Background

Li & Fung was established as an export trading company in Guangzhou (China) in 1906, by Pak Liu and Li To Ming. Although the Li family has long since sold its entire interests in the company to the Fungs, the name Li & Fung has been kept unchanged. When the Communists gained power in China in 1949 the Honk Kong office became the headquarters. Shortly after that, the Honk Kong trading was abruptly halted by the outbreak of the Korean War, when the US slapped a tough trade embargo on China.

However, the Hong Kong business community quickly adapted to the new environment by taking advantage of the vast pool of cheap labour created by the large influx of refugees from China and transformed itself into a low-cost manufacturing base. In the 1960s and 1970s, Hong Kong became a major exporter of textiles, toys and plastic products. The rapid increase in exports naturally brought great benefits to Li & Fung and other trading companies in the territory.

But the nature of Li & Fung's business, broking between overseas, mainly US buyers and Hong Kong manufacturers, hardly changed. In fact, the typical HK family-oriented management structure and style also remained more or less the same until Victor and William (third Fung generation) took over at the company in 1972. Like many HK heirs, Victor and William got a western business education (Harvard), but unlike many others they went back willing to apply what they learned instead of striking a big deal.

The first step was changing the ownership structure, as William says:

‘The purpose of the company was clearly one of keeping the livelihood of the family. At that time, shareholding was widely dispersed among my grandfather's eight sons, and senior management was firmly in the hands of family members, although many of them had no interest in running the business.’

'I remember telling my father this: "If you want this company to prosper, you'll have to separate ownership and management, and the way to achieve that is to take the company public",'

In fact, they have made good use of the capital markets. They went public in 1973, they took the company private in 1989 by buying out the minority interests and, finally, relisted the company on the Hong Kong stock exchange in 1992.

By 1978 China began to pursue economic reform and an open door policy. This triggered a rush by Hong Kong companies to establish production bases across the border to take advantage of the then almost unlimited supply of cheap land and labour.

'I really feel that Hong Kong pioneered the concept of borderless manufacturing in Asia,' says Victor. 'Now, manufacturers in Taiwan, South Korea and Singapore are following the example we've set.'

Li & Fung, however, has continued to stay out of manufacturing. Instead, it prides itself on its capability to subcontract assembly work for its customers to factories in the most cost-effective manufacturing sites. In fact, Li & Fung has thrived on its ability to take advantage of the rapid increase in intraregional trade and investment and the opening of China as a manufacturing and as a potential market.

The brothers' strategy to benefit from the widening choice of sources of supply and production sites has provided the flexibility to shorten production lead times for even quite large orders from five months to three weeks. 'That gives us a definite competitive edge because buyers are placing smaller orders and demanding shorter delivery times to meet fast-changing market trends,' says Victor.

In order to support this highly competitive strategy, the company has devised what is widely regarded in the industry as an exceptionally generous incentive scheme, which sets no limit on bonus pay. Under this system, managers can receive bonuses that are higher than their salary. William says that his total pay, salary plus bonus, is usually lower than some of the high flyers in the company. 'I'm only the third or fourth highest-paid guy in this company,' he says.

This incentive scheme enabled the break up of the company into separate divisions that retain the typical hong Kong entrepreneurial spirit. "We have 50 business units each headed by a small 'John Wayne'," says Victor Fung.

The Value Proposition

The way to stand out of the trading houses crowd was clearly to move up the value chain. As Victor explains: 'A product costs, say, US$ 1 when it comes out of the factory in Asia. By the time it gets to the retail shelves in the US, it's going to cost US$ 4. The secret is to try to earn a bigger share of that 4:1 markup.'

Li & Fung does that by what Victor describes as 'involving at both the front end and the back end of the production process'. At the front end, 'we do the marketing, design and engineering', he says. At the back end, 'we do the testing, packaging and shipping'. To carry this strategy a step forward, the company is planning to establish distribution channels in some markets, including China and the US.

In an aggressive move, in early 1995 the company nearly doubled its size through the acquisition of its major Hong Kong rival, Inchcape Buying Services (IBS), which provided Li & Fung with greater access to the European market.

Meanwhile, the group continues to expand the privately held retailing arm of its business, which focuses on the joint ventures with US principals to operate the Toys'R'Us superstores and the Circle K convenience store chain in Hong Kong. 'We're learning mass marketing and chain store operation from these joint ventures,' says William. 'The rising consumer purchasing power in this region is providing great opportunities for the retailing and wholesaling business.'

'Value adding is the challenge facing Hong Kong and other maturing economies of Asia,' adds Victor. 'The future of Asia doesn't lie in trimming production costs, but in its ability to upgrade its infrastructure and expertise so that it can move up the value-added chain in world trade '

Brief Analysis

I believe that the most interesting aspect of Li & Fung is their success in changing the ownership and management structure in an old, family owned company in a business environment dictated by relationships and personal values.

Also their strategic positioning in the value chain was very insightful, instead of doing the easy move into manufacturing, they decided to move closer to the end user into distribution, design and marketing.

Nevertheless, it seems that although they are able to provide value to their customers and to extract a 4% profit margin, which is double the industry average, their market position can be threatened at any time, as they don’t have any unique, difficult to replicate, characteristic.

Andre’ Reginato (November 20th, 1996)

Course 15.939