Case Study Analysis – Li & Fung

    Case Study Analysis – Li & Fung

    The report must include three components: (a) page 1: essential case facts, (b) page 2 –
    3: identification of major issues/dilemmas, pros and cons of two alternative paths of
    action, your recommendation, and rationale for your recommendation, (c) page 4: three
    essential concepts from the assigned reading(s) and a brief statement about how each
    one is connected with (or helps understand) the situations described in the case

     

    Li & Fung (A): Internet Issues

    the company. Two years later, silent partner Li To
    -Ming retired and sold his shares to the company.
    The company retained Li’s surname, a homophone for
    “profit” in Chinese, which, along with “Fung,”
    a homophone for “abundance,” had an
    auspicious ring when combined.
    Li & Fung relocated permanently to Hong Kong at the end of World War II, expanding its
    operations to include toys, garments
    , plastic flowers, and electronics.
    In the early 1970s, both Fung
    brothers had just returned from the United St
    ates: William had earned his MBA from Harvard
    Business School and returned to
    the business in 1972. Victor had recently completed his Ph.D. in
    economics at Harvard University and, following a two-year stint teaching at Harvard Business
    School, rejoined the business in 1974. Their return
    heralded Li & Fung’s tr
    ansition from a family-
    owned business to a professionally managed firm, with a planning and budgeting system in place for
    the first time. William and Victor,
    the third generation to run the company, felt that the next logical
    step in growing the company was to go public. In
    1973, Li & Fung became the holding company for
    the Group and was listed on the Hong Kong Stock Exchange. Throughout the 1980s, Li & Fung
    expanded its regional network of offices throughout the Asia-Pacific region as more sources of
    supply emerged in the rapidly industrializing Asia
    n economies. In 1988 the Group was privatized
    and streamlined, incorporated in Bermuda in 1991, an
    d its trading activities we
    re listed on the HKSE
    in July 1992. With the 1995 acquisition of Inchcape Buying Services
    5
    (formerly Dodwell), Li & Fung
    expanded its customer base in Europe while simultaneously shifting its sourcing network beyond
    East Asia to include the Indian sub-continen
    t, the Mediterranean,
    and Caribbean basins.
    By 2000, Li & Fung was a $2 billion global export trading company with 3,600 staff worldwide,
    sourcing and managing the global
    supply chain for high-volume, ti
    me-sensitive consumer goods.
    (
    Exhibit 1
    shows 1999 Li & Fung financial data.) By 2000, 69% of Li & Fung’s sales were in the United
    States and 27% in Europe. Key customers included
    The Limited, Gymboree, American Eagle, Warner
    Brothers, Abercrombie & Fitch, and Bed, Bath, & Be
    yond. Tesco, Avon Products, Levi-Strauss, and
    Reebok had become customers within the last two
    years; Royal Ahold, Guess Jeans, and Bebe had
    signed on in 2000.
    Li & Fung’s product mix included
    hard and soft goods. Soft goods referred to apparel, including
    woven and knit garments for men, women, and chil
    dren. Hard goods included fashion accessories,
    festive or holiday products, furnishings, giftware,
    handicrafts, home products, fireworks, sporting
    goods, toys, and travel goods. Hard goods provided
    higher margins than soft goods because, despite
    a generally lower item value per unit, they required
    higher value-added services for orders that were
    also usually much smaller than soft goods orde
    rs. Hard goods items such as watches, shoes,
    suitcases, kitchenware, or teddy bears required an
    inspector for quality control evaluation for even
    the smallest batch order, thereby greatly increasing
    what Li & Fung could charge. Margins for soft
    goods were roughly 6% to 8%, while margins on
    hard goods ranged anywhe
    re from 10% to 30%,
    depending on the degree of complexity involved in
    sourcing raw materials.
    Li & Fung attempted to
    expand its sale of hard goods. In 1998 soft and ha
    rd goods contributed 77.5% and 22.5% of total sales,
    respectively, while the proportion of hard-goods sa
    les grew to 25% in 1999 and was projected to
    increase to 27% in 2001 and 29% in 2002.
    Holistic Supply-Chain Management
    Although Li & Fung described itself as a trading company, by 2000 it was far more sophisticated
    than a typical Hong Kong import-export trading company and had come a long way from its roots in
    matching Chinese manufacturers with Wes
    tern buyers. In Victor’s words:
    5
    For details, see
    Acquisitions
    on page 5.
    Do Not Copy or Post
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    Li & Fung (A): Internet Issues
    301-009
    3
    We have been changing. Now we’re orchestratin
    g a whole production process that starts
    from raw materials all the way through to fini
    shed product. If you look at the old days,
    language skills could guarantee you margins better than we have now. My grandfather used
    to charge 15% or more, basically to be
    an interpreter. Those days are over.
    6
    With 48 offices in 32 countries, the company pr
    ovided value-added services across the entire
    supply chain in a so-called “borderl
    ess” manufacturing environment (see
    Exhibit 2
    ). A down jacket’s
    filling, for example, might come from China, the
    outer shell fabric from Korea, the zippers from
    Japan, the inner lining from Taiwan, and the elastics, label, Velcro, and other trim from Hong Kong.
    The garment might be dyed in South Asia, stitched in China, then sent back to Hong Kong for quality
    control and finally packaged for delivery to The Li
    mited or Abercrombie & Fitch. Victor explained:
    Say we get an order from a European retail
    er to produce 10,000 garments. We determine
    that, because of quotas and labor conditions, the best place to make the garments is Thailand.
    So we ship everything from there. And beca
    use the customer needs quick delivery, we may
    divide the order across five factories in Thailand. Effectively we are customizing the value
    chain to best meet the customer’s needs. Five weeks after we received the order, 10,000
    garments arrive on the shelves in Europe,
    all looking like they came from one factory.
    7
    Li & Fung clients benefited in several ways: supply-chain customization could shorten order
    fulfillment from three months to five weeks, and this faster turnaround allowed clients to reduce
    inventory costs. Moreover, in its role as a middlema
    n, Li & Fung reduced matching and credit risks,
    and also offered quality assurance to
    its customers. Furthermore, wi
    th a global sourcing network and
    economies of scale, Li & Fung coul
    d offer lower cost and more flexible sourcing than its competitors.
    In addition, through acquisitions and global expa
    nsion, Li & Fung was extending this knowledge
    base to Sub-Saharan Africa, Easter
    n Europe, and the Caribbean. Finally, Li & Fung provided up-to-
    date fashion and market trend information to clients.
    As a result of its Camberley acquisition in 1999
    it started offering clients virtual manufacturing, or product design services.
    According to Victor: “Li & Fung does not own an
    y of the boxes in the supply chain; rather, we
    manage and orchestrate it from above. The creation
    of value is based on a holistic conception of the
    value chain.” In recent years, however, Li & Fung had begun to improve operations by controlling or
    owning strategic links in the chain.
    In some cases, Li & Fung offered raw material sourcing. In the
    past when clients placed an order, Li & Fung
    would determine the manufa
    cturer best suited to
    supply the goods, and that factory would source its
    own raw materials. But Li
    & Fung understood its
    clients’ needs better than its manufacturing plants di
    d, so by offering raw materials to its suppliers,
    the company both ensured greater
    quality control and bought larger and thus more cost-effective
    amounts of raw materials, thereby pr
    oducing cost savings for each manufacturer. In such cases, Li &
    Fung also earned revenue by char
    ging its factories a commission on
    each raw material purchase they
    made. By mid-2000, nearly 15% of Group sales invo
    lved Li & Fung’s raw material sourcing service.
    Corporate Culture and Compensation
    From the 1992 privatization on, the division of labo
    r between the Fung brothers was clear-cut: as
    Group chairman, Victor was primarily concerned with the Group’s strategic issues and long-term
    planning. As the Group managing
    director, William attended to ever
    yday operations of the publicly
    6
    Gren Manuel, “Technology Journal: Historic Trader Keeps It
    s Cool—Li & Fung Says It’s Fo
    und a Place in the Internet
    Economy,”
    The Asian Wall Street Journal
    , March 27, 2000, p. 15.
    7
    Joan Magretta, “Fast, Global, and Entrepreneurial: Supply Ch
    ain Management, Hong Kong Style, An Interview with Victor
    Fung,”
    Harvard Business Review
    , September–October 1998, p. 106.
    Do Not Copy or Post
    This document is authorized for use only by John Zerio until September 2011. Copying or posting is an infringement
    of copyright. [email protected] or 617.783.7860.
    301-009
    Li & Fung (A): Internet Issues
    4
    listed trading arm, or as he joked in a recent interview, “Victor is the deep thinker, and I just make
    the money.”
    8
    In another interview, Victor joked that “William calls me the visionary, meaning that I
    don’t really know what’s going on.”
    9
    But both brothers lived in the same apartment building as their
    mother and sisters and conversed every day to keep
    abreast of developments at Li & Fung. The duo
    created a strong synergy that was described as follows by the CEO of the Group’s e-commerce
    venture:
    . . . a combination of both thought leadership
    and execution, with the unique relationship
    between Victor and William cementing the entire
    organization. They crea
    te a very particular
    kind of culture that blends pragmatism and, at
    the same time, a recognition of and openness to
    innovation.
    According to Victor, once the business was successful,
    it was essential to keep an open mind and,
    rather than resting on their laurels, to move past success and look forward. Furthermore, Victor held
    that it was imperative to cultivate a corporate
    culture that not only tolerated but encouraged
    diversity, or in his words, “keep the culture so th
    at it remains humble, agile, and responsive all the
    time and keep the people externally focused.” Bi-ann
    ual retreats were held in Hong Kong, and senior
    management meetings were attended by division-level managers in order to foster communication
    across the group.
    Li & Fung’s 3,600 employees were spread around the globe in offices ranging in size from six staff
    in Saipan to 1,100 in the Hong Kong head office. Five of the 48 offices were hubs—Hong Kong,
    Taiwan, Korea, Thailand, and Turkey. Each (except the Hong Kong office) had 200 to 300 employees.
    Li & Fung was entrepreneurial, allowing senior
    managers to run 90 small, worldwide management
    teams as separate and individual companies. These
    dedicated teams of product specialists focused on
    the needs of specific customers and were groupe
    d under a Li & Fung corporate umbrella that
    provided centralized IT, financial, and administrati
    ve support from Hong Kong. This decentralized
    corporate structure allowed for adaptability and rapid reaction to seasonal fashion shifts.
    As a meritocracy, performance-based promotion
    and compensation were cardinal principles.
    Each of Li & Fung’s top executives negotiated in
    dividual compensation packages. In contrast to
    companies that restricted executiv
    e bonuses to a fixed percentage of salary, Li & Fung bonuses were
    based on profits with no ceiling. In the words of one journalist:
    It’s not every company that calls its executives
    “little John Waynes.” But for Li & Fung, the
    image captures perfectly the drive, dedication
    , and independence of the company’s far-flung
    managers. As Li & Fung extended its geographic reach, it also expanded its mix of cultures.
    And to manage the mix it uses a simple formula:
    give managers the freedom to work as they
    see fit, so long as they get the job done.
    10
    Tripartite Growth Strategy
    In 2000 Li & Fung saw its future growth coming from a combination of organic growth, expansion
    through acquisition, and extension of its su
    pply chain to new markets via the Internet.
    8
    Louis Kraar, “The New Net Tigers,”
    Fortune Magazine
    , May 15, 2000, p. 310.
    9
    Joanna Slater, “Masters of the Trade,”
    Far Eastern Economic Review
    , July 22, 2000, p. 10.
    10
    Joanna Slater, “Corporate Culture,”
    Far Eastern Economic Review
    , July 22, 1999, p. 12.
    Do Not Copy or Post
    This document is authorized for use only by John Zerio until September 2011. Copying or posting is an infringement
    of copyright. [email protected] or 617.783.7860.
    Li & Fung (A): Internet Issues
    301-009
    5
    Organic Growth
    Since 1995, the Group had grown or
    ganically by receiving more orders from existing clients and
    by securing new mandates from strategic clients.
    Li & Fung further extended its network and
    diversified its sourcing around the globe with new offices in places as diverse as Bangladesh, Sub-
    Saharan Africa, and Manchester, England (see
    Exhibits
    3
    and
    4
    ).
    In 1996 Li & Fung adopted a “three-year plan” system, one which William described as having
    been adopted directly from the economic planning
    system of the Chinese Communist Party, which
    “allow[ed] the company to look ahead, but not too far ahead.” William elaborated:
    We thought that the Chinese had a neat system.
    They have five-year plans, fixed; we have
    three-year plans, fixed. We don’t want moving goalposts, we want set goals. At the beginning
    of every three-year plan we sit down and look
    at the business from its fundamentals. We use
    backwards planning, we recognize
    where we want to be in three years time, identify the gaps
    between that and where we are now, and see what we have to do to get there.
    During its first three-year plan (FY1993–1995), entitl
    ed “Filling in the Mosaic,” Li & Fung focused
    on filling in the gaps in its network of offices to cover new sourcing markets. The second three-year
    plan (1996–1998), “Margin Expansion,” was launched immediately after the Inchcape acquisition to
    increase Li & Fung’s profitability. A third three-year plan, “Doubling Profits” (FY1999–2001),
    established the goals of doubling profits every three years and achieving $3 billion in annual sales.
    Investors liked the results: Li & Fung outperfo
    rmed the Hang Seng Index (HSI) by over 75% in
    2000. The reward was inclusion in the Morgan Stan
    ley Country Index for Hong Kong in May 2000,
    subsequent inclusion in the HSI in August 2000, an
    d on the FTSE World Index Hong Kong Section in
    September 2000. With a market capitalization of $6.6 billion, by mid-2000 Li & Fung was the
    nineteenth-largest Hong Kong stock trading with
    a company record price-to
    -earnings (P/E) ratio of
    nearly 60. A local newspaper declared:
    It is difficult to find a bad word [about Li & Fung]. It could be a poster-child for
    shareholder value, with a return-o
    n-equity of 60.2% at the end of last year. The firm is well
    positioned to benefit from the opening of the
    mainland market and Beijing’s accession to the
    World Trade Organization, with 40% of so
    urcing on the mainland and Hong Kong.
    11
    Acquisitions
    Li & Fung’s acquisition strategy was based on buying rival sourcing companies, thereby gaining
    new client accounts, integrating their operations,
    and eventually bringing the operating margins of
    these acquired units up to Li & Fung levels. In 1
    995 Li & Fung acquired Inchcape Buying Services, a
    100-year-old company roughly the same size as Li & Fung and its closest competitor. The Dodwell
    acquisition brought access to sourcing markets on
    the Indian subcontinent and European export
    markets. This acquisition took nearly three years to be fully absorbed into Li & Fung’s operations.
    Within three years, Dodwell’s operating margins in
    creased from 0.8% to 3%, primarily through the
    provision of Li & Fung value-adde
    d services to Dodwell customers.
    In December 1999, Li & Fung acquired the export trading operations of the Swire Group (Swire &
    Maclaine) and Camberley, which were Li & Fung’s
    next-largest Hong Kong-based competitors, and
    in the process became the only listed supply-chain management company in Hong Kong. Like Li &
    11
    David Wilder, “Internet Key to More Gains for Li & Fung,”
    South China Morning Post
    , September 4, 2000, Business Post, p. 1.

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