Li & Fung Case Study

Li & Fung Case Study

Li & Fung is a trading company in Hong Kong, which has been around since the early 1900’s.   It was started in 1906 by Mr. Fung Pak-Liu and Mr. Li To-ming, and became one of the first Chinese owned export companies.  In the beginning the company exported porcelain and silk to the United States, and eventually expanded into exporting bamboo, jade, ivory, rattan ware, fireworks, and handicrafts.  Since buyers in the U.S. and sellers from China had trouble speaking each other’s language, bilingual traders became exceedingly important to the business.  Li & Fung officially became an established limited company in Hong Kong in 1937.

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During World War II, trading came to a halt for several years.  In 1943, Pak-Liu passed away.  Before the war ended, To-ming decided to sell his stake of the company to the Pak-Liu family.  Because of To-ming’s decision to sell, the Fung family became the sole owners of Li & Fung.  In 1949, Fung Hon-chu took over his deceased father’s company and restarted the trading operations in Hong Kong. At the time Hong Kong was under British control.  With the influx of refugees after 1949, Hong Kong developed as a manufacturing economy exporting labor intensive consumer products.[1] Because of the changing conditions, Li & Fung began exporting consumer products such as garments, electronics, plastic flowers, and toys.  The success of this strategy turned the company into Hong Kong’s biggest exporter.

In the 1970’s, trading in Hong Kong began to decline due to competition from Asia, Taiwan, and Singapore.  Hon-chu’s sons, William and Victor, became involved into the family business to help modernize and rebuild the company.  In 1973 the company was listed on the, then, Hong Kong Stock Exchange and the new issue was oversubscribed 113 times, a record that remained for 14 years.[2]  In 1979, the Chinese economy was starting to improve because of low labor costs.  Many manufacturers relocated their factories to southern China.  With such advantages put in place, Li & Fung established a regional network of offices in Asian countries such as Taiwan, Singapore, and Korea.  This helped the company grow into one of the key regional traders in Asia.

In the late 1980’s trade margins were decreasing.  In 1989, as part of a re-organization of the family’s interests, Li & Fung was taken private in one of the first management buyouts in Hong Kong.[3]  The company was restructured into two business groups.  One group was for export trading, and the other for retail.  In 1992, the export trading part of the business was re-listed on the Hong Kong Stock Exchange.  Shortly afterwards the company was looking to expand, but realized that they needed to grow outside of their regional area.  They started expanding worldwide, with most offices being built in Europe and the United States.  Besides building offices, internet technology was being put into place to help enhance the company internally and externally.

Before the turn of the century, Li & Fung became a main global trading company with more than 95 percent of its revenues coming from North America and Europe.    Their products during this time were soft and hard goods.  Soft goods were mainly garments.  Hard goods were fashion accessories, footwear, gifts and furnishings.  The company was now successfully positioned with 68 offices across 40 countries, with over 4,500 employees.  On the retail end, it operated as a license holder for Toys “R” Us and Circle K in the Chinese and Asian markets.  Some of its U.S. customers included Kohl’s, Abercrombie & Fitch, Ann Taylor, Disney, Reebok, and Warner Brothers.   Things were going very well for Li & Fung.  They were receiving recognition awards by numerous popular magazines.  The company’s biggest break came in 2004 where they were granted an export company license by the Ministry of Commerce of the People’s Republic of China.  This license gave them the advantage of being the first wholly owned foreign trading company to be offered direct export rights in China.  In the future, it is foreseeable that China’s export expansion and domestic market potential will provide unprecedented opportunities for Li & Fung to grow its businesses in trading, commodity distribution, logistics and retailing.[4]

From an Internal perspective, Li & Fung had numerous strengths.   In the very beginning, they expanded their product line from porcelain to six new items to export.  They had a competitive advantage of having traders that could speak more than one language. Years later they took advantage of the manufacturing economy by producing even more products.  When the company was struggling in the 1970’s they went public with their stock which held a 14 year record for being overscribed 113 times.  In the late 1970’s and early 1980’s when competition was getting stronger, sourcing companies were established in the countries competing with them.  Having the courage to go from public to private in the late 1980’s, gave them the opportunity to split the company into an exporting and retail organization giving them more leverage.  They had a decentralized management structure.  Using technology gave the company the ability to communicate globally expanding their product lines and customer networks.  Finally receiving an export license from the People’s Republic of China, gave them a enormous competitive advantage since they were the first wholly owned company to have direct exporting rights in China.

Li & Fung wasn’t always perfect as they did have their weaknesses. Initially they were lacking qualified personnel.  Until they expanded, they were suffering from stiff competition.  Their B2B initiative “StudioDirect”, failed forcing the company to restructure its operations.  Finally, in the early 2000s, they were criticized for failing to move toward an effective strategy to increase revenue in the European market.

Even though Li & Fung experienced internal threats and weaknesses, the company has always had a good eye for assessing their external environment and adapting accordingly.  For instance, the Li & Fung Company has been incredibly successful in manufacturing their own products.  Therefore, the company decided to present its wealth of information about the manufacturing processes to other companies.  This has made Li & Fung a leading competitor in the fast moving consumer goods (FMCG) market.

We will evaluate the external environment of the Li & Fung Company by using the Porter’s Five Force Model. First on Porter’s model is the risk of entry by potential competitors.  This particular module discusses the possibility of a company competing in an industry that they have not previously been in.  Li & Fung took a leap when they decided to help other, less fortunate companies, improve their manufacturing processes.  For example, in the late 1990’s the company assisted Coca-Cola in revamping its manufacturing process.  The soft drink giant found that their manufacturing process was outdated and expensive.  To counteract this Li & Fung created an extranet site for the company called, this enabled Coca-Cola to expedite shipping orders faster and it also allowed customers to adjust orders placed with company more efficiently.

            Second on Porter’s model is rivalry among established companies.  This module discusses how companies struggle to dominate a particular section of a market.  Presently it doesn’t seem as though the Li & Fung Company is out to dominate any one market.  Quite conversely, the company likes to be involved with a diverse amount of business endeavors.  They have their hand in everything from clothes manufacturing to being business consultants to other companies needing advice. Their business strategies have been geared towards the restructuring of this massive company, while maintaining its individual small divisions.

Third on Porter’s model is the bargaining power of buyers.  This module refers to the ability of buyers to bargain down prices charged by companies in the industry.  Li & Fung has great success in bargaining over the materials they buy, as well as the production of the product.  For instance, the company out sources to companies all over the world to find the cheapest materials.  Once the cheapest materials are located, they are then shipped to the factories with the most favorable labor conditions.  Distributing their manufacturing process to various companies like this allows Li & Fung to remain a top competitor in the manufacturing business.  They can essentially produce quality products quickly.

The fourth of Porter’s five competitive forces is the bargaining power of the suppliers. Suppliers of materials to the Li & Fung Company are at a disadvantage.  This is because if their prices are not favorable, the company will out source to a different supplier with a lower price or more quality supplies.  It would be in suppliers’ best interest to try and stay as competitive as possible.

The fifth of Porter’s five competitive forces is the threat of substitute products.   Li & Fung have a wide array of competition. However; the company need not worry about the threat of substitute products.  As long as Li & Fung continue to make a low cost, quality product, and they continue to produce these products quickly and efficiently, the company will always be a force to be reckoned with.

After further researching the external environment of the company, it seems that it would be a great place to work for.  They have a strong competitive position in their market and they also encourage entrepreneurial thinking and decision making.  The company is also very good at continuously analyzing its surroundings and making changes as necessary.  The company is also involved with a wide variety of businesses. This has to be exciting to any employee, the possibility of working on different projects any day of the week.  Employees never know what new field of business the Li & Fung Company will venture into.

When his trading business began to suffer, Fung Hon-chu solicited the assistance of his sons, William and Victor Fung. William had just received his MBA from Harvard University, where Victor was a professor. William and Victor’s friends were concerned that the trading business would eventually die out. However, William and Victor realized there was a huge potential for the trading business. So they returned to Hong Kong where they worked hard to modernize and rebuild Li & Fung into a well-structured, professionally managed organization. Li & Fung focused on efficiently managing the supply chain of its clients, developing a unique customer-centric organizational structure, leveraging information technology (IT) and the Internet to expand operations globally.

Li & Fung’s major strength was its ability to overcome the language barrier. In doing so, Li & Fung became an intermediary. Li & Fung started out as a regional sourcing agent. By establishing sourcing offices in Singapore, Taiwan, and Korea, the company had expanded its reach. This reach, along with Li & Fung’s knowledge, held value for the customer who did not have the necessary resources to deal with regions outside of Hong Kong.

In 1979, Li & Fung evolved into designing production programs. The firm created an entire manufacturing program designed specifically for the customer, which involved all tasks from specifying the product mix to scheduling the manufacturing process and delivery time. Hong Kong had become an expensive and noncompetitive place to manufacture. Li & Fung took advantage of the fact that the Chinese economy was being liberalized and moved production to a labor-intensive portion of Southern China.

Li & Fung used a method called “dispersed manufacturing” to allocate the production processes. The company dispersed different production processes to various manufacturers, based on cost of labor, quality, trade barriers, transportation costs, and other factors. Tasks were distributed to the different producers based on their capabilities and costs. Li & Fung would perform all high-end value-added activities and outsource low-end activities.

The company coordinated all processes in the value chain, managing the logistics and arranging the shipment of the finished order to the client. They also ensured that suppliers were in compliance with the rules and regulations pertaining to such areas as environmental standards and child labor in the importing countries. These standards, along with others, are outlined in the code of conduct which Li & Fung developed for its suppliers. Outsourcing the production processes to areas with lower wages resulted in lower costs for the customer. By maintaining control over product design, Li & Fung was able to ensure quality, which ultimately led to increased customer satisfaction.

As Li & Fung’s expertise in the area of supply chain management grew, companies began to outsource their entire supply chain management to Li & Fung to save time and reduce costs. The goal of supply chain management is to minimize inventory holding and maximize inventory turnover. (Note: Textbook definition) Obsolete inventory was a major area of concern for fast-moving consumer goods companies. Managing the whole supply chain of Li and Fung’s customers led to shorter product delivery cycles. This allowed the customer to make changes relatively close to the delivery date if there was a sudden change in market demand.

A major supplier management strategy of Li & Fung was to utilize anywhere from 30 percent to 70 percent of factory capacity of suppliers. They wanted to be the supplier’s most important customers. However, the company did not want the supplier to be dependent on them. This concern for the supplier gave them a positive image to potential suppliers. Li & Fung provided the supplier with performance feedback, pointing out the supplier’s strengths and weaknesses. The company offered incentives to suppliers so that they would willingly customize their operations for Li & Fung. Both parties benefited from the arrangement. The supplier had a loyal customer and Li & Fung had a dependable source of quality products. Li & Fung recruited new suppliers as well.

During the 1980’s, Li & Fung decided to adopt a new customer-centric structure. Prior to the customer-centric structure, Li & Fung was structured geographically. The company realized that this structure made it difficult for companies to maximize the value of the supply chain because of the lack of cooperation and coordination among country units. Under the new structure, each division was focused on serving a large customer. Each division acted as a profit center. Li & Fung hired entrepreneurial types to lead each division as if it was its own separate business. To motivate the division managers, the managers’ compensation was tied to the division’s bottom line. The goal was to run the company with the flexibility of a small company while having the strength of a large company.

Li & Fung believed the Internet would increase opportunities by helping drive supply chain costs down and integrating management. To take advantage of the full potential of the Internet, Li & Fung created dedicated extranet sites for major customers, enabling the company to interact with customers, assist in product development, and perform many other tasks.  Coca-Cola was a major customer who benefited from the use of Li & Fung’s extranet. For example, independent bottlers of Coca-Cola could check orders placed by other bottlers. This allowed them to compare orders and determine if the products ordered by other bottlers would be useful in their own markets. The Web also helped customers stay current on what products were in heavy demand.

In 2000, Li & Fung entered the e-commerce market through its Business-to-Business initiatives. The goal was to create economies of scale for small and medium-sized enterprises. Private-label manufacturing allows customers to have their own differentiated line. Intensive interaction is required to perform private-label manufacturing. To capture economies of scale, Li & Fung needed large customers. The Internet allowed Li & Fung to offer the option of private-label manufacturing to medium and small sized companies. The company collected orders from the Internet and aggregated them. Li & Fung would then mass produce large orders of the same product and allow each customer limited customization. This way the company was able to reap economies of scale but with enough customization to please the customer.

The Internet strategy included the formation of StudioDirect, Inc. in April 2000. The website allowed small and medium-sized retailers to place more customized orders. StudioDirect formed an alliance with Danzas AEI Intercontinental, a business division of the Danzas Group. Danzas would handle the logistics needed to deliver finished goods. Li & Fung advertised through direct mail. The goal was to reach approximately one thousand small- and medium-sized retailers in the first year.

As Li & Fung continuously grew, they realized that they required a vast network of sourcing offices to sustain the trading business. Sourcing offices were established across the world, mainly around the United States and Europe, which were its major markets. Li & Fung’s major strategy for expanding globally was its acquisition strategy. The company would acquire several different companies and form different alliances to take advantage of the strengths that the acquired companies possessed and that Li & Fung needed to improve upon.

            For example, in 1999, Li & Fung acquired Swire & Maclaine and Camberley Enterprises. Swire & Maclaine was a major provider of product sourcing and quality assurance services in Hong Kong, and Camberley Enterprises manufactured high-quality ladies sportswear, ready-to-wear garments, and home accessories. This acquisition offered Li & Fung expertise in the design process and strengthened the company’s customer base in the United States and Europe. It also further consolidated its business in Hong Kong by acquiring a major competitor in Swire & Maclaine.

            Because the majority of Li & Fung’s revenues came from North America, the company focused on expanding its customer base into non-U.S. markets. Li & Fung began to focus on the fast developing economies in Asia and the Southern Hemisphere. The increasing popularity of fashion retailing in Japan made it a potential market. An alliance between Li & Fung and Nichimen Corporation, a leading general trading firm in Japan, was formed in 2003 to offer higher value for Japanese retailers. Nichimen was well known for its customer servicing capabilities. In December of 2003, Li & Fung acquired two sourcing businesses which they combined to form International Sources. This acquisition was expected to strengthen the hard goods business and enable it to reach out to Mexico. By the end of 2003, Li & Fung had emerged as one of the few global consumer goods trading companies with geographic flexibility and depth of expertise.

Li & Fung’s organizational structure combines the disciplines of centralization and decentralization to construct a globally efficient, business-diversified corporation. Li & Fung’s corporate structure is centralized around the organization’s board of directors. Branching from the board is General Management, Risk Management, Nomination, Compensation, and Audit Committees. Corporate governance and compliance is comprises a subdivision of the Audit Committee. The board of directors essentially exercises control and management of the company, directing strategy, business ventures, and acquisitions. Li & Fung utilized various strategic functionalities including internet, proximity, acquisition, supplier management, global expansion, and supply chain management. Probably the most important strategy of all was deciding what to sell. The firm would gravitate towards hard and soft goods. Soft goods included garments while hard good consisted of footwear, gifts, furnishings, toys, stationery, etc. These strategies along with product differentiation helped cement Li & Fung’s global success in the export trading market as well as supply chain management.

Li & Fung’s internet utilization has evolved into a complex medium for e-commerce. Communication between Li & Fung’s individual business units developed into a major concern as the company growth increased and became more globalized. To enable the free flow of information, the company connected its network of offices with the introduction of its very own intranet. Utilizing the company’s proficiency and awareness of its internet capabilities, Li & Fung began to create extranet sites for major companies which would assist the customer in tracking their order, making last minute changes, and helping with the Li & Fung’s productive development in a cost-efficient manner. Li & Fung used the internet as a tool to construct more transparent supply chains.

Li & Fung’s proximity strategy fueled its drive towards globalization. This strategy’s purpose was to decrease the distance between Li & Fung’s production plants and the customer’s intended market. Combined with their focused acquisition and global expansion strategies, Li & Fung was able to expand sourcing networks, production lines, customer base, and a diversified worldwide presence. They expanded into the hard goods business as well as licensing well-known brand names. The combination of these strategies was an important growth driver as the company positioned itself as the prominent foreign trading company in addition to an expert in supply chain management.

Li & Fung’s supplier strategy also played a large part in the company’s success. To ensure shorter product delivery cycles, Li & Fung reached upstream to organize production and ensure small production runs resulting in an improved response time for retailers. For example, if Levi was known to request 1 million pieces of garments, Li & Fung would simply inform their suppliers ahead of time with an estimation of what would be needed so that it would be available at the time of the order. Another part of Li & Fung’s supplier management strategy was to utilize anywhere from 30 to 70% of the supplier’s factory capacity. Li & Fung ensured that it would not use up the entire capacity of the manufacturer to give itself flexibility to gain exposure to new suppliers. Li & Fung constantly explored various supplier alternatives utilizing those with the most favorable opportunities.

General Management’s responsibility is to manage the revenue and cost elements of the company while coordinating the strategic planning functions of the company. Essentially general managers oversaw all of Li & Fung’s marketing/sales functions in addition to day-to-day operations. Li & Fung developed a significantly unique and efficient approach to general management. Li & Fung adopted a customer-centric structure, where it subdivided its organization into individual business units focusing on large customers such as Levi’s, The Limited, and Abercrombie and Fitch. These individual divisions were managed by a single person, a lead entrepreneur, acting as if it were his/her own company.

Designated as the division manager, this person was responsible for understanding and satisfying the customer’s needs via mobilization of the group’s resources and processing network. The division however, was further categorized into specialized teams in areas such as technical support, merchandising, raw material purchase, quality assurance, and shipping. These divisions were kept relatively small and the managers were given considerable freedom to run their divisions. Li & Fung believed that autonomy would encourage free spirit, but to further ensure compliance and commitment of their managers Li & Fung offered and extensive and very lucrative compensation packages. There were no fixed ceilings on the size of bonuses and they were spread to other non-management employees as well.

These divisions promoted knowledge sharing from within and during their interaction with customers. This proved beneficial not only to the customers but to Li & Fung as well. The discussions not only expanded the fashion retailer’s knowledge with more creativity for designing garments for a season, but simultaneously strengthened Li & Fung’s awareness of the market as they increased the diversity of their business entering into clothing licensing projects with well-known brand names.

These divisions operated in dispersed manufacturing. Under this strategy, all high-end value-added activities such as design and quality control were completed locally in Hong Kong and all low-end activities like manufacturing were outsourced to other business locations across the world. Understanding the benefits of and gaining expertise in dispersed manufacturing, Li & Fung extended its network into other labor-intensive parts of China. As maturing markets became more and more competitive along with changing consumer trends, many countries were compelled to outsource not only their manufacturing but their entire Supply Chain Management (SCM) to reap cost and time benefits.

Experts on the subject of SCM, proved beneficial to Li & Fung due to the direction of the global economy. Companies looking to optimize SCM now requested Li & Fung’s guidance and knowledge. To further capitalize on its SCM by optimizing every step of the dispersed manufacturing technique, Li & Fung dissected the entire value chain from product design and development, raw material sourcing, production planning, quality assurance and factory inspections, production and logistics, timely delivery, to compliance. The company became a wide-ranging intermediary by linking and synchronizing the various links in the supply chain.

Risk management is the practice of measuring risk and developing strategies to manage it. Strategies such as transferring the risk to another party, avoiding the risk all together, reducing the negative effect of the risk, or accepting some or all of the consequences of a particular risk. There are many types of risk ranging finance, relationship, and process-engagement. These risks directly reduce the productivity of workers, cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Given the business depth at which Li & Fung operated, the risk management team contributed immensely to its success. Practically identifying all of its direct competitors and avenues to expand the company’s growth, Li & Fung entered into several acquisitions with the strategic mindset of increasing their sourcing network, product lines, and customer base.

In addition to managing the company, several committees assist the board of directors to ensure compliance with applicable laws and regulations as well as ethical behavior among management. The first and probably the most important being the corporate governance and compliance committee, which is responsible for the processes, customs, policies, laws, and institutions affecting the corporation’s direction and control. Corporate governance pertains to the relationships among the board of directors, shareholders, management, and other stakeholders such as customers, suppliers, lenders, and the community. The corporate governance committee reviews and makes periodic recommendations concerning the company’s corporate governance policies. The corporate governance committee implements guidelines and mechanisms protecting those individuals impacted such as the stakeholders and shareholders while optimizing economic conditions.

The purpose of the audit committee is to aid the board of directors in fulfilling its oversight responsibilities by analyzing the financial information which will be provided to the shareholders and others. In addition, the audit committee evaluates the systems of internal controls which management and the board have established and monitors the system by appointing and maintaining a staff of independent accountants who oversee the company’s accounting and financial reporting processes as well as the audits of the company’s financial statements.

The existing corporate structure and control systems in place are satisfactory for preventing any unethical acts by management while promoting good business practices with a strong solidified culture. Not only did Li & Fung ensure they were in full compliance, they also ensured that suppliers complied with the rules and regulations such as child labor and environmental standards. With the present business strategies, there is a high degree of fit with Li & Fung’s corporate structure. Li & Fung have identified the appropriate compensation packages for management to encourage continued commitment and cooperation as well as the appropriate avenues for managing any possible problems.

[1] 31 March 2007 Li & Fung
[2] 27 March 2007 Li & Fung
[3] 27 March 2007 Li & Fung
[4] 30 March 2007 Li & Fung

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