Li & Fung Third Generation Corporate Governance
Story A 2001 study of 495 companies by CLSA Emerging Markets found a strong link between good corporate governance, earnings and stock values. According to the study, the correlation between good corporate governance and share performance for the largest companies is "a near perfect fit." In that study, Li & Fung were rated as one of the top companies. (Day 2001) A corporate governance poll conducted by Euromoney magazine rated Li & Fung fourth highest globally in corporate governance, and second highest in Asia. (Euromoney 2003) Li & Fung, a family owned company founded in 1906 during the Ching Dynasty, acted as a trader - basically a broker, charging a fee to put buyers and sellers together. When they decided to make a public stock offering on the Hong Kong Stock Exchange in 1973, they had already begun changing their governance. William Fung, managing director of the company put it this way, "We typify the transition from a first-generation entrepreneurial firm to a company that is being made more professional to compete with Japan and the multinationals." (Kraar 1994) In 1989, to pay relatives who wanted to cash out, William Fung and his elder brother Victor, who is chairman of both the family company and Prudential Asia, arranged an LBO with bank financing. After cleaning up the privatized company and selling off fringe businesses like chartered boats, the brothers took it public again in 1992. (Kraar 1994) At Li & Fung, the Harvard-trained management has replaced family members in the company with professional managers, imported performance-related pay and instituted an open, western-style management regime. It accepts the need for stakeholding and transparent governance. (Caulkin 1996) Victor Fung explains, "You can run a large empire with very few people making few decisions. Now you need a large number of small decisions." (Economist 2000) Li & Fung represent good corporate governance in several ways: leadership in outsourcing to customize customer products, leadership in employee management and fiscal controls, and encouraging best practices among its suppliers.
Distributed Manufacturing Around the Customer's Needs
Li & Fung performs the high-value-added tasks such as design and quality control in Hong Kong, and outsources the lower-value-added tasks to the best possible locations around the world. For example, to produce a garment the company might buy yarn from Korea have it woven and dyed in Taiwan, then shipped to Thailand for final assembly, using zippers from Japan. For every order, the goal is to customize the product to meet the customer's specific needs. They call this supply chain outsourcing "distributed manufacturing." (Magretta 1998) Li & Fung is uniquely organized around the customer. They are divided into divisions and each division is structured around an individual customer or a group of customers with similar needs. Consider, for example, the Gymboree division where every one is focused solely on meeting Gymboree's needs. On every desk is a computer with direct software links to Gymboree. The staff is organized into specialized teams in such areas as technical support, merchandising, raw material purchasing, quality assurance, and shipping. (Magretta 1998)
People Management and Fiscal Controls
For the creative parts of the business, Li & Fung gives people considerable operating freedom. Substantial financial incentives tied directly to the unit's bottom line motivate the division leaders. There's no cap on bonuses. On the other hand, when it comes to financial controls and operating procedures, Li & Fung does not want creativity or entrepreneurial behavior. In these areas, Li & Fung centralizes and manages tightly. They have a fully computerized operating system for executing and tracking orders, and everyone in the company uses the system. (Magretta 1998) Since 1993, Li & Fung have changed from a Hong Kong-based Chinese company that was 99.5 percent Chinese into a truly regional multinational with a workforce from at least 30 countries. Victor Fung says, "We are proud of our cultural heritage. But we don't want it to be an impediment to growth, and we want to make people comfortable that culturally we have a very open architecture." (Magretta 1998)
Best Practices at Suppliers
Wherever Li & Fung operates, they follow local rules and best practices. They make sure their suppliers are doing the right thing when it comes to issues such as child labor, environmental protection, and country-of-origin regulations. If they find factories that don't comply, they will not work with them. This generally does not happened because of the company's long relationship with the suppliers. (Magretta 1998) Li & Fung, in the course of monitoring its supplier network, constantly compares the performance of hundreds of different companies. It then shares the information with all of them, giving them a detailed understanding of their performance gaps, ideas for addressing them, and strong incentives for taking action. Benchmarking, rather than being an occasional event, is an intrinsic part of process management. (Hagel 2002)
Discussion Questions
¦ How might Li & Fung's reputation for good corporate governance impact its ongoing business?
¦ As Li & Fung's auditor, which areas of the business would require the greatest test of controls?
¦ Which are the most significant substantive tests?