Two Threats to the Big China Dreams of Zara and H&M

Written by Guest Post on September 22, 2017


H&M and Zara are two companies I pay a lot of attention to in China.

  • They have great business models. Fast fashion is really impressive in general.
  • They are popular with Chinese consumers.
  • They are both following market leader Uniqlo in terms of expansion into second and third-tier cities.
  • They seem to be growing steadily, despite slowing growth in apparel overall.

Overall, both look like big winners in China going forward. But I think there are two potential threats emerging. More on this in a second. First a quick diversion.

I keep a list of questions that I think are both important but difficult. These are things I try to figure out over time. One of these questions is “will fast fashion work the same in China as elsewhere?”. As exemplified by Zara and H&M, fast fashion has been a stunningly powerful business model. It continues to expand in the Europe and US – and is now growing in emerging markets. But it’s still not clear to me how well it will do in China, where consumers are fickle, competitors are ferocious and mobile/ecommerce appears to be changing almost everything in retail.

My answer to this question, thus far, is that the Western fast fashion giants are well positioned for China and for rising Chinese consumers.

The Zara and H&M business model has been studied extensively. It relies on syncing consumer behavior in stores with centralized design/manufacturing capabilities. Zara is the more extreme case with manufacturing in-house and re-design and shipping done on almost a weekly basis based on customer purchases. H&M, in contrast, has most of its manufacturing outsourced to Asia.

This “quick reaction” apparel platform makes great sense in China. If >50% of a season’s merchandise is re-mixed and re-designed during the season, that enables you to change with rapidly changing Chinese consumers. In this, “quick reaction” has a strength (i.e., reacting in real time to changing tastes) where many other Chinese consumer-facing companies have a perpetual problem.

This operating model also enables them to push discount versions of the latest designs from the fashion capitals (Paris, Milan, etc.) to China stores in a couple of weeks. Having design centralized in Europe also probably helps these stores in China. It is a differentiating strength relative to both local Chinese competitors and to “slower fashion” houses like Gucci and Prada.

Overall, fast fashion still looks like a great approach for rising Chinese consumers.

One more quick aside

(skip to the below points if you’re reading quick).

One of the benefits of fast fashion is you can have multiple style waves instead of 2-3 fashion seasons per year. One result of this is that consumers tend to come in more often as there is frequently new stuff to see. This, in theory, gets you greater revenue (people come more and buy more). You also get a greater “share of the consumer mind” (a Warren Buffett term). Greater frequency of consumer activity generally creates a stronger brand and a better relationship.

Financially, these frequent style waves also show up as less discounting of goods (a perpetual problem in fashion retail), higher revenue, and better working capital. That’s the theory anyway. And H&M and Zara do produce tons of cash, which they can then put into more scale and more stores. It’s a powerful approach when compared to traditional department stores or luxury fashion houses.

That said, it’s not clear to me that you get these same benefits in China. In particular, I don’t know if you see the same increased visits and branding benefits. Cycle times are already pretty fast in China. Most of the textile/apparel production is actually done in China / Asia. And I’m not sure you have the same historical expectations for a seasons’ new merchandise to contrast with. So I’m not sure about the revenue and gross margins of this model in China. Gross margins are typically 60% elsewhere.

Ok. Back to my main point, that there are two threats to the big China dreams of these fast fashion giants.

Threat 1: Ecommerce, mobile, and O2O are happening fast in China – and these companies are not real fast at this stuff.

Retailers are pretty much ground zero for changes in Chinese e-commerce, mobile, and online-to-offline activity. Digital transformation is hitting this sector like just about no other (except maybe auto and transportation).

First, the rapid adoption of everything mobile in China is transforming the interface with consumers. It is no longer just about walking in the mall and then going into a nice store like it might happen in Sweden. The Chinese customer experience is already a combination of the mall, a store, your activities in various online ecosystems and a rapidly developing logistics/delivery network. The two words you hear over and over in Chinese retail are digital and delivery. How this offline-online mix is going to play out and what “new retail” is going to end up looking like is unclear. But Chinese retail is where it is happening really quickly.

Against this rapidly changing Chinese retail landscape, here are some disturbing facts. Zara didn’t have an online store until around 2010 (about a decade after the Gap). And H&M didn’t start online sales in the US until around 2012. They also didn’t open a shop on Tmall until 2014. These companies are notoriously slow in digital stuff.

Both Zara and H&M are awesome in inventory and logistics. That is their strength. They have a powerful supply chain that connects retail activity around the world with centralized design and manufacturing, almost in real time. But they have been pretty slow when it comes to ecommerce and mobile. And these are precisely the things that are happening quickly in China – and that their Chinese competitors are particularly good at.

Threat 2: The local Chinese competition is moving upmarket.

You also need to consider the recent actions of the Chinese apparel giants such as Peacebird, Heilan, and Septwolves. They operate about 10x more stores than the foreign companies. Zara, H&M, and Uniqlo have 200-500 stores each. Helian and Septwolves have 2,000-4,000 stores each.

These big local competitors have historically been cheaper but they are now upgrading and moving upmarket. They are going to increasingly challenge Uniqlo, Zara, and H&M, especially as they continue to expand into second and third-tier cities.

When you combine #1 and #2, things get really interesting. What happens when you combine rising Chinese competitors with big digital, mobile and ecommerce disruptions? Does that change the fast fashion business model that has been so powerful in so many countries? This is the question I have been thinking about.

Anyways, that said, both H&M and Zara do appear to be in great shape in China right now. They both continue to open tons of China stores each year. They have a nicely adaptable model that is well-suited to the continually changing preferences of Chinese consumers. And Chinese consumers keep getting wealthier and wealthier. So that is all pretty great.

These companies may well turn out to be unbeatable in China, just like in most other places. But I am keeping an eye on these two particular threats to their China plans. We’ll see.

The first version of this article was published here