According to Investopedia, the term “first mover” describes a competitive advantage that a business obtains through being the first to bring a specific product or service to market.
The story of Amazon highlights the advantages that being a first mover brings – the firm created the first internet bookstore and by the time its high street counterparts established an online presence, its dominance of this sector was so complete it had already begun to parlay its first-mover advantage into other products.
However, if you don’t have the advantage of being the first to move into a field, you can also come to dominate it by being the best at what you do and this is what has given Inditex an advantage over its peers in the field of fashion retail, according to Alistair Wittet, manager of the Comgest Growth Europe ex UK fund.
Inditex owns many household brands such as Zara, Pull&Bear, Bershka and Massimo Dutti, but with a strong physical presence – it has approximately 7,000 stores worldwide – Wittet said this is the sort of company you would have expected to suffer the most from the boom in e-commerce – especially as it didn’t establish an online presence until relatively late.
“When I first came across Inditex in 2006, it actually said it didn’t want to go online as it thought it wasn’t appropriate for its businesses model and it didn’t see it becoming a big thing,” he explained.
“It said at the time ‘people want to try on clothes, they don’t want to buy them over the internet’ and it was actually one of the last retailers to go online.”
When Inditex finally began to sell clothes online a couple of years later, it first carried out a deep analysis of the market to work out the best way to play this theme. Wittet said it discovered that far from being a huge burden, having a large physical presence could actually be used as a competitive advantage – and not for the more obvious reasons such as offering its customers the chance to try on clothes.
“What it found was that in many cases where a consumer bought online, about a third of the time they went into a store to pick up the clothing instead of waiting in at home for it to be delivered,” he explained.
“And what’s more, when customers came to return the clothes, in two-thirds of the cases they went into the store even though it was free to have it delivered and returned online.
“Analysis carried out by shopping mall operator Unibail Rodmaco also shows that three-quarters of the time when a consumer picks up an order or makes a return instore, they make another purchase in that store.
“So they find some sort of inspiration – in fact that’s actually one of the reasons why consumers go into the store, particularly on the returns side, it’s because they are interested in seeing what they can try on in a different size or a different model.”
However, while Inditex found there was a synergy between online and physical retail, Wittet said it had to completely re-think the way it was using its stores. For example, whereas a decade ago passengers at large train stations would arrive early to browse physical stores, they are now more likely to get straight on the train and browse through the online store on their phone.
But while secondary locations are becoming redundant, primary locations such as Oxford Street and the Westfield shopping centres, for example, are becoming more important. Analysis from Unibail Rodmaco shows these are bucking the trend of declining retail traffic, demonstrating a healthy increase in footfall.
“Inditex moved very quickly when it realised this,” Wittet continued. “So in 2012 it had about 5,000 stores, but it closed about a fifth of those over the course of the next five years.”
Again though, the manager said the decision of which stores Inditex selected to close down did not follow the obvious route. Rather than simply shutting down unprofitable stores and ploughing the money into those it expected to make money, it is shutting down many profitable stores where it fits in with its long-term strategy.
“Inditex is actually a company with a family of shareholders behind it and I think you would be hard pressed to find a FTSE-listed company closing profitable stores,” the manager explained.
“And the reason it is doing it is that, yes, it is losing some profit in the short term, but it is very clear in the direction that it thinks the retail industry is going. It would rather take the hit now and position itself well with prime real estate shopping centres than have to wait five or six years and wait for these stores to turn loss-making and have to do a catch-up job then.”
“So it proactively closed a fifth of its stores, then remodelled two-fifths of its stores for online and enlarged them. In 2012, the average store size was less than 1,000 square metres – it now sees the optimal store size of around 3,500 square metres, so a huge store that has all of the ranges within it, and it becomes a bit of an advertising front for the retailer.”
Wittet said: “This is where the consumer goes in, you have what should be a pleasant shopping experience where you are kind of browsing, looking at what there is to buy, and then you may go home and buy it online if you want.
“But the shop is no longer a practical place where you are buying, it is much more than that, it is like an experience.”
Inditex’s share price has taken a hit recently, falling by approximately one-third since last June. However, Wittet is relatively unconcerned, pointing out the market had simply got ahead of itself and that earnings have continued to grow over this time – the company is currently trading on a P/E (price-to-earnings) ratio of 23x compared with approximately 30x last year.
There had been question marks about a decline in certain fundamentals – its gross margin fell from 60 per cent in 2012 to about 56 per cent today, but the company attributed this to currency movements and said that excluding this effect, the figure would be flat.
Like-for-like sales growth has also fallen from a peak of 10 per cent to about 4 or 5 per cent today. However, Wittet said the spike in sales coincided with a take-off in its online proposition, which led to improved footfall in its stores and an acceleration in sales at its retail outlets as well. The manager added that the current number is more in line with Inditex’s long-term average and that the most important number to look at concerns its growth potential.
“Our view is that if you take its most mature brand, Zara, it has about a 15 per cent market share in Iberia and 3 per cent in Mexico,” he said.
“Apart from that, you are talking about a sub-1 per cent share in pretty much every single one of its markets. Looking at it from that angle, its most mature brand is probably not going to get to Iberia levels, but can it get to a 4 to 5 per cent market share in a lot of these markets? Why not?
“So I think Zara itself has huge growth potential and then you are not even factoring in the other seven brands, some of which like Zara have mass market appeal and are not just niche brands. Bershka or Pull & Bear, for example, these are mass-market fashion brands and there is no reason why they can’t become as successful as Zara.”
Data from FE Analytics shows Wittet has made 66 per cent since he started running money in January 2015, almost twice as much as the 34.44 per cent from his peer group composite.
Performance of manager vs peers over career
Source: FE Analytics
The top-performing Scottish Mortgage Investment Trust holds Inditex in its top-10, as do two funds in the IA universe: Seilern Stryx Europa and Seilern Stryx World Growth.