CASE STUDY ( Li & Fung)

Company Perspectives:
Global Supply Chain Management is our business. Working in partnership with our customers,
we cater for their needs of competitive pricing, quality, on-time delivery, as well as ethical
sourcing. We manage the logistics of producing and exporting goods across many producers and
countries.
A one-stop-shop service--Small, dedicated teams of product specialists focus on the needs of
particular customers and organize for them. We provide the convenience of a one-stop shop from
product development, through production management, to customs clearance and delivery when
required.

Key Dates:
1906: Fung Pak-liu and Li To-ming begin exporting jade and porcelain in Guangzhou, China.
1937: Li & Fung Limited is formally established in Hong Kong.
1949: When China turns Communist, Pak-liu's son Fung Hon-chu reinvents the company to
export goods manufactured in Hong Kong.
1973: Hon-chu's sons William and Victor persuade him to list Li & Fung on the Hong Kong
Stock Exchange; the Fung brothers institute a more modern management style.
1979: China opens up for trade, and Li & Fung develops a trading network throughout East Asia.

1989: The Fung brothers buy out family shares and take Li & Fung private in a management
buyout.
1992: After being reorganized to focus on trade, the export division of Li & Fung is relisted.
1995: Li & Fung acquires the British trading company Inchcape Buying Services.
2001: The "dispersed manufacturing" approach has helped Li & Fung double profits twice over
the previous six years.

Company History:

During the course of its nearly 100-year history, Hong Kong-based Li & Fung Limited has
grown from a simple exporter to an expert in "global supply chain management." The company
coordinates product design, raw material and factory sourcing, production management, and
quality assurance for clients that have included The Limited, The Gap, Coca-Cola, and Kohl's
Corporation. Li & Fung deals primarily with garments but is increasing its focus on promotional
items, toys, sporting goods, and housewares.

When one of its clients needs a product, Li & Fung does much more than just find the lowest-
price source. The company breaks apart the manufacturing process to find the best supplier for
each stage of production. For example, if a client orders a polo shirt, Li & Fung might buy
American cotton, have it knitted and dyed in China, and send it to Bangladesh for sewing. The
company's 65 sourcing offices in 38 countries give it the global connections it needs to pull off
this "borderless" manufacturing process.
Founded in 1906 as an exporter in Guangzhou, China, Li & Fung has survived World War II,
China's move to Communism, and eventual reopening of China for trade. More recently, the
company has adapted to the transition from a manufacturing to a service-based economy in Hong
Kong and the emergence of the Internet. The company is now led by Victor and William Fung,
the third generation of the Fung family to deal in exports. Li & Fung's flexibility and its expertise
in East Asian and global manufacturing have allowed it to move beyond the role of a simple
trading intermediary and develop a range of services that are still in demand in the 21st century.

Basic Exporting: Early 20th Century Through World War II

In 1906 Fung Pak-liu and Li To-ming founded an exporting company in the southern Chinese
city of Guangzhou. The company was the first Chinese-owned exporter in a field controlled by
foreign merchants. As a former teacher of English, Fung Pak-liu was able to act as an
intermediary between Chinese-speaking factories and English-speaking buyers. He received a 15
percent commission for his interpreting services. In the first few years, Li & Fung dealt primarily
in porcelain and silk, and later moved into bamboo and rattan ware, jade, ivory, handicrafts, and
fireworks. The company came up with a new way to make fireworks in 1907, using a paper
rather than a mud seal. The new product produced less dust and, because it was lighter, saved
tariff costs since the U.S. import duty was based on weight. The design became the industry
standard.

Because the river port in Guangzhou was too shallow for oceangoing clippers, the British colony
of Hong Kong served as the deep water port for South China. So Fung Pak-liu's son Fung Hon-
chu went to Hong Kong and established a branch to handle the shipping of goods. On December
28, 1937, Li & Fung was formally established as a limited company in Hong Kong.

World War II put a halt to trading for several years. Fung Pak-liu died in 1943 and control of the
firm moved to the second generation. Li To-ming, who had been a silent partner, sold his shares
to the Fung family in 1946. After the war, China became a Communist country and a flood of
refugees came to Hong Kong. Li & Fung was now cut off from its factory sources in China and
needed to find a new way of doing business. Fung Hon-chu reinvented Li & Fung as an exporter
of the labor-intensive consumer goods that began being produced in Hong Kong during the
postwar period. The company dealt in garments, toys, electronics, plastic flowers, and wigs. Its
primary customers were retailers in the United States. As Hong Kong's manufacturing economy
grew, Li & Fung grew with it.

The Third Generation: Modernization in the 1970s

Fung Hon-chu's sons Victor and William attended universities in the United States. The older
son Victor attended the Massachusetts Institute of Technology, then got a Ph.D. in applied
mathematics from Harvard, while his younger brother William studied computer science at
Princeton and got his M.B.A. at Harvard Business School. The two might have pursued careers
in the United States, but in 1972 their mother called and pleaded with them to come home and
help their father so he would not have to work so hard. Having been exposed to Western business
practices, the two were hesitant to go back to a traditional family-owned enterprise. "Trading is a
sunset industry," their friends in the United States warned them. But their father suggested that
they come back and show him how to run the business better. William returned in 1972 and
Victor in 1974.

By the 1970s, competitive pressure was pushing Li & Fung's profit margins down to 5, or even
3, percent. Taiwan and Singapore had cheaper labor and were developing enough manufacturing
capacity to vie with Hong Kong. Meanwhile, buyers were more inclined to bypass the
middleman and deal directly with the manufacturer. If Li & Fung had nothing to offer beyond
the ability to connect buyers with factories in Hong Kong, the company would have trouble
surviving. Hong Kong as a whole was moving from a manufacturing to a predominantly service
economy, and Li & Fung's best prospect was to find a way to make that transition itself.

The Fung brothers of the third generation brought a new perspective on the company's future, but
they encountered a difficult environment for making drastic changes. Li & Fung was still run like
a traditional patriarchal Chinese family conglomerate on the idea that the purpose of the
company was to serve as the family's livelihood. More than 30 cousins had stakes in the
company and, even if they were not particularly skilled at business, they were hanging on to
management positions in order to retain shareholder benefits. So William and Victor's first
initiative was to convince their father to take the firm public. In 1973 Li & Fung was listed on
the Hong Kong Stock Exchange in an issue that was oversubscribed 113 times. "It was the only
way to get a lot of disgruntled relatives off our backs and attract professionals into management,"
William Fung told the Far Eastern Economic Review in 1992.

Now that the roles of ownership and management were separated, it was easier to make changes
at the firm. The brothers established offices in Taiwan, Korea, and Singapore in order to
diversify their manufacturing sources. As more and more East Asian countries industrialized, Li
& Fung developed a buying network throughout the region. In 1979 China opened up for trade as
well. Many Hong Kong manufacturers relocated to China, and China once again became a key
sourcing point for Li & Fung as it had been in the first decades of the company's existence.

By expanding geographically, Li & Fung acquired broader regional expertise and a more
substantial base of manufacturing contacts, and thus was able to offer its clients a more valuable
service. For example, the company knew that Taiwan did better work with synthetic fabrics but
Hong Kong was the best choice for cottons. Li & Fung was also well-practiced at negotiating the
system of quotas that governed world textile trade and knew how to move orders between
countries as quotas filled up. With expanded knowledge and resources, the company could
expertly source large orders by putting together a package from the entire region.

From Middleman to Manager in the 1980s

Still, regional familiarity was a basic service without much potential to lift Li & Fung's profit
margins out of the single digits. The company's trade margins were squeezed throughout the
1980s, exposing the need for a more sophisticated business strategy. The answer was to become
more involved in the entire production planning process. The traditional way of operating was
that a customer requested a specific product and Li & Fung found the best supplier. By the late
1980s, though, Li & Fung was offering a broader range of services. Once a company had an idea
of the product it needed, it would send design sketches to Li & Fung. Li & Fung would find the
right type of yarn and fabrics, create prototypes for the customer, set up contacts for each step of
the supply process and develop a production schedule that covered the entire fashion season. Li
& Fung was gradually making the transition from middleman to program manager.

The company also branched out into the area of retail in the mid-1980s. It acquired 50 percent
shares in Circle K convenience stores and Toys 'R' Us chains in Hong Kong. In addition, Li &
Fung established a venture capital enterprise in the United States in 1984, in part out of chagrin
for not having taken advantage of an early chance to invest in its successful client The Gap, Inc.
Known as LF International, the investment company's purpose was to identify companies that
had good design ideas but could benefit from Li & Fung's experience in sourcing materials. LF
International made modest investments in about four to five enterprises a year.

In 1981 Victor Fung succeeded his father as managing director, but in 1986 he left the executive
position to set up an investment bank. William Fung took over as managing director and Victor
continued to guide the company as a nonexecutive chairman. William Fung saw the need for
more changes at the firm but was hampered by the fact that 75 percent of Li & Fung was still
held by a family trust. There were disagreements with the older generation, who remembered the
difficult postwar transition, over whether Li & Fung should trust Communist China. To resolve
the impasse, William and Victor formed a holding company, acquired the outstanding family
shares, and privatized Li & Fung in a management buyout in 1989.

As a private company, Li & Fung had the flexibility to make drastic structural changes. William
Fung refocused the company on its core trading business, selling off unrelated shipping,
insurance, and real estate enterprises. He organized the company into two divisions: export
trading and retail. Instead of assigning responsibilities by country, he organized services by
customer. Each division was free to cross borders to find the best way to serve its client. For
large clients like The Limited or Gymboree, an entire division at Li & Fung would devote itself
to the product line and sourcing needs of one company.

By the beginning of the 1990s, the Fung brothers' changes were bearing fruit. Li & Fung was
well established with 900 suppliers in the East Asia region in countries that included Indonesia,
Singapore, South Korea, Taiwan, Thailand, and China. Retail clothing stores in the United States
continued to be its major customers. The company began a period of exceptionally rapid growth
in 1991, when net revenue grew 56 percent to HK$2.8 billion and net profit reached HK$86.9
million.

In order to acquire funds for further expansion, Li & Fung relisted its export trading division in
1992. The company issued 25 percent of its equity, raising HK$275 million. The now public
trading division became known simply as Li & Fung Limited, while the retail division, with the
profitable Toys 'R' Us and Circle K branch stores, remained a wholly owned subsidiary of the Li
& Fung Group.

Borderless Manufacturing in the 1990s

After the public listing, Li & Fung's services evolved further toward truly borderless supply
chain management. In a 1998 interview with the Harvard Business Journal, Victor Fung
explained how Li & Fung reached the stage of "dispersed manufacturing." As manufacturing in
Hong Kong became increasingly expensive, he said, almost all labor-intensive work moved
across the border to China, while design, packaging, and other technically advanced
manufacturing techniques were still done in Hong Kong. Eventually the whole East Asian region
was pulled into the manufacturing process, depending on each country's particular industrial
strengths. A garment labeled "Made in Thailand" might contain Korean yarn that was woven and
dyed in Taiwan, sewn at five different factories in Thailand, and fitted with zippers made in
China by a Japanese company. Li & Fung became expert at finding the best solution for each
step in the manufacturing process. Fung told the Journal, "This is a new type of value added, a
truly global product that has never been seen before ... We're not asking which country can do
the best job overall. Instead, we're pulling apart the value chain and optimizing each step--and
we're doing it globally."

This global array of services supported rapid growth and acquisitions at Li & Fung throughout
the 1990s. Net profit in 1993 reached HK$185 million on revenues of HK$5.38 billion. Then the
firm nearly tripled its size with the HK$475 million acquisition of Inchcape Buying Services
(also known as Dodwell) in 1995. Inchcape was a British trading company with a network of
offices in India, Pakistan, Bangladesh, and Sri Lanka. The acquisition of Inchcape, with its
European customer base and sourcing points across the Indian subcontinent, balanced Li &
Fung's American customer base and East Asian sourcing network.

Now that growth had taken off, William Fung began using three-year plans to set ambitious
growth targets. In 1998, despite some instability caused by the Asian financial crisis, the
company achieved its goal of doubling profits from the 1995 level. Net profit reached HK$470
million on revenues of HK$14.3 billion, compared with HK$242 million and HK$9.21 billion in
1995, respectively.

In the following years Li & Fung continued to diversify geographically, moving into emerging
centers of production in northern Africa such as Egypt, Tunisia, and Morocco. By 2000, the
company was making an effort to move production closer to its North American and European
end markets and began sourcing from factories in Central America, the Caribbean, and Turkey.
Li & Fung also was courting new end markets with forays into Japan and Australia. Although the
Fung brothers still took pride in their company's Chinese heritage, Li & Fung was becoming a
multinational company with a workforce based in dozens of countries.

With the rise of the Internet in the late 1990s came predictions of a "frictionless economy" where
companies would bypass middlemen like Li & Fung and buy all their parts online. Li & Fung,
however, capitalized on the Internet to strengthen communications with customers and branch
offices. In areas with less developed telecommunications, personal visits, phones, and faxes were
still necessary to ensure that manufacturers delivered the product on time. Li & Fung's decades-
long personal relationships with suppliers, as well as their practical expertise in things like textile
quotas and quality assurance, kept their business relevant in the digital age.

In 1999 Li & Fung acquired the export trading firms Swire & Maclaine Limited and Camberley
Enterprises Limited, adding to their U.S. and European customer base. The following year the
company acquired Colby Group Holdings Limited, its main competitor, in a deal valued at
almost HK$282 million. Revenue continued to grow, but 2001 net profit was hurt by the closing
of an e-commerce venture in the United States known as StudioDirect. The company was set up
in February of that year to let smaller enterprises build their own brands on a web site without
having to place large orders. But the site failed to catch on, and Li & Fung shut down the venture
after less than a year. The year 2001 marked the end of another three-year plan. The company
announced that it had met its goal of doubling continuing operating profits over the period and
reported 2001 net profits of HK$667 million on revenues of HK$33 billion.

Although Li & Fung was posting strong results, the company was vulnerable because nearly 80
percent of its revenue came from U.S. clothing retailers. The company began pursuing customers
in the hard goods sector in order to develop a more balanced clientele. In 2002 Li & Fung landed
a deal to make promotional items for Coca-Cola. That year it also acquired Janco Overseas
Limited, a Hong-Kong based company that supplied nonfood hard goods to supermarkets in the
United States and Canada. In 2002 hard goods accounted for 32 percent of Li & Fung's turnover.
The company remained heavily focused on the United States, with North American customers
contributing 76 percent of turnover.

Li & Fung got off to a slow start on the 2002-04 three-year plan due to an economic slowdown
and the terrorist attacks of September 11, 2001, in the United States. The company was about
half a year behind on its goal but was still optimistic that it would once again double continuing
operating profits over the three-year period. Such feats were more difficult now that Li & Fung
had grown to be a relatively large company. Yet whether or not the company was able to sustain
the rapid growth of the 1990s, it had shown it had the flexibility to continue playing a key role in
the global market of the 21st century.

Principal Subsidiaries: Basic & More Fashion Limited; Camberley Enterprises Limited; Colby
International Limited; CS International Limited; Dodwell (Mauritius) Limited; Janco Overseas
Limited; Li & Fung (Exports) Limited; Lloyd Textile Trading Limited; Maclaine Limited; Shiu
Fung Fireworks Limited; Toy Island Manufacturing Company Limited; Verity Enterprises
Limited; LF International Inc. (U.S.A.).

Principal Competitors: APL Logistics, Ltd.; William E. Connor & Associates, Ltd.