Outsourcing May Hurt Fashion Manufacturers' Bottom Line
STANFORD GRADUATE SCHOOL OF BUSINESS — Most companies in the fashion industry are firmly entrenched in a business model that involves outsourcing production and distributing products through cheaper, "slow boat" channels. Research at Stanford Graduate School of Business, however, suggests that while this approach seems to make economic sense it may actually create gross inefficiencies that cause firms to miss out on significant profits.
Researchers say fashion firms are best off when they combine highly fashionable, trendy product designs with short production and distribution lead times — in many cases producing goods closer to home. By getting goods into shoppers' closets when they are in demand, and not producing leftover unneeded inventory that will be dumped onto a sale rack, retailers are more likely to get customers to buy early at full retail price. The profit margin increase under this combined scenario is exponential.
Using the more traditional outsourcing models requires long production lead times — generally six to nine months — handicapping success because producers may miss trends or changes in consumer tastes. By timing production to take place a few weeks before the selling season rather than half a year or more, a firm can capitalize on more accurate estimates of demand.
Researchers find that when both rapid production and enhanced design are done together — allowing the latest merchandise to get into the hands of consumers quickly and with little overstock — a firm's profits increase by up to twice the sum of the extra profits that would have been earned from each activity alone.
"For example, say a firm were to earn 10% more through creating trendy products alone, and 10% more by achieving rapid production," explains Robert Swinney, assistant professor of operations, information, and technology at Stanford Graduate School of Business, and one of the authors. "If that company were to accomplish both together, it would earn much more than a 20% increase in profits. In fact, it would earn something more like a 40% increase. Fast fashion is thus more than the sum of its independent components."
The fast fashion system circumvents one particular problem that has long plagued the apparel industry: consumers who wait around for end-of-season sales. "This phenomenon hurts retailers," says Swinney, who authored the paper with Gérard Cachon of the Wharton School of Business. "Fast fashion trains customers not to expect that highly desirable items will be left on the clearance rack," he says. Because supply is more accurately tied to demand, the good stuff doesn't linger.
The model shows that combining high fashion with rapid production works extremely well to induce even the most sale-oriented individuals to buy early. In fact, a firm's profits can spike up as much as 350% among this die-hard group.
Fast fashion is not just good for retailers, say the researchers, it's also good for consumers. "From a social point of view, 75% of the time fast fashion leads to greater overall welfare," says Swinney. "People get a premier item that they value highly. Because production times are short, they get it when they need it. Plus, there's less overproduction and waste."
But Zara's success also exemplifies what Swinney and Cachon's model demonstrates: Profits still significantly outweigh costs. "Zara can take a design from the drawing phase to the storefront in a few weeks. If they outsourced, this process would take half a year or more," says Swinney. "The approach allows them to anticipate, spot, and take advantage of consumer needs and trends, and tag production to actual demand. They do very, very well using this strategy."
The paper therefore has important implications for apparel companies that outsource their production. "Firms might want to reevaluate the supposed economic utility of this practice," says Swinney. "It may be that it's better to have production facilities closer by so that it takes less time to get your merchandise from point A to point B."