribution centre and the product

is available in the store goes from 24 hours for European stores up to a maximum of

48 hours for American and Asian stores.

This manufacturing process it is just carried on with those trendy articles, which

constitute the 80 percent of the 30.000 models that the Group was able to place in the

market during 2005; while the remaining 20 percent correspond to the Basic

collection, timeless articles which are imported directly as finished products, mainly

from Asia7. A big proportion of the European suppliers are located in the north-west

part of the Iberian Peninsula and the Group takes advantage of its closeness in order to

save time ensuring the product compliance to the time schedule and gaining control

over the processes.

Additionally, Inditex develops its products for a global market and this bears the

advantage of exploiting economies of scale, and a common worldwide image quite

useful to attract clients, and international customers. Finally, the company has a

special policy regarding the locations, all the chains integrating the group have similar

governance, and the election of the stores placement is a common key issue due to the

lack of promotion and marketing campaigns. As a result, points of sale must to be

placed in the best locations, since shop windows are the primary resource to attract

clients. Stores must be located in very popular zones highly frequented by people.

7 Inditex annual report 2005

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3.3. INDUSTRY ANALYSIS

3.3.1. PORTER’S FIVE FORCES ANALYSIS

A company has to be aware of the dynamics of the industries and markets where it

carries on its activities in order to compete successfully in the market and develop

suitable strategies for the changing situation. Michael Porter suggests a framework in

1979, which uses concepts, related with the strategic behaviour of a company and

consequently derive in 5 forces determining the attractiveness of a market. Porter

deals with factors outside an industry that influence the nature of competition within

the mentioned industry, those factors are known as forces inside the industry -these

forces build the microenvironment- that influence the way in which firms compete,

and so the industry’s expected profitability. A change in any of the forces, as the

market is a dynamic environment, normally requires a company to review its position

on it.

The sector of cloths retailing includes all those companies that commercialize these

types of products in any of its variants. To use the analysis of the five forces in this

industry we have to consider the main attributes of the sector where Inditex is

developing its activities and strategies. Porter defined four forces which drive

competition; bargaining power of customers, the bargaining power of suppliers, the

threat of new entrants, and the threat of substitute products, combine with other

variables to influence a fifth force, the level of competition in an industry. Each of

these forces has several determinants: Porter suggests that the intensity of competition

is determined by the relative strengths of these forces.

Force 1: Degree of Rivalry

This is the most evident force of the model and is also placed on the centre of the

diagram, the intensity of rivalry helps understanding the extent to which the potential

value of an industry is distributed among the different competitors and which are their

advantages to increase its market share. But although the evident influence of this

force in order to determine the situation of the company, the model puts emphasis on

the interaction between the fifth forces and not the isolated action of one, as rivalry,

- 44 -

although is an important issue, is one of the several factors determining the

attractiveness of an industry.

In the national arena, the number of competitors in this sector is very high, though

stable. In the following table we can see how there has been an increase of the

retailers in the textile sector during the last years, this means that although the number

of competitors remains steady, some of them have expanded more on the market than

others. As a result, the number of competitors is not growing but competitors

themselves are.

Figure 7. Acotex, 2005

EVOLUNTION OF THE NUMBER OF RETAILING ESTABLISHMENTS IN SPAIN

64.00066.00068.000

70.00072.00074.000

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

The national market is a concentrated sector, in which few companies of great size

possess an important market share, whereas the rest of the share it is owned by many

small companies. Regarding exit barriers, they almost do not exist, allowing the

companies to move from a segment to other one within the industry. This situation

makes possible to manufacture other articles that use the same productive systems.

The articles of the sector are not very specific and consequently, the costs incurred

deriving of clothes and related articles storage are very low, since garments do not

expire, and so the company does not need big infrastructures in order to preserve

specific storage characteristics.

Related to exit barriers, due to the mentioned lack of specify of the products, asset are

relatively easily transferred and companies can leave the market and reallocate its

resources recovering some of their investments. The costs arising from the dismissal

of personnel are moderately low, since the widespread use of temporary contracts in

the sector. There do not exist practically barriers of entry in this sector for some

reasons; the costs deriving from opening a store for selling clothes are very low and

- 45 -

thus the capital needed to start with the activity is small. Concerning brand equity,

final consumer in the Spanish market gives value fundamentally to two product

attributes; the price and the brand due to the fact that quality differentiation is less

evident between two products from different but popular brands.

Force 2: Threat of Entry

The threat of new entrants is usually a consequence of the market entry barriers. If

there are strong market barriers there will be fewer competitors, entry barriers exist

whenever it is hard for a foreign company to compete with local companies (Porter,

1980). These barriers can be different but the reason of its existence is common, they

are used to prevent firms entering into a profitable industry. Here, we can see some of

the most common of entry barriers, as economies of scale. There is a significant

characteristic of the Spanish sector as well as in the international marketplace, which

affects negatively the companies when taking advantage of economies of scale, is the

frequent changes of the trends and tastes of the consumers, but due to the particular

organization processes of the Inditex Group, this characteristic is positive due to its

negative impact on its competitors.

Barriers or administrative restrictions at the time to enter the Spanish sector do not

exist. This lack of regulation helps a foreign company to enter the market although

there are some regulations once companies increase their size in order to protect

market competition in favour of final consumers. The reactions of the already existing

companies when facing the entrance of new competitors are almost void because

these existing companies are generally very small groups of distribution, with familiar

structure and with few market share, which make difficult joint decisions among

existing companies leading to avoid the entry of new competitors. The position of

Inditex concerning distribution channels in Spain is quite strong. The company has

developed its activities during the last decades within the Spanish Market growing at

the same time as the sector and so its activities. This experience provides the company

with a high level of knowledge about the market.

Differentiation does not constitute such a relevant entry barrier in this particular case,

as taking an advantage based on the differentiation of clothes is relatively difficult and

momentary as competitors copy each other quite fast due to the lack of especial

- 46 -

characteristics of these kind of products. Although differentiation in another areas,

more intangible than the product, as manufacturing, distribution or management

process means a valuable advantage for Inditex Group. Other characteristic of the

Spanish market is the existence of high costs of acquisition of raw materials and

manufacture, when the production is made on the national market and this is why the

big companies of distribution rather manufacturing out of our borders, especially in

Asia and so these high costs do not really constitute an entrance barrier for companies

competing at Inditex level, since both save costs reallocating specific processes of the

chain.

Force 3: Threat of substitute

This threat depends on the relation between the product and its price which also

depends on the existence of other products to which customers can turn to satisfy the

same need. This relation is two sided as the inexistence of substitutes will raise the

price of the product. Apart of the existence of substitutes and its price, consumers are

also influenced by the switching costs, which are the costs arising from shifting one

product for other one fulfilling the same need.

Force 4: Bargaining power of customers

The power of customers is a big influential factor of the Industry value. The most

important attributes of the buyers’ influence are its size and concentration, but there

are other factors as the buyers’ access to information, the differentiation of

competitors or the existence of substitutive products. This bargaining power is rather

high in the markets where there are few and big customers, and increase

proportionally to the number of companies, as in this case customers set the

conditions. In the Spanish market, as in foreign markets due to the characteristics of

the retailing sector, there are lots of customers compared with companies. Those

customers are very small all of them; the volume of their individual buys is rather

small and they have little relation among themselves, resulting in a small bargaining

power opposite to the distributors influence. Nevertheless there are some

organizations of customers to gain a major purchasing power, obtaining this way

better prices and higher quality of products and services, these organizations defend

and promote the rights of the consumers, like OCU in Spain.

- 47 -

The risk arising from non-payment in this sector is almost inexistent as usually the

most of the sales are paid using cash money, even though almost all the companies

accept the credit card payment, like Inditex that even have its own credit card variant

called Affinity card. Due to the wide offer of clothes as well as significant changes in

buyers’ habits of purchase or tastes, customers are progressively less dependent.

Switching costs also influence buyer’s decisions. In this sector the costs of changing

from an establishment to another one is relatively low, if customers do not find what

they are looking for in a store, they visit others up to finding what they are searching

for. This also make that customers are not loyal to a single store as there are many,

this makes that companies in this sector, try to offer the price, quality or service that

buyers are demanding in order to ensure customers’ loyalty.

Force 5: Bargaining power of suppliers

Supplier bargaining power is pretty similar to the bargaining power of buyers, and

also similarly the most important characteristics of suppliers are its size and

concentration compared with the companies, and there is also another factor

conditioning its position, which is the degree of differentiation in the products that

they are supplying. When there are many companies in the market, opposite to the

amount of suppliers, their power increases and so their ability to vary their prices in

order to increase returns. In this situation, the sector is characterized by high supplier

power and as a consequence by low buyer power (Porter). The amount of bargaining

power of suppliers rises when their concentration is lower than firms’ concentration

ratio. In the particular case of the Spanish markets there are many suppliers as well as

companies, but the concentration of big groups as Inditex is higher than the one of the

suppliers, especially in the Galician region. But as we are going to see now, in this

particular case this force is the less relevant due to the vertical integration of the

company. This force is also affected by the threat of forward integration by suppliers

relative to the threat of backward integration by firms; the volume that the supplier

provides to the company is also a determinant of its power as well as the cost of the

inputs compared to the price that they reach.

There are many suppliers, and this means that the prices for distributors are very low,

and therefore this is more beneficial for the companies’ interests. In the case of

Inditex, this is not a really important factor, since the Group is vertically integrated,

- 48 -

and this means that the company manufactures and distributes its own articles. The

products that they commercialize are not perishable products, and so the most easily

storable, which favours the manufacturers at the moment of selling its goods; although

they have to consider that every season the trends can change. Suppliers do not

constitute a major threat for the already established distributors. To a small extent

they are potential competitors since they can start their own business as an alternative

way of promoting their products. There is also an increasing importance of the

hypermarkets, since these commercial formats already have the 20 percent of the

market share of the textile sector distribution.

Companies must try to understand its competitive environment in order to get deeper

insights of its situation. This understanding will be useful for companies to establish

appropriate strategies to achieve its objectives. Porter’s five forces model is a useful

tool for companies to appreciate threats and forces of its strategy. As final conclusion,

to indicate that the most influential force is the rivalry among the competitors in the

market and this force, together with the valuation of the remaining ones lead us to the

conclusion that the degree of attraction of the sector, as a whole, is average. This

attraction degree is higher for companies that have developed any competitive

advantage as the Inditex Group on the contrary; the companies without any

competitive advantage would consider this market less attractive.

Threat of New entrants

Bargaining Power of

Customers

Bargaining Power of Suppliers

Threat of substitutes

Competitive

Rivalry

Figure 8. Porter, 1980

- 49 -

3.2.2. ACTUAL COMPETITORS

Inditex direct competitors need five months of production for its collections while

Inditex brands develop its collection in three weeks. After its entrance in the Spanish

stock exchange, Inditex becomes the strongest textile group of the country, -as El

Corte Ingles sells all kinds of products-. The different concepts constituting the group

are able to fully control its sales, manufacture and distribution processes. The time

that Inditex needs to produce and distribute an entirely new line of clothes is the

fourth part of the time that its rivals need and it is also able to release three or four

lines per season, the same time that its competitors need to present one. The

company’s success is based on a model of business which consists of a synergy of the

design, “just in time” production, marketing and sales. This business model provides

the company with enough flexibility to face the market changes faster than its rivals.

The company can supply its stores with a brand new line in 3 weeks comparing with

almost 9 months for other big international clothing chains, which have to treat with

hundreds of different suppliers. To have low stocks and a high rotation at low costs is

what makes the firm very competitive in prices.

Respecting local competitors, the sector is basically controlled by four big groups: El

Corte Inglés, Inditex, Mango and Cortefiel. The biggest five textile distribution

groups of the country control the 33 percent of the whole market. This rate indicates

that there is a market concentration of a few firms in spite of the existence of many

companies and this is due to their small market share.

Mango: Clothes designed for young woman from classic styles to more comfortable

and less formal clothes. One of its main goals, maybe the most important, is to

increase its market share, market where the group Inditex leads followed by Cortefiel.

To be able to grow, Mango mainly opens franchised shops, allowing the company to

increase quickly the number of the locations of its stores, which is the main form used

by the firm to increase its market share. Though by using this strategy, Mango loses

control over its stores. As strong assets, it is necessary to mention that Mango focuses

all its efforts towards a specific market sector as is that of the young woman. The

company is integrated vertically, designing, producing and selling on its own

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locations. The price of its clothes is a weak point for Mango as they are higher than

those of the format Zara, which is the chain of Inditex with more similarities to

Mango on its orientation to the female young sector, more classic than the rest of the

chains of the group.

El Corte Inglés: The Company offers a wide range of products, in the textile sector;

their clothes include all the customers’ target, from children up to adults, men and

women with touches that go from classic to less formal. El Corte Inglés

commercialize their own brands as well as independent brands like Ralph Lauren,

Tommy Hilfiger, Paul & Shark, Levi's or Pepe Jeans among other prestigious ones.

The goal of the company is not based exclusively in focusing on a certain sector, but it

tries to include all the different kinds of public, attenuating a bit its rivalry with

Inditex. El Corte Inglés also offers major quality products to higher prices,

fundamentally the company sells clothes of popular brands with international prestige

and consequently with higher prices. Nevertheless, El Corte Inglés also offers articles

of the distribution brand, but these articles do not compete in the same market

segment as Zara does.

One of the company strong assets is its brand image, which makes that its consumers

are ready to pay more for its products. Another advantage is that offers multitude of

services and products, not only textile, which attract its clients. As a weak point, it is

necessary to mention that the price of its articles is considerably higher than the one

that Zara offers in similar ones.

Cortefiel: This Company is constituted by different chains of clothes as Inditex

Group. Its products are designed for a target group who goes from teenagers to adults,

both women and men. The Cortefiel group includes several formats: Cortefiel -that

gives its name to the group as a whole-, Milano, Springfield, Pedro Del Hierro,

Women's Secret, Fifty Factory and Douglas, besides having 50 per cent of Don

Algodón's share. Therefore Cortefiel does represent a consistent threat for Zara. One

of its main goals is to try to dress both men and women, of from head to toes. One of

the ways of reaching their aim is the use of fidelity cards. Cortefiel manages these

cards very effectively, since the company divides its clients into different target

groups, and this way is able to offer those groups personalized promotions.

- 51 -

In the Spanish market there are also other national competitors, fashion designers of

recognized prestige in the national market like Adolfo Domínguez or Purificación

García, but their activity does not constitute a direct threat to Inditex. There are also

foreign companies inside the Spanish market and therefore competing with Zara like

H&M, Benetton or Burberry.

Currently, the strategy carried on by the Inditex Group is the more successful in the

Spanish market respecting its foreign competitors; GAP, H&M or Benetton, they try

increase the number of their customers by decreasing their costs subcontracting

independent agents to develop activities from their production chain; manufacture,

distribution or stores management by franchising or using local associates. This

strategy decreases the speed of replacement of collections in their stores and therefore

its ability to satisfy the real demands of their clients. The sector also includes haute

couture competitors, like Armani, Versace or Loewe, but these ones are not direct

competitors as they are directed to another market niche.

3.3.3. DEMAND

In order to have a broader view of the situation of Inditex, we are going to analyse the

demand, which bears the consequent analysis of the market share of the Group

Inditex, as well as a wider analysis of the overall demand of the sector where the

company carries on its activity.

3.3.3.1. Market Share

During the last decade, there is a declivity of the multibrand stores, the traditional

commerce in favour of the specialized chains which compete in proximity and

fashion, and also favouring hypermarkets distributing clothes as well, which compete

in prices, and finally the new entrance of the outlet stores, also competing in prices.

The classic distribution, which is centred basically on the independent multibrand

stores, have lost a significant piece of its market share from the eighties, almost the 50

percent of its market share since 1985; from 66,1 percent in 1985 till 34 percent in

2005. Department stores remains the same, with small variations, and this loss from

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the Multibrand stores is reflected on the Specialized chains which increase its share in

ten years, from 7,8 percent up to 24 percent, experimenting the biggest growth.

Followed by the hypermarkets, its textile division, that have grown 13,7 percent rate

from 1985. Finally it is also remarkable in order to have a broad view of the Spanish

sector evolution within the last decade, the entrance of the Outlet format during 2001.

This format has evolved in five years, from being a completely unknown concept up

to account the 5 percent of the national market share.

NATIONAL DISTRIBUTION OF THE TEXTILE COMMERCIAL FORMATS

Multi-brandStores

Other marketsOutlets

Hypermarkets

Specialized Chains

Department Stores

Figure 9. Acotex, 2005 The most representative companies of the Spanish retail textile sector are as

specialized chains as the group Inditex, the group Cortefiel or Mango and the

department store El Corte Inglés. In the Figure below we can have a wider view of

their size and the volume of their activities from the year 2004. It is necessary to point

that the following analysis are estimated on the data collected during 2004 and the

previous years due to the lack of availability of more recent numbers in the case of

Cortefiel and some national surveys.

The biggest company considering its sales volume in the Spanish market is El Corte

Inglés, with 14.607,72 million euros in 2004, which supposes an increase of 7,1

percent respecting 2003. This amount corresponds to the consolidated invoicing of the

group, and so it includes a big percentage which do not correspond to the textile

sector, as the activity of the company includes a wide variety of goods as furniture,

food, sports equipment, computers or music; the big stores of El Corte Inglés had a

volume of sales of 10.197,94 million euros in 2004, whereas the specialized chain of

the Company, Sfera Joven, S.A. sold 40 million euros in 2004. The second company

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of the chart, as the main Spanish company specialized in the textile sector is the group

Inditex, which grew 23,3 percent during 2004, respecting the previous year with

5.670,4 million euros as total sales. The company is the most spread of the

classification in the Spanish market as well as abroad. The second Spanish chain

specialized on textiles is Cortefiel, the company is focused on expanding its activities

and the process includes the opening of 60 new shops during 2006.

During 2004, Cortefiel opened 140 stores of its different chains. For 2005, it was

relying on an expansive plan that was including the opening of 198 points of sale and

the reform of those most obsolete shops. During 2004 the company grew a 5,4 percent

respecting the previous year. In the third place of the classification is placed the chain

Mango, which expansion in 2004 and the foreseen one for 2005 are similar, focusing

on its international expansion. This way, in 2004 the group opened 87 stores, of which

just 16 were located in Spain. Mango had a growth of 6,4 percent in 2004. These are

the strongest companies of the Spanish textile industry but it is also necessary to

mention the Spanish subsidiary of the Swedish group H&M, in the fifth position

although nowadays its weight is relatively low in Spain, due to its recent entry in the

country, 2000, it is already in the fifth position, its volume of sales during 2004 was

213 million euros and experienced the biggest growth of the whole industry; 87,2

percent respecting the previous year. This important growth indicates that H&M aims

to increase its presence in our country up to the importance that the company already

has in the international markets, especially in Europe. This company started in 2004

thirteen new shops and during 2005, it opened other nine establishments.

Just the five first market leaders of the classification concentrate almost the half of the

market share of all the companies listed in the figure below. The companies of the

chart were the market leaders in 20048. The Inditex weight between the first five

companies is the 25,43 percent, following El Corte Inglés that has the biggest market

share with the 65 percent, this amount loses relevancy if we consider, as pointed

before, that the company does not limit its activities to the textile market. Cortefiel

would represent the 4,36 percent of these companies while Mango would have the

3,73 percent and H&M the remaining 4 percent. These numbers decrease if we take

8 Acotex, sector information 2005

- 54 -

into consideration the rest of the companies of the Sector. Although Inditex market

share seems small, it should be considered that the number of competitors is high;

According to the Annual survey of trade of the INE9, in the year 2004 the number of

companies specializing in distribution to for minor of textiles rose up to 77.308, of

which 57.025, the 73,8 percent, correspond to companies selling clothes and the

remaining 20.283, the 26,2 percent to textile manufacture companies.

Inside Inditex, Zara is the most spread format; the chain possesses the 54 per cent of

the total amount of stores owned by the Group in 2004. The market share of Zara is

not low if we compare it to the market share of the Group Inditex though it is

significantly bigger than the rest of the formats share. This is a consequence that

Zara's sales represent 67 percent of the sales of the Group. Textile sector is

characterized by the great presence of SMES. The most of these companies are family

enterprises, which they use to an average of 20 workers.

COMPANY Nr. OF STORES SALES 03 SALES 04 VARIATION

03/04 El Corte Inglés, S.A. 671 13.643,52 14.607,72 7,10Grupo Inditex* 1321 4.599,00 5.670,40 23,30Grupo Cortefiel* 617 921,25 971,27 5,40Mango MNG Holding, S.L.* 228 782,00 832,00 6,40H&M Moda, S.L. 40 113,76 213,00 87,20Prenatal, S.A. 100 142,72 140,00 -1,90Grupo Adolfo Domínguez* 290 122,64 126,45 3,10Sociedad Textil Lonia, S.A.* 60 86,00 115,00 33,70Bassi, S.A.* 163 94,94 95,00 3,10Pepe Jeans, S.L. 59 69,17 95,00 37,30Caramelo, S.A.* 20 69,12 92,10 33,20Depósitos Almacenes número uno, S.A. 76 47,06 68,23 45,00Julián Rus Cañibano, S.L. 110 59,41 61,34 3,20Sumbawa, S.L. 47 48,00 55,00 14,60Promod España, S.A. 52 48,00 53,30 11,00Franchising Calzedonia España, S.A. 239 39,78 45,00 13,10Groupe Zennier España, S.A. 66 40,84 39,38 -3,60Milla Med, S.A. 181 34,00 39,00 14,70Industria Franco Española de Moda, S.A. 64 32,15 36,13 12,40

Figure 9. Alimarket

9 INE – Instituto Nacional de Estadística, Commercial Survey, 2004

- 55 -

3.3.3.2. Demand Analysis There are two differentiated kind of factors determining the demand as a whole,

according to their nature, the uncontrollable and controllable factors; while the first

kind escape to the control of the company and use to be in the environment where the

company develops its activities, the second ones can be controlled by the company in

order to influence its demand, making possible the achievement of the firm’s

commercial aims.

On one hand the uncontrollable trends are difficult to predict and so are its

implications for the commercial retailer. On the other hand, controllable trends like

customers’ preferences deriving from their time and space convenience, apart of some

other classical variables as price or promotion. This convenience leads potential

customers to search for textile retailers with easy access, near geographically and

consequently reducing the time that it takes to go shopping. Some market

researchersF

10F have identified some significant trends in the Spanish consumers

affecting their behaviour as the influence in the social and demographic aspects or the

change in their habits as the rest of the society evolves. The most important

demographic factor, as it has been described previously, is the increase of the Spanish

population due to the immigration and also a longer life expectancy. The immigration

phenomenon is reflected in the incorporation of 3 million people to the Spanish

market. Additionally consumers are more exigent and demanding, with more

information and therefore more difficult to satisfy; they are sensitive to innovation,

new products with additional value and also less loyal to specific brands or

establishments than some years ago. The buyer looks for variety taking advantage of

its economic environment as well as the increase of competitors in the retailing

industry and due to the growth of the consumerism, customer’s behaviour is more

influenced by desires than by needs. Essentially, every consumer will choose buying

in the establishment offering the demanded services in the most efficient way.

As result of the factors described above we can see that the global demand,

understood as the amount of sales of a product during a time period in a specific

place. In this case the location is the whole textile sector in Spain which has been

changing during the years, at a higher or lower rate but generally with a positively

10 ACNielsen Research, 2003

- 56 -

variation, as a consequence of the growth experimented by the economic environment

affecting the market. This way the demand, in terms of the total amount of sales in the

Spanish market of textile products, during the last decade increased from 15.841,68

million euros in 1996, to 21.962,12 million euros in 2005.

0

5000

10000 15000

20000

25000

1996 1998 2000 2002 2004

EVOLUTION OF THE SALES - SPANISH TEXTILE SECTOR

Unit: million Euros Figure 10. INE - Instituto Nacional de Estadística. Once the global sector demand has been described we can focus on the particular

demand of The Inditex Group products. The specific demand has been growing at a

steady rate, not just because of the intensive opening of new stores worldwide, but

also because of the growth in the amount of sales of the group as a whole as well as

each of its chain.

As we can see in the figure below the most popular and profitable as well, chain of the

Group with the 66 percent of the total sales, it is Zara and its specific demand during

2005 meant 4.440,8 million of sales to The Group. This fact points that the demand of

the whole Inditex Group, and specially Zara which is also the elder and most spread

chain, experiences these growth rates as a consequence of the good acceptance of its

products by the market. We also have to emphasize that though generally the textile

sector has faced different economic situations, the Group has not been affected by

these decreases in its demand, as the volume of its sales during the last years has been

increasing without attending to economic cycles.

- 57 -

INDITEX CHAINS SALES EVOLUTION

010002000300040005000

2000 2001 2002 2003 2004 2005

Pull & Bear Massimo Bershka Stradivarius Zara Oysho Kiddy's Zara Home

Unit: million Euros Figure 11. Inditex

Concerning the life cycle of the product, we can conclude that each of the chains that

constitute the Group is in growth stage, at a higher or lower proportion. Considering

that the products which Inditex commercialize are clothes it turns out contradictory

that an article like this is in stage of growth after many years of life, but if we

orientate this perception, understanding the products as “fashion”, since it is the case

of this kind of goods, it is not strange that are located in this phase, as these products

are constantly renewed and its life cycle is especially short. The purpose of the Group

is to manufacture, distribute and finally sell new products in a short period of time,

with a small life cycle, in order that consumers continue buying as fashion trends

change. From this point of view, the textile sector is very dynamic, which means that

it is constantly changing its products, adapting them to its clients' desires. For this

reason it is considered that products are in a growth stage and not in their maturity, as

happens with other products with so many years of life.

3.3.4. SWOT ANALYSIS

By conducting this analysis we provide additional insights to the Five Forces pattern

exposed previously. As the structure of the Retailing Textile Industry is continuously

changing by new technologies, political situations or merely fashion trends, Porter

Analysis provides a limited vision due to its static nature (Haberberg and Rieple,

2001). Therefore the SWOT Analysis becomes a useful framework examining

additional information in order to complete the view of the Group’s position.

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The strategic analysis can be synthesized in the SWOT analysis. This one includes the

situations of the company and its environment. The SWOT matrix is an important tool

to analyze relevant factors of the company and its environment for the future

performance of the company and the development its competitive advantages. This

analysis consists of making concrete the evaluation of the strong and weak points of

the company -competition or aptitude to generate and support its competitive

advantages- in relation with the threats and external opportunities, looking for a

homogeneous adjustment among its internal capacities and its competitive external

position.

The strong and weak points into this category we can distinguish come assets related

to the Marketing of the company; like brand image, market share, distribution or

customers’ loyalty. It is important to underline that strong points do not mean

automatically a competitive advantage and that it is not necessary to correct all the

weak points. Both fortresses / weaknesses are internal and turn out to be important

since they can help to understand Inditex competitive position.

The threat is understood as the danger rose by an unfavourable trend of the

environment that could lead to the loss of market share of the company or to the

disappearance of the brand and or the company itself.

The opportunity is the set of positive circumstances for the company, of the retailing

sector, in which Inditex might perform successfully in order to take advantage of the

favourable situation. The group might increase its performance respecting certain

marketing actions to generate the major value for the consumer.

The components described above shape the SWOT analysis, across these different

aspects, to be able to have a broader view of the situation of the company respecting

the Spanish market. The situation of the Inditex Group is based on a series of

strengths, interacting simultaneously with some weaknesses. These two aspects are

going to be useful to determine the present situation of the company. Related to the

external environment of the company, I should analyse both the opportunities offered

by the sector, as well as the threats that could arise. The main purpose of the analysis

is to promote the strengths of the Company and by using these strengths to take

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advantage of the opportunities, to counterbalance threats and to correct weaknesses.

As threats and opportunities are located outside the company, this implies to analyze

the main competitors and their competitive position, the market trends, the impact of

globalization and international competitors entering the Spanish market, imports and

exports as well as some other relevant macroeconomic factors like social, legal,

technological or political environment. On the other hand, strengths and weaknesses

are placed inside the internal structure of the company and there are some factors as

quality, quantity of the resources of the company or efficiency and innovation of the

company’s procedures

External Analysis - THREATS

The threats for a textile company like Inditex are centred mostly on the high level of

competition existing in this sector, as we have seen previously. In which, specialized

competitors arise constantly in any of the product lines that Inditex covers, or expands

their variety of products as the case of El Corte Inglés with its new chain of clothes

for young customers, Sfera. Companies that compete with Inditex in other segments

can create a new line of business focused on new market niches taking advantage of

the experience and position that they already have inside the market. Not only these

chains but also hypermarkets, like the case of Carrefour, and the increasing level of

sales obtained with its white labels, as Tex, which are growing in popularity.

Likewise, due to a more global environment and to the strong growth of

industrialization of emerging countries, the competition of those countries like China

characterized by its low salaries and consequently cheap prices, every day is bigger.

In addition Inditex is not an exception to the imitation of its products. Other threat for

the group, since it quotes in Stock exchange, is exposed to losing value due to the

different political situations regarding its competitors.

Many of the International warlike conflicts, can concern the company directly,

especially in the zone of Middle East, where Inditex has stores. Problems like the

situation in Iraq or Afghanistan, leads to an economic instability worldwide, which

can affect negatively in the International markets where the company is present. In

countries where there exist political or cultural differences with Spain or the European

countries, sales can diminish significantly whether Spain is considered an allied

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country or not for them. Facing these situations, the company is defenceless, since

these situations do not depend on any kind of company’s reaction.

The existence of possible negative attitudes from the consumers towards the stores

belonging to multinational companies, constitute another additional threat. As the

group is a multinational company with international presence, is not identified with

any particular country and this characteristic plays in favour of local companies

respecting their customers’ loyalty. Nowadays the increasing social conscience of the

customers can derive into a sales reduction, as people in more concern and

multinationals can be easily associated with politics of exploitation of its workforce

and suppliers. This one is an inherent risk in the global strategy of the companies.

Although the creation of a local brand is an alternative to avoid this problem, other

difficulties would arise, like the lack of recognition of the brand internationally,

economies would not take advantage of the large scale production, etc

Since the concentration of the suppliers in the markets is growing, and the case of the

suppliers of raw material it is not an exception, though it always exist small

producers, they have little importance in the sector. The increase of the suppliers

bargaining power constitutes a problem. As a consequence of this concentration, the

number of companies which are able to supply of raw materials –special fabrics that

Inditex do not manufacture- to the different chains integrating the Inditex Group, are a

few and with a great size. The bargaining power of the company is reduced regarding

its power before the concentration. In this situation the only thing that Inditex can do

is try to increase its manufacture volume, and therefore its sales, up to a level so big

that suppliers would consider the group as an important client and therefore do not

acquire this power that would be very dangerous for the Inditex.

External Analysis -OPPORTUNITIES

The opportunities for Inditex are centred on taking the most advantage of all the

markets in which the group can sell its products. On the one hand, the company can

extend business on the markets where is already present, this is the current situation in

the European Union where Inditex chains are successfully performing. The new

incorporation of the East European countries, increasing the free trade zone of the

European Union, means an even better chance to consolidate its presence. The

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company has increased its presence in the North of America, opening up to 18 stores

in United States, and 14 in Canada but the market is big enough to increase the

number of stores of Inditex chains. Other attractive markets are Russia, where the

Inditex group has 14 stores, and finally the great Chinese market, where the Group

will open its first store during 2007.

The development of new technologies opens new business possibilities for companies.

Electronic commerce constitute a new source of opportunity, although Inditex at the

moment is not interested in this kind of commerce as it does not fit with its way of

conceiving retailing business and with its concept of personal client service. The

improvement in the field of communications and infrastructures optimizes the

efficiency in logistics, fulfilling the delivery times of the raw materials from suppliers

as well as the delivery of the products of the company to the stores of the company.

New technology regarding computer matters like for example, the EDI system,

increases the flexibility of the different processes deriving from the flow of

information inside the company which is constantly updated regarding the sales of the

different chains. This information is a high value asset in order to avoid stock failures.

The changes in consumption behaviour are a good chance to extend the scope of its

products, men nowadays is more fashion concerned than some years ago, though

women continues being the principal target costumer, the segment of the male clothes

and accessories gains importance. Finally, the close of many familiar or other small

business due to the fact that they cannot compete with the price and quality offered by

multinationals like Benetton, H&M or Inditex, constitutes an additional advantage for

these multinationals.

Internal Analysis - STRENGTHS

The strengths of the group are originated from many advantages, some of them have

been already mentioned, and these advantages have made possible the development of

the company. On the one hand, the good relation quality/price of the different

products is one of the key factors attracting customers as they can obtain products

with average-high quality with lower prices than the ones of its competitors. If the

Inditex Group is able to offer these prices is due to the cost reduction that supposes

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the big magnitude of the its products’ production as well as low manufacture costs, as

consequence of the location of the factories in countries which labour force is cheap

and economies of scale. All of these factors increase its bargaining power and it is

translated in costs reduction.

Though there are some other influence factors concerning the cost reduction, as the

saving in the stocks storage that does not produce benefits, this savings are possible

due to the dynamical vertical integration, which together with the use of the new

technologies, allows renovating the products of the chains constantly, across the

world. As a result, the group saves in storage costs and offers a wide variety and

possibilities to the clients with look upon fashion trends. For this purpose, the

company counts on employees that search for those tendencies in the streets,

designers and some other people targeting its competitors’ style. This business model

let us see that the different chains of the group do not try to sell something but to

guess what clients want. Besides, the different formats of the company and specially

Zara, enjoys abroad of a high prestige, in many cases above the one that the company

has in Spain. Its strong brand image, it is a product of years of work and of a location

strategy of its stores which are placed in the most important streets of the popular

cities in the fashion industry, like the Champs Elysees in Paris or the 5th Avenue in

New York.

The Group charges its clients before paying to its suppliers. This method allows

Inditex to make its investments without need of to the banks assistance. The system of

remuneration of its staff, looks for its workers’ implication and its self motivation, this

is due to the fact that their salaries is made of both fixed and variable amounts so they

are given the possibility of increasing it, besides the company rewards them with

Inditex stocks

Internal Analysis - WEAKNESSES

The company has also weaknesses; one of the most remarkable is the excessive power

concentration in the person of Amancio Ortega. It is rather unusual in a business of

such an international importance as Inditex that a person possesses 60 percent of the

shares. If something happens to Mr. Ortega, this could lead to the division of the

holding, threatening many working places. It is a difficult work to find managers who

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fulfil the requirements of the company and who share the philosophy of the Group.

When Mr. José María Castellano Ríos, former chief executive, deputy chairman of the

Group and public face of Inditex, resigned after 30 years in September of 2005, the

shares of Inditex wobbled11F. The board appointed Pablo Isla to succeed him as chief

executive. Mr Isla, had large experience as a former co-chairman of Altadis, a

French/Spanish tobacco company but he is unfamiliar with the fashion industry, so his

appointment followed a long search for someone able to manage a fashion company

like Inditex that will become more complex as it grows.

Normally the company tends to the internal promotion of their employees, although

this was an extreme case. This fact favours the motivation of their personnel due to

the possibility that they can be promoted inside the company. Another difficulty that

threatens the Group is the dominant position of El Corte Inglés in the Spanish market.

It is possible that taking in consideration alternative uses as the electronic commerce

would increase the Group’s benefits, but as mentioned before, this alternative goes

against Inditex policies respecting personal treatment of the client. Similarly, they

might use in a more effective way the advertising methods, nevertheless the Group’s

policies of using as the only advertising the design of its shop windows placed in the

strategic centres of the main cities, seems to be really effective.

Finally to point that Inditex, as it becomes bigger, finds more difficulties to keep a

tight control on all the productive cycle phases in its vertical integration model. As a

consequence the company uses in some cases the subcontracting, and franchisees -

only with companies which are capable of supporting the market image of the

company, never with individuals- in those countries and situations where the cost

justifies it. By having based its manufacture and distribution processes on the system

“just in time”, any random small mistake can lead to a break in the stock of some of

its shops. This is not a very probable situation, since one of the differential advantages

of the Group is this system in order to avoid storage, but it is always necessary to have

a contingency plan to be able to face more efficiently, any failure or mistake of this

kind. The Group needs abundant work force. This weakness in inherent to the 11 Newspaper El Mundo – Economy 25/09/2005 The Financial Times – 06/06/2006

- 64 -

business, since the company relies on advanced equipment to be able to adapt its

collections to the market requirements in a short period of time, the use of this

equipment needs a high amount of workers. Small problems can arise also in the

distribution net as Inditex production logistics are too concentrated in the Spanish

head office.

3.4 WHY DOES INDITEX GO ABROAD?

Regarding the motivations of the group according to the previously described

classifications (Czikota, Ronkainen and Moffet, 1996; Albaum et al., 1989) the

motives leading Inditex into the international arena are both offensive and defensive.

The most evident motivation for Inditex is to increase its profits (Hollensen, 2001);

the company wants to expand its presence in order to increase its returns due its

commercial nature, nevertheless the company is also concern about increase its

presence on the markets where is already developing its activities. New markets

constitute new opportunities for Inditex as its innovative retailing conception

constitutes a strong competitive advantage in terms of competition and profits. The

firm tries to enter markets where competitors have already presence and others where

the firm can be the first mover (Sternquist, 1998). For the company, scale economies

are also a strong motivation as the Group can save costs buying larger scale of raw

materials like fabrics or related goods, which can be used by the multiple chains of the

firm.

Although the Spanish market constitutes nowadays the most important for Inditex,

accounting the 43 percent of its total sales, the company already has a high rate of

market share, since local market is becoming narrow for the company and there are

some domestic restrictive regulations regarding the market share of companies

(Dawson, 1994; Sternquist, 1998). Some regions of Spain have their own policies

concerning these competences, like Canary Islands or Catalonia, in the last one there

is a law in force from 2000, Ley de Equipamientos ComercialesF

12F establishing that

commercial group can not hold more than 25 percent of the total sales location of

Catalonia, and thus limiting further growth of leading companies. Inditex Group, with

its different chains, already owned 142 stores meaning the 17,33 percent of the total

12 Law 17/2000, December 29 , Ley de Equipamientos Comerciales

- 65 -

Catalonian commercial surface in January 2005F

13F. Similarly in Japan there is law

known as Daitenho regulating the large-scale retailing store, occupying more than

1000 square meters, in order to protect small retailers from large competitors. As a

consequence of these kinds of regulations additional growth is more viable in foreign

markets where Inditex position is as consolidated as in the Spanish market. Opposite

to local restrictions we have foreign motivations as the increasing elimination of

various entry barriers (Dawson, 1994) this situation also generates new opportunities

for the company. A big example is the progressive creation of a single market in the

European Union which benefits directly the expansion of Inditex reducing the use of

joint ventures in favour of more direct investments.

Between these drivers we have also mentioned the life cycle of the products (Vernon,

1966) and its seasonal characteristics (Hollensen, 2001). In retailing clothing industry,

where Inditex is included, once the season is over, companies can take advantage of

their stocks in geographical zones where the season is starting (Albaum, Strandskov

and Duerr, 1998). Although the company has specific products changing from one

season to another, this factor is not such a strong incentive as for the rest of its

competitors, due to its just in time production strategy and concretely to its stock zero

strategy.

The proximity to customers (Weinstein, 1977, Dawson, 1994) is a key determinant for

the expansion of the company. Not in the sense of following customers to foreign

markets as Inditex sells its products directly to the final customer, more numerous

than other companies which sell its goods to other companies, the Group will pay

more attention to other characteristics of the markets, like its size or its potential

growth looking for new clients. But Inditex provides a service together with its

products thus closeness to customers is essential to create and enforce the brand

image. The Group is geographically dependent, as a fashion manufacturing and

retailing company, it needs to have physical presence in foreign markets to be able to

attend its clients. It is also quite important for the company to consolidate its presence

in those markets in order to create a brand image to be identified by customers.

13 El País Newspaper, 11/01/2005

- 66 -

Being the first-mover (Sternquist, 1998) also provides location advantages especially

in the retailing sector where the first company entering a new market has more

possibilities of finding attractive locations available, since every city has a limited

selection of appropriate places. The location of its stores have a fundamental function

for Inditex by means of brand image and marketing, in some cases the Group enters

new markets or chooses commercial partners just when the desired locations are

available, like the selection of the Japanese local partner.

Once the company enters new markets, Inditex looks locations accessible for

domestic customers, as it happens with the opening in 2003 of a Zara store in

Roppongi, a district of Tokyo where the most of the embassies are located. Many

occidental employees works in that location and they know that they can find the

same products available in their domestic countries in the store, as well as avoiding

other problems arising from differences with the Japanese size classification. An

additional motivation is the diversification of locations as a tool for risk

diversification (Rugman, 1981, 1982). Inditex does not rely on the particular

performance of a market but instead diversify locations compensating unfavorable

situations with more profitable ones. The company grows in foreign markets faster

than its local competitors, in this sense its behaviour is proactive but with reference to

global rivals this behaviour turns into a reactive position.

Between the motivations of the company concerning Dunning’s classification (1993)

which distinguishes between four different groups of companies regarding their

motivations; market seeking, resource seeking, efficiency seeking and strategic asset

seeking. Inditex can be placed in the first and fourth categories; market seeking, as the

group can barely keep on growing in the Spanish saturated market, and efficiency

seeking, since the firm diversifies its activities in order to increase its efficiency,

reduce associated risks and take advantage of scope and scale economies.

Diversifying strategies on its different foreign activities provide Inditex with high

flexibility to be able to face environmental changes, depending on the market specific

risk.

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• Inditex regarding internationalization theories

Concerning the Traditional Internationalization Approach, Inditex possess

characteristics constituting specific advantages which compensate the cost of

performing its activities in the international markets or the so called cost of

foreignness (Hymer, 1976), the firm has advantages coming form its particular model

of business, logistics, communication flow inside the company, managerial skills or

economies of scale which makes its production process more flexible respecting its

competitors. This framework is a useful tool focusing on the advantages of the

companies.

Additionally, in the Transaction Costs Approach, Coase makes two basic premises;

the location as a way of saving costs and the internalization evolution of firms. The

first is not fully applicable to this particular case since the Inditex group, opposite to

its competitors, does not locate the whole of its facilities where manufacturing costs

are lower. Some part of the manufacturing process is allocated in developing countries

in order to save costs, as Coase predicts, but an important part of its production

facilities is placed in Spain in order to coordinate manufacturing processes and

logistics reducing the time gaps. So in this particular case, the company sacrifices -or

invests- part of the advantages derived from lower costs in favor of gaining flexibility

on its distribution chain, which constitutes a major asset.

The pattern followed by Inditex fits perfectly the second premise of Coase as the

company internalized its activities, and thus obtained a high degree of vertical

integration which constitutes its core business. By implementing this vertical

integration the company can perform more efficiently than its competitors as it

controls a higher part of its activities without depending on external firms. The Group

rely some part of its process to several companies which have costs advantages as all

the sewing processes of its different chains. As a result, costs inside the company are

lower than those of the market. Under these conditions, the company is not

completely integrated on the Transaction Cost Approach although internalization fully

describes the pattern developed by the firm.

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As the company uses mainly the FDI to extend its activities, specially its own

subsidiaries and is highly vertically integrated, it saves transaction costs and

minimizes dissemination risks. The Eclectic theory constitutes a practical framework

explaining its actions regarding internationalization, as a combination of ownership,

location and internalization. Inditex wants to keep the control over its activity and

therefore it gives a special importance to the ownership of its advantages,

consequently Inditex prefers internalizing the most of its processes instead of

contracting them with external agents in order to maintain the ownership over its

advantages on the international arena. Still some part of these processes is

subcontracted with many external agents minimizing their individual power. Finally

the company combines ownership and internalization of its advantages with specific

foreign locations which are determined by factors like physic distance,

communication and transportation cost. Although the costs of inputs is important,

previous factors have a higher influence in Inditex as we have mentioned before,

concerning the first premise of Coase exposed in the Transaction Costs Approach.

Consequently this approach could be useful explaining a part of the

internationalization of the company but not the whole process as the firm also uses

alternative entry modes that Dunning leaves aside; additional strategies like

franchising or FDI alternatives such as joint ventures and does not go through

acquisitions.

Concerning the Life Cycle analysis developed by Vernon, on his framework, he

stresses out the technological innovation role, scale economies and uncertainty in

business patterns from one country to another. Retailing products innovation is

limited in technological means but due to the fast changes in trends, by updating its

collections companies are able to enlarge the life stages continues innovating their

offer .Retailing products would be in an advance maturity stage close to decline as

rivals compete mainly in prices. Once the market reaches this stage, the firm move to

new markets but this not mean that Inditex leaves the Spanish market which still

constitute its biggest country market, but intensify its foreign activities. Rivalry also

affects this move as companies match the strategies of international competitors

(Graham, 1978; Krugman, 1989). The approach developed by Vernon provides a

good and dynamic explanation of the reasons leading to international markets, but do

not consider the next steps as choose of market or entry modes.

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An additional dynamic model is the one provided by researchers of the Uppsala

School (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977) with

their internationalization theory based on incremental knowledge and the increasing

involvement of the company, regarding commitment to foreign markets. Inditex could

fit into the sequential establishment chain in the for stages but with some variations as

exportation has never constitute its expansion alternative as consumers attention

constitute an important part of its sales process and the company does not want to

transfer this aspect to independent companies, but basically as the company

knowledge increases the commitment to new markets raises as well. This theory

explains the evolution of the activities of Inditex regarding both commitment and

knowledge limiting its scope to the evolution of the company.

Finally, with the Network Approach researchers try to connect the foreign increasing

evolution of the company by means of external relationships (Johanson and Mattson,

1988; Hollensen, 2001). Basically companies depend on different networks

established with their customers, suppliers and also on its competitors’ nets. As

Inditex is highly integrated vertically, the company reduces to some extent its

dependency on some networks, as most of its manufacturing processes are

internalized as well as logistics or design. Its customers are small in size and volume

of buys, their loyalty to the company is low and therefore they share its buying

networks with the rivals of Inditex and consequently this network is not so strong. The

Suppliers networks of the company are numerous in order to be less dependent on

external companies, and the coordination of the networks that the company is able to

control works with a high level of flexibility constituting a source of strength for the

firm. But in the markets there are many networks that companies can not control as

the networks of their competitors, although companies can react to their actions

improving their position.

This approach distinguishes between four different market positions as a combination

of the degree of internationalization of both market and company. As a result of this

combination we can include Inditex in the position, international among others as a

result of high market and high company internationalization, as Spanish retailing

competitors are expanding internationally at a fast rate, the company must preserve its

current position, taking advantage of its access to new international networks.

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4. INDITEX INTERNATIONALIZATION PROCESS

4.1. SPANISH MARKET TOWARDS INTERNATIONALIZATION

During the nineties, economic and social changes in the International situation have

derived in new environments for the companies nowadays. The most important

changes in the textile and confection industry, particularly in the clothing industry - as

the growth of the sector has been mostly in this kind of goods - are the following;

- Commercial Trade Liberalization, the most influential trigger to those

changes arises from the increasing liberalization of the textile commerce, the

successive agreements of the GATT, now WTO, lead to the progressive opening of

the international markets and consequently, the growth of the trade has been more

intensive than the international manufacturing volume. The most representative

sample of this is the Marrakesh agreements, signed in 1994, establishing the

progressive elimination of the quotas regulating the textile and clothing trade since the

seventies until the total liberalization of commercial trade in 2005, just restricted to

few countries. This process has been also promoted by the European Union which has

helped developing countries in order to improve the access to the European market of

their textile products, by establishing the lowest duties of the world and setting the

Generalized System of Preferences (GSP) to some countries.

- Globalization, understood as a growing interaction between the different

economies of the world. This phenomenon is not new in the clothing industry,

because since the sixties there has been a wide range of commercial connections

among different countries and zones. Nevertheless, this phenomenon has speed up

during the nineties due to several factors, like the strong growth of the sector in the

developing countries, the entry of China as new economic power; the entry in the

world trade of the ex-communist countries like western European countries, the

creation of free trade zones, the progressive improvement of the communications and

the decrease of transport costs, etc.

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- The recent evolution of developing countries is evident overcoming the weight

of the developed countries during the nineties becoming the first world power of the

Industry. However the geographical analysis of the evolution shows that the Asiatic

countries prevail over the rest, especially China.

- The regional specialization, due to global exchanges are influenced by zones,

as this process has been promoted by the politics of the developed countries which

reallocate some phases of their productive process, mainly the ones that imply major

contribution of labor force, to other countries where the same processes imply lower

costs. Most of this phenomenon is given in the confection of clothes. This way, the

European Union exports fabrics to East European countries or Asian countries where

the products are made, and once are finished, it returns to the European Union.

The development policies based on the protection of the home market limited the

entrance of the Spanish textile companies into foreign markets. Consequently the

exportations until the eighties were essentially circumstantial type to compensate the

periods with low national growth with an increase of the exterior activity.

On the other hand, the in force tax system was protecting the home market and meant

an important support to the exportation. This situation finished in 1986 with the

Spanish entry in the European Economic Community (EEC), which ended with the

existing tax protection placing it between the lowest levels of taxes worldwide. In

three years the level of the duties diminished, affecting both the community imports

and external community imports.

As a result of the difference between the Spanish duties and the EEC duties, Spanish

market increase its efforts materialized in a strong growth of the imports, coming

from Europe as well as other countries. The evidence of the union is that within the

first years there was an important growth of the exchanges between Spain and the

EEC, this factor together with the disappearance of the existing protection and the

opening of a new market with a low level of foreign exchanges constituted an

attractive chance for foreign companies. At this time the presence of products coming

from non European countries in the Spanish market has been growing at a higher rate

that the Europeans imports. The pressure of these imports influence national

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companies when setting its products’ prices in order to compete with the foreign

products. This impact affects the whole textile industry, as this industry is composed

by interrelated sectors, like textile manufacturing or distribution.

The EU has been the strongest incentive to the aperture of the Spanish market,

offering many opportunities like inside-Europe acquisitions or agreements as well as

exposing Spanish firms to foreign competition. These factors together with the

internal circumstances of the economy as well as the technological and managerial

progress of the companies made attainable foreign opportunities for Spanish

companies.

4.2. THE INTERNATIONALIZATION OF THE SPANISH COMPANIES

As a logic consequence of the situation, Spanish companies have tried to face the

importation flow by redirecting their efforts to major foreign markets. This trend it is

easy to see if we have a look to the evolution of the Spanish exports of the textile

sector which have almost triplicate its value since the 1994 increasing its volume at an

average annual growth rate of 5 percentF

14

This evolution is a result of the development of the competitive level of the

companies in terms of the design and quality of its products as well as its services.

Nevertheless, the concept of internationalization is not limited to the exports but also

with the relations between companies and foreign environments. During the last

decades, the Spanish Direct Investment rose significantly, especially in South

America where Spain became the second investor after United States. As a result of

this process during the nineties many Spanish companies established its

manufacturing facilities in other countries in order to achieve competitive advantages

saving costs or gaining access to markets. In other cases, this reallocation arises form

cooperation agreements between Spanish and foreign companies to develop their

activities or distribute their products abroad, situations which place Spanish

companies in the international arena. Inditex constitutes one of the most popular cases

14 Instituto Nacional de Estadística – Nacional Exports and Imports (Agencia Tributaria. Departamento de Aduanas e Impuestos Especiales.)

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since the company obtains in the exterior more than the half of its total sales, 56,9

percent in 2005.

The internationalization is also related with supplies. Hereby many companies of the

sector use imported goods in their industrial processes or to extend their own offer

with products that would not be profitable to manufacture in Spain, as it happens with

Spanish companies subcontracting the manufacture of clothes mainly in Portugal,

Morocco, Tunis or more recently in the Eastern European countries like Romania15F.

This process has been carried on especially by companies with their own distribution

networks which represent an important part of commercial flows.

4.3. INDITEX INTERNATIONAL EVOLUTION

In spite of the fact that Inditex is not constituted until 1985, its creator Mr. Amancio

Ortega Gaona, begins working in the textile sector during the Fifties acquiring a

valuable professional experience, from the contact to the trends of the growing

confection until the direct contact with fabric manufacturers and distribution channels.

He learns to know costumers needs and attempts to take the chance of the fast

satisfaction of those needs. Previously detailed experience would become later some

of Inditex success keys. During the Sixties he sets his own activity with his family

support, designing, manufacturing and distributing their own products without

intermediaries with low prices. In 1971, Mr. Ortega founds Confecciones Goa,

together with his brother and sisters; this company manufactures and distributes

clothing for women to wholesalers, retailers, purchasing plants and big chains

emerging in the Spanish market. At this stage Goa includes design and manufacture

delegating distribution. Four years later, 1975, when Goa reaches a considerable size,

Mr. Ortega opens his first Zara shop, the 15th of May in La Coruña, an important city

in the northwest of Spain.

During Zara first years of life, between 1975 and 1980, the company develops an

initial expansion within the local market. Zara develops vertical integration and

gradually covers the emerging demand of quality and design of the sector, its fills the

15 Textile Confection Report, 2003 - Ministerio de Industria, Turismo y Comercio

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demand of design and quality with reasonable prices. Companies like C&A in

Germany or GAP in United States attend to the same sector of the market. As a

consequence, Zara includes distribution to its manufacturing cycle being a pioneer in

the fashion sector and reducing its costs, increasing the margin and decreasing the

final price. After opening shops across the Galician region, its stores are reaching

increasingly remote locations of the Spanish geography, firstly in the north-western

part of the Iberian Peninsula and then spreading its chain of shops in the shape of a

reversed fan. During 1985, Inditex, S.A. is constituted as the nexus of the group,

starting a new stage and one year later its main business, Zara, is present in the main

Spanish cities such as Madrid, Bilbao, Valencia or Barcelona among others. Great

part of the chain success stems from the election of the suitable location, as the

company limits its advertising investments saving costs along with other reasons. At

this stage Inditex gives more importance to its proper design and turns part of the

production aside to particular workshops, created with independence of the Group,

increasing its manufacturing capabilities.

4.3.1. ZARA GOES ABROAD

The national market was getting small for the company and in 1988, Zara gives its

first steps abroad carefully and the first international shop is opened in Porto,

Portugal’s second largest city. The Group’s Galician roots and its similarities with the

north part of Portugal, where Inditex contracts already some of its production phases,

are key factors for the country election. In 1989, Zara also establishes a shop in New

York due to its large popularity as a representation of the global economy. New York

constitutes a new market with a huge cultural distance, and strong rivalry and Inditex

takes this experience as a learning process to increase its presence. The main

characteristic of the Company experience in the United States Market is the prudence,

even nowadays. During 1990, Zara opens a new shop in Paris; both cities – New York

and Paris - represent a strategic attempt to set up Zara’s presence in two important

markets as well as an effort regarding the image of the company, due to the

importance of these cities as fashion reference spots. Paris constitutes the entrance to

the powerful French market, which gives testimony of the increasing success of the

company in Europe but the next destination for the company is not located in Europe

but in South America. The Group establishes a new shop in Mexico in 1992 betting

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for this area with an important determinant like the common language and it increases

this commitment even more with new openings in Argentina and Venezuela in 1998;

Uruguay, Brazil and Chile during 1999; Puerto Rico in 2001; El Salvador and

Dominican Republic in 2002, Panama two years later and finally Costa Rica in 2005.

Through the nineties, Zara increases its international presence in Europe opening in

Greece 1993, one year later it founds new shops in Sweden and Belgium, It settles

shops in countries like Malta, 1995; Cyprus, 1996; Norway, 1997 or Turkey, 1998,

but without neglecting the national market. During 1998, the Company entered

another big marketplace, the British one where the company succeeds, and within the

next year Zara enters reunified Germany, Netherlands and Poland, in 2000, Andorra,

Austria and Denmark; throughout 2001, Ireland, Iceland, the Czech Republic,

Luxembourg and finally Italy. The list of European locations where Zara is present

increases with countries like Finland or Switzerland by the end of 2002 and Monaco

in 2005. The Group also spreads its activity through Eastern Europe with new

openings in Slovenia, Slovakia, Russia during 2003, one year later it enters Estonia,

Latvia, Romania, Hungary and Lithuania and Serbia in 2006.

The expansion is not carried out only in the countries with Western culture as Inditex

enters markets like Israel during 1997 or Japan one year later, and its presence in Near

East countries is intensified by means of new facilities in Lebanon, Kuwait and the

United Arab Emirates in 1998. The Company in addition opens new shops during

next years in Saudi Arabia and Bahrain in 1999, one year later in Qatar, Jordan in

2001, Morocco in 2004 and more recently in Tunis, during 2006. Asia is another

destination for the group which starts its activities in countries such Singapore in

2002, Malaysia two years later 2003, Hong Kong in 2004, Indonesia, Thailand and the

Philippines both in 2005. Finally Continental China closes the list of Asiatic countries

during this year.

During this evolution, Inditex advances in two directions; On the one hand the

company increases its presence in the Spanish market and on the other hand it enters

on new foreign markets opening stores in up to 60 countries at present. The

international expansion carried out by Inditex within the nineties is impressive but the

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evolution of the company’s growth in the domestic market was as remarkable as

abroad.

Leaving aside the geographical context, within the last decade the textile sector also

experiences changes, the demand evolves and the old and basic differentiation

between women – men – children clothing sectors remains old fashioned. Young

people and their different cultural guidelines, changing all the time, represent a new

pattern of segmentation to follow. The industry becomes more and more dynamic,

with new brands emerging to fulfil those needs and facing these changes, Inditex

follows a defensive strategy as well as an offensive one. In the defensive aspect, the

company keeps on offering the same attributes as quality or price but it increases its

range of products. At this point the firm has reached a dimension big enough to permit

Inditex getting into new formats as the main aspect of its offensive strategy. The

company starts its brand diversification taking the chance to satisfy this new demand

sector. As a consequence of this diversification plans, there are incorporations of new

chains to the Group.

4.4. HOW COMPANIES ENTER INTO FOREIGN MARKETS?

There are extensive literature explaining the different modes or strategies that

companies chose to enter foreign markets. At the time to go abroad companies follow

some steps in order to choose the optimal way according with its activity. Some

authors have identified two different modes of market selection, the systematic and

non-systematic approach (Andersen and Buvik, 2002); in the systematic approach the

decision maker firstly define the decision, the choice criteria -country-specific,

market-specific- in order to weight these criteria to generate further alternatives which

will be rated in order to find the optimal decision. The non-systematic approach does

not follow the same pattern as companies decide the most suitable mode attending to

circumstances as opportunities arising form the market, incremental international

experience of the company which grows at the same time as psychic distance

(Johanson and Valhne, 1977).

Firms which decide to enter new markets can either export their goods to foreign

countries from their own domestic production facilities; they can yield the company’s

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advantages to another foreign company in exchange for some economic compensation

by creating contractual international agreements like licensing, franchising,

distribution contracts, etc..., and finally the company have the possibility of obtaining

benefit from its competitive advantages directly in the new markets when several

factors, as location advantages, international trade barriers, distribution costs etc,

make possible this foreign exploitation, moving its facilities to other countries and

establishing wholly owned subsidiaries, Foreign Direct Investment -FDI-, or

collaborating with another local corporations, Joint Ventures. Some authors

differentiate between equity entry modes, like owned subsidiaries or joint ventures,

and non equity entry modes, (Harzing, 2004) as exporting or contractual entry modes.

Root (1994) distinguishes between export entry modes, contractual entry modes and

finally foreign direct investment entry modes.

Exporting. Companies can export directly or indirectly depending on their

involvement with foreign clients. If they use intermediaries, then there are

exporting indirectly but when the company interacts with its customers then

they are directly exporting. This entry mode does not imply any production

process or ownership in the foreign country (Czinkota et al, 1996).

Contractual entry modes include a broad variety of strategies although just

licensing and franchising are mentioned in this case. By licensing, one firm,

the licensor, arranges with other, the licensee, the use of its intellectual

property in exchange of a payment or economic compensation and for a

limited period of time, the licensor does not yield the ownership over its

intellectual property (Luostarinen and Welch, 1990). Licensee invests in

facilities, marketing and distribution and takes the risks and benefits arising

from the activity. The main difference between licensing and franchising is the

relation with the parent company as franchisor gives franchisee the right to use

the name of the company and its logo, marketing, organization and

management, normally also training and support. Brand image is essential as

makes franchises a visible representation of the company. There is an

important feature characterizing the franchising strategy, the degree of

standardization is considerable and of course bigger than in licensing.

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Foreign Direct Investment, this kind of investment varies depending on the

degree of ownership of the company; we can distinguish among joint ventures,

and wholly owned subsidiaries. A joint venture involves the share of equity,

risks and managerial expertise to achieve a common objective. Normally

companies look for a foreign partner due to government regulations, needs of

skills or need of assets. Sometimes Joint ventures are the only way of entering

a foreign market (Czinkota et al, 1996). By establishing a wholly owned

subsidiary, companies are able to enter a new market with the entire ownership

over its activities, there are two different ways; by acquiring an existing

company or by making a Greenfield investment. A firm can acquire an

existing company in the target market, transferring the local firms’ assets to

the market entrant or it can make a Greenfield investment which consists on

the establishment of a new wholly owned subsidiary in the foreign country,

this alternative is in turn more complex as it requires negotiations and time.

There is a direct relation between the degree of control chased by the company and

the amount of resources committed to the market and together with these factors, the

risk associated to both of them.

To move towards more developed internationalization stages implies the increase of

knowledge and experiences of the company about the foreign market, and through the

process (Root, 1994; Alonso y Donoso, 1994). This process is accumulative in the

sense that companies evolve by gaining experiences that reduce the uncertainty and so

the risk. To some extent this knowledge can be transferred by the company between

different countries but another is market specific.

4.5. FACTORS INFLUENCING ENTRY MODE SELECTION

Entry mode to foreign markets is a process leading the company to expand its

presence in terms of products, procedures, management and human resources in new

countries. Once these companies decide to enter foreign markets they have to

determine the most suitable mode for them as this decision may have major

consequences on the performance of the company (Root, 1987; Davidson, 1982;

Killing, 1982). There are many classifications between the modes that companies

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choose to enter new markets, as entry modes differ considerably from each other in

terms of advantages for the companies as well as cost incurred by firms. One of the

first decisions that firms must take when choosing a strategy to follow is related with

the degree of ownership and control (Erramilli, 1991) that the company is willing to

have in the new venture, and consequently it must decide between equity, like wholly

or partially owned subsidiary, and non-equity modes, like licensing or exporting.

Years of investigation in this field bring us many relevant identified factors that firms

should take into account when deciding which kind of entry mode is more suitable. In

many cases those influencing factors are a source of conflict inside the company for

its choice of entry mode. The decision process of the company to determine the

appropriate way of entrance is a result of the nature of its products, its flexibility,

knowledge, speed or resources to commit to new markets as well as other things like

control or risk perception. But also external factors like environmental, country

intrinsic risk, cultural distance; government and some other are attributes determine

this decision. Among the variables influencing the election of the modes of entry, we

can find three basic factors interacting with each other, and recurrently appearing in

the existing literature. These three factors determine the attitude of the companies

towards entry modes; commitment, control and risk.

Resource commitment is the allocation of certain specific assets to the activity; these

assets cannot be easily reallocated to alternative activities without incurring in

additional costs. The different entry modes imply diverse degree of resources

commitment (Vernon, 1966). All international operations involve commitment of

resources, tangible and intangible, to the new markets. This level of commitment

differs from an entry strategy to another, Licensing is the mode which requires less

level of commitment, since licensees face the costs arising from the opening and

additional activities and so the licensor resources commitment is limited to the

training processes and the franchisee control activities. The degree of commitment of

the Joint Venture stands between the licensing and the wholly owned subsidiary

depending on the agreement between the partners and the distribution of the

ownership. Wholly owned subsidiaries require a high level of resources committed to

the market as the company incurs in all the costs arising from the foreign activities.

Once the company entries the market, resource commitment constitutes an exit barrier

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limiting its strategic movements, as costs incurred entering the market cannot be

recovered. But, as we will see later, we cannot consider resources commitment

without talking about the size of the company.

Different entry modes entail diverse degrees of control over foreign activities (Caves,

1982; Davidson, 1982; Root, 1987). Control meaning the capability of the company to

take decisions related with the company and its international performance. The

highest level of control is obtained by establishing a wholly owned subsidiary since

the decisions are taken by the central office of the company, though some operations

are delegated to the subsidiary, after the wholly owned subsidiary we find Joint

ventures, these are determined by the part of ownership of the new venture belonging

to the company and finally licensing or franchising as the company yield the control

over strategy in the foreign country to the licensee in exchange for a payment.

Risk is a critical issue when companies chose a strategy; we can distinguish two

different kinds of risk. One type is the risk associated to the increase of resources

commitment to the market since non profitable companies would find serious

difficulties to reallocate their resources to additional business. The second is the

dissemination risk (Hill, Hwang and Chan Kim, 1990) arising from the appropriation

of Know-how or other intangible assets from licensees or Joint Venture partners.

Many companies own competitive advantages coming from special features related

with technology, marketing or special managerial procedures. By using some entry

modes those competitive assets can be extended and therefore the position of the

company would be threatened. Licensing implies that the licensor allows licensee to

use a specific know-how to carry on its activities although it is difficult to control

whether the licensee would use this know-how to alternative businesses.

ENTRY MODES Control Source

Commitment Risk

Dissemination

Licensing Low Low High

Joint Venture Medium Medium Medium

Wholly owned subsidiary High High Low

Figure 12. Hill, Hwang & Chan Kim, 1990

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Consequently, the higher the investment, the bigger the commitment of resources

linked to the new market. As investment and commitment grow, the degree of risk

also increases and the flexibility of the company diminishes.

Kogut and Sight (1988) set a classification of variables influencing the selection

between Joint ventures, greenfields and acquisitions although we will use their

classification considering alternative strategies, as their differentiation between

cultural characteristics, firm variables and industry variables constitutes a useful tool.

Firm variables are those intrinsic features determining the situation of companies;

Authors consider that firms familiarized with diversification would be more used to

the transfer of products innovation and therefore they prefer to enter new markets by

acquisition instead of establishing a brand new business (Wilson, 1980; Caves and

Mehra, 1986). Some authors like Caves and Mehra (1986) argue that Multinational

experience understood as the market knowledge acquired by entering multiple

countries, is directly related with acquisitions over greenfields and joint ventures since

as the international experience increases the company is more skilled in coordinating

subsidiaries and the need of a partner is less significant. Similarly, but in a smaller

scale, as the company increases individual country experience, the need of a partner

diminishes. Companies entering for the first time a new business will be more likely

to make small investments and then increase gradually their resources commitment.

Learning is incremental (Barkema et al., 1996), the company accumulates experience,

which will be able to use in later situations, by entering more business. This

knowledge accumulation reinforces decision makers’ confidence regarding the

situation of their companies respecting local competitors (Petersen, Petersen and

Sharma, 2003).

Finally Asset size is related with the size of the company, as the bigger the company,

the greater its resources available. Dubin (1975) and Wilson (1980) found that that

smaller firms tend to acquire more frequently than larger firms, as the later ones are

able to allocate more resources to Greenfields although Caves and Mehra (1986)

consider that as companies are bigger they prefer acquisitions over greenfields. On

the other hand smaller companies use to have fewer opportunities than big companies.

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These resources are not just monetary as managerial, marketing or technology skills

are also critical factors when choosing the appropriate entry strategy (Sharma and

Erramilli, 2004).

Industry Level variables are different from one country to another. Research and

Development and Marketing variables differ and constitute a motivation to choose

between different modes of entry. Companies with a higher level of technology than

the market would be reticent of choosing a Joint venture in order to preserve their

advantages while lower technology companies with higher marketing would be prone

to search for partners.

Country Level Variables mainly determined by two factors; uncertainty avoidance

and cultural distance; Uncertainty derivates from the lack of knowledge about the

foreign country, and the degree of uncertainty that the company is able to deal with,

part of this lack of knowledge comes from cultural distance (Hofstede, 1980) between

the domestic country and the target one, as some cultures are more distant than others.

Other authors as Williamson (1985) relating cultural distance with the transaction

costs theory estates that as cultural differences are bigger, the company might increase

the level of control over its activities (Root, 1987; Kim and Hwang, 1992) moving

towards wholly owned subsidiary. This cultural gap includes differences in social

structure, behavior, values or language in the foreign country. Large cultural distance

tends to favor low commitment entry modes. This is a consequence of the lack of

intangible knowledge coming from experience; therefore firms tend to invest in

similar countries due to the uncertainty. In addition, companies prefer entering

cultural close markets (Root, 1994)

Hill, Hwang & Chan Kim established a framework of factors influencing the chose of

the strategy of entry, they basically differentiates three group of variables to consider

when making the decision; strategic variables, transaction variables and

environmental variables.

Authors distinguish two main strategic variables, global strategy, which is

common for all the markets where the company enters, and multi-domestic

strategy (Hout et al., 1982) derived from differentiation between the markets

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leading to multiple strategies. There is established a relation between these

strategies, control and scale economies. Multi-domestic strategy implies to

delegate some activities to subsidiaries to adapt to different conditions,

consequently the level of control is lower and by using this strategy, companies

will rather prefer joint-ventures or licensing. In other cases companies prefer to

distinguish common preferences from one country to another as a result of the

increasing development of infrastructures or technology and allowing the use of

scale economies, saving costs, thus they carry a common strategy which requires a

higher level of control as the company has to coordinate the different operations.

This strategy is less attractive for licensing or joint ventures as business partners

are reticent to accept these control requirements over their actions. Similarly in

global markets exists a high concentration of companies as there are limited

powerful companies competing with each other in many countries. As a result of

this concentration, the use of a global strategy it is more profitable to be able to

compete (Hymer) and therefore the companies tend to centralise their activities

regarding price, marketing and sometimes unprofitable subsidiaries in order to

optimize their global activities. Business partners are hard likely to accept this

situations hence, companies would prefer to set their own subsidiary.

Environmental variables include external factors as country risk, competitive

and demand conditions and location familiarity; there are four kinds of country

risk (Root, 1987) political risk, arising from political fluctuations, ownership risk

like government intervention, operations risk, as local requirements and finally

transfer risk arising from currency fluctuations. When the level of risk is high the

company prefers to limit the resources commitment to the market, limiting also its

ownership (Bradley, 1977) and thus they prefer a low commitment entry mode as

licensing or joint venture, as their local partners’ level of risk is lower than the one

associated to a new wholly owned subsidiary. Companies are also influence by the

nature of the competition since changing markets require a high level of flexibility

and adaptation. The more the commitment of resources the less the flexibility of

the company and consequently firms in changing markets prefer a lower resources

commitment mode as licensing or joint venture. Concerning the demand of the

new country, when companies are not familiar with markets and there are

uncertainties they prefer to allocate limited resources. Once the market matures

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the firm is eager to increase its commitment but when entering companies prefer

low commitment modes as licensing or joint ventures. This assumption is opposite

to the previously mentioned transaction cost theory (Williamson, 1985) as

companies under uncertainty conditions would prefer to avoid contracting modes

such licensing in order to avoid opportunistic behaviour or dissemination risks.

Finally the distance between domestic market and the foreign ones is related to the

variable, culture distance (Hofstede, 1980). It constitutes another trigger or

obstacle as the company is more or less familiar with the environment. The more

the familiarity, the higher the resource commitment; contrary, in unfamiliar

countries firms are more likely to choose a low commitment strategy like

licensing or Joint venture than setting a wholly owned subsidiary.

Transaction-specific variables are based mainly in the relevance of transaction

costs, as some companies might have intangible assets like know-how and they

want to keep their competitive advantage in the market (Dunning, 1981; Rugman,

1981) The risk of dissemination -depending on the nature of the know-how-

constitutes a big barrier for some companies to choose Licensing or Joint Ventures

as partners can use their advantages in an opportunistic way and so companies

would loose its advantage. As an alternative companies can specify the rights and

obligations in the contract although costs incurred when negotiating, monitoring

and enforcing the contracts are significant. As a result some authors conclude that

if transaction costs arising from a contractual mode are higher than the ones of

setting a wholly owned subsidiary, companies would prefer the later alternative

(Hennart, 1982).

There are additional kinds of factors which influence the selection of an entry

strategy, we can classify them in two groups, External and Internal factors attending

to its nature. External factors are related to the situation of the domestic market, and

market objective as their sizes, economic stability, business policies and regulations,

costs and other environmental factors. The internal factors include the resources

available for the company, its product characteristics or the international experience

or knowledge (Root 1994).

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Internal factors are companies’ attributes like its size, previously described position of

the company in the domestic market, management or the nature of its products like

differentiation. Normally differentiated goods can compete in foreign markets with

higher prices than standard products. This margin between the prices of both kinds of

products can cover expenses arising from transportation and taxes allowing

exportation as a way of entering the market, while standardized products are more

dependent on price, and companies might have a presence in the target market.

External factors are coming from the local market as well as the foreign one, at it

influences not only the selection of the entry strategy but also have an impact on the

election of a specific country to enter. While the size of the local market encourages

companies to expand their business, target market size influences the way they do it;

large markets have a big growth potential therefore companies are more eager to

increase their presence and production rather than exporting. Costs related to raw

materials, skilled labor or energy also encourage firms to establish subsidiaries or

production facilities. Physic distance is a significant factor since companies prefer to

select close countries to start its internationalization processes in order to save

transportation costs and many times, not always, physic distance is related with

psychic distance.

4.6. HOW DOES INDITEX ENTER INTO FOREIGN MARKETS?

In this section we are going to analyze different entry strategies followed by Inditex

on the basis of factors previously discussed. The Inditex Group has always tried to

keep the maximum control over its operations since its main strategy in order to grow,

is the wholly owned subsidiary formula, although in the last years this policy has

changed and the Group has developed other alternative strategies, such as joint

ventures and franchising agreements. FDI is seen by Inditex as the best alternative

over other modes of entry in the host market like franchising, as the company does not

use licensing or exporting. One of the most important assets of the Inditex Group is

brand image, and its activities are not limited to clothes manufacturing since they also

provide a service in their stores and both exporting and licensing strategies would not

entirely fit this business model. Concerning FDI, although the company has used the

Acquisition strategy previously to expand its activities, its major reason was to

diversify its products, these firms were not acquired to gain access to a foreign market

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and consequently, we will focus our efforts on Greenfields as the only way followed

by the Group, of establishing a wholly owned subsidiary. Opposite to existing theories

(Kogut and Sight, 1988; Caves and Mehra, 1986) concerning the distinction between

Greenfields and acquisitions mentioned in the previous part, although Inditex has a

valuable management, and considering that acquisition reduce the time that it takes to

enter into new markets, the target company does not have necessarily to match Inditex

business model and this is the reason why the Group generally prefers greenfields

over acquisitions.

Consequently, there are mainly three different strategies followed by the company to

enter into new markets, and these strategies depend largely on the situation of the

target country.

• Franchising

This alternative to the international expansion arises from the fact that a local firm

which possesses an advantage over another country companies in a particular line of

activity does not necessarily set its own business in foreign countries. These cases

increase when the local firm does not produce its products in the target market, so the

company could easily export the product in which the advantage is personified. When

the company deals not only with goods but also with additional services related with

the customers, exporting is a narrow tool to enter new markets. However an

alternative to exporting would be licensing, renting, or else selling these skills. The

election between selling the product containing the advantage and selling the

mentioned advantage determines the amount of direct investment that the company is

ready to face. Although Franchising is similar to Licensing, both concepts differ on its

motivations and services. Whilst Licensing is a contractual agreement where the

contractor grants the access to a protected asset, the Franchising goes farther. In this

strategy, the franchisor provides the franchisee with the permission and rights of using

the company’s name, brands, technology and in addition –unlike the license- supports

the franchisee with the managerial, marketing and organization aspects under an

intended permanent agreement (Root, 1994). The franchise must be internationally

identifiable, this does not mean that it might be completely identical but to a certain

extent internationally recognizable.

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Inditex is using Franchising contracts in limited occasions to expand its international

presence in countries where FDI is not viable. The number of stores opened by

franchising by the end of January, 2006 is 310, representing the 11 percent of the total

sales of the group. In 1998, Zara makes a franchising agreement with a local partner

in United Arab Emirates (UAE); Since then until now, the law ruling United Arab

Emirates’ companies, stipulates that foreign companies wishing to invest might own a

49 percent as a maximum share of a company registered in the UAE, so the share of

the company which controls the business must remain with a UAE national

company16. This sole-agency rule makes a Joint-Venture unviable for Inditex as the

group aims to increase progressively the control over its partner in the new ventures,

using this entry mode as a way of wholly own the new company arising from the

Joint-Venture. We find the same situation in Kuwait where Inditex entered the market

in 1998, before the release of a new law17 for certain sectors, avoiding 100 percent

foreign ownership. But until 2003, before the enactment of the law, foreign investors

were limited to a 49 percent fixed by the Law of Commerce. Bahrain, where Inditex

enters during 1999, allowed the same percentage at the time, similarly to the rest of

the countries in the Middle East where Inditex is present.

This entry mode provides a chance of testing foreign markets without increasing

commitment of involvement of capital; the company is able to avoid barriers as

political risks as franchisees use to be local companies and thus the expropriation risk

diminishes (Root, 1994). Political risk is understood as the risk deriving from political

situations within the host country and changing political relationships between the

host and the local market, this is one of the main reasons for using this formula. The

Group uses the franchising method in countries like Israel due to its special

characteristics. These factors project an image of the country as a risky location

because of its problems arising from Jews and Palestinians conflict. Even though this

political situation, Zara opens a store in Israel in 1997 by using a franchise and

nowadays the store is very profitable. Franchising is also one of the fastest ways of

entry for companies and it also might be cheaper -reducing economic risk- than other

ways of entry from the economic point of view.

16 Library of Congress – Federal Research Division Country Profile: United Arab Emirates, March 2006 17 Law No. 8/2001, Resolution No. 1006/1/2003

- 88 -

In some cases, cultural differences, risks associated to the economic activity in some

countries or the size of the company makes that Direct Foreign Investment loses

attraction. The flexibility characterizing Inditex, makes franchising a good alternative.

This kind of agreement is done just with an associate in each country -except in Spain

where Zara still have a few franchises with various franchisees- and this associate

might be a company with big experience in fashion retailing and distribution, and with

experience in the foreign country.

There is also the need of availability of human resources as well as financial and

structural factors in order to develop Inditex business model by the associated fast and

in an efficient way. There are some differences between the traditional Franchising

model and the one carried on by the Company. Inditex model of Franchising is

integrated on the offer, order and distribution procedures from the logistic centres of

the different chains, like the rest of the shops. Franchisees also, have the possibility of

returning the goods and clothes not sold during the current season. Following this

pattern, the investment on fixed assets of the store as well as its human resources

contracting corresponds entirely to the franchisee. As compensation, the associated

has the geographical exclusivity of the Franchise meaning that there can not exist

another franchisee in the same area but Inditex saves itself the right of opening shops

in the same area by establishing a wholly own subsidiary.

In the set of stores of the Inditex Group there has been an increase in the number of

franchises of the Zara chain during the last years as a result of the expansion of

Inditex across the Middle East where corporate properties can not be foreign-owned

like we have seen before in the case of U.A.E., Kuwait or Bahrain. The company

carries out its expansion through these countries by using this mode of entry since

1998. The need of stability in investment risk is particularly important for countries in

the Middle East and North Africa region, which traditionally have a higher level of

instability associated with politic situation than developed countries. Nevertheless, the

rest of the formats of Inditex Group tend to reduce the franchising weigh in Inditex by

opening wholly owned subsidiaries or turning its franchises into its own property

stores. Other reason for this behaviour is the dread of that the franchisee does not

reach the quality standards consequently the existence of a suitable control process

- 89 -

would be necessary to ensure the right use of the franchised assets characterizing

Inditex market image.

As a disadvantage for the franchisee, this entry arrangement means a lack of control

respecting the franchisor (Root, 1994) which retains a substantial degree of weight;

the foreigner may have no ownership at al1 yet still exercise some control through this

kind of agreement while the franchisee might follow Inditex policies and patterns in

order to keep the identity of the concepts, some of these patterns are the allocation of

the clothes inside the store, the design of the shop windows or the store furnishing.

Normally dissemination risk constitutes another threat, but since the franchisee does

not have access to the same products or infrastructures and the Group is vertically

integrated, in this case is not such a big threat.

Concerning the control, this mode of entry might derive in a lack of flexibility for the

licensee if he wants to change the ownership allotment. Another example of

Franchising is the one that Inditex establishes in Russia in 2003 with the finish group

Stockmann. This group is not unknown for Inditex, as Stockmann is the franchisee of

the Group in Finland since 2001, and it is also the first European distribution group

who enter the Russian market. Franchising is a good alternative due to the lack of

experience of the company in Russia and some of the entrance barriers as the policies

that regulate the land property, restricted for foreigners18 or the intricate law system

resulting from the transition of the USSR to the capitalism, common feature between

some other former Eastern Block Countries re-established following the collapse of

the Soviet Union. Despite the barriers described above, Inditex makes an agreement to

acquire the Russian Franchise in 2006. Through the last four years Inditex gains

experience and specific knowledge and once the Group is familiar with the market it

is easier to continue its expansion and the company foresees the opening of seven new

stores by the end of the year, with a full control over its activities and profits.

But the Russia Franchise is not the only one that Inditex acquires, similarly, the Group

is increasing its ownership of the franchise agreement with its franchisee in Poland.

This agreement is settled during 1999, but a few years later, in 2005, once the Group

gains experience in the new market and commercial relations of Poland are more 18 ICEX Files – Spanish Economic and Commercial Bureau in Moscow 2004

- 90 -

favourable for foreign investment, due to the adjustment of the local law to the

European regulations, the company makes a preliminary agreement to buy the 51

percent of the Franchise with the option of increasing its share of Zara Poland’s

capital up till 80 percent in 2008. The Inditex Group perceives the potential of the

Polish unsaturated market. Besides, the Mexican franchise of Massimo Dutti is

acquired in 2005; this chain was the only one of the Group operating by a franchisee

in Mexico.

Although Latvia, Estonia and Lithuania’s Legal policies respecting foreign companies

are equivalent to those ruling local businesses, the Inditex Group chooses Franchising

to enter both markets. As these countries are moving towards European standards

related with trade policies, an alternative with a higher degree of ownership is

feasible, but the company formalizes an agreement with the Lithuanian company

Apranga leader of clothing retail in the three Baltic Republics to enter its markets and

ensure a good reception. One of the reasons of choosing Franchising in this European

region, apart of the facilities that the Lithuanian Group offers, is the speed of entry in

three countries with a great potential of growth due to the lower saturation of its

markets and the increasing presence of its global competitors.

• Joint-Ventures

Mainly due to their low set-up costs, joint ventures are a good alternative for

companies seeking to enter the international arena, especially for those companies

with more limited resources. A joint venture could be defined as a contract between

two or more corporations compromising them to create a new firm to achieve a

specific purpose that is not necessarily common. Another definition related with the

decision-making, joint ventures involve two or more legally independent companies

and each of then share actively the decision making of the jointly owned new

company (Geringer, 1988). Joint ventures provide a suitable mode between licensing

and totally owned subsidiaries, and in many cases the only way allowed by the host

country. Specific countries legislation may require the foreign company to join a local

partner to be able to operate, eliminating the possibility of fully owned subsidiary.

The local company generally will provide access to the market, mainly useful insights

of the local market, legislation and domestic politics. All of these factors contribute to

the decrease of risk as a consequence of distributing this risk among two companies

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-risk-sharing-. The first variable defining the venture is the amount of control of both

partners; when one of the companies has control over the other; its decisions have

more weigh. The other is the ownership, by means of the percent of equity of the

venture owned by the partners. There exists a direct relation between both variables.

When a corporation has a higher amount of equity ownership its control over the

venture increases, hence its situation is more dominant.

In the case of Inditex, Joint-ventures agreements are just adopted when some business

characteristics, like real-estate market or specificities of the distribution activity,

recommend taking advantages coming up from relying on local associates as they

contribute to the business with their experience or especial assets. The company is

conscious of the Joint Ventures drawbacks (Geringer, 1988) as the coexistence of two

-in Inditex cases- parent companies can make this kind of alliances difficult to deal

with and in some of the previous research, with reduced performance. The main

reason that Inditex have for avoiding this kind of operations are the risks associated to

expose its strategy. Although the firm can protect some of its process by using

patents, another kind of resources like know-how can result exposed to its present

partners. By incrementing the control over the joint venture Inditex would reduce to

some extent these kinds of problems, but still these types of revelations can affect the

company’s situation in the market. If the company does not perform effectively

controlling the new entity, it may have great difficulties managing the joint venture or

as Geringer and Herbert (1989) points “a firm that agrees to participle in an IJV

inevitably complicates its life”. On the other hand, Inditex might rely on its

managerial skills, its know-how as means of guarantee its participation in the daily

operations. The Inditex Group has formalized various joint-ventures with companies

like “Otto Versand” to gain access to the German Market, “Bigi” in Japan, “Gruppo

Percassi” in Italy, or “Reitmans” in Canada.

As a result of the alliance with “Otto Versand” in 1998; “ZARA Deutschland GmbH”

is created and this strategic move allows Inditex to take advantage of the experience

of the German Group, which is the biggest seller via catalogue of the world19 and

specialized on the distribution sector. “Otto Versand” experience is a high value asset

19 Expansión Newspaper 09/09/1999

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for Inditex, as the German market is one of the most important in Europe and the

partnership starts with a balanced situation between the partners; Inditex initially

controls the 50 per cent of the share capital. As result of this union, the entrance and

later expansion through this market has been very fast; since the opening of the first

store in Cologne in 1999, the Group nowadays has 59 stores in the most important

German cities. But these stores are not just Zara stores as “ZARA Deutschland

GmbH” includes the rest of the chains of the Group; by now just Zara and Massimo

Dutti have presence in the German marketplace. But the situation of equilibrium is

broken eight years after the first contact between both companies. In March 2006,

Inditex comes to an agreement with its German partner to raise its participation up to

78 per cent of Zara Deutschland GmbH, while Otto Versand holds the remaining 28

per cent.

The case of the joint venture with the Canadian group “Reitmans (Canada) Ltd.” had a

shorter life period than the one described previously. Inditex starts its joint venture

with Reitmans; a publicly traded retailer, leader in the Canadian Industry, in July 1999

with the creation of “Zara Canada Inc.”, this joint venture is created with the aim of

open Zara stores in Canada. Zara opens its first stores using the ones that Marks &

Spencer left because of its withdrawal from the Canadian market20 . In “Zara Canada

Inc.”, Inditex has bigger participation with the 95 per cent of the new company; this

joint venture is dominated mainly by Inditex, the predominant parent company

following Geringer and Herbert classification. The company’s predominant situation

makes the alliance easier to manage and therefore more successful, but once the

company is familiar with the market, during 2002, Inditex buys the remaining 5 per

cent share of the Canadian group ending this short joint venture and fully increasing

its control.

21

But the joint venture arranged in the Italian market was far more complex. Before

Inditex gets in touch with the “Gruppo Percassi”, the company decides to set a

business alliance with one of its biggest competitors, the Benetton Group, a giant

textile distributor with more than 5.000 stores mainly managed by independent

20 Canadian News Wire 21 Reitmans Interim report 02/11/2002

- 93 -

partners around the world. Inditex wants to enter the Italian market22 and in March

1997 is looking for an Italian partner with enough experience to share both risk and

cost as this market is completely strange and exigent for the company. The Group

signs a contract with Benetton in which they commit to build a new company in the

Italian market as established in the joint venture. Although Zara is a threat for

Benetton, because of this potential competitiveness, they rather have some control

over this new venture and increase its benefits instead of its competence. But this joint

venture breaks down. After two years searching, the Group Benetton simply argues

that they cannot fulfil Inditex requirements respecting the kinds of location demanded

by Zara format. Following Zara’s opening policy; Inditex was searching for locations

in the main cities of Italy with a minimum area of 1500 squared meters, but the lack

of these forced Inditex to withdraw from this operation. In this unsuccessful venture,

due to the lack of coordination between both groups, Inditex looses time to enter in

Italy while more sceptical observers claim that Benetton Group was trying to delay

the entrance of a group that would mean a threat to its own business. In this case

exists a division of interests, due that Inditex Group might rather to achieve objectives

that Benetton Group might not.

Nevertheless this experience is not enough to persuade Inditex to move away from the

Italian market, on the other hand, this market has big similarities to the Spanish one,

and they find another way of entering into this market by establishing a new joint

venture with the Percassi Group in October 200123 The Percassi Group is a strong

distributor in the Italian market (Benetton distributor and franchisee too) also with

wide experience in the real-estate sector, a valuable expertise for Inditex. Percassi’s

share in the new venture is 49 per cent opposite to the remaining 51 per cent that

belongs to Inditex. The participation of the Italian partner is not limited just to Zara

but also to the rest of the Inditex formats and the alliance arises with the objective of

increasing the presence of Inditex chains through the next years. During the next five

years, Inditex Group together with Percassi Group, manage to open the Italian market

to all of Inditex formal opening 120 stores across the Italian peninsula but in the end

of 2006 the alliance ends with the acquisition of Inditex of the remaining 20 per cent

stake of the capital controlling the whole Italian business.

22 Expansión Newspaper 19/03/1999 23 El País Newspaper 25/10/2001

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The last joint venture mentioned before, is the one that allows Inditex entering the

Japanese market in 1997. Japanese firms tend toward joint venture entries, the called

Japanese effect (Kogut and Sight, 1988) Inditex group creates a join venture with a

Japanese clothing company; The Bigi Group. The reasons of choosing this partner are

that Bigi Group have more than 20 years of experience in the textile sector, a wide

knowledge of the Japanese real-estate issues, -particularly critical factor in Japan

where wide spaces are a limited and expensive assets- and specially the possibility

that Bigi offers Inditex of opening their first store just one year after the creation of

Zara Japan Corporation, in one of the best locations of Tokyo. The Bigi group has the

50 per cent share of the new corporation while Inditex has the remaining 50 per cent.

During May 2004, Inditex acquires 35 per cent of Bigi’s participation increasing its

total equity up to 85 per cent. With this decision Inditex Group also raises its level of

commitment with the Japanese market as well as its control position in the joint

venture due to its decision capability over the Bigi Group.

Since the creation of the joint venture until the end of 2004, Zara Japan Corporation

has opened 12 stores in Japan. As the group gain experience in Japanese market, the

joint venture loses attraction and just one year later Zara throws a call option over the

rest of the shares of the Bigi Group and gets the remaining 15 per cent of Bigi’s

shares24 . By December 2005, Inditex Group possesses Zara Corporation, ending this

joint venture and achieving the goal of incorporating the corporation to its list of

wholly owned subsidiaries, with a total of 18 stores in Japan, just as it was done with

its subsidiaries in Canada or Italy. For the period of 2006 until 2009, following the

designed Strategic Plan, the company aims to enter new markets like China,

Thailand or South Korea to continue its expansion process through Asia. This

strategic plan forecasts the opening of up to 100 new stores in Asia.

25

Following the mentioned Strategic Plan, by the end of 2006, a new joint venture is

planed in Korea with the distribution group “Lotte Shopping Co, Ltd” to open the

Korean market to the Group. Zara Korea would be created as a result of a partnership

where Inditex Group possesses the 80 per cent of the shares while Lotte has the

remaining 20 per cent. Lotte Shopping Co. Ltd is a distribution company with

24 El Mundo Newspaper 14/12/2005 25 Inditex web site

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experience and a big presence in the South Korean market as well as in some other

Asian countries.

In the Italian and Japanese cases the partnerships start with a balanced situation,

which means that Inditex, as in both situations does not have the privileged position

-like in Zara Canada, Inc.- has to unify its criteria with its partner in terms of strategy

and control in order to optimize their common performance. But in the Japanese joint

Venture, as in the Canadian one, we can see a common tendency in the behaviour of

Inditex. The Group moves towards the complete ownership of the new companies.

Many companies change their appointments with the local partners (Johanson and

Wiedersheim-Paul, 1975; Hymer, 1960, 1976), the existing literature classifies two

different changes (Benito, Pedersen and Pedersen, 2004) depending on the aim of the

corporations; within-mode switches, these includes the firm’s changes of foreign

partner but in this particular case, both of the switches carried on by the company, are

orientated to another operation mode instead of its partners between-mode switches.

We identify various switch motivators, these are factors reducing the perceived need

of a continuing with the local partner from Inditex; The increase of resources; not in

the financial aspect as Inditex is a company with financial resources but more in the

managerial field, this motivator is related with another important one the steady

accumulation of market knowledge. This kind of knowledge reduces uncertainty and

moves Inditex in the direction of the increase of commitment, as the risk perceived

from the market decreases.

Other causes for the change of mode are dissatisfaction with the intermediary, as we

have seen previously with the relationship between Inditex and Benetton, sometimes

the partners have different targets, and Inditex can perceive a poor performance from

the other company due to two alternatives; the intermediary does not possess the skills

needed or does not want to spend its time and resources in the Joint Venture, the

partner intentionally under-performs (Benito, Pedersen and Pedersen, 2004) This

behaviour is related to the well known “Agency theory” (Jensen and Meckling, 1976,

Levintahl, 1988) where the agent, in this case the Benetton, finds other activities, or

the lack of them, to be more worthwhile for its own aims. In other cases the

responsibilities of one and the other company are not well defined, consequently

control related problems arise.

- 96 -

• Greenfields

The Group prefers to focus on directly-operated stores. Following this strategy, the

firm settles a store in the foreign country, assuming all the costs incurred. For a

company in a foreign market the cost of acquiring market information can be

considerable, although is a fixed cost (Hymer, 1960, 1976), meaning that once there

costs are satisfied it might not be incurred again. As the main advantage, Inditex

preserves total control over the business, since the Group takes its own decisions the

flexibility is high and its adaptation power increases, and the flexibility is one of

Inditex key factor of success. Another plus is that benefits are entirely for the

company and Inditex is able to protect its trade secrets. On the other hand the

company can be seen as a foreigner that is not going to share its profits with local

people. In given countries foreigners and nationals might receive different treatment

(Hymer, 1960, 1976) by governments and the risk and costs, as we have seen before,

increases considerably.

The vertical integration of the company is developed enough to facilitate the

management of the business activities by the own Group. This is the most common

patter followed by Inditex on its Internationalization strategy. In fact the number of

fully owned stores of the Group by the end of 2005 is the 88 percent of the totality of

the stores meaning 89 percent of the total sales of the Group. As this is the favourite

formula, the rest of the strategies are carried out when the legal policies or political

situation of the country or another intrinsic attributes of the market does not allow the

Group this option. To establish an entirely owned subsidiary abroad, the Group may

acquire an existing company in the foreign country or build one itself; the so-called

green field investment is the formula that Zara uses to follow.

In 1998 Inditex Group approaches the Latin American markets -except Mexico where

the company enters in 1992-, with great expectations of growth in the short run. This

entrance starts in Argentina, Venezuela and spreads intensely over the major South

American markets within the next five years. The strongest reason why Inditex uses

Argentina as a springboard on its Latin-American expansion is due to the similarity

between Argentinean preferences in terms of clothing to the European ones. Although

this is a risky operation, Inditex expectations are fulfilled and this operation succeeds.

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As a result, the company decides to continue with its South American gait by opening

wholly owned subsidiaries. The company does not find major problems with any

government of the region, since these countries are open to foreign direct investment

which helps developing its economies.

5. CONCLUSION

The general aim of this thesis was to understand the processes and variables pushing

companies towards foreign markets in order to accomplish this objective, and after

providing an extensive review of the most relevant literature on the theory of the

internationalization of firms, the study makes use of this theoretical framework to

analyze the international growth of the Spanish retailing multinational Inditex.

Additionally, the paper goes one step further and once we are aware of the

opportunities of the company, extensive alternatives are provided in order to find the

most suitable mode of entry. Thus, relevant theories and literature have indeed proved

to be very useful as a tool in order to understand the strategies developed by the

company. Inditex is as well used as a reference to reflect some of the existing theories.

The paper starts by reviewing the academic literature to define and explain the

concept of the internationalization of firms, stressing the principal reasons or

circumstances which companies face when deciding to go abroad. We found different

classifications, mainly depending on the nature of those reasons, and once we pointed

out these motivations, we examined the most relevant models existing nowadays -like

the Traditional Internationalization Approach, the Transaction Cost Approach and the

Uppsala Model among others-; some of them arising from the influential factors

described earlier -as competitive advantages, position or internalization-. These

patterns combined several variables when creating a useful framework, variables such

as time, competitive advantage of the companies, risk diversification or foreign and

domestic market situation

After the review of the literature, the analysis was conducted. Due to the wide

extension of the business internationalization issue, the analysis was structured around

four main research questions:

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• The first question formulated regarding the expansion of the company was:

Why does a firm (Inditex) enter international markets? Section three tries to

answer this question by reviewing relevant literature combined with various analysis

of the domestic situation of the company. This local environment constitutes a big

source of motivations for the company. By answering this question other firms are

able to understand the range of factors they have to think about, when they start

expanding their international activities. Inditex not always has been a multinational

firm, but its main reason when its activities were restricted to the Spanish market lasts

up to the date, with some modifications the growth is essentially the driving force of

the company. This growth constitutes a source of economic profits as well as market

share. Once the company became the retailing leader of the country, domestic market

turned into a narrow domain and its natural evolution was to expand its activities

abroad, getting into a higher level of competition.

• The second question was: What are the internal and external motivations

and faced by the company on its internationalization process? To be able to

answer this question, there is a presentation of the domestic market of the company.

Since many of the motivations of the firm rise form the local market situation and due

to its relevance, some analysis like the five forces model or the SWOT study are

conducted to gain deeper insights of Inditex position. Focusing on the existing

literature combined with a broad analysis of the domestic market situation, we

observe several ways of organizing the numerous motivations described across the

second section of the paper. Between these classifications we find one distinguishing

among reactive and proactive motivations. This categorization distinguishes two

different categories which in turn, define at the same time the position of the company

on its domestic market. Between the proactive motivations leading Inditex towards

international markets we find the increase of its profits taking advantage of its

innovative retailing process until rivals target its advantage. Economies of scale also

constitute a proactive motivation, since the company also includes different chains,

while expanding its activities, Inditex decreases their costs.

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As reactive motives we distinguish saturation in the Spanish retailing market and

some location restrictions driving the company to search for foreign opportunities.

Strategies followed by its competitors towards internationalization influence the firm

in a lower extent since currently the company is a pioneer establishing the trends of

the market. Finally as an important reactive motivation, Inditex diversifies both its

lines of business, with its different chains as well as its locations; consequently the

firm minimizes risks of instability arising form political fluctuations as it expands its

activities abroad balancing the situation. According to an alternative classification of

the companies regarding its influential factors, we find that Inditex is both an

efficiency seeker as well as a market seeker, expanding to optimize its organization as

well as looking for attractive countries since the situation of foreign markets also

constitutes a strong stimulus for the expansion of the company.

• Section four tries to provide an answer to the question: How does Inditex

select its foreign markets? There are some variables which determine the general

attractiveness of a market; this attractiveness can be seen as a combination of its sales

potential and risk, the company does not follow its customers or foreign orders as its

client is the final consumer and therefore the demographic size of the target country

plays an important role. During the first years of expansion of the company, we can

observe a move towards closer countries, in physically and psychically terms, in order

to minimize risk; since geographically closer countries means lower transportation

costs and cultural closeness reduces uncertainty. Information availability plays a key

role, consequently as Inditex gains international experience we observe that its foreign

expansion progress at a faster rate and its initial concept of attractiveness evolves,

considering other factors.

• Finally, we analyse the existing literature in relation with the company to

answer the last question: How does Inditex choose its mode of entry into foreign

markets? The selection of the entry mode influences the future performance of the

firm and it requires extensive attention. The company chooses the market first and

depending on its situation uses a specific entry mode or another. The

internationalization process can be done by many different ways of entry, although in

the paper we have just focused on three basic and well know modes; franchising, joint

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ventures and wholly owned subsidiary, inside the last group, Inditex uses greenfields

over acquisitions. The primary difference between market entry modes has been

introduced; they differ from each others mainly in the degree of ownership and market

commitment, although location plays an important role. Inditex tries to keep the

higher level of control possible, thus using wholly owned subsidiaries. The company

has extensive resources and consequently, more entry mode alternatives than firms

with limited sources. In particular countries wholly owned subsidiaries are not

allowed due to legal restrictions of similar factors and the firm uses alternative ways

such franchising or joint ventures but always trying to increase its level of control.

The company is vertically integrated so its dependence on local partners is small.

In summary, we have underlined the relevant factors leading companies

towards foreign markets, once firms identify business opportunities, a suitable

internationalization pattern must be followed considering these additional factors

influencing the situation of the company. In order to optimize the international

expansion of firms, they must find a combination of these issues and identify

attractive markets and their characteristics to be able to select the appropriate entry

strategy. All of this process is continuously evolving and variables change all the time

so firms must also increase their flexibility in order to be able to face changing

situations.

Because the field of internationalization is so broad, there are many interesting topics

still to be covered. It must be considered as well, due to the fact that a single company

is analysed, that it does not reflect all the existing combinations of processes which

companies use to expand their activities internationally, but the ones relevant for the

firm and its circumstances. Some suggestions to issues of further study are the

following,

• Which are the differences in market selection concerning the motivations of

the companies?

• To what extent local market affects the entry mode choice?

• How do companies choose partners to expand their international businesses?

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APPENDIX

CONTENTS……………………………………………………….…………………...i

1. INDITEX MANUFACTURING PROCESS………………….................................ii

1.1. Design…………………………………………………..………………...iii

1.2. Production……………………………………………..………………….iv

1.3. Distribution………………………………………………………………..v

1.4. Retailing……………………………………………….…………………vi 2. SWOT ANALISYS………………………………………………..........................vii 3. MARKET SHARE EVOLUTION IN TEXTILE RETAILING……. …………...viii 3. SPANISH TEXTILE EVOLUTION……………………………………………..viii 4. INDITEX SALES PER CHAIN…………………………………………………...ix

i

APENDIX

1. INDITEX MANUFACTURING PROCESSES

1. DESIGN

Inditex designs all its products. More than 30.000 different models were designed

during 2005. The Group designs two seasonal collections per year. The stuff of

designers of Inditex is integrated by 300 professionals, just 200 for Zara, in charge of

searching for new trends and adapting them for final customers together with the

stores managers who inform about customers’ tastes. The design department is

integrated by fashion stylist, commercial management professionals and store

professionals. The last group, store professionals, analyzes the different markets; they

choose the design and location of the stores, its merchandising and the design of shop

windows. They rely on the information received from the different countries and

markets. This information is coming from two directions; one source arises from the

designers of the different chains who visit local malls, discotheques, coffees,

universities, boutiques, events, potentially rival shops, fashion shows, as well as all

that activities related to the life and attitudes of the each of the segments to which

Inditex formats are directed to.

The other source of information comes directly from both the national and

international stores depending on the clothes that are more demanded or successful.

From all of this information, the Group selects just the one that can be useful for all

the markets in which Inditex is present. The result is a high variety of products for a

global market available in all the stores; however the amount of each product varies

from store to store depending on the demand arising from the different markets, as

well as of the weather conditions.

The managers provide feedback about the acceptance of the current designs available

in the stores influencing the design and production processes. Communications and

workflow within the design center is very important.

2. PRODUCTION

Almost the half of its production is produced before the season, while the rest is

manufactured during the rest of the period attending to the demand and responding to

ii

APPENDIX

customers’ preferences. If a product is successful, the company is able to manufacture

and distribute additional units in a short period of time and depending on the fabric

availability, but if the article is not demanded then further units can be eliminated and

the company can release an alternative product. Following this behavior the company

is able to respond to market demand within the season. The production of the period is

determined on the basis of the reactions of customers and demand of the collection

released before the season. And the information flow between the stores of the chain

and its centers is one of the key competences of the Inditex Group.

The Group obtains the most of the fabrics used to manufacture its collections from its

own companies, in the case of Zara, the chain acquires the most of its fabrics from

Comditel, S.A., that manufacture basic cloths, for more specific fabrics Inditex relies

mainly on external suppliers. Some of the basic fabrics produced by Comditel are

bought without being dyed and sent to Fibracolor, S.A., another subsidiary of the

Group which colors the fabrics depending of the current trends and increasing

flexibility. Once the company has the fabrics, skilled workers cuts them following

designers specifications reflected in patterns and using robots. The fabric pieces are

sent for sewing. Inditex subcontracts its sewing processes from many external

suppliers, in order to decrease its dependence to those suppliers. In 2005 the 80

percent of the total production of the Group was manufactured in Europe while the 20

percent was produced in Asia. A big proportion of the European suppliers are located

in the north-west part of the Iberian Peninsula, in Spain and Portugal consequently the

Group take advantage of its location mainly in order to save time ensuring the product

compliance to the time schedule and gain control over the processes. The Asiatic part

of the production is mainly basic products, more classical and therefore less

dependent on fashion changes.

Inditex develops its products for a global market and this bears a series of advantages

as well as disadvantages for the Group. As Advantages, we can find the possibility of

exploit economies of scale. Important cost savings coming up from the existence of

global brands and avoiding the creation of local brands in each of its markets, as a

result of this strategy the different chains of the group also take advantage of a

common worldwide image quite useful to attract clients, and international customers.

iii

APPENDIX

As disadvantages of the global strategy, the chains lack of local identity that in turn,

can difficult the identification of its clients with the brands. Other weakness is the lack

of adjustment to the local characteristics and possible opposition to the establishment

of a foreign company in the country of destiny from the government and potential

market of this country. The price is an essential variable for the Group. The decision

of the price calculation is a responsibility of the design department. As mentioned

before, we can observe differences on prices by looking at the price tags of the

products. The company uses a system of target pricing when taking this decision. This

system starts with a prototype designed by the department, and relying on quantitative

and qualitative market information and research, the department sets a price that,

theoretically, the target market is ready to pay for the product. Afterwards the

managers of the company set the percentage of benefit to obtain with the products.

Once established the objective price of sale and the margin of considered benefit, the

budget is determined to be able to develop on a new market. So the price is not fixed

by the production internal processes but by the prices of sale on the market which is

the factor that is going to determine the processes. Once decided the kind of product,

its price and quantity, the process of provisioning, production and marketing starts.

Regarding the location, all the chains integrating the group Inditex have similar

structures and common decision and control processes, so the election of its stores

placement is a key issue due to the lack of marketing campaigns, as a result, points of

sale must to be placed in the best locations, since the primary resource to attract

clients are the shop windows. They must be very popular zones highly people

frequented and this is the reason why their stores are located in the most important

commercial streets of every city.

Originally the clothes for women, men and children constitute the products of the

group. Nevertheless Inditex has managed to diversify its line of products by using the

influence of its brand image. Customers associate many ideas with a brand, like a

certain culture, a way of life, a level of acquisition or their personality. The different

chains of the group offer clothes, necessary for the daily life, but with the added value

the style, modernity and trend to attainable prices. As the Group has a strong brand

image nationally as well as internationally, this means an additional guarantee for

iv

APPENDIX

customers at the time of buying. Inditex releases its new product lines –accessories,

shoes, make up- into the market by using its most popular chain, Zara. The strategy

makes that these new products are soon accepted by the customers. But Inditex goes

one step further by diversifying its products into different chains directed to diverse

segments of customers and in some cases with different products. With Massimo

Dutti, Inditex sells higher quality and higher price respecting those of Bershka or

Stradivarius. This diversification also encloses a strategy, relating to demographic

information, the aging of the population on the markets where the group is present.

The diversification of the chains also assures the permanence of Inditex customers’

fidelity through their lives, since Kiddy’s class to Massimo Dutti.

Zara contrasted its pricing strategy to many others on its business, which set price

equal to cost plus a target margin. During its long expansion through 2001, Zara

printed price tags for multiple locations showing on the single tag all different prices

depending on the countries. This simplified the tagging procedure and also permitted

goods to be moved from store to store without retagging.

3. DISTRIBUTION

The twice-a-week cycles of production constitute its real distinctive competition.

Zara, Bershka, Stradivarius or Pull & Bear receive products two times a week, not

only current products but also new ones in order to renew the offer of the chains. The

speed of change in their collections spread a climate of shortage and opportunity,

since the clients do not know if next week they would be able to find what they like

today. The buyer must take a fast decision, take the chance. By using this strategy,

customers also know that they should visit Inditex stores since their collections are

often changed. This cycle it has been possible, among other factors, due to the

introduction of the just-in-time system although this strategy is not new, is innovative

and efficient in the textile and retailing Industry.

This system has the advantage of changing quickly the production to face the demand,

providing the company with the power and flexibility to answer rapidly to any change

on the fashion trends by eliminating stocks and reducing manufacturing and

v

APPENDIX

distribution time. This time between the order is received in the distribution centre

and the product is available in the store goes from 24 hours for European stores up to

a maximum of 48 hours for American and Asian stores. The manufacturing process

described previously, it is not widespread for all the products sold by the chains. This

process is carried on with those trendy articles, which constitute the 80 percent of the

30.000 models that the Group was able to place in the market during 2005; while the

remaining 20 percent correspond to the Basic collection, timeless articles which are

imported directly as finished products, mainly from Asia. Once accepted the design of

the products, and calculated the cost of each one, the design is sent to the

manufacturing factories to obtain the finished product that, again, will return to the

head office from whose centre of distribution will be sent to each point of final sale.

From the Group logistic centres, placed in Galicia for Pull & Bear and Zara, this chain

has another centre in Zaragoza as well with Kiddy’s Class. In Cataluña are located the

logistic centres of Massimo Dutti, Stradivarius, Bershka and Oysho, and finally a

common logistic centre for all the footwear of the Group in the Valencian

Community. These articles are produced in nearby factories. Attending to the

instructions of the distribution responsible, the products will be accumulating in the

spaces settled for every store. Then, some clothes in boxes and some still hung will be

disburdened in trucks for the European stores and by airplanes for the establishments

outside Europe.

4. RETAILING

The stores of the different chains are uniform in terms of decoration, lighting,

furniture and window display, as well as the allocation of the clothes. The Group has a

team of architects and decorators who adapt the buildings and spaces where the stores

are located to the different image of the chains. The location of its stores in a new

market is a quite important characteristic of the group. The store must be located in a

prestigious place. Some examples of good locations of its stores are the one located in

5th Avenue in New York or in the Champs Elysees, in Paris. Concerning commercial

aspects related to their establishments, such as merchandising, shop window design,

decoration and furnished of the stores; the lines are common and subsidiaries follow

those established by the design department in order to keep a consistent identity

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APPENDIX

through the time. Each chain of the group has its own identity which communicates to

all of its subsidiaries through its products, locations and design of its shops. As for the

logistics, Inditex follow the politics of delivery of the products twice a week,

changing all the products of high rotation, quality and trends every two weeks.

Normally the Inditex group politics respecting communication has been based in

"mouth to mouth", considering that the suitable location of the shops in central streets

and malls with high stream of popularity and human traffic, as well as the agreeable

exhibition, merchandising, window dressing and decoration of the stores, are the

major assets of its communication activities. Its campaign of advertising is limited to

scantly review during the season sales. In an International level, the company gets

adapted to the country specific relevant aspects like the dates of the season sales

periods, the language or the legal obligations. Nevertheless, given the characteristics

of the chosen location and if the group settles its first store opened in a new country,

the Group carries on certain communication activities during the previous weeks

before the opening.

2. SWOT ANALYSIS

STRENGHTS WEAKNESSES

INTERNAL ANALYSIS

• High level of Flexibility • Strong Brand Image • Low manufacturing costs • Self-financing

• Management concentration • Lack of skilled management • Possibility of unsatisfied demand

OPPORTUNITIES THREATS

EXTERNAL ANALYSIS

• Emerging markets -i.e.

East European countries- • Existing markets with

high potential -i.e. Canada, US- • Consumption behaviour • Better Infrastructures

• Existing competitors – i.e. El

Corte Inglés, Mango, Cortefiel- • Emerging Competitors –i.e. China- • Market Saturation • Political situation • Customers' negative attitude

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APPENDIX 3. MARKET SHARE EVOLUTION IN TEXTILE RETAILING

KINDS OF RETAILERS AND PERCENTAGE

1985 1995 1999 2001 2003 2004 2005

Multi-brand Stores 66,1 56,6 43,1 39,8 38,6 36 34 Department Stores 15,4 13,7 15,8 16,1 16,2 16 15 Specialized Chains 7,8 10,2 18,9 20,8 24,1 23 24 Hypermarkets 6,3 8,3 14 15,5 17 19 20 Outlets 0 0 0 0,9 1,5 4 5 Other Markets 4,4 11,2 8,2 6,9 2,6 2 2 Source: Acotex

0

10

20

30

40

50

60

70

1985 1995 1999 2001 2003 2004 2005

Multi-brand Stores

Department Stores

Specialized Chains

Hypermarkets

Outlets

Other Markets

4. SPANISH TEXTILE EVOLUTION

Years Sales

1996 15.841,68 1997 17.389,32 1998 18.343,17 1999 18.813,51 2000 19.223,64 2001 19.621,57 2002 20.347,56 2003 21.059,73 2004 21.516,72 2005 21.962,12

Source: Acotex Unit: Million €

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APPENDIX

5. INDITEX SALES PER CHAIN

2000 2001 STORES COUNTRIES TOTAL SALES STORES COUNTRIES TOTAL SALES Pull & Bear 229 10 172,60 249 13 225,70 Massimo D. 198 12 184,10 223 17 241,40 Bershka 104 4 134,90 151 7 202,00 Stradivarius 100 7 72,50 120 8 93,50 Zara 449 33 2.044,60 466 19 2435,10 Oysho 0 0 6,00 0 7 5,30 Kiddy's C. 0 0 0 41 0 47,60 Zara Home 0 0 0 0 0 0 Others 0 0 0 34 0 4,50 TOTAL 1080 33 2.614,70 1284 39 3.255,10

2002 2003 STORES COUNTRIES TOTAL SALES STORES COUNTRIES TOTAL SALES Pull & Bear 296 16 266,20 350 18 287,9 Massimo D. 250 23 287,30 297 23 388,9 Bershka 197 9 299,30 253 13 395 Stradivarius 153 9 124,10 191 9 162 Zara 531 28 2913,40 626 34 3219,6 Oysho 72 7 23,40 76 8 45,1 Kiddy's C. 59 2 60,40 103 2 89,7 Zara Home 0 0 0 26 4 10,6 Others 0 0 0 0 0 0 TOTAL 1558 94 3.974,10 1922 48 4598,8

2004 2005 STORES COUNTRIES TOTAL SALES STORES COUNTRIES TOTAL SALES Pull & Bear 371 19 367,20 427 23 445,10 Massimo D. 326 25 458,40 369 27 533,80 Bershka 302 23 508,80 368 20 639,40 Stradivarius 227 10 241,90 263 14 341,10 Zara 723 42 3.759,70 852 59 4.440,80 Oysho 104 8 71,70 154 10 107,00 Kiddy's C. 129 2 120,60 149 2 155,40 Zara Home 62 6 40,40 110 14 78,10 Others 0 0 0 0 0 0 TOTAL 2244 56 5.568,70 2.692 62 6.740,70

Source: Inditex Unit: Million €

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