Li & Fung’s strategy to make the maths work

June 2, 2014 5:43 pm

Li & Fung’s strategy to make the maths work

By Demetri Sevastopulo

Different figures: the Juicy Couture brand is owned by GBG, the unit that Li & Fung plans to list separately

When Li & Fung was set up in Canton, now known as Guangzhou, in 1906, it specialised in exporting traditional Chinese goods – from silk and porcelain to tea and fireworks – to the west.

Over the past century it has transformed itself into the world’s biggest sourcing company, with turnover last year approaching $21bn.

Wherever you live, there is a good chance that some of your clothes, toys or household goods were sourced by Li & Fung from factories in China and around the globe for retailers such as Walmart, fashion companies such as Calvin Klein, or brands owned by the group, such as Juicy Couture.

Now based in Hong Kong, Li & Fung has succeeded by finding manufacturers to make goods cheap­ly for retailers such as Target and Marks and Spencer. But it has faced criticism in recent years that its model – acting as the intermediary between factories and retailers – was becoming unsustainable, particularly as labour costs rise rapidly in China.

William Fung, the 65-year-old chairman of the company co-founded by his grandfather, says it received too many accolades in the past and is now being unfairly criticised. Nevertheless, it recently took a “zero-base look” at its business to find a model more suited to the global environment, and thereby an­swer its critics and rescue a share price that has halved over the past three years.

“We’ve got to find a growth driver in Li & Fung, given our size, because now arithmetic is against us,” says Mr Fung, in his Kowloon office in Hong Kong. “When we were small you could grow at 20-30 per cent . . . now­adays [if] we get a new ac­count even for half a billion dollars, it doesn’t move the needle that much.”

In preparing its new three-year plan, Mr Fung says, the company realised that it must “develop a whole new market”. The result was a big departure from its traditional model: instead of treating the 15,000 factories in its network as suppliers, it would see them as customers. This realisation formed the first element of a three-pronged strategy to help boost Li & Fung’s future growth prospects.

“We’d better get very serious about this game of supporting our factory base,” says Mr Fung, adding that the move could help factories outside China “to pick up some of the slack that China is going to create by being more expensive”.

The new business takes Mr Fung back in time. When he and his brother Victor, honorary chairman, returned to Hong Kong from the US in the 1970s, China was taking baby steps towards becoming a manufacturing powerhouse. Over time, it attracted all the links in supply chains previously located in countries such as Japan, Taiwan and South Korea. Now the reverse is under way.

Driving the new model is what Mr Fung says is a “very clear sign that production for labour-intensive manufacturing will migrate out of China”.

Li & Fung’s new plans range from assisting factories in locations such as Bangladesh to get trade finance, to helping manufacturers in China move up the value chain. The latter is being encouraged by the Chinese government as rising wages make the country less competitive for labour-intensive manufacturing.

Rarely standing still

While Li & Fung may be pausing in one sense, to review its business models, William Fung, above, is not. He began running at the age of 55, and has completed five marathons. The extended Fung clan – who live in the same 34-floor apartment building – eat lunch every Sunday at his brother Victor’s apartment, which is “like a zoo”, says Mr Fung, because of the number of small children.

Mr Fung says the brothers avoid talking business on those occasions. But they do rib each other about their history, joking that “every generation makes a dramatic mistake in business”.

William and Victor Fung used to tell their father that he had made a big mistake by not emulating Li Ka-shing and getting into property. He would reply that his own father erred by not getting into the opium trade.

Asked what their children will say about them, Mr Fung demurs uncharacteristically.

“I’m not going to speculate. It would be self-incrimination.”

On a recent tour of a factory in Guangdong province owned by United, a Taiwanese garment manufacturer, Lesley Ho, one of Li & Fung’s top quality assurance executives, points out the ways in which the sourcing company has helped ad­vance “lean manufacturing”. This includes everything from making production lines more efficient to reducing the amount of wastage in cloth – the most expensive part of production.

Ms Ho says a concentrated push to raise productivity at a much less advanced factory in India increased productivity 90 per cent over six months. As Li & Fung introduced ways to speed up, workers who get paid per piece saw their monthly wages rise from 1,000 rupees ($17) to 4,000 rupees, and absenteeism plummeted.

In this way, vendor support services will provide an important complement to Li & Fung’s traditional core business, says Mr Fung.

“It’s going to take us a year or two of investment but by the end of this three-year plan we think that will be a significant contributor to our operating profits.”

The second part of the three-pronged strategy involves an investment in logistics through its March acquisition of China Container Line, a sea freight forwarding business. The aim is to generate more bargaining power via larger volumes, providing cost savings on shipping of 5 to 15 per cent.

The third, and according to some analysts, most controversial element involves Li & Fung spinning off a unit called Global Brands Group into a separate listed company as soon as it receives approval from the Hong Kong stock exchange, which is expected within months.

GBG owns a range of brands such as Juicy Couture, but also holds licences from fashion labels such as Tommy Hilfiger and J. Lo – the brand started by film and music star Jennifer Lopez – to produce and sell their products.

Some analysts have criticised GBG, saying the unit used acquisitions to mask a lack of organic growth.

Mr Fung says the rationale to split the companies was that they will pursue very different models. The sourcing business provides low margins but a steady income, while the other “is more volatile but overnight it could be a fantastic success”.

Spencer Fung, Victor’s son, will become chief executive of Li & Fung while Bruce Rockowitz, the current chief executive and former tennis coach, will head the new company.

“It will give clarity to me as to what kind of staffing I need on each side,” explains Mr Fung. “One type is the guy who has a machete cutting his way to the next cheapest factory in a jungle, the other kind is a guy who could romance a J. Lo to give him or her the licence.”

Could both businesses not have been kept within the group, but under different management? Mr Fung responds that there was concern that GBG might over time be seen as a rival to Li & Fung’s retail customers.

“We don’t want any suspicion or any doubt in our existing customers’ minds about our role. We want 494 [Li & Fung’s stock code] to remain a pure play sourcing company,” says Mr Fung.

He hopes that investors will buy his story. Several analysts have applauded the move, and the stock has risen about 10 per cent since the announcement. But some have a less rosy view, such as Spencer Leung at UBS. In a recent note to clients, he expressed concerns that GBG is taking a higher proportion of Li & Fung’s liabilities relative to its size, and that the sourcing business is overvalued due to limited growth potential.

Addressing one criticism that has been levelled at Li & Fung, Mr Fung says it does not plan any big acquisitions over the next three years: “We really need to pause and just get growth.”