On either side of the Taiwan Strait, there is probably no enterprise quite like Hong Kong-based Li & Fung Group in its ability to bring together so many disparate elements.

It is the world’s largest and most flexible, oldest and yet most innovative Chinese trading group, amalgamating both Occidental and Oriental features.

Li & Fung grew out of a small shop in Guangzhou in the waning years of the Qing dynasty in 1906. The founder Fung Bo-liao relied on his fluency in foreign languages to sell porcelain, antiques and artworks to foreign traders, making it perhaps the first Chinese-funded export trading company.

Over a century later, Li & Fung has shed its erstwhile identity as a small trader, becoming a leading global supply-chain management group.

Today, Li & Fung has created a virtual manufacturing empire on which the sun does not set. There are 8,300 factories with over 1.6 million employees worldwide that, although not under the Li & Fung name, are nonetheless willing to await orders from the Hong Kong group round the clock to produce readymade garments, toys or various types of household goods. These goods are destined for the shelves of global retail giants such as Victoria’s Secret, American Eagle and Disney stores.

In 2006, the Li & Fung Group’s business volume stood at NT$ 290.4 billion with a net profit margin of 3.2 percent, giving the company a ranking of 36 among theTop 1,000 Listed Companies of Greater China.

In contrast to manufacturing-based, capital-intensive Taiwanese enterprises, Li & Fung uses what many call a “light-capital” operations strategy. And its capacity for innovation is world class.

The group’s innovative business model has been the subject of study at Harvard Business School on four separate occasions. Time magazine praised Li & Fung as being the best middleman in today’s trading world. The group helps the world’s retail giants command the manufacture of household goods worldwide, developing an operational concept of “borderless manufacturing.”

Li & Fung, along with the Spanish company Zara, rely on quick reactions in the rapidly changing readymade garment industry to make profits. In today’s management circles, these two companies are often mentioned in the same breath as Oriental and Occidental models of supply-chain management efficiency.

Presiding over the largest Chinese-run trading group in the world, third-generation Li & Fung Group chairman Victor Fung has been dubbed “Asia’s smartest businessman” and is ranked among the world’s top 600 most influential business figures.

One Hard Dollar vs. Three Soft Dollars

How is it that Li & Fung can create such high profits year in and year out? Just what is the operating philosophy of the century-old group?

Against the backdrop of the Victoria Harbor, Li & Fung Group’s chairman, Dr. Victor Kwok-king Fung, sits in the board room of the company headquarters, working hard to speak in Mandarin as he explains the formula for a broader vision of worldwide production costs: 25 percent is earmarked to production costs within the factory, and 75 percent involves the cost of getting a product from the factory floor into the hands of the consumers.

Li & Fung found that it is very difficult to lower costs on the production end, making it hard to squeeze out any profits. This is why he calls this method the “hard dollar.” Conversely, it is easier to save on costs by properly managing the logistics, information and capital that make up the middle of the supply chain – what he calls the “three soft dollars.”

“What should we pay attention to in order to minimize the cost to consumers? In this business, that’s the question we need to ask ourselves.” Dr. Fung still has the air of a scholar, as he clearly notes, “The basic orientation here at Li & Fung is concentrated on supply-chain management.”

Assembly Line vs. Dispersed X-Ray Network

The secret to Li & Fung’s supply-chain management is not merely in the company’s ability to help keep costs down; more importantly, its ability to help customers create value has driven Li & Fung’s upgrade.

The Li & Fung Group does not stress an assembly-line approach the same way Ford Motors and Toyota have done for the past hundred years. A better analogy for Li & Fung would be an X-Ray network that disperses supply-chain management services from Hong Kong to the four corners of the globe, completely shattering the top-to-bottom, link-related linear production model.

For example, if Li & Fung wanted to help a customer produce a ski jacket, they would search the world for the best possible raw materials, perhaps getting the lining from Taiwan, clothing labels from Hong Kong and zippers from Japan. They would then send the materials to China, where cheap labor is abundant, for finishing. Even if Li & Fung would receive the same order on a following occasion, the group would allocate an entirely different supply chain than with the previous order, based on the manufacturing situation at cooperating factories.

“Like someone doing a dissection, we cut the manufacturing process into specific components, giving the job to the supplier that is the most efficient,” explains Victor Fung.

He also observes that it is very important to shorten the production period as consumers are increasingly demanding changes, and there is more of a trend toward detail in goods. As Li & Fung has built close relations with its customers, the customers often provide only the idea for a product, leaving the complete design, purchasing and production process up to Li & Fung.

If Li & Fung can shorten the production period from three months to three weeks, the extra time can be given over to researching what kind of materials and colors consumers prefer. In this way, the next time the group places an order with a supplier, there is more of a chance that it will more closely adhere to the current market demand, which in turn helps customers create higher sales volumes.

Fung adds, “We are now cognizant that the process is not so much a matter of commerce as a matter of service.”

The need for the services Li & Fung provides is even greater as the group helps customers create value.

Fung says that Li & Fung has already gone from being considered a “middleman” operation to more of an “integrator” company.

“A middleman is merely a broker that takes from the left side and gives to the right side. Middlemen add no value – their only value is in market carrying.” Fung’s tone then picks up and his hands dance in the air as he continues to explain, “But if I am an integrator, then I become very important. If it weren’t for me, customers would not be able to find different yet efficient suppliers worldwide to get the job done.”

It is very important to shorten the production period, as consumers increasingly demand change and greater detail in goods.

Using Fifty Cents to Make a Dollar

Another key to the success of Li & Fung is in the company’s tight control of operating capital.

“The circulation of capital is very important,” says Fung. Attesting to this reality was the Li & Fung purchase of competitor Inchcape Buying Services in 1999. At that time, Inchcape’s operating capital ratio was 18 percent, but after Li & Fung made adjustments, it has dropped to a present rate of only 5 percent.

“We use fifty cents to create a dollar’s worth of business. In the export trade sector, operating capital is a burden. Suppliers give Li & Fung credit and we pass the surpluses along to our customers,” Fung offers proudly.

Chinese University of Hong Kong Department of Decision Sciences and Managerial Economics professor Zhao Xian-de observes that although Li & Fung’s profit ratio is not that high – only 3 percent – its return on equity (ROE) is nearly 30 percent. This indicates that “although the company earns little on each deal, the tempo of spending money to make money is very fast. In other words, Li & Fung makes slight profits in each transaction but makes up for that in the abundance of sales.”

Even though its secret operation model and the details of its day-to-day management have been broken down, written up and published by Harvard Business School, Li & Fung still plays a decisive role in the global supply-chain management business to this day. The company’s 2007 business volume is projected to reach US$ 10 billion.

What are the reasons it is hard to emulate Li & Fung?

Looking back, Li & Fung helped develop a unique aspect of supply-chain management, which was not to own any factories itself, and instead opting to outsource manufacturing work.

“If you could look at us from a higher perspective, what would you see that Li & Fung actually does? We are part of a symphony, a global network, with each factory a Li & Fung partner,” Victor Fung suggests. During the entire interview, he used the word “partner” repeatedly to describe the company’s relationship with its 8,300 suppliers worldwide.

But the relationship between Li & Fung and its partners is a “loose network.”

Li & Fung occupies at most between 30 and 70 percent of the manufacturing capacity of its supply partners, never 100 percent. This is because Li & Fung hopes that its partners have the opportunity to cooperate with other companies. If there are any new ideas or lessons learned in the process, then they will come back to profit Li & Fung in the end.

The question remains, though, why are the suppliers so willing to always produce goods for Li & Fung?

According to Victor Fung, this is because Li & Fung has such an abundance and a diversity of customers. If a supplier works with Li & Fung on a project now, it has the opportunity to go from manufacturing low-quality to high-end products. Fung offers the example that some large-scale retailers look for steady suppliers that can produce similar style patterns every year, but that annual price drops of 10 percent can “grind you into the ground.”

“The fact that Li & Fung helps partners upgrade is very important and also the reason why this network was able to come together,” Fung explains slowly, elucidating his twenty years of business experience. This is the essence of Li & Fung’s business philosophy – developing long-term cooperative relationships with suppliers over time that build mutual trust and produce a win-win situation for all involved.

Professor Zhao believes, “This is the hardest thing to imitate.” He adds that Li & Fung provides a lesson for other companies. In today’s business world many enterprises are stressing “innovation to be more competitive,” but success in the future will depend on finding mutually beneficial relationships with trustworthy partners, as no one company will be able to go it alone. This concept is something like a “virtual company.”

Beginning in 2003, Li & Fung used its superiority in supply-chain management to again upgrade its business by expanding into the new terrain of brand licensing. Li & Fung won business contracts from world-renowned brands such as Levi Strauss & Company, Royal Velvet and Tommy Hilfiger to design, produce and sell their products.

“Li & Fung has been the most profitable downstream company within the supply-chain management sector. This strategy is beautiful,” says Chou Li-ping, chairman of Taiwan-based Makalot Industrial Company, who has kept an eye on Li & Fung for many years and uses the group as a model for his own business. “Through brand licensing, Li & Fung will only increase its global sourcing power.”

The thing that satisfies Victor Fung most, however, is that the company’s innovative supply-chain model has been able to create more job opportunities around the world.

“Now that I have diversified the supply chain, manufacturing is no longer centered in one place, which is the equivalent of democratizing the global supply chain,” he says in a quick, strong voice. “This has allowed more and more small and medium-sized enterprises to take part in the global production process, and gives them the chance to go global very early.”

The Best of Both Traditions

Last year was Li & Fung’s 100th anniversary. Throughout the century it has been in business, the converging lifeblood of Chinese and Western cultures has flowed.

It has always been Li & Fung’s tradition to give big bonuses to its employees. Generally speaking, most employees’ fixed salaries are only about 20 percent of their income, with the rest coming from performance bonuses. This means that there can be some huge discrepancies among employees’ final take-home pay.

Both Victor Fung and his younger brother William had originally emigrated to the United States, but returned at the behest of their mother to help run the business. Upon their return, they felt that the bonus system was a good one, but that it was not transparent enough. They changed it so that employees can fill in their own amount every year with no upper limit – all they need to do is reach their performance targets, and the bonuses are given according to regulations.

“My brother is our CEO. Every year he gladly says that he is the fifth highest-paid employee in the company and I am the sixth,” Victor Fung says with a big smile. The advantage of this system is that it creates an atmosphere of creativity and innovation, as each employee works hard on his or her own career projects.

Li & Fung has also tried to establish a corporate culture emphasizing continual improvement. In 1993, Li & Fung began promoting “three-year plans,” using three years as one measurement period to set future development objectives for the company and individuals.

“Each year we look three years ahead, and once the plan is in place there is no changing it,” Dr. William K. Fung told CommonWealth Magazine in a previous interview. Setting lofty goals allows the company to make some turnover even if they are not reached each time. The results speak for themselves – as of last year Li & Fung has enjoyed twelve-fold growth in business volume since the project was first implemented in 1993.

Despite using a rational approach to corporate operations adopted from the West, Li & Fung still maintains the Oriental tradition of close personal relationships with employees.

In the book Li & Fung One Hundred Years, an accountant that has worked for the company for fifty-three of those years recalls how the Fung brothers have a dinner together with all their employees on Chinese New Year’s Eve. They reserve one hundred tables every year and even the ladies that clean the building are invited. Every time an employee works overtime, William Fung calls a cab to take him or her home that night. The accountant telling these stories has worked into her seventies for Li & Fung, as each year the company kept hiring her back.

Victor Fung says, “If your employees feel an attachment to the company, this is the best type of outside promotion.”

After a flourishing hundred-year history, how is Li & Fung going to begin a new century of prosperity? The outside business world has taken a keen interest in the issue of a Li & Fung successor. William Fung says he has a son and a daughter, both working at the company, “but I don’t think the next CEO will necessarily be named Fung.”

Keeping up with the times and seeking innovation and change has been the road Li & Fung has taken in building the largest Chinese-run trading group.

Translated from the Chinese by Steven Marsh

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Chinese Version: 中國移動　主宰三億五千萬人的溝通