ASSET LITE
How an asset-light business model broadens the functions of a CFO
By Abe De Ramos

To see Frank Leong in action is to know that a CFO's job in Asia will never be the same. Leong is a relaxed, but intense, man, with a winning smile and an iron-trap mind for detail. He needs it. He begins a typical morning poring over cash balances, reconciling a unit's financial statement, and ironing out a new strategy to keep costs of a project down. He informs unit managers that their upgraded computers are on the way. He phones another to guarantee that a network connection will come on-line. He signs several appointment letters and confirms two transfers. He then finds time to decamp to a warehouse to inspect the quality of one of his company's shipments. Wandering amid the teddy bears, he looks like a kid in a toy store. Only two hours have passed, and already he has spent time between finance, human resources and information technology.

If you think that Leong is the CFO of a US$10 million company and does all this because he can't afford to delegate, you'd be wrong. Leong is CFO of Li & Fung, a US$4.2 billion-a-year Hong Kong company with offices in 40 countries across the globe. Leong manages this way out of choice, because it's the best way to do his job under Li & Fung's asset-light business model. Asset-light, you say? Meet the homegrown Asian corporation that gave meaning to the term. The 96-year-old firm is in the supply-chain business, making sure that retailers such as Levi's and The Limited have enough apparel to hang on their racks for the next fashion season. At its core is a business strategy that allows it to match clients with factories, and monitor the design, production and delivery of the goods, at speeds faster than its rivals do. Behind it is an organizational structure that masks its size: Li & Fung is made up of pockets of business units - some with as little as a head count of one. Each acts as its own corporation, with its own customers and profit and loss accounts..

Sister Act

PA success like Li & Fung isn't created in a vacuum. It's no surprise that another Asian trading company has deployed the model in a different business - and struck gold. Noble Group, also based in Hong Kong, has inserted itself into the supply chain for coal and cocoa. Going Li & Fung one better, it is now including financing and risk management in its mix of offerings. And proving that Leong is no exception, it has a jack-of-all-trades in the guise of a finance manager at its core.

"The comparison with Li & Fung is not by accident. We have followed them in parallel, only we're less high profile," admits David Sullivan, Noble's group treasurer. "Li & Fung is known as a garment trading company, but it's not; it's an integrated logistics company. Likewise, we don't see ourselves as a commodities trading company, but as an integrated merchant company on a global scale," says Sullivan. So far, taking inspiration from Li & Fung has worked well. In 2001, Noble made a record US$1.9 billion in sales, up 53 percent from 2000, while net profit grew 11 percent to US$23.5 million.

One other glaring similarity between the two companies is the level of responsibility their CEOs have given their CFOs - far beyond reporting, accounting and calculating hurdle rates. Leong runs the machinery that gave Li & Fung the agility to double profits every three years since 1995. Sullivan, meanwhile, runs an internal bank that mitigates the price and physical risks of moving time-sensitive commodities.

Harvard Business School has already written a case study on Li & Fung's supply-chain system. It may be time for another, because the asset-light model stands at the center of Asia's recovery hopes. Salomon Smith Barney economist Donald Hanna spoke recently in Hong Kong about an encouraging development: Asian companies are beginning to produce more goods with less capital, a long-term trend that will deliver enormous benefits to the region's economies. While much of the increased productivity is due to low wages, experts now see improved business methods as a key driver. Within Li & Fung's and Noble's grasp is a paradigm that matches conservation of capital with flexibility of control. In this environment, the CFO must reign supreme over all fundamental company operations.

"I'm like the CEO of an internal service company," Leong says of his role as the head of Operation Support Group (OSG), Li & Fung's back-office hub. With few fixed assets and capital investments to manage, Leong finds himself in a position to become a business partner. This is exactly how Li & Fung has positioned him to be. Victor Fung, the chairman, takes care of long-term vision. William Fung, the CEO, looks after the day-to-day progress of the business. Two executive team members oversee the US business; another manages the merger with Colby, a former competitor that is being maintained as a separate brand; a fourth takes care of Europe; and a fifth manages hard goods sourcing (including furniture, which makes up 28 percent of revenues). Leong, the sixth member of the team, takes sole responsibility for oiling the machinery by which Li & Fung operates.

Leong thinks a CFO becomes a business partner when he or she takes a holistic view of the business. He may be a perfect fit for his role, having an undergraduate degree in IT and accounting from New Zealand and an MBA from Australia. But Leong makes a case for his role by arguing that the CFO is, in fact, best positioned to handle functions that impact the whole organization. "To run a business efficiently, you have to control the cost while upholding standards, and at the same time balance the service level of your company," he says.

Leong does all that by running the OSG, the nucleus of Li & Fung. Its tentacles reach out to every single business unit - currently 120 in 40 countries - that specializes by product, product line or customer. "Each business unit is the single point of contact of the customer, and this makes us as customer-focused as possible," says Leong.

This fa?ade is backed by a powerful engine - an IT system that keeps a database of 6,000 factories around the world. (About 2,000 of them are producing for Li & Fung's 700-plus customers at any given time.) The database is accessible to the whole supply chain, from the headquarters in Hong Kong, to the business units, factories, shippers and retailers. It contains not just profiles of each factory in terms of products and capacity; it is also a hub for customers to check the progress of their orders, from production to shipping. From his fourth floor office at an obscure building in noisy Kowloon, Leong runs and maintains this network, which is a crucial element to Li & Fung's value proposition.

Trade Oomph

AThis is how the company adds oomph to traditional trading. Instead of simply sourcing clothes for mostly US and European retailers, Li & Fung works with them on the design of their products. "Our people sit down to share with them the latest information from the production side - what sort of material is hot, what new colors are available, where a product can be produced," says Leong. This expands the fashion retailers' knowledge of materials available in the market, and thus gives them greater creative (and financial) liberty in designing their clothes for the season.

"We then take their concept, and from there develop a prototype of the garment," says Leong. All the information that Li & Fung needs to work with customers is in the database, which is updated real-time, so any business unit can quickly respond to a client regardless of volume of order or complexity of design. After a design has been finalized, Li & Fung places the order on the customer's behalf, and sends quality control people to check the production. Because garments are not just produced in one place - a yarn may be bought in Korea, dyed in Taiwan and sewn in Thailand - Li & Fung also provides logistical support for each stage. "A lot of our customers arrange their own shipping, but we can organize shipping for them," says Leong.

The OSG supplies each unit with personal computers and a network connection. "We provide an IT system across the world, and charge them per PC, which covers the whole network - order processing, production tracking, email communications," says Leong. "If you need 15 PCs, I will charge you for 15 PCs; if tomorrow you decide you need just five, you give the ten back, I charge you for five, and I'll use the ten for somebody else," he says. The charges are taken from the units' revenues, which all go to Leong's centralized treasury.

The logic behind this model is for the business units to function like independent companies without having to worry about their back-end needs. But the more important reason is competitive advantage. The supply chain industry is riddled with players both big and small. In the US, for example, Li & Fung is the leader in its industry, even though it holds just 5 percent of the market. It has acquired or merged with a number of competitors, and it hopes to cannibalize both sides of the competitive spectrum. "We're marrying the strength of being small and big together," says Leong. "Big companies tend to get bureaucratic, while small companies can do specialized products. Our small business units act extremely fast, but at the back-end, they get the level of service of a huge company," he says.

Aside from IT, the OSG also acts as an in-house HR provider, offering recruitment services, internal matching of staff and training. Equally impressive, Leong acts as the chief banker of these units. Because all revenues go to Leong in US dollars, he is able to support business units by pooling their cash balances. "They can borrow from us, and the rate we charge is cheaper than if they go outside," says Leong. When necessary, Li & Fung also provides trade financing to its clients. "If the customer wants us to do it, they will open an L/C (letter of credit) to us, and we will open an L/C to the vendors wherever they are," he says.

As with anyone who runs a business, Leong's performance is measured against his own P&L. "I am subject to scrutiny, which is why the system is quite good. If my technology is far behind, I get a complaint. If I spend a lot of money, I would have to charge higher - which my internal customers don't want - or else I face a loss," he says. As such, while mindful of the cost of OSG in a micro view, Leong is actually managing the cost of the entire business.

To be sure, Li & Fung reached its maturity through acquisitions. In 1995, the Australian sourcing company Dodwell, where Leong was finance director, broadened Li & Fung's client base in Europe, and expanded its sourcing network beyond east Asia to include south Asia, the Mediterranean and the Caribbean. The acquisition of two Hong Kong competitors, Camberley and Swire & Maclaine in 1999, gave it the design process expertise, and clients such as Laura Ashley and Ann Taylor. Last year, the merger with Colby, a California supply chain manager catering to US department stores, consolidated Li & Fung's market leadership position.

In each case, Leong was able to leverage the scale of his IT operations. Colby, for example, had budgeted up to US$10 million to upgrade its IT systems before the merger. "After we merged, they got the upgraded IT system, but we only spent a few million Hong Kong dollars to increase the capacity of our systems," says Leong. "Because of the scalability of our systems, and our ability to customize according to Colby's needs, we were able to achieve economies of scale. Our major cost is actually people," he says.

As its asset-to-sales ratio proves, the Li & Fung model is working almost flawlessly. And what of shareholder value? Li & Fung is so cash-rich that every year it divvies up 70 to 80 percent of its earnings among shareholders. Currently, it has US$300 million cash in deposits. This Leong doesn't mind, given that some of Li & Fung's ventures are not asset-heavy. But they are positioned for "prospective acquisitions," he says. A recent strategic partnership with the Japanese supply chain integrator Nichimen only cost him US$4 million in purchases of Nichimen's clothing stock. The partnership is a tiny cross-shareholding structure, the payment a symbolic exercise. Still, it will put Li & Fung on the map in fashion-crazy Japan.

Like Zinc for Chocolate

IWhile geographic diversification has been Li & Fung's approach to expansion, Noble Group's has been through its products. Noble started with metals, and through acquisitions ventured into sugar, grains, coal, and last year, cocoa. "Commodities are cyclical. At the same time we went into grain, some of our other businesses were going flat and we didn't see that there was a potential growth cycle going forward," says Sullivan.

Noble's value proposition is similar to Li & Fung's. For example, instead of buying cocoa from farmers and selling them in the same form to cocoa distributors, Noble gets involved in processing the cocoa seeds into a form marketable directly to chocolate manufacturers. To reduce the risk exposure, cocoa seeds bought from farmers in the Ivory Coast are washed, peeled and warehoused in the same country before they are shipped, says Noble's group financial controller Louis Tang. Sullivan adds: "We're supplying producers with material, we're providing credit, we're providing logistical support. If you look at the way Li & Fung is involved in each stage of their business - from sourcing to shipping to storing to distrubution to sale - it's parallel."

True enough, Noble has structured its organization somewhat like Li & Fung. The support services - finance, logistics and technology - are distinct and separate from the core activities of trading in agriculture (cocoa, sugar, wheat, corn, soybean, rice and pulses), energy (coal and coke), and metals and ores (alloys, manganese, zinc and nickel), which account for much of the group's revenues.

Given this structure, which was adopted when Sullivan and Tang joined the company in 2001, Noble becomes a one-stop-shop for its customers and suppliers. This includes Noble Trade Finance, which offers them insurance products and hedging strategies, and of which Sullivan is managing director. "In commodities, you buy goods, store them, ship them, store them again and sell them. We need a lot of structured finance, and banks in Asia are not very good at this," he says. Unlike traditional commodities traders, Noble does not take positions for gains in commodities exchanges. "We're a physical business, not a derivatives business, so we know who we're going to sell to," says Sullivan.

Because margins in commodities trading are razor thin (in grains, says Sullivan, it's all of 1 percent), Noble pursues an active risk management strategy. "If you're buying grain in the world market, you will buy at world prices, and if you're selling in Indonesia, the local price has completely different fundamentals," he explains. If the local price at any period of time is much higher than the world price, hedging is less imperative, he says. "But if you know there is a chance the local price will fall below world prices, then you need to hedge to protect your prices," Sullivan adds.

Noble also provides logistics support by arranging shipping, either with any of the three ships it owns, or from other shipping companies. In the latter case, Noble pursues a hedging strategy by buying routes or freight space in advance, and trading them in the dedicated exchanges, says Tang. But what differs Noble from Li & Fung is that Noble takes these support services one step further by extending their capabilities for external customers. For example, Sullivan sells political and credit risk insurance and structured finance products to other traders.

The ship management business is also one of its most profitable. "This is probably one of our most asset-light businesses, because it only involves people," says Tang. Noble has a database of 2,000 shipping crew - people who manage ships from supply provision to technical troubles - it can use when it takes on shipping management contracts from ship owners. "We actually own the three ships just to prove that we have expertise in ship management," says Tang.

Acquisition Mode

Another difference is that Noble is preparing itself to add fixed assets to its balance sheet. Currently in its metals and ores business, Noble is trying to widen its margins by taking equity stakes in several small mines in Australia, and soon, Indonesia. Noble's strategy is to forge partnerships with entrepreneurs who have the cash to buy mines from the government. "We're taking these strategic smaller stakes, and getting contracts to manage the mines from the owners who don't want to manage them," says Sullivan. By investing 20 to 30 percent equity stakes in the means of production, Noble gets a guaranteed supply of product. "They give us the management contract. We can arrange the financing and the contractors," he says.

In its energy commodities business such as oil and gas, Sullivan says Noble is also looking to become a distributor itself, as opposed to a seller to distributors. "You can trade oil, but do you get to the stage where you're putting oil into cans and selling in a certain market? There is huge scope to get closer to end-users. We've stopped selling to traders who sell to distributors. We try more and more to sell to distributors, but some of the distributors are also retailers," says Sullivan. "So if we want to become a distributor ourselves, maybe we also have to go into retailing of certain commodities. I think there's huge potential for that. I can see one day when we have petrol stations," he says.

To remain asset-light, however, Sullivan has a counterstrategy. Having been a banker for ten years before joining Noble and establishing Noble Trade Finance, Sullivan wants to expand the financial services business. "We have a lot of expertise to increase the activity of financing and insurance with our supply chain, and I think that is something that doesn't burn your balance sheet," he says. Like Li & Fung, Noble is still in an acquisition mode.

A good glimpse of where Noble and Li & Fung are headed, however, happened during a taxi ride that Sullivan shared with Noble CEO Richard Elman not too long ago. In the backseat of a worn-down cab in downtown Manhattan, Elman was talking with Sullivan about his ambitions. Elman came to New York in search of opportunities to expand, or finance the expansion, of his company. As the taxi careened to Fifth Avenue, Elman was piqued by the shiny, curvy logo of a shop guarded by an army of masculine mannequins in dark woolen pinstripes. He paused briefly, then turned and threw a question to Sullivan. "Do you know who might one day buy Brooks Brothers?" asked Elman. Sullivan sat in silence. "Probably Li & Fung," Elman said. Sullivan then snapped with a grin. "I thought you were going to say Noble."

Abe De Ramos is a senior writer for CFO Asia based in Hong Kong.