Li & Fung (0494.HK) has risen to prominence thanks to its core business of sourcing products from emerging markets, notably China, and shipping them to consumers in Europe and the US. Last year, the Hong Kong-based firm made several acquisitions, but the buyout of IDS Group, an Asia-focused logistics player, stands out.
The move is supposed to better position Li & Fung to provide for Asian consumers – a profound statement of how the supply chain business model is changing.
Li & Fung’s clients include some of the world’s largest and best-known consumer goods retailers and brand owners, including Wal-Mart (WMT.NYSE), Target (TGT.NYSE), Liz Claiborne (LIZ.NYSE) and Limited Brands (LTD.NYSE). Its capabilities are built upon “dispersed manufacturing,” whereby a product is manufactured not just in several different factories, but possibly in several different countries.
The onus is on supplier management – the company has a network of more than 11,000 suppliers – rather than owning factories. It means Li & Fung can create supply chains of greater scale, flexibility and responsiveness and managers can concentrate on customers rather than making sure depreciating assets are being utilized.
Fallout from a crisis
How the global financial crisis and recession has affected this business model is still being revealed. Li & Fung took a direct hit from the drop in consumption in the US and Europe. The latter, which accounts for around a quarter of the firm’s revenue, is still a challenging environment. As for the indirect consequences, freer global trade enhances Li & Fung’s value proposition, while increased protectionism affects the capacity to carry out dispersed manufacturing across borders.
Finally, the recession has put a stronger spotlight on the potential of the consumer in emerging markets.
The IDS buyout is intended to bring more control over distribution in markets like China where logistics services are still below-par. But logistics aside, how realistic is the possibility that Li & Fung can flip its business model to serve consumers in the markets where it currently does most of its sourcing? On paper there is much in its favor, even when you leave out the company’s reputation as an agile supply chain innovator.
Decades of sourcing experience mean it has a good knowledge of the risks, competition and regulation in various markets. This is particularly true for China, which accounts for the lion’s share of its sourcing operation.
Li & Fung also has experience selling to Asians. One of its companies, Trinity, owns hundreds of high-end menswear stores in China and other parts of Asia under brands including Kent & Curwen, Gieves & Hawkes, D’Urban and Cerruti. Meanwhile, the group owns 500 convenience stores in Hong Kong and South China, and Toys ‘R’ Us stores in eight Asian markets.
The retail network is complemented by capabilities in product design – Li & Fung staff attend fashion shows in Paris and Milan to advise customers on new trends and designs. These capabilities could be used to develop own-brand and private-label products for Asian consumers.
However, the case for converting “factories to markets” and “sourcing to selling” is easier said than done. In a market like China, there are strict limitations on export-focused businesses selling to domestic consumers. To stock its Toys ‘R’ Us outlets in China, Li & Fung is currently required to export the toys to Hong Kong and re-import them at substantial cost.
Restrictions will diminish as the market matures, but a more general and more notable challenge is the unpredictable nature of the retail and distribution sectors. Time and again we see how on-paper – and frequently Western-designed – business models fail to translate to success in China. For evidence of this, just ask any international logistics company trying to build its business here.
Li & Fung has been very successful at capitalizing on globalization and becoming probably the world’s most innovative manager of supply chains between East and West. The question now is whether it can keep international shareholders and fund managers happy while doing what needs to be done in an emerging market whose workings are still often globally misunderstood.