Middleman becomes master: Wal-Mart watch out—giant Hong Kong trader Li & Fung boasts an information system to beat - Regional Report/Asia

Chief Executive, The, Oct, 2002 by William J. Holstein

The Holy Grail of the late 1990s was that the Internet would allow companies to buy all their parts and components online through giant electronic marketplaces. This would create a "frictionless" economy in which all greedy, inefficient middlemen would be effectively cut out of the action. Blissful companies would be able to see every link in their global supply chains to the producers of basic commodities. They would have to hold precious little inventory as a result.

Of course, it didn't work out that way for the vast majority of companies. So it's ironic that one of the middlemen that was supposed to get blown away has proven a master of Internet-based supply chains. It's doubly ironic that this success story, Li & Fung, is a trading company that began in Canton in 1906 selling porcelain, bamboo, rattan ware and firecrackers.

Today, Li & Fung is based in an industrial section of Hong Kong's Kowloon district and maintains offices in 40 countries, which oversee the production of merchandise for many American retailers. Its sales last year were $4.2 billion. "We've moved from being the perennial Chinese sort of middleman doing everything you associate with my grandfather's days to fully embracing the supply chain management concept," says William Fung, group managing director and CEO.

Fung and his older brother Victor are the family's third generation to run the business, which handles both soft goods such as textiles and hard goods like toys, sporting equipment and household items. Both men were educated at universities in the U.S. William studied computer science at Princeton during the era of punch cards and the Fortran and Cobol computing languages. "Everything I learned in those days is totally useless," he jokes. After Princeton, he went to Harvard Business School. Victor did his undergraduate and masters work at MIT and then got a Ph.D. at Harvard in applied mathematics.

The short road home

They might have pursued careers in American academia or the corporate world had it not been for a phone call from their mother in 1972. "If one of you boys doesn't come back and help your father, he's going to kill himself working so hard," she said. William returned that year, and Victor in 1974. At that time, most of the goods they traded were made in Hong Kong, then a bustling manufacturing hub.

Over the years, the brothers professionalized and modernized the business, which is publicly traded. As Hong Kong lost its manufacturing competitiveness with the rise of cheaper-labor bastions elsewhere in Asia, they established relationships with manufacturers throughout the region, but never actually made anything themselves.

In 1997, they also started contending with the Internet. Franklin Warren McFarlan, a senior associate dean at Harvard Business School who first met Victor when he was a student and now sits on the company's board, recalls that the Fungs were worried their company would be disintermediated and therefore disappear. But rather than lament the new technology, they figured out how to use it to secure Li & Fung's middleman role. "What they discovered was that the Internet allowed them to provide more value-added services and intensify the relationship with their customers," says McFarlan, the technology "guru" who, according to William Fung, helped guide the firm.

What the Fungs created is a hybrid system. Today, the company maintains Internet-based communications with its major customers. Almost 76 percent of those are large retailers in the United States including Avon, The Coca-Cola Co. and Disney, all of which rely on Li & Fung for promotional items. Its largest customer in the U.S., Kohl's Department Store chain, accounts for 13 percent of Li & Fung's sales.

For these large customers, Li & Fung has created extranet sites dedicated to them. Information about the products they've ordered comes from Li & Fung's Electronic Trading System, now in its fifth generation of refinement and known as XTS 5.

Li & Fung's XTS is also linked to its own network of offices, where it has 5,000 people supervising the manufacturing of customer items. The nature of its electronic connections varies depending on the sophistication of a country's telecommunications system. In more advanced countries, a Li & Fung local office can be linked immediately to headquarters in Hong Kong. The branch office can tap the company's central databases and send digital photos of fabrics or products back and forth. The geeks at Li & Fung call that a "thick" connection. In cases where telecommunications are more primitive, however, the company depends on emails and email attachments, using Lotus Notes. That's a "thin" connection.

Li & Fung uses Hewlett-Packard and Compaq computers and Oracle database software to manage information and store the data, but has largely designed and written the software that makes up its XTS. "The important part is what we do with the technology," Fung says. Altogether, the system currently holds a very respectable 1.5 terabytes of data, which is equivalent to 1.5 million books.