NEW YORK — With $4.23 billion in revenues last year and offices in 40 countries, Hong Kong-based Li & Fung Ltd. has become the powerhouse of international contract sourcing.

Company executives estimate the goods it sells to brands from Leslie Fay to the Limited to Abercrombie & Fitch represent $15 billion in sales at retail, primarily in the U.S.

But that’s not enough for group managing director William K. Fung. His current three-year plan calls for Li & Fung to double net income by fiscal 2004 to reach the $250 million mark. To do that, he aims to pump up margins by extending Li & Fung’s sourcing functions beyond their current range, which runs from buying the yarn and trim to getting the goods onto a boat.

Fung wants the firm’s reach to cover the chasm that must be crossed to take the creation of a garment from the tip of a designer’s pencil to the selling floor of major retailers.

"The supply chain starts with the idea. We want to take it from concept to delivery," the Harvard-educated Fung said over breakfast during a recent stop in New York. "What Li & Fung is doing is expanding the definition of the supply chain. It’s been everything from raw materials to delivery. But now we think the supply chain starts with the idea. That is the first step."

While Fung acknowledged that his branded apparel wholesale clients — like The Leslie Fay Co., which recently signed Li & Fung on as its sole supplier — don’t need the company to give them ideas, he contended that buyers of private label apparel at major department stores often are looking for help. But that’s not even the prime market Fung has in mind when he talks about expanding into product development.

"The biggest opportunities we see are the food people getting into the non-food business, and that’s apparel," Fung said.

Taking their inspiration from European hypermarkets and taking aim at the supercenter formats that discount giants Wal-Mart Stores Inc. and Target Corp. are building, Fung expects to see North American supermarket chains beef up their apparel offerings.

"At first, it will be things like hosiery, underwear, basic shirts and T-shirts," he said. But there’s no reason that supermarket apparel assortments need to stop there, he said, citing U.K. retailer J. Sainsbury’s Jeff & Co. line as an example of a successful venture into dressier apparel by a food retailer.The George line, which bowed at U.K. supermarket chain Asda 12 years ago and is now popping up in its parent Wal-Mart in the U.S., is often cited as the brand that started the trend of selling stylish clothing at supermarkets.

"The Americans really learned from the Europeans in this respect," Fung said. He added that food retailers "have shoppers in their stores two to three times a week, or at least once a week, where the department stores have people in there a couple of times a month. They have the traffic, so why not capitalize on it?" But, "The food people don’t have the product development experts."

That’s why, in the past few years, Li & Fung has built its product development staff up to about 40 people in Hong Kong and 50 in New York. It plans to open a product development office in London next year.

"So far, we’ve been taking product ideas from our customers and saying, OK, we can make this this way," Fung said in a Sept. 5 presentation to investors at the Goldman Sachs Global Retailing Conference in New York. "What we haven’t been doing very well — and what we are investing heavily in — is developing new product ideas.

Fung emphasized that the staff he’s building will focus on development — deciding what materials to use in a pair of pants and where the seams should go — rather than pure apparel design. However, for clients that need design help, Li & Fung will contract out design work, similar to the way it contracts out manufacturing.

While Li & Fung has 67 sourcing offices on five continents — all but Australia and Antarctica — the company owns no factories. It outsources all production, which allows the company to shift quickly into new countries when bargains arise.

This year, that’s meant rapidly expanding production in Vietnam, which recently gained normal trade relations status with the U.S., but still hasn’t had quotas slapped on its imports. Last year, Li & Fung produced $29 million worth of goods in Vietnam — where apparel factories had long been selling to customers in Europe, Li & Fung’s second-biggest regional market. This year, Fung said, the company is on track to ship $140 million of goods out of Vietnam.Li & Fung divides the world into six regions for management purposes. Four regions are important for their low cost, two for their proximity to major consumer markets.

The four low-cost regions are: East Asia, including Hong Kong, Taiwan, South Korea, China and Mongolia; Southeast Asian, including Saipan in the Northern Marianas Islands and the Asean nations of Vietnam, Thailand, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines and Singapore; South Asia, which is primarily the Indian subcontinent, including Pakistan, Bangladesh and Sri Lanka, and southern Africa.

The quick-response regions are: Central America, primarily Guatemala and Honduras for the U.S.; and Turkey, Portugal, Northern Africa and Eastern Europe for the EU.

John Short, chief executive officer of Leslie Fay, said he believed one of the key advantages of working with Li & Fung is its global reach.

"What we’ve done initially is we’ve put in place teams in five or six countries, including a team here in New York so that we have an opportunity to be constantly gathering information from around the globe," said Short, who noted that the relationship between Leslie Fay and Li & Fung dates back to the Eighties. "What we gain by virtue of the deal is flexibility."

Still, consultant Jeanne Atkinson, of Global Marketing Strategies, noted that even production powerhouses have their limits, contending that businesses in some developing nations, like in Eastern Europe, are sometimes reluctant to do business with Far Eastern companies.

"The Li & Fungs of the world are very good, but they’re not the only answers," she said. "They don’t know everything."

In the year ended Dec. 31, Li & Fung recorded net income of $100.4 million, down 10 percent from 2000. The decline was the result of a $21.7 million loss related to discontinued operations. Last year, the company radically downsized its StudioDirect e-commerce venture, and pulled back most of its investment in the firm. Operating profits for continuing operations were $116 million, up 8.9 percent.

Last year’s total revenues of $4.24 billion were 32.2 percent ahead of 2000’s earnings.The company does the bulk of its sales into the U.S., with North America representing 75.2 percent of 2001 volume. Since 1996, it’s been expanding in the EU, where it did 20.4 percent of its sales. About 3 percent of sales came from the Southern Hemisphere and 1.3 percent from East Asia, primarily Japan. Soft goods represented 72.1 percent of sales, although the company is growing its hard goods sales, which last year represented 28 percent of sales, up from 24 percent.

Li & Fung reports its financial results in Hong Kong dollars. All figures have been converted to U.S. dollars at last month’s exchange rates.

As reported, 2002 first-half profits were up 0.6 percent, with revenues ahead 5.4 percent. The company noted that first-half results reflected orders taken during the tumultuous second half of 2001, and said that first-half 2002 orders were stronger.

William Fung and his brother, Victor, who serves as chairman, together own more than a 40 percent stake in the company, which is a component of the Hong Kong’s Hang Seng Index. While the company’s stock price has slid in the past year as a result of concerns about the U.S. economy, its market capitalization this month remained well over the $3 billion mark.

The brothers rely on three-year plans to manage the company. The current plan calls for 15 percent annual revenue growth, a boost in earnings before income and taxation from 2.8 percent to 4 percent and a doubling of last year’s profits by 2004. The company also wants to boost its cash reserves, currently more than $250 million, to about $300 million, so it can make more acquisitions.

Given the tight economy, Goldman Sachs, which rates the company a "market outperformer" regards the margin improvement as a tough goal to reach. In a recent research report by analyst Mike Warren, the financial advisory and investment firm based its earnings projections on flat operating margins for the coming three years. That marked a revision, as previously, Goldman expected 2004 operating margins to hit 3.2 percent.

While acknowledging the move to offer more product development services, and another initiative to handle shipping, will likely boost margins, Warren wrote, "We believe the potential upside from those two factors should assist in offsetting the downside risk on operating margins from the tougher operating environment."The report forecasted Li & Fung’s 2004 net profits would be up 84 percent from the 2001 level. Factoring out discontinued operations, they’d be up 51.4 percent.

Still, Fung said he’s not alone in looking to boost margins in an economic downturn.

When the U.S. economy started to slow last fall, Fung said, his specialty-store customers started asking Li & Fung to find a way to cut manufacturing costs. Their goal, he said, was to push up initial markups so that the cost of goods only came to 25 percent of the initial retail price.

"They said, ‘What I bought last year I want for 10 percent less,’" he explained. The lower price targets — which Li & Fung met — gave merchants more markdown wiggle room.

"That is their reaction to the environment," Fung continued. "They wanted better protection going in if they were going to take a risk on inventory."

In addition to looking for lower prices, Fung noted that retailers also started ordering in smaller chunks.

"An order of 50,000 pieces, instead of coming in as one big order, will be three orders, four orders," he said.

Thomas Haugen, executive director of the company’s Li & Fung (Trading) Ltd. division, said in the interview that what sets specialty retailers apart in sourcing is their understanding of timing.

"Sourcing doesn’t have to be high-risk, but you have to make decisions at the right time," he said. "The misconception is that you can just delay."

For instance, if a company is producing a shirt in the Caribbean Basin of Asian fabric, which Li & Fung commonly does, after making a decision on color and fabric, a designer might be able to tweak styling details in the three weeks the fabric will take to travel by boat across the Pacific.

"The specialty stores test style a, b, c and d," Haugen said. "They are quite scientific in the way they go about it."

The U.S. in recent years has passed many trade initiatives intended to help nascent apparel industries in developing nations. The cornerstone of this effort was the 2000 Trade & Development Act, which extended duty-free and quota-free benefits to apparel made in the Caribbean Basin and sub-Saharan Africa, subject to certain requirements on fabric origin.Li & Fung buys from factories in bothregions, but Haugen acknowledged that in most cases the company buys from factories owned and managed by Asian interests, which are a sizable presence, particularly in Africa.

"They understand the business, they understand flexibility," he explained. "They don’t base their operating model on long runs, which is not how the business is done now."

In Central America — the source of 15 percent of the apparel the company sells to U.S. customers — Li & Fung primarily relies on Asian fabrics, even though that prevents it from getting duty and quota benefits. Even without the benefits, the Asian fabrics still prove cost-effective, he said.

The company more often takes advantage of the trade breaks in sub-Saharan Africa, where the fabric requirements are much looser.

"Duty-free is still a good thing," he said. "And in a lot of the countries, we can use Asian fabric, which is cheaper than we can get in the U.S. and better than we can get in Latin America."

He noted that African manufacturers "are pretty competitive on knits. They are not competitive on time. But that is changing."

Still, he considered Africa to be the next growth market for low-cost apparel production, partly because of the trade breaks. But he suggested that South America, which is also in line for trade benefits, could eventually prove more competitive because it is closer to the U.S. market.

Haugen admitted that’s a development he’d like to see. As a boy growing up in Bakersfield, Calif., he dreamed of traveling to South America, but the continent is one of the few places in the world to which his career in sourcing hasn’t taken him.

While Africa and South America both have the potential to develop apparel industries, most eyes in the industry are focused on China, where Li & Fung was founded 95 years ago by Fung’s grandfather, Fung Pak-liu, and his partner, Li To-ming, as a Canton-based export company. Li retired and sold his shares to the Fung family in the Forties.

The company has become international in its culture — it tries to hire locals in most countries where it opens offices.Haugen joked that "We’re like a little U.N. when we have our meetings."But to Haugen, who came up in the U.S. corporate culture, it has some discernable Chinese notes.

"One of the key effects is that they are extremely loyal to our employees," Haugen said. Referring to Fung, he added: "His dad told him, ‘If you have someone who did a great job for you in the past, you have to take care of them.’

"We spend time fitting people into the right slots," he continued. "Everyone can shine in something."

The company also tends to keep the staff of companies it acquires, as Haugen can attest. He joined the firm in 1995, as a result of its purchase of the Dodwell trading house.

While China’s growth potential in the apparel industry is clear — it’s pulling back ahead of Mexico as the number one supplier of imported garments to the U.S. and is expected to grow even more after quotas are lifted among World Trade Organization members in 2005 — Fung and Haugen said they don’t see China becoming the center of the garment-production industry.

Though the company has 16 offices in China, Fung noted: "China’s prices are by no means always the best."

He listed India and Vietnam as nations where manufacturers regularly underprice Chinese suppliers, and added that while there is an ample supply of labor, China lacks a large supply of key raw materials, including cotton.

While the nation’s importance as a production center will likely continue to grow, Fung said: "It’s very naïve to say everything will go to China."

To continue reading this article...

load comments
blog comments powered by Disqus