Hku849 PDF Eng Li&Fung Case Study

Grace Loo prepared this case under the supervision of Professor Stephen Ko for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes.

© 2009 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise (including the internet)—without the permission of The University of Hong Kong.

Ref. 09/430C

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STEPHEN KO

LI & FUNG: GROWTH FOR A SUPPLY-CHAIN SPECIALIST

Hong Kong-based Li & Fung Ltd (“Li & Fung”) was a trading company renowned for skilful management of its supply chain. The bulk of its business came from the trading of garments and apparel with the US and, to a lesser extent, Europe. Through its extensive network of suppliers, provision of value-added services and entrepreneurial corporate culture, it had become a major player in garment trading worldwide. In 2009, the global economic downturn following the collapse of the American housing and credit markets yielded a serious impact on the fashion industry. How could Li & Fung continue to grow its business and achieve its target of doubling turnover to US$20 billion for the period 2008–2010?

Li & Fung

Li & Fung was established in Guangzhou province in southern China in 1906, with the trading of silk and porcelain as its main business activity. The company moved its headquarters to Hong Kong in 1937 amid political turbulence in China. When the Communists came to power in China in 1949, Li & Fung, by force of circumstances, began working with Chinese emigrants who set up their businesses in Hong Kong, a process that transformed Li & Fung’s business into a garment-trading company, reflecting the predominant business activity of those emigrants.1

The Business Li & Fung was part of the Li & Fung Group, whose other core businesses included distribution and retailing. These businesses were conducted through Integrated Distribution Services Group Limited and Convenience Retail Asia Limited, respectively. All three entities were publicly listed on the Hong Kong Stock Exchange. The group also privately held other retailing entities. In total, the group had more than 26,000 staff across 40 countries.2

1 Schiller, B. (Autumn 2006) “William Fung”, European Business Forum, http://www.ebfonline.com/Article.aspx?ExtraID=20

(accessed 1 December 2008).2 For details, see Li & Fung’s website: www.lifung.com.

HKU849

09/430C Li & Fung: Growth for a Supply-Chain Specialist

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Li & Fung traded mainly in soft goods, or merchandize that is soft to touch, namely garments and apparel. It also dealt in hard goods, or consumer durable goods, such as fashion accessories, furniture, fireworks and promotional items. Aside from sourcing factories and handling production on behalf of its clients, it also provided design, quality control, marketing and distribution services to them in many instances. In the 2000s, it further diversified into a third product area: health, beauty and cosmetics. Its major market was the US, followed by Europe, which contributed approximately 25% of its turnover.3 In terms of market segment, Li & Fung had traditionally been strong from the mid-high market to hyper stores such as Wal-Mart, though it began expanding into the high-end market in the 2000s.4

Li & Fung was renowned for its strength in supply-chain management, helping clients to maximise the efficiency of each step along the chain. Li & Fung had an extensive network of suppliers, with 80 buying offices in about 40 countries in 2008 [see Exhibit 2]. This international network allowed customers to take advantage of the most efficient manufacturing base for each part of the manufacturing process, and to shift their production geographically as political, economic and regulatory conditions around the world changed.

Li & Fung actively used acquisitions to expand its network of buying offices. To ensure the success of its acquisitions, it paid for only a portion of acquisitions upfront, with the rest spread out over three to five years. A portion of the balance would be paid if the venture reached a certain target each year following the acquisition. Even though the practice was more costly than paying upfront, it created incentives for the management team of each acquired venture to stay and maintain the success of the venture.5

Li & Fung also used venture capital actively for “filling in the mosaic”,6 or plugging the holes in its product and service offerings. Such investments, generally capped at US$15 million,7targeted mostly entrepreneurial firms with design and marketing capabilities, which could also take advantage of Li & Fung’s sourcing network and financial support to create a win-win situation. Working with such companies gave Li & Fung the ability to provide designs to its customers and support them in marketing, on top of its traditional trading role.

Li & Fung had a customer-centric organisational structure and culture that played an important role in its success.8 Each division centred around one customer or group of similar customers so that the team could develop customer expertise to provide the best service to customers. Each division ran a business responsible for between US$20 million and US$50 million in revenue and was kept deliberately small to maintain an entrepreneurial mindset among the staff. Li & Fung had a tradition of hiring managers who would like to run their own business if they had not been working for Li & Fung. The upside of working with Li & Fung was that they could enjoy the administrative, financial and management backing of a large corporation. Li & Fung’s division managers were given a great deal of autonomy. They had their own space in Li & Fung’s head office in Hong Kong and also their own teams in offices overseas if required, with team members being hired by the division managers themselves. Li & Fung tied bonuses for managers with their divisions’ performance and put no ceiling on the bonus a manager could receive. Li & Fung’s structure and incentive system enabled it to grow in size without becoming bureaucratic or compromising the entrepreneurial spirit needed to drive a trading company. 3 Li & Fung (2007) “Annual Report”. 4 FD (Fair Disclosure) Wire (13 August 2008) “Interim 2008 Li & Fung Limited Earnings Conference Call” Thomson Reuters

Market. 5 Ibid. 6 Ibid. 7 Ibid. 8 Joan, M. (September–October 1998) “Fast, Global and Entrepreneurial: Supply Chain Management, Hong Kong Style: An

Interview with Victor Fung”, Harvard Business Review, 76 (5), pp. 103–114.


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Performance For the year 2007, Li & Fung Group’s total turnover amounted to US$11.854 billion, 9

exceeding its three-year plan’s target of US$10 billion for 2005 to 2007 [see Exhibit 1]. Soft goods, which comprised garments and apparel, contributed 69% of the group’s turnover, representing a 38% increase from the previous year.10 The remaining turnover came from hard goods. Geographically, the US contributed 65% of the group’s turnover, compared to 71% in 2006, while Europe contributed 26%, almost doubling its contribution from the previous year. The shift in turnover between the US and Europe reflected the group’s effort to balance its customer portfolio through diversifying into the European market.

Transformation

In the early 1970s, the third-generation Fung brothers returned from Hong Kong from the US to help with the family business at the request of their mother. Victor Fung was teaching at Harvard Business School, from which William Fung had just graduated. Over the next four decades, the two brothers transformed Li & Fung into a dynamic organisation and one of the foremost players in international garment trading, renowned for its strength in supply-chain management [see Exhibit 3].

The 1970s Upon their return from the US, Victor and William Fung began to reform the family business in three phases.11 In the first phase, the two brothers turned Li & Fung from a local trading company into a regional sourcing agent by establishing offices in Asian countries such as Taiwan and South Korea, enabling them to take advantage of the cheapest suppliers capable of providing the best quality in the region. This was a value-added service for their clients, as few buyers were knowledgeable about the whole of Asia, even though many possessed in-depth knowledge about manufacturing in one or two Asian countries.

The 1980s In the second phase, Li & Fung began to move beyond acting as a mere sourcing agent and started to work with clients from product concept to prototyping to planning their whole production programmes.

The 1990s The 1990s saw Li & Fung moving into dispersed manufacturing and the third phase of its transformation, during which it focused on increasing the efficiency in each link of the supply chain. The manufacturing, dyeing and weaving of yarn into fabric and the final cutting and sewing of the garments might each take place in different countries in order for Li & Fung to take advantage of the expertise, price advantage or delivery time that each manufacturing country could offer. Hong Kong was used as a base for activities such as design and quality control. To achieve short production lead times (which was critical in the fashion industry because placing orders only as trends emerged translated to reduced inventory and markdowns), Li & Fung used its clout and relationships with material suppliers to help factories in sourcing and to shorten the delivery cycle. For hard goods, it ordered parts from different countries and packed them into toolkits, which were then sent to China for assembly. Packing the parts into toolkits helped to minimise errors during the assembly stage. On the

9 Li & Fung (2007) “Annual Report”. 10 Ibid. 11 Joan, M. (September–October 1998) “Fast, Global and Entrepreneurial: Supply Chain Management, Hong Kong Style: An

Interview with Victor Fung”, Harvard Business Review, 76 (5), pp. 103–114.


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logistics end, Li & Fung began to offer consolidation services to its clients. Li & Fung would collect goods from different factories and group the goods that were to be delivered to each customer’s distribution centre before they were shipped, making the distribution process more efficient. Li & Fung described such cost-reduction measures, which focused on reducing the distribution and logistics costs along the way from the manufacturer to the client, as “tackling the soft $3”.12 Traditionally, both buyers and trading companies focused mostly on putting pressure on factories to lower costs.

Strengthening the Product and Service Network Fashion brands and retailers worked with different networks of suppliers based on their geographical locations, and many geographical locations offered advantages that China could not match. European fashion brands and retailers, for instance, produced in Turkey not only because Turkey’s production costs were lower than China’s but also because its geographical proximity translated to shorter transport times and lower transportation costs. Finished garments could reach western Europe from Turkey by road in seven days. For garments to reach western Europe from Hong Kong in the same turnaround time would require them to be air freighted, whereas the cheaper option of sea freight would take 25 days 13 Thus, many European buyers used Turkey for fast production and Asia for pre-planned programmes. In order to fulfil the needs of such customers, Li & Fung opened a buying office in Turkey and, by 2008, had become the largest exporter of garments from Turkey.14

Aside from establishing its own buying offices around the world, Li & Fung also used acquisitions actively to extend its supplier network. In 1995, it acquired British trading firm Inchcape Buying Services, which had a strong presence in South Asia, with buying offices in India, Pakistan, Bangladesh and Sri Lanka.15 In 2006, it acquired the worldwide buying division of German retailer KarstadtQuelle AG, which gave it access to production capacity in Italy and eastern Europe. 16 Acquisitions not only extended Li & Fung’s network of suppliers but also its customer base. Inchcape’s customer portfolio was predominantly European, helping Li & Fung to diversify from its largely American customer base, and the acquisition of KarstadtQuell gave Li & Fung a strong foothold in the German market. In 2008, Li & Fung acquired Hong Kong-based Silvereed Group and Wilson & Wong Trading Co. Ltd, which brought with them a high-end customer base that filled a gap in Li & Fung’s customer portfolio.17

Because acquisitions were part of Li & Fung’s expansion strategy, it had also created a structure to support its activities in that area. Li & Fung used an information technology system that centralised data across its multiple offices, allowing an executive anywhere in the world to access information about Li & Fung’s supplier base and track orders. The system was built with plug-and-play capability, enabling it to be installed into the warehouse of any newly acquired venture and commence operating with ease.

12 Joan, M. (September–October 1998) op cit. 13 Mason, R. et al. (2007) “Managing Complexity in Agile Global Fashion Industry Supply Chains”, International Journal of

Logistics Management, 18 (2), pp. 238–254. 14 FD (Fair Disclosure) Wire (13 August 2008) op cit. 15 Ibid. 16 Lee, S. (3 October 2006) “Li & Fung in 60m Euro Deal”, Hong Kong Standard,

http://www.thestandard.com.hk/news_detail.asp?pp_cat=1&art_id=28579&sid=10199442&con_type=1 (accessed 15 December 2008).

17 FD (Fair Disclosure) Wire (13 August 2008) op. cit.


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Onshore Business

In 2004, Li & Fung began experimenting with a new onshore business model through San Francisco-based Li & Fung USA, which played the role of importer instead of exporter. Many big US retailers had their own in-house buying offices and showed little interest in Li & Fung’s sourcing service. In order to capture business from these large US retailers, Li & Fung USA provided not only sourcing but also other services such as design, product development, quality control and distribution.

Li & Fung USA focused mainly on three business areas: • Proprietary brands, which were brands that were sold only through one retailer • Private labels, which were in-house brands belonging to retailers • Licensed brands, which consisted of merchandise featuring images of licensed

entertainment characters. By 2008, Li & Fung US had more than 100 licensed brands in its portfolio.18

Compared to its traditional sourcing business, the onshore business yielded a higher profit margin because of the value-added services it provided.19 Between 2004 and 2007, Li & Fung USA did US$1 billion worth of onshore business.20 Li & Fung set up Li & Fung Europe in early 2008 to transplant the model to the European market. Li & Fung planned to grow its onshore business to US$4 billion between 2008 and 2010, with about US$3 billion coming from the US and US$1 billion from Europe. Li & Fung had also reserved US$100 million for new acquisitions in Europe.21

Diversification

Li & Fung’s customer portfolio had long been predominantly American but had slowly begun to diversify into the European market, as reflected in the increase of its European business from 18% in 2006 to 26% in 2007. Its acquisition of the worldwide buying unit of KarstadtQuelle, for instance, had given it a strong foothold in the German market.

In 2007, Li & Fung extended into health, beauty and cosmetics through the acquisition of Hong Kong-based CGroup. CGroup sourced and developed products for retailers and brands in the health, beauty and cosmetics product category worldwide. In 2008, Li & Fung further acquired Asia-based Imagine, which designed and developed point-of-sale displays for US-based cosmetics retailer and beauty products supplier RT Sourcing. RT Sourcing also had an office furniture division, which complemented Li & Fung’s general furniture business.

Economic Turbulence

In the beginning of 2009, the American housing and credit market bust was having a global impact. One of Li & Fung’s clients, US-based KB Toys, went bankrupt and more than 40 Hong Kong manufacturers were chasing Li & Fung for losses totaling US$10 million22 as Li and Fung had issued the letters of credit for KB Toys’ orders . Li & Fung, for its part, claimed

18 Lisanti, T. (1 July 2008) “Brand Licensing’s Newest Strategy”, License! Global,

http://www.licensemag.com/licensemag/Cover+Story/Brand-Licensings-Newest-Strategist/ArticleStandard/Article/detail/530879 (accessed 12 December 2008).

19 FD (Fair Disclosure) Wire (13 August 2008) op. cit. 20 Hall, J. (1 June 2008) “The World’s Biggest One-Stop Shop”, Sunday Telegraph.21 Wang, Z.L. (17 December 2008) “Alerted to

”, 21st Century Business Herald.22 AFP (5 January 2009) “Hong Kong Toymakers Urged Li & Fung to Pay Up for US Failed Retailer”.


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it had merely acted as a buying agent for KB Toys. The economic downturn was expected to worsen as the year went on, with more retailers expected to close down. Historically, Li & Fung had managed to weather economic contractions as its clients stepped up outsourcing to focus on core strengths. Nonetheless, exports from China, the core of Li & Fung’s business, had declined 2.2% between November 2007 and November 2008.23 It was imperative for Li & Fung to plan ahead, given the increasing environmental uncertainty. What could Li & Fung do to safeguard the growth of its business? How could it achieve its target turnover of US$20 billion between 2008 and 2010?

23 Jacobs, A. and Barboza, D. (11 December 2008) “Unexpected Drop in China’s Imports and Exports”,

http://www.nytimes.com/2008/12/11/business/11yuan.html?_r=1&partner=rssnyt&pagewanted=print (accessed 6 January 2008).


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EXHIBIT 1: CONSOLIDATED PROFIT-AND-LOSS ACCOUNT FROM 2002 TO 2007

2008US$’000

2007US$’000

2006US$’000

2005US$’000

2004US$’000

2003US$’000

2002US$’000

Turnover Continuing operations 14,195,143.2 11,925,546 8,772,008 7,173,566 6,084,096 5,498,512 4,808,575 Discontinued operations -- -- -- -- -- -- --

14,195,143.2 11,925,546 8,772,008 7,173,566 6,084,096 5,498,512 4,808,575

Operating profit Continuing operations 390,309.7 464,337 311,143 243,077 200,699 161,482 146,654Discontinued operations -- -- -- -- -- -- --

390,309.7 464,337 311,143 243,077 200,699 161,482 146,654 Interest income

14,454.9 26,853 12,703 8,969 5,567 4,949 6,395Interest expenses

(61,560.9) (64,447) (19,098) (2,757) (1,479) (1,266) (1,159)Share of profit less losses of associatedcompanies 792.2 638 1,368 1,169 4,231 56 (211)Profit before taxation 343,998.2 427,381 306,115 250,458 209,018 165,221 151,679Taxation (33,268.8) (32,575) (22,144) (19,508) (16,800) (13,405) (11,978) Profit for the year

310,729.4 394,807 283,972 230,950 192,218 151,816 139,701

Attributable to: Continuing operations 310,504.6 394,685 283,992 230,911 192,339 153,378 139,672Discontinued operations -- -- -- -- -- -- --

Shareholders of the company 310,504.6 394,685 283,992 230,911 192,339 153,378 139,672Minority interests

224.7 394,685 283,972 230,950 192,218 151,816 139,701315,857.6 789,370 567,964 461,861 384,557 305,194 279,373

Earnings per share (US cents)

Basic 8.9 11.5 8.7 7.2 6.0 4.8 4.4 Continuing operations 8.9 11.5 8.7 7.2 6.0 4.8 4.4

Dividend per share (US cents) 7.3 9.2 7.1 5.9 4.9 4.1 3.6Special dividend per share (US cents)24 -- 2.9

Source: Li & Fung (2007) “Annual Report”.

24 Ibid.


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EXHIBIT 2: LI & FUNG’S OFFICES WORLWIDE

Europe & the Mediterranean

South Africa

North Asia South-East Asia

South Asia The Americas

Amersfoort Amsterdam BarcelonaBremerhaven Bucharest Cairo CasablancaDenizli DüsseldorfHuddersfield Istanbul Izmir Keighley LeedsLondon LuccaMadrid Milan Moscow Oporto ParisSofiaSt. Gallen Trowbridge Vienna Vilnius Warsaw

Antananarivo Durban Moka

Beijing Changsha Chengdu Dalian Dongguan Guangzhou Hangzhou Hepu Hong Kong Liuyang Longhua MacauNanjing Ningbo Qingdao SeoulShanghai Shantou Shenzhen Suzhou TaipeiTokyo Zhanjiang

Bangkok Hanoi Ho Chi Minh CityJakartaJohorMakati Phnom Penh SaipanSingapore

Amman Bangalore Chennai Colombo Delhi Dhaka FaisalabadKarachi LahoreMumbai Sharjah Tirupur

Boston Gaffney Guadalajara Guatemala City Managua Mexico City New York City San Francisco San Pedro Sula Santo Domingo

Source: Li & Fung (2008) “Annual Report”.


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EXHIBIT 3: VALUE-ADDED ACTIVITIES IN LI & FUNG’S SUPPLY CHAIN

SUPPLY CHAIN LI AND FUNG’S VALUE-ADDED ACTIVITIES

Design Design support and trend information

Material sourcing Sourcing from an extensive network of manufacturing bases worldwide, co-ordination of sourcing activities

Manufacturing Quality control, testing support

Shipping Consolidation of goods for easy delivery, customs clearance through its onshore business

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Hku849 PDF Eng Li&Fung Case Study