CASE STUDY ( Li & Fung)Company Perspectives:Global Supply Chain Management is our business. Working in partnership with our customers,we cater for their needs of competitive pricing, quality, on-time delivery, as well as ethicalsourcing. We manage the logistics of producing and exporting goods across many producers andcountries.A one-stop-shop service--Small, dedicated teams of product specialists focus on the needs ofparticular customers and organize for them. We provide the convenience of a one-stop shop fromproduct development, through production management, to customs clearance and delivery whenrequired.Key Dates:1906: Fung Pak-liu and Li To-ming begin exporting jade and porcelain in Guangzhou, China.1937: Li & Fung Limited is formally established in Hong Kong.1949: When China turns Communist, Pak-lius son Fung Hon-chu reinvents the company toexport goods manufactured in Hong Kong.1973: Hon-chus sons William and Victor persuade him to list Li & Fung on the Hong KongStock Exchange; the Fung brothers institute a more modern management style.1979: China opens up for trade, and Li & Fung develops a trading network throughout East Asia.1989: The Fung brothers buy out family shares and take Li & Fung private in a managementbuyout.1992: After being reorganized to focus on trade, the export division of Li & Fung is relisted.1995: Li & Fung acquires the British trading company Inchcape Buying Services.2001: The "dispersed manufacturing" approach has helped Li & Fung double profits twice overthe previous six years.Company History:During the course of its nearly 100-year history, Hong Kong-based Li & Fung Limited hasgrown from a simple exporter to an expert in "global supply chain management." The companycoordinates product design, raw material and factory sourcing, production management, andquality assurance for clients that have included The Limited, The Gap, Coca-Cola, and KohlsCorporation. Li & Fung deals primarily with garments but is increasing its focus on promotionalitems, toys, sporting goods, and housewares.When one of its clients needs a product, Li & Fung does much more than just find the lowest-price source. The company breaks apart the manufacturing process to find the best supplier foreach stage of production. For example, if a client orders a polo shirt, Li & Fung might buyAmerican cotton, have it knitted and dyed in China, and send it to Bangladesh for sewing. Thecompanys 65 sourcing offices in 38 countries give it the global connections it needs to pull offthis "borderless" manufacturing process.Founded in 1906 as an exporter in Guangzhou, China, Li & Fung has survived World War II,Chinas move to Communism, and eventual reopening of China for trade. More recently, the
company has adapted to the transition from a manufacturing to a service-based economy in HongKong and the emergence of the Internet. The company is now led by Victor and William Fung,the third generation of the Fung family to deal in exports. Li & Fungs flexibility and its expertisein East Asian and global manufacturing have allowed it to move beyond the role of a simpletrading intermediary and develop a range of services that are still in demand in the 21st century.Basic Exporting: Early 20th Century Through World War IIIn 1906 Fung Pak-liu and Li To-ming founded an exporting company in the southern Chinesecity of Guangzhou. The company was the first Chinese-owned exporter in a field controlled byforeign merchants. As a former teacher of English, Fung Pak-liu was able to act as anintermediary between Chinese-speaking factories and English-speaking buyers. He received a 15percent commission for his interpreting services. In the first few years, Li & Fung dealt primarilyin porcelain and silk, and later moved into bamboo and rattan ware, jade, ivory, handicrafts, andfireworks. The company came up with a new way to make fireworks in 1907, using a paperrather than a mud seal. The new product produced less dust and, because it was lighter, savedtariff costs since the U.S. import duty was based on weight. The design became the industrystandard.Because the river port in Guangzhou was too shallow for oceangoing clippers, the British colonyof Hong Kong served as the deep water port for South China. So Fung Pak-lius son Fung Hon-chu went to Hong Kong and established a branch to handle the shipping of goods. On December28, 1937, Li & Fung was formally established as a limited company in Hong Kong.World War II put a halt to trading for several years. Fung Pak-liu died in 1943 and control of thefirm moved to the second generation. Li To-ming, who had been a silent partner, sold his sharesto the Fung family in 1946. After the war, China became a Communist country and a flood ofrefugees came to Hong Kong. Li & Fung was now cut off from its factory sources in China andneeded to find a new way of doing business. Fung Hon-chu reinvented Li & Fung as an exporterof the labor-intensive consumer goods that began being produced in Hong Kong during thepostwar period. The company dealt in garments, toys, electronics, plastic flowers, and wigs. Itsprimary customers were retailers in the United States. As Hong Kongs manufacturing economygrew, Li & Fung grew with it.The Third Generation: Modernization in the 1970sFung Hon-chus sons Victor and William attended universities in the United States. The olderson Victor attended the Massachusetts Institute of Technology, then got a Ph.D. in appliedmathematics from Harvard, while his younger brother William studied computer science atPrinceton and got his M.B.A. at Harvard Business School. The two might have pursued careersin the United States, but in 1972 their mother called and pleaded with them to come home andhelp their father so he would not have to work so hard. Having been exposed to Western businesspractices, the two were hesitant to go back to a traditional family-owned enterprise. "Trading is asunset industry," their friends in the United States warned them. But their father suggested thatthey come back and show him how to run the business better. William returned in 1972 andVictor in 1974.
By the 1970s, competitive pressure was pushing Li & Fungs profit margins down to 5, or even3, percent. Taiwan and Singapore had cheaper labor and were developing enough manufacturingcapacity to vie with Hong Kong. Meanwhile, buyers were more inclined to bypass themiddleman and deal directly with the manufacturer. If Li & Fung had nothing to offer beyondthe ability to connect buyers with factories in Hong Kong, the company would have troublesurviving. Hong Kong as a whole was moving from a manufacturing to a predominantly serviceeconomy, and Li & Fungs best prospect was to find a way to make that transition itself.The Fung brothers of the third generation brought a new perspective on the companys future, butthey encountered a difficult environment for making drastic changes. Li & Fung was still run likea traditional patriarchal Chinese family conglomerate on the idea that the purpose of thecompany was to serve as the familys livelihood. More than 30 cousins had stakes in thecompany and, even if they were not particularly skilled at business, they were hanging on tomanagement positions in order to retain shareholder benefits. So William and Victors firstinitiative was to convince their father to take the firm public. In 1973 Li & Fung was listed onthe Hong Kong Stock Exchange in an issue that was oversubscribed 113 times. "It was the onlyway to get a lot of disgruntled relatives off our backs and attract professionals into management,"William Fung told the Far Eastern Economic Review in 1992.Now that the roles of ownership and management were separated, it was easier to make changesat the firm. The brothers established offices in Taiwan, Korea, and Singapore in order todiversify their manufacturing sources. As more and more East Asian countries industrialized, Li& Fung developed a buying network throughout the region. In 1979 China opened up for trade aswell. Many Hong Kong manufacturers relocated to China, and China once again became a keysourcing point for Li & Fung as it had been in the first decades of the companys existence.By expanding geographically, Li & Fung acquired broader regional expertise and a moresubstantial base of manufacturing contacts, and thus was able to offer its clients a more valuableservice. For example, the company knew that Taiwan did better work with synthetic fabrics butHong Kong was the best choice for cottons. Li & Fung was also well-practiced at negotiating thesystem of quotas that governed world textile trade and knew how to move orders betweencountries as quotas filled up. With expanded knowledge and resources, the company couldexpertly source large orders by putting together a package from the entire region.From Middleman to Manager in the 1980sStill, regional familiarity was a basic service without much potential to lift Li & Fungs profitmargins out of the single digits. The companys trade margins were squeezed throughout the1980s, exposing the need for a more sophisticated business strategy. The answer was to becomemore involved in the entire production planning process. The traditional way of operating wasthat a customer requested a specific product and Li & Fung found the best supplier. By the late1980s, though, Li & Fung was offering a broader range of services. Once a company had an ideaof the product it needed, it would send design sketches to Li & Fung. Li & Fung would find theright type of yarn and fabrics, create prototypes for the customer, set up contacts for each step ofthe supply process and develop a production schedule that covered the entire fashion season. Li& Fung was gradually making the transition from middleman to program manager.
The company also branched out into the area of retail in the mid-1980s. It acquired 50 percentshares in Circle K convenience stores and Toys R Us chains in Hong Kong. In addition, Li &Fung established a venture capital enterprise in the United States in 1984, in part out of chagrinfor not having taken advantage of an early chance to invest in its successful client The Gap, Inc.Known as LF International, the investment companys purpose was to identify companies thathad good design ideas but could benefit from Li & Fungs experience in sourcing materials. LFInternational made modest investments in about four to five enterprises a year.In 1981 Victor Fung succeeded his father as managing director, but in 1986 he left the executiveposition to set up an investment bank. William Fung took over as managing director and Victorcontinued to guide the company as a nonexecutive chairman. William Fung saw the need formore changes at the firm but was hampered by the fact that 75 percent of Li & Fung was stillheld by a family trust. There were disagreements with the older generation, who remembered thedifficult postwar transition, over whether Li & Fung should trust Communist China. To resolvethe impasse, William and Victor formed a holding company, acquired the outstanding familyshares, and privatized Li & Fung in a management buyout in 1989.As a private company, Li & Fung had the flexibility to make drastic structural changes. WilliamFung refocused the company on its core trading business, selling off unrelated shipping,insurance, and real estate enterprises. He organized the company into two divisions: exporttrading and retail. Instead of assigning responsibilities by country, he organized services bycustomer. Each division was free to cross borders to find the best way to serve its client. Forlarge clients like The Limited or Gymboree, an entire division at Li & Fung would devote itselfto the product line and sourcing needs of one company.By the beginning of the 1990s, the Fung brothers changes were bearing fruit. Li & Fung waswell established with 900 suppliers in the East Asia region in countries that included Indonesia,Singapore, South Korea, Taiwan, Thailand, and China. Retail clothing stores in the United Statescontinued to be its major customers. The company began a period of exceptionally rapid growthin 1991, when net revenue grew 56 percent to HK$2.8 billion and net profit reached HK$86.9million.In order to acquire funds for further expansion, Li & Fung relisted its export trading division in1992. The company issued 25 percent of its equity, raising HK$275 million. The now publictrading division became known simply as Li & Fung Limited, while the retail division, with theprofitable Toys R Us and Circle K branch stores, remained a wholly owned subsidiary of the Li& Fung Group.Borderless Manufacturing in the 1990sAfter the public listing, Li & Fungs services evolved further toward truly borderless supplychain management. In a 1998 interview with the Harvard Business Journal, Victor Fungexplained how Li & Fung reached the stage of "dispersed manufacturing." As manufacturing inHong Kong became increasingly expensive, he said, almost all labor-intensive work movedacross the border to China, while design, packaging, and other technically advancedmanufacturing techniques were still done in Hong Kong. Eventually the whole East Asian region
was pulled into the manufacturing process, depending on each countrys particular industrialstrengths. A garment labeled "Made in Thailand" might contain Korean yarn that was woven anddyed in Taiwan, sewn at five different factories in Thailand, and fitted with zippers made inChina by a Japanese company. Li & Fung became expert at finding the best solution for eachstep in the manufacturing process. Fung told the Journal, "This is a new type of value added, atruly global product that has never been seen before ... Were not asking which country can dothe best job overall. Instead, were pulling apart the value chain and optimizing each step--andwere doing it globally."This global array of services supported rapid growth and acquisitions at Li & Fung throughoutthe 1990s. Net profit in 1993 reached HK$185 million on revenues of HK$5.38 billion. Then thefirm nearly tripled its size with the HK$475 million acquisition of Inchcape Buying Services(also known as Dodwell) in 1995. Inchcape was a British trading company with a network ofoffices in India, Pakistan, Bangladesh, and Sri Lanka. The acquisition of Inchcape, with itsEuropean customer base and sourcing points across the Indian subcontinent, balanced Li &Fungs American customer base and East Asian sourcing network.Now that growth had taken off, William Fung began using three-year plans to set ambitiousgrowth targets. In 1998, despite some instability caused by the Asian financial crisis, thecompany achieved its goal of doubling profits from the 1995 level. Net profit reached HK$470million on revenues of HK$14.3 billion, compared with HK$242 million and HK$9.21 billion in1995, respectively.In the following years Li & Fung continued to diversify geographically, moving into emergingcenters of production in northern Africa such as Egypt, Tunisia, and Morocco. By 2000, thecompany was making an effort to move production closer to its North American and Europeanend markets and began sourcing from factories in Central America, the Caribbean, and Turkey.Li & Fung also was courting new end markets with forays into Japan and Australia. Although theFung brothers still took pride in their companys Chinese heritage, Li & Fung was becoming amultinational company with a workforce based in dozens of countries.With the rise of the Internet in the late 1990s came predictions of a "frictionless economy" wherecompanies would bypass middlemen like Li & Fung and buy all their parts online. Li & Fung,however, capitalized on the Internet to strengthen communications with customers and branchoffices. In areas with less developed telecommunications, personal visits, phones, and faxes werestill necessary to ensure that manufacturers delivered the product on time. Li & Fungs decades-long personal relationships with suppliers, as well as their practical expertise in things like textilequotas and quality assurance, kept their business relevant in the digital age.In 1999 Li & Fung acquired the export trading firms Swire & Maclaine Limited and CamberleyEnterprises Limited, adding to their U.S. and European customer base. The following year thecompany acquired Colby Group Holdings Limited, its main competitor, in a deal valued atalmost HK$282 million. Revenue continued to grow, but 2001 net profit was hurt by the closingof an e-commerce venture in the United States known as StudioDirect. The company was set upin February of that year to let smaller enterprises build their own brands on a web site withouthaving to place large orders. But the site failed to catch on, and Li & Fung shut down the venture
after less than a year. The year 2001 marked the end of another three-year plan. The companyannounced that it had met its goal of doubling continuing operating profits over the period andreported 2001 net profits of HK$667 million on revenues of HK$33 billion.Although Li & Fung was posting strong results, the company was vulnerable because nearly 80percent of its revenue came from U.S. clothing retailers. The company began pursuing customersin the hard goods sector in order to develop a more balanced clientele. In 2002 Li & Fung landeda deal to make promotional items for Coca-Cola. That year it also acquired Janco OverseasLimited, a Hong-Kong based company that supplied nonfood hard goods to supermarkets in theUnited States and Canada. In 2002 hard goods accounted for 32 percent of Li & Fungs turnover.The company remained heavily focused on the United States, with North American customerscontributing 76 percent of turnover.Li & Fung got off to a slow start on the 2002-04 three-year plan due to an economic slowdownand the terrorist attacks of September 11, 2001, in the United States. The company was abouthalf a year behind on its goal but was still optimistic that it would once again double continuingoperating profits over the three-year period. Such feats were more difficult now that Li & Funghad grown to be a relatively large company. Yet whether or not the company was able to sustainthe rapid growth of the 1990s, it had shown it had the flexibility to continue playing a key role inthe global market of the 21st century.Principal Subsidiaries: Basic & More Fashion Limited; Camberley Enterprises Limited; ColbyInternational Limited; CS International Limited; Dodwell (Mauritius) Limited; Janco OverseasLimited; Li & Fung (Exports) Limited; Lloyd Textile Trading Limited; Maclaine Limited; ShiuFung Fireworks Limited; Toy Island Manufacturing Company Limited; Verity EnterprisesLimited; LF International Inc. (U.S.A.).Principal Competitors: APL Logistics, Ltd.; William E. Connor & Associates, Ltd.