This is the second part of my latest call with Richard Chamberlain, Head of Consumer Discretionary research at RBC Capital Markets Europe. The live session was exclusive to RBC clients, but these are the notes from the meeting.
You can read the first part here
RBC: How have supply chain bottlenecks changed the way fashion retailers think about their level of inventory?
Alfonso Segura: I feel retailers learned that a made-to-stock model and 3-4 months lead time, where 45 days are ocean shipping, is a high risk when you own a global seasonal business within such volatility.
Fast fashion receives heavy criticism in the industry but most fashion retailers, from sportswear to luxury, are breaking seasonality as well, with micro-collections, drops, limited editions, collaborations with other brands or customizations. The goal is to reduce overstocking risks, reducing days of inventory and increasing cash flows.
Nearshoring is also reducing the risk of supply chain bottle necks. Traditional retailers commit around 60% of their purchases 6 months in advance (during pre-season). Inditex commitment is around 20%, so they can purchase during in-season with higher probabilities to meet demand. This is about reducing the quantity of items by purchase order. In relation to this, algorithms and artificial intelligence are helping brands to improve demand forecasting, assortment and allocations optimization, gaining operational efficiencies (sending the right quantity, to the right place, at the right time).
Finally, more hardware, more software, more data to make better decisions. For instance, RFID to track and trace inventory or systems to orchestrate inventory balancing between channels and integrate stock to allow ship from store or click&collect.
RBC: Do you see benefits from RFID and stock integration still to come for Inditex?
This is Inditex’s competitive advantage compared to other retailers. Inditex has RFID across its value change whereas some others have it only in the warehouse. That means the entire supply chain is aligned and gives flexibility right the way from suppliers to stores.
RBC: Do you think the pandemic has resulted in a structurally lower level of discounting, or will this return to normal over the next 1-2 years?
We observe a decrease in discounts, as well as their percentatges. If you compare peak sales period or recent events like Black Friday, you will see that retailers didn’t make so many discounts (less items in discounts and also a lower percentage of discount). The reason is mostly coming because of lower level of purchased orders (also important to note that many suppliers couldn’t produce due to covid because some factories were closed), but also because retailers are improving the way they manage merchandise planning, including merchandise financial plan, demand forecasting and store allocations, enhanced as well by omnichannel capabilities. More and more companies are learning how to manage the buying process during uncertain times.
Technology and data are allowing companies to optimize their inventories, therefore taking better decisions when doing discounts (eg what % of discount to apply, or what categories or items to discount). Another important change is how leading brands are investing in data analytics, artificial intelligence, CRM systems (Customer Relationship Management solutions) and loyalty programs. These brands won’t only do general discounts, with large advertisements in high-streets but individual discounts using messages, mails, apps notifications and social media ads. The future is about individual personalized promotions.
RBC: Have fashion retailers made such good profits online during the last two years, that as stores now come back they’ll see a negative impact on their margins?
Physical retail shopping is increasing again. Some brands are closing stores, but are opening bigger ones as well in areas with more traffic. The pandemic is also impacting on retail location. Some street that were profitable before the pandemic are not profitable any more. Shopping is social and in many cultures and age segments, is part of the lifestyle. In that sense, retail is not dying at all.
If you ask me about online business margins….Knowing if a fashion retailer is making profits in online seems a big secret in the industry. I didn’t see any online P&L published but I can tell you that online is not a very profitable business in many cases. Online sales are growing but profitability is not increasing at the same level. Margins are decreasing: digital marketing costs increased; production costs are increasing; shipping costs are increasing; and returns are very high (around 40%) while the cost of managing this returns is quite unknown and returns usually go directly to outlet stores or discount outlets.
Online needs physical stores, and physical needs online. The complexity is orchestrating the omnichannel business and factors such marketing, sales channels, pricing strategy, product, logistics, commissions, and so on. Omnichannel brands will be the ones with higher profits, but they need best-in-class capabilities and systems to deal with such complexity.
RBC: Are you seeing a shift in retailers’ expansion plans as a result of recent political developments? eg Inditex appear to be focusing more on the US (now their second biggest market after Spain), having been pushing so hard in Asia for many years.
Inditex has over 7,000 stores in 96 countries worldwide, so its expansion plan is far different from brands that are still in earlier maturity phases. It’s surprising to see how Inditex, specially Zara is having success in the US because most European fashion retail brands in the mass-market segment and even in the affordable luxury segment, failed many times there (eg Mango).
The geopolitical situation and its impact could redefine expansion plans. Retail departments will reduce risks so I expect brands to focus in fewer geographies, and also keep collaborating with local partners. I see also marketplaces as a channel to increase expansion in different markets. Omnichannel is giving more tools or redefining expansion strategy. Now brands can define the expansion in a country by phases. For example, first phase entering through marketplaces, then to open an ecommerce (owned site), next opening pop ups to keep building bran awareness and then opening through department stores and direct owned stores.
Finally, in relation to expansion and new players, I expect more and more startups, pure-players, opening physical stores. I met recently with different pure-players that sell accessories, apparel, sneakers…and they told me margins are decreasing and physical channel is key to them.
RBC: How concerned should fashion retailers like H&M and Inditex be from the rise of Shein? Does its rise indicate fast fashion is still growing but some new players are taking share?
Shein seems to be transforming the industry, or at least, adapting to a generation faster than leading retailers like H&M or Inditex. It’s incredible to see how many products they launch every day and how they partner with designers and take advantage of their platform. It’s fast fashion in the long tail economy empowered by social media.
I don’t have enough information about them in relation to sales, margins, inventories…but I’m sure competitors are realizing that new generations shop differently. I expect Primark and other low-cost brands having issues to compete with such a retailer. In Europe, there is no brand selling online at this price points. Even Primark is not selling online due to low-margins and the cost of selling online (digital marketing, reverse logistics cost, and so on). Shein is giving free delivery for purchases over 9€ and free returns. If I calculate logistics cost, I already see a risk in profitability and I didn’t included headcount, COGS or marketing.
There is at least one thing that don’t convince me about Shein and it is their poor transparency, far from Inditex and H&M. I’m talking about suppliers visibility, human rights, use of raw materials and recycled fabrics… In fact, they faced trademark disputes, human rights violations, and health and safety concerns. Shein could face challenges to sell in some western countries if regulations increase. What if Europe and other regions increase their restrictions in relation to brands and sustainability? Another question is: young generation care about sustainability?
Finally, and as already commented by other experts, social polarization is increasing so we could expect an increase in low-cost brand sales, while luxury keeps growing.
Q&A – Question 1: I understand you’re based in Spain in the Barcelona area. What consumer trends are you seeing there, in particular are consumers starting to react to cost inflation pressures?
Inflation is high, mostly due to the price of energy and gas but fashion is something very cultural in Spain – summer is coming, people like to socialise and so they will reduce the purchases of some categories that they don’t need. But fashion should be resilient as it’s a kind of self-marketing. People like to look good and so fashion remains an important purchase, at all brand levels. After two years of pandemic people want to spend and are saving money in other sectors. LFL sales are increasing in Spain.
Q&A – Question 2: How do you see the competitive landscape evolving? Is it more difficult for new entrants to build brands on online marketplaces, that favour incumbents?
If we speak about Shein as a fairly new entrant, Shein is doing what Amazon did – it is trying to gain market share, which is why it is happy to lose money in some countries in the short term. Competition in Europe will be difficult for them due to the brand awareness of H&M, Inditex and others. However, the new generation are purchasing from sites like Shein, plus receiving an item in 24 hours is not as important for them. Data and analytics will help retailers to adapt to younger generations.