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WŽƚĞŶƚŝĂůdŚƌĞĂƚƐƚŽ>ŝΘ&ƵŶŐ͛ƐƵƐŝŶĞƐƐDŽĚĞů;ϮͬϮͿ͗Internal  
November  15,  2010  

The  pace  of  change/expansion  at  Li  &  Fung  is  a  lot  faster  than  at  most  other  companies.    In  the  one  
hand  it  seems  the  company  is  over-­‐extending  itself  into  multiple  direction  at  the  same  time,  but  
then  when  you  look  at  their  rolling  3-­‐year  plan,  they  do  seem  to  have  one  major  aim  at  a  time.    It  
was  top  line  growth  in  2005-­‐2007,  and  more  margin  improvement  in  2008-­‐2010  and  likely  to  be  
business  model  expansion  through  focusing  on  accessing  Chinese  consumers  for  2011-­‐2013.    Is  Li  &  
Fung  trying  to  run  marathon  like  a  sprinter,  or  is  it  just  quicker,  more  agile  and  more  flexible?  

The  potential  threats  I  have  identified  are:  

x Organizational  complexity  
x Ambitious  value  chain  expansion  
x Improving  margin    
x Competition  with  customers  
x Hazy  strategy  over  asset  ownership  
x Competition  with  suppliers  

I  did  not  rate  them,  because  they  are  all  high  impact  and  high  probability  threats.    However,  in  
my  opinion,  the  chance  for  these  threats  to  materialize  in  the  coming  3-­‐4  years  is  quite  low.    Li  &  
Fung  took  the  aggressive  expansion  only  recently,  and  it  has  managed  well  so  far.    Also,  even  the  

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more  obvious  flaws  at  less  well-­‐managed  organization  often  take  time  to  manifest.    Plus,  current  
external  environment  is  quite  favorable  to  Li  &  Fung.    The  fact  that  Li  &  Fung  is  running  instead  of  
walking  itself  does  not  predict  impending  failure,  but  it  does  mean  the  need  to  monitor  
closely.    And  below  is  detail  of  the  threats  that  I  have  identified:  

Threat1  :  Organizational  Complexity  

Li  &  Fung  historically  grew  by  acquisition  but  it  kept  acquired  organizations  more  or  less  in-­‐tact.    Li  
&  Fung  brought  cost  saving  to  customers  by  1)  empowering  what  used  to  be  middle-­‐office  2)  well-­‐
ĂůŝŐŶĞĚƐƚƌŽŶŐĐĂƐŚŝŶĐĞŶƚŝǀĞƚŽ͞>ŝƚƚůĞ:ŽŚŶtĂLJŶĞ͕͟ĂŶĚϯͿŬŶŽǁůĞĚŐĞĂƌďŝƚƌĂŐĞ͘    That  is  why  
ŚŝƐƚŽƌŝĐĂůůLJ>ŝΘ&ƵŶŐ͛ƐĨŝŶĂŶĐŝĂůƌĞƐƵůƚĚŝĚŶŽƚƐŚŽǁŽƉĞƌĂƚŝŶŐůĞǀĞƌĂŐĞ͘    However,  from  around  
2006,  Li  &  Fung  centralized  shipping  and  compliance  function  of  its  sourcing  divisions  serving  
various  customers,  and  it  also  started  sharing  regional  office  resources  across  different  teams  
serving  different  customers.    I.e.  Li  &  Fung  is  increasing  middle  office  functions.  

This  brings  the  long-­‐missing  economies  of  scale,  but  at  the  same  time  poses  some  potential  
problems.    First  of  all,  calculating  the  contribution  of  LJWs  is  not  as  easy  as  before.    Second,  there  
is  a  chance  that  it  gets  overly  complicated.    Think  of  Li  &  Fung  as  SAC  of  sourcing  industry  and  
imagine  yoƵƌƐĞůĨƚŽďĞ>ŝΘ&ƵŶŐ͛Ɛ>:t͘    What  attracts  people  to  SAC  is  not  how  efficient  SAC  is  but  
how  simple  and  transparent  the  SAC  structure  is  no  matter  what  the  culture  is.  

.    

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Threat  2:  Ambitious  Value  Chain  Expansion  

Li  &  Fung  is  expanding  across  the  value  chain.    I  am  sure  Li  &  Fung  will  capture  more  $  in  its  initial  
stage  of  expansion,  but  as  the  expansion  continues,  there  is  a  good  chance  that  li  &  Fung  will  also  
turn  into  a  dinosaur.    If  its  customers  were  unable  not  handle  all  process  of  the  value  chain  
efficiently  enough  and  thus  outsourced,  then  why  should  Li  &  Fung  be  able  to  do  that?  

Previously,  even  if  Li  &  Fung  was  expanding  product  categories,  its  role  was  still  knowledge  
arbitrager  and  network  orchestrator.    Today,  for  example,  with  IDS  acquisition,  it  is  largely  locked  in  
ƚŽ/^͛ƐůŽŐŝƐƚŝĐƐnetwork.    There  is  nothing  wrong  with  this  move  itself.    After  all,  it  is  all  about  
finding  the  right  balance,  but  with  increasing  integration,  the  risk  of  losing  the  balance  has  grown.  

Threat3:  Improving  margin    

As  you  can  see  in  the  below  graphs,  Li  &  &ƵŶŐ͛ƐŵĂƌŐŝŶŚĂƐďĞĞŶŝŵƉƌŽǀŝŶŐ͕ĂƐĂƌĞƐƵůƚŽĨĂďŽǀĞ-­‐
mentioned  efficiency  improvement  initiatives  and  expansion  into  higher-­‐margin  on-­‐shore  
businesses.  

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And  with  the  expansion  of  higher  value-­‐adding  areas  of  value  chain,  it  is  likely  to  become  higher  
after  the  initial  stage  of  building  up  the  scale.      

/ĚŽŶ͛ƚŬŶŽǁĞdžĂĐƚůLJǁŚĂƚůĞǀĞůŝƐƚŽŽŚŝŐŚƚŽĂƚƚƌĂĐƚĐƵƐƚŽŵĞƌƐƚŽƚĂŬĞŝƚback  to  in-­‐house.    The  


current  5%  may  seem  high,  but  considering  that  it  is  with  the  recent  efficiency  gain  through  taking  
ĂĚǀĂŶƚĂŐĞŽĨƚŚĞƐĐĂůĞ͕ǁŚŝĐŚŝƚŚĂƐďƵƚŝƚƐĐƵƐƚŽŵĞƌƐŽƌĐŽŵƉĞƚŝƚŽƌƐĚŽŶ͛ƚŚĂǀĞ͕ĂŶĚŵŝdžƚƵƌĞŽĨ
off-­‐shore  and  on-­‐shore  business,  the  chance  it  would  immediately  attract  competitors  is  
low.    ,ŽǁĞǀĞƌ͕ƚŚĞŚŝŐŚĞƌ>ŝΘ&ƵŶŐ͛ƐŵĂƌŐŝŶďĞĐŽŵĞƐ͕ƚŚĞŵŽƌĞƌĞĂƐŽŶƐƚŚĞƌĞĂƌĞĨŽƌŝƚƐ
competitors  to  jump  in  and  for  its  customers  to  reconsider    working  with  Li  &  Fung.    No  wonder  
the  company  discloses  less  and  less  about  revenue  and  margin  split  by  businesses.  

EŽƚĞ͗>ŝΘ&ƵŶŐ͛ƐƌĞĂůŵĂƌŐŝŶŝƐŚŝŐŚĞƌƚŚĂŶǁŚĂƚŝƐƐŚŽǁŶŚĞƌĞďĞĐĂƵƐĞ>ŝΘ&ƵŶŐĚŽĞƐŶŽƚƚĂŬĞŝŶǀĞŶƚŽƌLJƌŝƐŬĨŽƌƚŚĞŐŽŽĚƐ͘    The  above  margins  are  calculated  


based  on  the  gross  revenue,  but  whĞŶĐĂůĐƵůĂƚĞĚĂƐйŽĨŶĞƚƌĞǀĞŶƵĞ͕>ŝΘ&ƵŶŐ͛ƐKWŵĂƌŐŝŶŝƐŝŶŵŝĚϯϬйůĞǀĞů͘  

.  

Threat  4:  Competition  with  Customers  

Li  &  Fung  more  or  less  owns  Roots  Asia.    It  pays  licensing  fee  to  Roots  of  Canada,  but  it  does  
everything  from  product  development  to  marketing  and  sales.    For  example,  recently  Li  &  Fung  
ĚĞǀĞůŽƉĞĚŶĞǁĐŚŝůĚƌĞŶ͛ƐƐůĞĞƉǁĞĂƌůŝŶĞŝŶ-­‐house,  procured  it  through  its  supplier  network,  and  
ƐŽůĚŝƚƐƵĐĐĞƐƐĨƵůůLJŝŶdŽLJƐ͟Z͟ƵƐƐŝĂƐƚŽƌĞƐǁŚŝĐŚ>ŝΘ&ƵŶŐŐƌŽƵƉŽǁŶƐƚŚƌŽƵŐŚƵŶůŝƐƚĞĚ
subsidiary.      

Is  this  just  an  exception  or  is  it  a  prelude  of  more  to  come?    Li  &  Fung  might  say  it  is  just  part  of  an  
expansion  strategy  of  helping  customers  reaching  Asian  customers,  but  few  will  believe  it.  

.  

Threat  5:  Hazy  Strategy  over  Asset  Ownership  

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>ŝΘ&ƵŶŐ͛ƐďƵƐŝŶĞƐƐ  is  asset-­‐light.    The  company  has  negligible  amount  of  PP&E  and  inventory  and  
in  fact,  it  has  negative  net  tangible  asset.    However,  IDS  owns  manufacturing  facilities,  and  
ŝŶǀĞŶƚŽƌLJ;ƚŚŽƵŐŚŝƚĚŽĞƐŶ͛ƚƚĂŬĞŝŶǀĞŶƚŽƌLJƌŝƐŬͿŝƐĂďŝŐŐĞƌƉŽƌƚŝŽŶŽĨƚŚĞŝƌĂƐƐĞƚ  base.    Also,  Kenas  
furniture  Li  &  Fung  acquired  in  August,  owns  manufacturing  facilities  and  takes  inventory  risks.  

The  question  is  not  whether  asset-­‐light  model  is  superior  to  asset-­‐heavy  model,  but  whether  the  
asset  the  company  owns  is  value-­‐adding  or  not.    I  agree  that  owning  Listerine  bottling  facility  is  
relatively  more  value-­‐adding  than  owning  sweater  manufacturing  facilities;  but  I  am  not  sure  
whether  it  is  value-­‐adding  in  an  absolute  sense.    /ĂŵŶŽƚďĞŝŶŐƐŬĞƉƚŝĐĂů͕ďƵƚ/ũƵƐƚƌĞĂůůLJĚŽŶ͛ƚ
know.  

These  assets  Li  &  Fung  acquired  are  unlikely  to  create  sub-­‐par  value  as  of  today.    Had  it  been  the  
case,  the  company  would  have  decided  (or  will  soon)  decide  to  divest  these  assets.    However,  the  
company  is  likely  to  keep  these  assets,  and  over  time  it  can  cause  hazy  strategy  over  asset  
ownership.    As  all  flexible  rules  do,  what  is  initially  owning  well-­‐selected  strategic  assets  can  evolve  
into  owning  many  non-­‐strategic  political  assets.  

.  

Threat  6:  Competition  with  Suppliers  

As  I  mentioned  above,  Li  &  Fung  now  has  one  toe  in  manufacturing.    It  is  not  in  direct  competition  
to  the  majority  of  its  suppliers  who  make  garments,  bags,  and  shoes.    However,  as  Li  &  Fung  
expands  its  product  category,  what  the  tension  with  suppliers  could  grow.  

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