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Term paper in MGMT 5027 08.08.2012 Student: Erlend Opdahl Individual term paper. Emerging markets in the global economy Maintaining integration while going global” 08.08.2012 Harvard University 2012
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Term paper in MGMT 5027 08.08.2012 Student: Erlend … paper in MGMT 5027 08.08.2012 Summary Li & Fung have a 100-year history as a market intermediary.

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Page 1: Term paper in MGMT 5027 08.08.2012 Student: Erlend … paper in MGMT 5027 08.08.2012 Summary Li & Fung have a 100-year history as a market intermediary.

Term paper in MGMT 5027 08.08.2012

Student: Erlend Opdahl

Individual term paper.

Emerging markets in the global economy

”Maintaining integration while going global”

08.08.2012

Harvard University 2012

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Table of contents

1. Table of contents 0

2. Summary 1

3. Introduction 1

3.1 Main problem. 2

4. Company background. 2

5. Internal factors and environment. 4

5.1 Company structure 4

5.2 Holistic value chain management 5

5.2.1 “Orchestration from above”. 5

Trading: 6

Logistics: 6

Distribution: 6

5.3 Three year plans as strategic tool 7

5.4 Acquisitions as a growth strategy 8

5.5 Integration of acquired businesses. 9

5.6 Internal culture 9

5.7 The new leaders 9

5.8 Information technology and welcoming change as a core strength 10

6. External factors, challenges and opportunities. 10

6.1 Rise of labor cost in China 11

6.2 Opportunities 11

7. Conclusion 12

8. Referances a

Exhibits b

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Summary

Li & Fung have a 100-year history as a market intermediary. Through the years they have

moved up to the very top of the value chain and are now the market leader in retail and

consumer goods from the east. The business has been expanding at a high pace since the Fung

brothers bought out the rest of the family in 1989. A main factor for this growth has been the

high number of acquisitions, their size and the very successful integration of them. My goal

was to analyze this and try to find some of the key factors of this success. It seems like the

companies highly professional management has played a big role, together with the company’s

historical and cultural values when it comes to welcoming change and innovations. Integration

of the value chain also seems to be of great importance. Some of this success is based on the

use of computer systems and technology and some are on people, and local capabilities. At the

end I point out that one of the challenges Li & Fung now face is the rise of labor costs in

China. I would recommend that Li & Fung to a higher degree would consider moving more of

its production to other low cost production lands so that the risk is diversified. However rising

income in China could also be seen as a opportunity to capture a new market.

3. Introduction

Li & Fung is a company that has gone through a period of tremendous growth and has

established itself as a world leader in consumer goods design, development, sourcing and

distribution. When the two brothers, Victor and William Fung bought out the rest of the family

in 1989 they started out by implementing a more active strategy for growth. Through their

three-year plans they put up high targets for revenue and profits, and by making a number of

acquisitions alongside with organic growth and successful implementation of acquired

businesses they are now in the position as one of the worlds leading retailer firms.

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As a result from their aggressive strategy of acquisitions and growth they have incorporated a

very fine-grained value chain. In this paper I will try to identify which key factors that lies

behind the strengths that has made it possible for Li & Fung to win at such a broad spectrum of

business and economies. What are the tools that the two young men brought back from

Harvard in their intellectual backpack to use in their family`s business? And what are the

challenges they face into the future?

3.1 Main question.

What are the key factors that have lead Li & Fung`s aggressive growth strategies to success

and what challenges should they be aware of in the coming years?

4. Company background.

Fung Pak-Liu and his partner Li To-Ming founded Li & Fung in 1906. Although Mr. Fung was

born in a small town, he was lucky to be granted with the opportunity to go out and develop a

career in the world outside. He went to Hong Kong and started studying at Queen`s college.

Here the young man learned how to speak fluent English (Feng, 2007, p5), a skill that laid the

foundation for his first business. At this time coastal cities like Guangzhou and Shanghai was

influenced and opened up by communication with seafarers from the western world. There was

however a lack of English skills in the population. After the studies Fung Pak-Liu wished to go

back to Guangzhou to use his new knowledge to do business. In 1904 Pak-Liu met Li To-Ming

and started working as an export manager in his merchant company selling mainly fine

porcelain products. However, the market was to a degree monopolized by the British trading

companies. Mr. Fung thought that Chinese companies could have an advantageous position

over their Western counterparts because of their connections and knowledge of local products.

He therefore wanted them to start their own export company to tap into the opportunities and

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advantages they had as Chinese men with local anchoring and knowledge.

To start with, Li and Fung was basically an export trading company that charged a commission

for putting buyers and sellers together. As a transaction facilitator (Khanna and Palepu, p. 71.)

they where exploiting the language barriers between the trading parties. English speaking

buyers who were primarily from the US where not able to communicate with the producers.

The lack of English understanding among the Chinese producers and sellers made it difficult

the other way. Using their local knowledge and contacts they traded largely in porcelain and

silk before exporting jade, ivory handicrafts and fireworks. Through the 1920s and 1930s they

diversified their business into warehousing and manufacturing of handicrafts. Fung Pak-Liu

passed away in 1943 and his son Fung Hon-Chu took over in his place. In 1945 Li To-Ming

retired and sold his shares to the company. However they kept the Li & Fung name as the word

“Li” was a homophone for “profit” and Fung was a homophone for “abundance”.

“Together they gave a auspicious ring ” (Internet issues, 2005 ).

At the end of World War II they relocated their headquarters in Hong Kong and expanded their

business to also include toys, garments, plastic flowers and electronics (Internet issues, 2005 ).

In the early 1970`s Fung Hon-Chu´s two sons William and Victor Fung came back from the

US to join the family firm. William had archived a major in electrical engineering from

Princeton University and a MBA from Harvard. The other brother had also been quite clever

and came home with a Ph.D. in business economics. He had also been working as an assistant

professor at the Harvard Business School for a while (Hutcheon, Robin. 1991. p. 50 .).

When they started to look at the company`s organization from their professional management

perspective they went into a process that transferred it from a family owned business to a

professionally managed firm. A professional budgeting and planning system was put in place

for the first time, and in 1973 they took the company public on the Hong Kong stock exchange

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(Internet Issues, 2005 ). Throughout the 1980s the company grew into a fully incorporated

supply chain manager, which oversaw all the processes from producer to costumer. Li & Fung

was ensuring the quality in the whole spectrum of the value chain, ranging all the way from

design to quality assurance and delivery tracking of the orders. They also started to use

“dispersed manufacturing” a method in witch the production process is separated into modules.

Labor-intensive parts of production was outsourced to China, while more high value activities

such as inspection and packaging remained in Hong Kong (Li & Fung 2012 ). From 1992 to

2010 Li and Fung experienced a compound annual growth (CAGR) of 21% in turnover and a

increase in CAGR of 22% in core operation profit (Exhibit 2 ). This numbers witnesses of a

highly successful integration of a strong growing business, since both the turnover and profit

developed at this speed.

5. Internal factors and environment.

Li & Fungs vision is “to be the premier trading firm that delivers the right product at the right

prices at the right time to consumers across the world.”( Feng, Bang-yan, 2007.)

5.1 Company structure

From the headquarters in Hong Kong, Li & Fung manages about 300 offices around the world.

They are represented in about 40 economies with a staff of about 41.000(funggroup.com).

As we can see from Exhibit 1, Li & Fung is today a company that is divided into four

divisions. The holding company is Fung Holdings (1937) Limited. Li & Fung Limited is

incorporating the main activities that are trading, logistics and distribution, but they also have a

retailing division from which they manage their own retail brands as Toys “R” Us that is it`s

own entity and Circle K, which operates under Asia Convenience Retail Asia Limited.

According to Khanna and Palepu (p. 71) Li & Fung has evolved into an aggregator, distributor,

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credibility enhancer, information analyzer and adviser (Khanna and Palepu, table 3-1) in three

lines of business: trading, distribution and retailing.

5.2 Holistic value chain management

Since it was founded in 1906, Li and Fung have gone a long way up value chain. They have a

strong track record of implementing changes and it’s amazing to see how they have evolved. In

the start they where basically just a market intermediary, exploiting the lack of English

knowledge among the producers and the lack of understanding of Chinese amongst the buyers

of the products. Li and Fung`s core business and strength is today built around their ability to

deliver products to the costumers from a very complex map of more than 15000 production

facilities and delivering this to their about 7700 costumers in soft and hard goods. They are

even able to meet their demand at a fast pace. An example could be if a costumer from the US

orders a jacket, some of the buttons might be made in Bangladesh while the zipper could come

from China and everything would be assembled in Guatemala. All this could happen in weeks

from the time where the order is placed. And this ability is also one of the factors that put Li &

Fung in “pole position”. Through at all time optimizing the value chain and by continuously

being able to stay “value added” in meeting their costumer needs.

Taking on such a high tempo of growth, together with their business model of exploiting small

differences in production costs in different locations has resulted in a highly complex and

fine-grained distribution chain (Gupta and Wang , p. 112). From 1989 when the Fung brothers

took over, they have experienced revenue growing from less than US$500 million to US$16

billion. This could not have happened if it where not for successful dissection, optimization

and integration of the whole value chain as they expanded.

5.2.1 “Orchestration from above”.

As Victor Fung puts it: “Li & Fung does not own any of the boxes in the supply chain; rather

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we manage and orchestrate it from above …”

“The creation of value is based on a holistic conception the value chain ...”(funggroup.com ).

Instead of looking at which country that can produce most of their goods at the cheapest price,

they are pulling apart the value chain and optimizing every step and asking “who can produce

this zipper or that button at the cheapest price .”

Li & Fung is today is separated into three core businesses. Trading, logistics and distribution:

Trading:

Li & Fung is taking care of a network of about 15.000 suppliers in over 40 countries. Their role

is to be a market intermediary between the buyer and the seller in the network. There are

serving as much as 7.700 costumers.

Logistics:

The Company offers a comprehensive menu of logistics solutions, from warehousing,

transport, repacking, customs brokerage, freight forwarding, hubbing and consolidation, and

other value added services, including supply chain analytics and value engineering work.

Distribution:

Li & Fung first began its distribution business in the U.S. in 2005 and then expanded to Europe

in 2008. By working closely with brands and retailers, Li & Fung address their specific needs

in the area of design, sales, marketing and distribution, as well as managing the supply chain

(Lifung.com). As I have pointed out earlier, Li & Fung has a fine-grained value chain.

According to Gupta and Wang p. 112(Figure 4.2 ) such companies should have good

capabilities at cross border integration. In a era where communication as well as transportation

technologies are advancing exponentially, Gupta and Wang suggest to overinvest in integration

capabilities. It seems to me from the research I have done, that this capability is one the key

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strengths of Li & Fung. Like CEO Rockowitz puts it in Li & Fung 2012:

“If we didn`t integrate the acquired business, we would just be a conglomerate. We give them

new wings: better sourcing, better logistics, more costumers, and more products..”

5.3 Three year plans as strategic tool

When the Fung brothers bought out the rest of the family in 1989, they started crafting out and

implementing three year plans as the superior development strategy. Inspired by the “five year

plans ” of the Chinese Government, the plans sought out to take a “zero point perspective ” on

the status of the company (Feng, Bang-yan, 2007. p. 237 ). Meaning that they look at their

company with new eyes every three years, asking themselves how they could manage their

opportunities and resources the best way in the future. As explained by William and Victor

Fung (Feng, Bang-yan, 2007. p. 239-241) the process of making these plans take place in four

steps.

1. Analyzing the business environment and making a forecast of this scenario

2. Based on company`s vision and the projected scenario they come up with a

development goal that is challenging.

3. Look at the status quo of the company from the vantage point of the new goal,

determine the distance in between, and figure out the strategy to beat that distance.

4. Formulate and (make) implementation plan for the strategy.

The input factors to this process are shown in Exhibit 5 .

It starts with where they want the company to be in the projected business environment in the

end of the period (LI & Fung 2012). Individual goals for revenue for the different divisions are

then crafted and if goals are not met at the end of the period, they need to measure and analyze

why they failed. Some of the benefits that William Fung mentions is: It’s easier to maneuver

through rough times and it lessens work fatigue amongst the people involved.

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“The three-year plan turned a corporate marathon into a three-year sprint ” says CEO Bruce

Rockowitz (Li & Fung 2012). The companies incentive programs are also connected to the

three-year plans, providing extra motivation for managers and employees to follow them up.

In the present plan going from 2011 to 2013 Li & Fung targets to double core operational profit

from 725 million to 1,5 billion dollars (Exhibit 6 ).

5.4 Acquisitions as a growth strategy

William explains this in a interview with CNBC Squawk box Asia: “It’s a two handed

strategy..” On one hand they have organic growth and on the other hand they have acquisitions.

He explains that they also pursue organic growth, but when that is not present buying other

companies is natural. Also because that in bad times there is usually a good climate to make

acquisitions (CNBC ). Even tough they focus on organic growth, a central part of the growth

strategy since the 1990s has been to acquire other companies. Most of the time it has been

done as a measure to “fill the mosaic ”. This means to use acquisitions to position themselves in

markets where they lack presence, expertise or talent. But, also to gain control over the rival’s

client accounts and integrate their operations (Li & Fung 2012 ). Finally they would implement

their management and systems to bring their margins up to Li & Fung levels. “By far the

greatest development of the mid 1990s was the purchase of Inchape Buying Services Ltd (IBS)

for HK$450 million – with the advantage of being financed primarily from internal

resources“(A burst of crackers p. 73). They had went out and bought a company almost their

own size without even having to raise a considerable amount of capital from external sources.

This move was one of the main factors that made Li & Fung able to more than double its

growth between 1990-1995. These acquisitions as with other actions of the same character

extended the company`s resources in many ways as for instance sourcing, outlet network,

intellectual resources and qualified management. The acquisitions have also made the group

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less vulnerable to stresses in the market by diversification of the product portfolio and stronger

at tackling cyclical changes. CEO Rockowitz believes their acquisition expertise is as good as a

private equity firm. Its also a fundamental point that Li & Fung adds value to the companies

they buy by giving them “new wings in form of “better sourcing, better logistics, more

costumers and more products ”(Li & Fung 2012). “Between 1992 and 2010 they had made over

70 acquisitions and became a truly multinational company” (Li and Fung 2012).

5.5 Integration of acquired businesses.

According to CEO Rockowitz, an important part of the acquisitions strategy is to quickly

integrate them into the culture of Li & Fung. Within 100 days after the takeover the people

should be located in their right place. They have a so called “plug and play” model of computer

systems to integrate the management, accounting, handling of orders etc. Both the Fung

brothers also believed that informal contacts between colleagues are an important factor,

making it important to create inter-personal relationships at an early stage.

5.6 Internal culture

People oriented approach. The staff more than doubled from 13.000 to 27.000 only in the fiscal

year of 2010(Li & Fung 2012 ). But Li and Fung still strive to maintain entrepreneurial spirit.

Managing a portfolio of 300 small profit centers, and the managers of those referred to as the

“little John Wayne’s ”. These units react quickly to changes in the environment, and many of

the entrepreneurs that started the companies remain behind the wheel of them as managers after

it had been sold to Li & Fung. These are also given profit sharing incentives based on profit

performance. Long term commitment where also secured by stock options with lock-in periods

for as long as nine years (Li & Fung 2012 ).

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5.7 The new leaders

“Victor is the deep thinker, and I just make the money .” – William Fung joking about their

roles in a interview with Forbes magazine (Forbes).Going from a family run company in the

70s, Li & Fung may be a excellent example that implementing professional management really

matters. As the business grew and they kept on buying other businesses it was essential to keep

going forward. According to Victor: “Once the business was successful, it was essential to

keep an open mind and, rather to rest on their laurels to move past success and look forward.”

This sounds just like the same reasoning as for the zero based perspective of the three-year

plans. It`s kind of a “keep looking forward, even if you`re doing good” philosophy.

To manage the ever-growing diversity of cultures they went by the strategy of giving all

managers the freedom to work as they see fit, as long as they get the job done (Far eastern

economic review ).

5.8 Information technology and welcoming change as a core strength

“The ability to manage change is imprinted in the DNA of the company ” -Victor Fung,

”Since our founding in 1906, a constant ingredient in our development into a Hong Kong-based

multinational group is the way we adapt to new market opportunities brought about by global

and local economic changes ”. -Lifunggroup.com

Li & Fung has always been aggressive in adapting new technologies (Internet issues, 2005 ).

The adoption is also a central part of their infrastructure for dealing with integration of

acquired businesses as well as an key factor for dealing quickly with costumer needs and

processing orders and deliveries across their highly advanced and fine grained value chain that

we will take a look at in the following chapter.

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6. External factors, challenges and opportunities.

Even tough Li & Fung seem to have done a tremendous job of implementing new technologies

they should not be resting on laurels. The exponential development of technological tools is

making it easier for costumers to get transparency when looking in to a new market and more

and more knowledge is at costumer’s fingerprints through the web. Governments are also

taking measures to open up markets for foreign players, and costumers finds information

themselves about products, making it easier for them to make decisions of witch product to

buy. These examples together with the institutional voids being filled, should as I se it make it

a top priority issue for Li & Fung to watch these changes and make efforts to only play in the

“fields” where they are needed.

6.1 Rise of labor cost in China

An important change in the context for Li & Fung is now the rise of costs of workers in China.

As they are still sourcing as much as 30 % from China (Exhibit 7), their exposure to this effect

is considerable. In Chinas new 5-year plan, which ranges from 2011 to 2015 the target is to

raise the minimum wages by 13% annually. This makes the total rise in minimum salary a total

of 80% trough these years. William Fung points out that this mainly started with the “Foxconn

episodes ” (WSJ.COM ) and that we now might see a situation where China for the first time is

contributing to making costs higher since they opened up their markets in 1979 and made a

huge low cost labor force available to the world market. This has been depressing developed

market prices for the last 20-30 years. He also points out that the governments focus has shifted

from focusing on export, to creating more inland consumption (Cnbc ).

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6.2 Opportunities

On the other hand we can read from the 2011 annual report (Lifung.com ) that they expect the

cost of production to go down. One question is if this implies that they are planning to ramp

up the production in other low cost countries since wages in China is going up?

William Fung mentions this in the interview with Cnbc.com when asked if they are going to

produce more in the “Cambodias ” and “Bangladeshes ” of the world and mentions that

Bangladesh and India is competitors to sourcing from China. But, these changes in the macro

economic context will also increase inland buying power significantly. This together with the

tremendous size of this market should make it an interesting opportunity. It actually seems like

it has already started. If we look at exhibit 8 we can see that sales in Asia has went from only

4% in 2010 to 12% in 2011, and according to Mr. Fung they now have a own Asian leg in their

sales division. It will be interesting to see how big part of the turnover that in the future would

come from China and how much of the products that will be sourced in countries like

Bangladesh, Cambodia. Seeing their history of adapting to changes we should however not

expect Li & Fung to be something else than on the winning team as globalization evolves. As

we can see from exhibit 3 they do not have much presence in South America. Since the US is

their biggest market (Exhibit 8 ), it seems that it could be beneficial for them to research the

possibility to tap into the low cost labor market in South America. This will also be closer in

distance from the US market. Another possibility that I have not seen discussed anywhere, but

should at some time be considered is listing abroad. The New York Stock Exchange (NYSE)

would for instance be a good platform for them to diversify capital market and investor

exposure. As of today they are only listed on the Hong Kong Stock Exchange.

7. Conclusion

The main factors behind Li & Fung`s success story seems to evolve from their culture,

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historical values and uppermost the managements ability to select and pursue the right

strategies for growth and integration of a highly complex value chain. Strong leadership, good

adaption to market changes, new technologies and the implementing of the acquisitions made

Li & Fung to grow at a very fast pace. From another point of view they should closely watch

the cost position in China and consider further diversification of the cost base. However there

are also opportunities in these market changes as Asia could someday be in the end of the value

chain as inland buying power increase as a result of a rise in income.

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8. Referances

1. CNBC. Interview with William Fung on CNBC Squawkbox 24 of march 2011.

Available from address: http://video.cnbc.com/gallery/?video=1857007033

(visited 03.08.2012)

2. Internet issues, 2005. Warren Mcfarlan, F and Young, Fred. Li & Fung (A): Internet

Issues, Harvard Business School.

3. Li & Fung, 2012. Warren Mcfarlan, Shih-Ta Chen, Michael and Chi-Ho Wong Keith,

2012. Havard Business School.

4. Forbes magazine. May 15, 2000, p.310

5. Far eastern economic review. July 22, 2000. p. 10.

6. Feng, Bang-yan, 2007, “100 years of Li & Fung: Rise from family business to

multinational” .Thomson Learning, Singapore.

7. Hutcheon, Robin, 1991. “A burst of crackers: The Li & Fung story ”. Second edition. Li

& Fung limited, Hong Kong.

8. Wikipedia, Li & Fung. Available from address:

http://en.wikipedia.org/wiki/Li_%26_Fung (visited 04.08.2012)

9. Khanna, Tarun and Palepu, Krishna G. 2010. “Winning in emerging markets”. Harvard

business press, Boston.

10. Gupta, Anil K and Wang, Haiyan, 2009. “Getting China and India right ”. Jossey-Bass,

San Francisco.

12. Wall street Journal, Shai oster, May 9, 2011. “China's Rising Wages Propel U.S. Prices ”

Available from url:

http://online.wsj.com/article/SB10001424052748703849204576302972415758878.html

(visited 08.08.2012)

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Exhibits

Exhibit 1. Business overlook.

Source: Lifung.com

Exhibit 2. Financial development. 1992-2010.

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Source: Lifung.com

Exhibit 3. Global network.

Source: Lifung.com

Exhibit 4. China real GDP growth 2011- 1Q2012

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Source: National bureau of statistics of China .

Exhibit 5. Process of making the three-year plans.

Source: Kwok-King, Victor. Fung, William. Fung,Yoram Wind. Competing in a Flat World:

Building Enterprises for a Borderless World

Exhibit 6. Current three year plan, core operation profit targets. 2011-201

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Source: Lifung.com

Exhibit 7. Sourcing trends.

Source: Lifung.com

Exhibit 8. Geographical turnover 2011.

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Source: Lifung.com