Founded in 1965, the Benetton Group started with limited resources that necessitated the strategy that ultimately resulted in rapid international growth. Since the beginning, Benetton concentrated on devoting its skills to the design and manufacture of quality clothing instead of providing direct consumer retailing. Benetton established a competitive advantage by establishing its brand as the best-known Italian apparel manufacturer, concentrating mainly on fashion-conscious young consumers from their mid teens through mid thirties. Since almost 85% of its production is subcontracted to approximately 500 contractors both in Italy and abroad, and most retail stores are independently owned, Benetton does not have direct managerial control over production and sales operations. Additionally, Benetton's in-house operations and manufacturing partners are largely centralized in Italy (as much as 82% of core manufactured products were produced in Italy), making them susceptible to exchange rate fluctuations. On the retail side, Benetton utilizes contracted agents working on commission to establish and support retail outlets.
The entrepreneurial agency system helped Benetton to rapidly expand their retail network, and thus, push more Benetton products. However, the agency system does not provide the operational support to retail stores found in centrally controlled retail competitors, like The Gap, and cannot enforce any commonality in layout, stocking, or d'ecor from store to store. Additionally, the compensation structure for agents only encourages sales. There is little direct incentive to share best practices with other agents in different territories, to share business intelligence with Benetton, or to devote resources to helping build the Benetton brands. In other words, the agency system encourages the 'free-rider' effect. It is recommended that Benetton alter its strategy in four steps to defend its core markets, and to prepare itself for future global expansion into new markets.
In other words, Benetton needs to achieve globalization for its long-term growth, and to achieve production efficiencies to compete, but must first address structural problems in its current core markets. The drawbacks in the current retail system of independent retailers being identified, established, and supported by agents working on commission were discussed earlier. It is recommended that Benetton's first operational change is to begin transitioning retailer support in-house, in order to provide better service to retail outlets, to provide more control over retail representation of the Benetton brands, and to reduce the free rider effect. Direct control of retail support will also yield better demand forecasting for Benetton, by allowing more influence over the product mix ordered by retailers. Benetton estimates that filling the role of the agents will require 500 people worldwide. Given sales of $1.
7 billion in 1993 (Exhibit 5 of the case), a 4% commission means that Benetton can afford to spend $136, 000 per year for each of the 500 new employees necessary to fill the agent role with no impact on expenses, which appears reasonable. Additionally, extrapolating a ratio of agents to stores from the data given for the United States (six agents supporting 265 stores) yields an estimate of 141 people necessary to service all 6, 113 stores worldwide. This assumes that one Benetton employee fills the role of one agent, but if this assumption is true, it appears that Benetton's estimate of 500 people is quite liberal. As a second step, it is recommended that Benetton establish more flagship stores under direct corporate control.
At a negligible cost of $500, 000 per store, Benetton can double the number of flagship stores in large commercial centers of cosmopolitan cities for a total cost of $17, 500, 000, or approximately 1% of 1993 sales. These flagship stores serve not only as high-volume retail outlets, but also provide Benetton with a directly controlled channel to exhibit its brand image, and to test out new ideas, promotions, and marketing concepts. The concept of taking over all 6, 113 retail outlets in order to mimic the model of The Gap and The Limited was rejected for several reasons. Cost of over $600 million (approximately 6, 000 stores at a conservative estimate of $100, 000 acquisition cost each) is certainly a consideration, but the fact that Benetton has never concentrated on large-scale worldwide retail operations seems to be a recipe for failure.
Additionally, Benetton's profit / sales ratio of 7. 6% exceeds that of The Limited, and is roughly equivalent to The Gap, meaning that Benetton is not missing out on large profit margins from owning and operating their own retail establishments. By comparison, Nike's profit to sales ratio of 9. 3% validates their strategy to stay away from large-scale retail operations. By expanding its stable of flagship stores, Benetton will enjoy the same benefits that competitors get from retail outlets that mirror the brand's image, without the administrative burden, cost of capital, lack of flexibility, and lack of fit for Benetton to operate all 6, 000 locations. Michael Porter stated, "The role of the domestic nation seems to be as strong, or stronger, than ever.
While the globalization of competition should lessen the importance of the nation, it does actually increase this importance... The domestic platform is where the competitive advantages of the firm are created and maintained." This view is applicable in the case of Benetton, and defines the logic behind the third recommended strategic initiative. Benetton is a global firm with footprint in 120 countries, but its operational and strategic roots are still deeply grounded in Northeast Italy, as illustrated in Appendix 1. Benetton possesses a significant competitive advantage with its domestic elements: centralized design, production and distribution.
Additionally, the European market accounts for upwards of 80% of Benetton's total sales (in both volume and revenue, Exhibit 6 of the case), with the Italian domestic market consuming approximately 30% (Exhibit 7 of the case), making it the largest national market. Benetton derives a great deal of its brand identity from its European design and production, as demonstrated by its investment in Formula 1 auto racing and high-concept advertising campaigns. Benetton does not want to risk the retailer and customer backlash in Europe that it experienced in Japan in reaction to imported garments. In order to preserve this brand identity advantage in its largest market, Benetton should strive to achieve lower overall production cost for the same high quality output to maintain its competitive advantage.
Integrating retail support into Benetton will aid in this effort, by making demand more predictable, as will the plan to reduce the number of product line items available. Additionally, Benetton should continue to invest in its "local" elements, by developing new technologies for better design processes, more cost-efficient and flexible manufacturing processes, and distribution systems that can speed fulfillment. But the key for Benetton retaining its current European market position is the high product quality and the flexibility to quickly respond to customer demand afforded by its partnerships with local subcontractors. Casting these longtime partners aside would not only remove Benetton's flexibility in production, but could prove detrimental to product quality and brand image. Pursuing a strategy of investing in European capacity and capability does not address the exchange rate fluctuations that led to pricing difficulties in the North American market (see Appendix 2 for regression analysis demonstrating relationship between exchange rate and unit sales), resulting in drastic declines in number of stores and product volumes. However, because currency fluctuations are short term economic concerns, it is not recommended that Benetton radically revamp its strategy and operations to address what may be a In order to grow, Benetton also needs to initiate a long-term strategy to be "more global" after it secures its European market.
Benetton already has a global sales network with more than 6000 stores in 120 countries. However, Benetton's next step should include expansion of its sales network and its production capability to other markets. Benetton has tried this approach in Japan and U. S. in the past. It had mixed results in Japan (established more than 600 retail stores but little profit due to high production cost and increasing emphasis on value among Japanese consumers) and failure in U.
S. market (due to currency fluctuations and the shortcomings of the agency system). These experiences should not dissuade Benetton from expanding into China. With 30% to 40% lower production cost and 300 million prospective consumers, China is an irresistible market for Benetton in worldwide expansion. Initially, China will be able to consume all domestic production, given that in order to achieve most efficient production, a plant in China must produce at least 4 million garments. By comparison, the North American market consumed just over 4 million garments in 1994, with a market of approximately one-third the size.
This strategy will enable Benetton to not only develop a new market to sell its products, but can also look in the longer term to produce products for markets outside of China. With its longer lead times but lower costs, Benetton can elect to transition production of select high volume "base" stock products (products ordered at the beginning of the season) to China for export as capacity is increased. Because of cultural and business differences, Benetton must find a well-established Chinese garment manufacturer with whom to form a joint venture (a Stage 3 venture) as the first step in its entry into China. While the Chinese partner will provide labor, manufacturing facilities, and a distribution system, Benetton will provide technology on cost and quality control, product design, and marketing.