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Author: Roco Snchez Heres Supervisor: Jens Vestergaard

Aarhus School of Business

MSc. in Finance & International Business February / 2007

ABSTRACT..3 1. INTRODUCTION..4 1.1. BACKGROUND..6 1.1.1. Inditex brief history.....7 2. REASONS BEHIND INDITEX INTERNATIONALIZATION9 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 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 Analysis44 3.3.1. Porters Five Forces..44 3.3.2. Actual Competitors...50 3.3.3. Demand.52 Market Share52 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 companies73 4.3. Inditex international evolution74 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



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 Porters 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.


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 Diseo 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.


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


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.


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


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.


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 Corua.

Right alter this first opening, between 1975 and 1980. The Company established more Zara shops in different cities of its region, Galicia -La Corua, 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. -7-

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 Corua, 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 Len.
YEAR OF INDITEX's ENTRY ON ITS DIFFERENT MARKETS YEAR 1.975 1.988 1.989 1.990 1.992 1.993 1.994 1.995 1.996 1.997 1.998 1.999 2.000 2.001 2.002 2.003 2.004 2.005 2.006
Figure 1. Inditex COUNTRY

Spain Portugal United States France Mxico Greece Belgium, Sweden Malta Cyprus Norway, Israel Argentina, United Kingdom, Venezuela, Lebanon, Arabs Emirates, Kuwait, Turkey, Japan Netherlands, Germany, Poland, Saudi Arabian, Bahrain, Canada, Brazil, Chile, Uruguay Andorra, Qatar, Austria and Denmark Puerto Rico, Jordan, Ireland, Iceland, Luxembourg, Czech Republic, Italy Finland, Switzerland, El Salvador, Dominican Republic, Singapore Slovenia, Slovakia, Russia, Malaysia Hong Kong, Morocco, Estonia, Latvia, Romania, Hungary, Lithuania, Panama Monaco, Indonesia, Thailand, The Philippines, Costa Rica. Serbia, Continental China, Tunis


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, Kiddys Class in 2002, and finally the most recent format Zara Home in 2003.


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, -9-

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 companys 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 Vernons 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 Vernons 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.


Managerial Urge Marketing Advantages Economies of scale Unique product competence Risk Diversification Extended sales of a seasonal product Excess capacity of resources

Foreign Market opportunities Change Agents


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 companys 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.


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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Following Penroses (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 firmspecific, 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 - 17 -

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 Porters 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 -homedemand 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.




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.


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 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.

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

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

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As its own name states an eclectic theory is a conceptual approach that does not hold 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 Dunnings approach.

Dunning (1988) has combined elements of internalization of processes with another 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.

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

The second condition states that the firm must have internalization advantages; that 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 companys 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

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generally, lacks of dynamic considerations, at the time of describing why a company goes international, Dunnings 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 companys 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

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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 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.

Vernons basic premise is that manufacturers in developed countries are closer to the 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.

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

Knickerbocker (1973) found that oligopolistic firms tend to match their rivals 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 companys attitude

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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 Grahams 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 Rugmans 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.

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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) 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

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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 Vernons 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

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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.








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

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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 partare 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.





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

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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 firms 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

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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 companys current activities.

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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 firms 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

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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 companys 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.


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 Degree of COMPANY internationalization LOW HIGH

The early starter

The late starter The international among others

HIGH Figure 6. Johanson and Mattson, 1988

The lonely international

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).


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 (Durn, 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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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 Ingls 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 decade 2 as a consequence of the decentralization -from Spain to developing countries where the labour costs are lowerof some textile processes of the manufacture, since 2002 the percentage has increased near 1,8 percent.

1 2

Distribucin y Consumo Magazine, 2004 Acotex 2005 annual report, El comercio textil en cifras

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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 clothes 3 . 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 1991 4 . 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 4

Spanish Chambers of Commerce, 2003 Lneas de Negocio en Internet Lus Alonso lvarez, 2000. Vistiendo a tres continentes

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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 inhabitants 5 , a 6,7 percent of the Spanish population 6 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. 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 6

Secretara de Estado de Inmigracin y Emigracin Instituto Nacional de Estadstica

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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 Asia 7 . 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.

Inditex annual report 2005

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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 industrys 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.
74.000 72.000 70.000 68.000 66.000 64.000 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Figure 7. Acotex, 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

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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.

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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 buyers 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. Porters 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 Suppliers

Competitive Rivalry

Bargaining Power of Customers

Threat of substitutes

Figure 8. Porter, 1980

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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 companys 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 Ingls, 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 - 50 -

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 Ingls: 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 Ingls 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 Ingls 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 Ingls 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 Algodn'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.

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In the Spanish market there are also other national competitors, fashion designers of recognized prestige in the national market like Adolfo Domnguez or Purificacin Garca, 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. 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 - 52 -

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.
Other markets Outlets Hypermarkets Multi-brand Stores

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 Ingls. 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 Ingls, 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 Ingls 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 2004 8 . The Inditex weight between the first five companies is the 25,43 percent, following El Corte Ingls 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

Acotex, sector information 2005

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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 INE 9 , 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.
Nr. OF STORES 671 1321 617 228 40 100 290 60 163 59 20 76 110 47 52 239 66 181 64 VARIATION 03/04 7,10 23,30 5,40 6,40 87,20 -1,90 3,10 33,70 3,10 37,30 33,20 45,00 3,20 14,60 11,00 13,10 -3,60 14,70 12,40

COMPANY El Corte Ingls, S.A. Grupo Inditex* Grupo Cortefiel* Mango MNG Holding, S.L.* H&M Moda, S.L. Prenatal, S.A. Grupo Adolfo Domnguez* Sociedad Textil Lonia, S.A.* Bassi, S.A.* Pepe Jeans, S.L. Caramelo, S.A.* Depsitos Almacenes nmero uno, S.A. Julin Rus Caibano, S.L. Sumbawa, S.L. Promod Espaa, S.A. Franchising Calzedonia Espaa, S.A. Groupe Zennier Espaa, S.A. Milla Med, S.A. Industria Franco Espaola de Moda, S.A. Figure 9. Alimarket

SALES 03 13.643,52 4.599,00 921,25 782,00 113,76 142,72 122,64 86,00 94,94 69,17 69,12 47,06 59,41 48,00 48,00 39,78 40,84 34,00 32,15

SALES 04 14.607,72 5.670,40 971,27 832,00 213,00 140,00 126,45 115,00 95,00 95,00 92,10 68,23 61,34 55,00 53,30 45,00 39,38 39,00 36,13

INE Instituto Nacional de Estadstica, Commercial Survey, 2004

- 55 - 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 firms 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 researchers 10 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, customers 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

ACNielsen Research, 2003

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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.

25000 20000 15000 10000 5000 0 1996 1998 2000 2002 2004

Unit: million Euros Figure 10. INE - Instituto Nacional de Estadstica.

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.

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5000 4000 3000 2000 1000 0
Pull & Bear





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 Groups 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 - 59 -

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 companys 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 Ingls 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 companys 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 - 63 -

fulfil the requirements of the company and who share the philosophy of the Group. When Mr. Jos Mara Castellano Ros, 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 wobbled 11 . 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 Ingls in the Spanish market. It is possible that taking in consideration alternative uses as the electronic commerce would increase the Groups 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 Groups 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

Newspaper El Mundo Economy 25/09/2005 The Financial Times 06/06/2006

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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 Comerciales 12 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


Law 17/2000, December 29 , Ley de Equipamientos Comerciales

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Catalonian commercial surface in January 2005 13 . 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.


El Pas Newspaper, 11/01/2005

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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 Dunnings 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








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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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 - 72 -

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.


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 percent 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

Instituto Nacional de Estadstica 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 Romania 15 .

This process has been carried on especially by companies with their own distribution networks which represent an important part of commercial flows.


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 Corua, 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


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.


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, Portugals second largest city. The Groups 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 Zaras 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 - 75 -

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 companys 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.


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 companys - 77 -

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 - 80 -

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 Licensing Joint Venture Wholly owned subsidiary Control Source Commitment Risk Dissemination

Low Medium High

Low Medium High

High Medium 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 - 83 -

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 - 84 -

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-howconstitutes 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.


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 - 86 -

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.


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 companys 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 company 16 . 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 law 17 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.

Library of Congress Federal Research Division Country Profile: United Arab Emirates, March 2006 17 Law No. 8/2001, Resolution No. 1006/1/2003

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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

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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 foreigners 18 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

ICEX Files Spanish Economic and Commercial Bureau in Moscow 2004

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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 Polands 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 Lithuanias 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.


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 - 91 -

-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 companys 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 world 19 and specialized on the distribution sector. Otto Versand experience is a high value asset

Expansin 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 market 20 . 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 companys 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 21 ending this short joint venture and fully increasing its control.

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 21

Canadian News Wire Reitmans Interim report 02/11/2002

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partners around the world. Inditex wants to enter the Italian market 22 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 Zaras 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 2001 23 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. Percassis 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 23

Expansin Newspaper 19/03/1999 El Pas 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 Bigis 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 Bigis shares 24 . 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 25 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.

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 25

El Mundo Newspaper 14/12/2005 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 firms 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 -


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. - 97 -

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.


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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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


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 Kiddys 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

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 Kiddys Class. In Catalua 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 vi

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


High level of Flexibility Strong Brand Image Low manufacturing costs Self-financing

Management concentration Lack of skilled management Possibility of unsatisfied demand

OPPORTUNITIES EXTERNAL ANALYSIS Emerging markets -i.e. East European countriesExisting markets with high potential -i.e. Canada, USConsumption behaviour Better Infrastructures

THREATS Existing competitors i.e. El Corte Ingls, Mango, CortefielEmerging Competitors i.e. ChinaMarket Saturation Political situation Customers' negative attitude




KINDS OF RETAILERS AND PERCENTAGE Multi-brand Stores Department Stores Specialized Chains Hypermarkets Outlets Other Markets
Source: Acotex 1985 66,1 15,4 7,8 6,3 0 4,4 1995 1999 2001 2003 2004 2005 56,6 13,7 10,2 8,3 0 11,2 43,1 15,8 18,9 14 0 8,2 39,8 16,1 20,8 15,5 0,9 6,9 38,6 16,2 24,1 17 1,5 2,6 36 16 23 19 4 2 34 15 24 20 5 2

70 60 50 40 30 20 10 0 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





Pull & Bear Massimo D. Bershka Stradivarius Zara Oysho Kiddy's C. Zara Home Others

229 198 104 100 449 0 0 0 0 1080

10 12 4 7 33 0 0 0 0 33

172,60 184,10 134,90 72,50 2.044,60 6,00 0 0 0 2.614,70

249 223 151 120 466 0 41 0 34 1284

13 17 7 8 19 7 0 0 0 39

225,70 241,40 202,00 93,50 2435,10 5,30 47,60 0 4,50 3.255,10



Pull & Bear Massimo D. Bershka Stradivarius Zara Oysho Kiddy's C. Zara Home Others

296 250 197 153 531 72 59 0 0 1558

16 23 9 9 28 7 2 0 0 94

266,20 287,30 299,30 124,10 2913,40 23,40 60,40 0 0 3.974,10

350 297 253 191 626 76 103 26 0 1922

18 23 13 9 34 8 2 4 0 48

287,9 388,9 395 162 3219,6 45,1 89,7 10,6 0 4598,8



Pull & Bear Massimo D. Bershka Stradivarius Zara Oysho Kiddy's C. Zara Home Others TOTAL
Source: Inditex Unit: Million

371 326 302 227 723 104 129 62 0 2244

19 25 23 10 42 8 2 6 0 56

367,20 458,40 508,80 241,90 3.759,70 71,70 120,60 40,40 0 5.568,70

427 369 368 263 852 154 149 110 0 2.692

23 27 20 14 59 10 2 14 0 62

445,10 533,80 639,40 341,10 4.440,80 107,00 155,40 78,10 0 6.740,70