PROFIT LEGENDS
How Asia's top CFOs are perfecting the fine art of expanding margins.
By Abe De Ramos

It may be the good fortune that the Year of the Monkey is tipped to deliver. Or perhaps, the gravity-defying 9.9 percent economic growth that China achieved last quarter. Whatever the reason, Mary Ma has not been this optimistic in more than two years. "The market is slightly picking up," she says, echoing a view that has been appearing more frequently in business pages in the region. And for the CFO of Legend Group, which sells computer products in the Middle Kingdom, the silver lining means that a change in business strategy is in order. "The environment is different; now we can push for revenue growth higher than market growth," says Ma.

Brave words, those. But with good luck and macroeconomics, the target may well be easily achieved. In fact, Legend could do well even if the market disappoints, if it's able to sustain the performance it showed in a Bain & Co survey of Asia's best profit performers based on four financial metrics.

Conducted exclusively for CFO Asia, the survey showed Legend growing its revenues, earnings, margins, and return on assets from 2000 to 2002 - the toughest two years in the sector. Legend, after all, used the period of slow growth to improve its profitability, and the steps it has taken to achieve this are the reason why Ma can afford to look ahead with such confidence.

Legend is one of a robust few. Of the 150 listed companies surveyed - all being the top five by revenues in four sectors or the top five overall - only 34 made the cut. (See boxes.) Of those, the majority were found to have initiated programs aimed specifically at profit-hunting. Says Oliver Stratton, vice president at Bain in Hong Kong, who led the survey: "Companies that substantially improve margins often use profit hunt programs."

Profit what? It's a phrase the US consulting firm uses to describe a systematic approach to boost revenues and reduce costs. Companies often resort to these moves in a downturn, and those that emerged in the survey are no exception. While their goal is the same, they mostly took divergent paths to get there. Some reduced distribution costs, squeezed their suppliers, or cut internal costs through attrition or salary reduction. All, however, made a bid at revenue enhancement. But instead of stimulating sales at the expense of margins, they focused their efforts on their core businesses, and reaped immediate results. And as Ma likes to believe, they are now in a better position to ride the coming tide of recovery.

Soul Searching

For Legend, which has been battling with competition from domestic and foreign brands, one thing was clear. "The PC has become a commodity, so we had to emphasize differentiation of our products," says Ma. It was a step the company desperately needed to do, as its margins flirted with disaster. For five years until the fiscal year ending March 2002, Legend's EBIT margin - the ratio of earnings before interest and taxes to sales - averaged at a razor-thin 0.6 percent, according to an estimate by investment bank UBS. Efforts to reverse this began in 2001, when Ma increased allocation for research and development (R&D) from next to nothing to about 1 percent of revenues.

Although a pittance compared to global peers, that amount proved enough for Legend to introduce a series of innovative desktop and notebook computers (which currently make up 85 percent of total sales) beginning late 2001. These ranged from dual-mode consumer desktops (set boxes that can function both as a conventional PC as well as a multimedia center) to corporate models that provide security such as platform verification. "In a nutshell, Legend is now leading the herd with its unique designs and special features," says Florence Cheung, analyst at Sun Hung Kai Research, in a recent report.

But product innovation was only half the story. Legend coupled its newfound interest in R&D with an equal eagerness to understand the buying patterns of customers. While the company had two clear target markets - consumer and corporate - its customer segmentation didn't go deep enough. In 2001, Legend hired Gallup, a market research firm, to conduct an intensive, nationwide customer survey to better understand demand. "If we were to differentiate our products, we had to serve individual customer segments," says Ma. "We realized that consumers have different requirements, and even among corporations the needs of small, medium, large, and private entities differed," says Ma.

The result led to a radical change not just in its product models but also in its distribution system. For example, Legend found that low-end and first-time computer users in China were unwilling to spend anywhere near 8,000 renminbi for a basic unit. As such, it introduced entry-level computers for less than 4,000 renminbi. At the same time, it found it could command premiums by offering multi-year warranties to high-end consumers who chose to customize their desktops. Although local competitors offered similar models at similar prices, buyers gravitated towards Legend's brand name.

Surprised by how highly its brand was perceived, Legend narrowed its consumer distribution to chain stores and department stores in major cities, away from the previous model of an extensive network. That model, too, was previously applied to small- and medium-sized enterprises (SMEs) in major cities. Not anymore. Many of these businesses are actually emerging in second-tier cities where Legend has a limited direct presence. There, both entrepreneurs and consumers "needed services as much as the machines themselves, because they didn't know how to use them," says Ma. As such, it abandoned its direct model in the provinces and replaced it with a wider network of regional partners.

The partnership model enabled the company to cover a larger area than it had before, while at the same time offering Legend-trained services to SMEs (under which is included the rural education sector). For Ma, it was also cost-efficient. "It would have been very costly if we set up our own team to serve, say, 150 schools in Anhui province in the middle of China," says Ma. The effort paid off. Its market share in the SME sector is 32 percent nationwide, better than its total market share of around 28 percent.

Its direct distribution model for large corporations remained unchanged. What changed, however, is its aggressiveness in selling its products. Until recently, Legend's servers were snubbed by corporate users. "They would say, 'We'll buy your desktop, but we want IBM servers,' because they didn't believe we have the technology to produce servers," says Ma. Encouraged by its R&D advances, Legend created what would become one of the world's 25 fastest supercomputers. On top of that, it seeded an IT consulting business, to boost its image and break into the high-margin server market.

Ma believes a combination of these efforts prevented competitors, including foreign brands Dell and HP Compaq, from eating away Legend's market share, which it allowed to stagnate at year 2000 level while it focused on margin enhancement. Better still, in the year to March 2004, Legend is expected to make HK$1.3 billion in profits, from HK$1 billion last year. Its EBIT margin should improve to 5.4 percent from 4.9 percent - a far cry from the days when its products offered little value-added. As CFO, Ma is quick to add that at the back of this achievement is a remuneration system tied to a performance index that includes sales, profit, and profit margin..

Smarter Times

In fact, a change in the remuneration system could be a force in driving profit hunt programs, as SmarTone Telecommunications learned. Until 2000, the Hong Kong-based company was a loss-making, run-of-the-mill mobile phone operator and wannabe internet service provider. When a new management took over in 2001, they decided to change its fortunes and focus on a growing trend in telecommunications. It was something the staff was new to, and which executive director Patrick Chan says required that ever-enigmatic paradigm shift. What better way to implement a "re-centering program" that aims to "change the corporate culture and mindset" than by hitting them where it matters most: their paychecks?

Prior to 2001, SmarTone rewarded its employees like many other Asian companies do: across-the-board year-end bonuses regardless of profit performance. That was later scrapped. "One area of re-centering was exactly that: changing the remuneration, bonuses, and commission [policies] to [prompt] behavioral change," says Chan. Now, Chan estimates that only 40 percent of bonuses are based on targets, while the rest is based on individual behavior that gives high points for initiative and productivity.

Chan credits the remuneration scheme for helping SmarTone save on staff costs, which, along with the divestment of certain assets, helped bring back the company to profitability in just a year. But more importantly, it may also spell the performance of SmarTone's profit growth strategy going forward. "What we have been doing is focus on data services," he says. "Content operation and content design is a new business for mobile operators, and for us to do it, the whole company had to change its mindset."

In concrete terms, that meant giving up the non-core internet and satellite businesses, and abandoning a marketing strategy that promoted low-margin voice traffic. Instead, the company decided to promote the use of data, or text and graphics-based services, through mobile phones and handheld computers. "Voice has become a commodity and more increasingly we see data becoming important for mobile companies," says Chan. This is where the so-called paradigm shift comes in. Because the use of data services depends heavily on ease-of-use, SmarTone began to see itself less as a technology company, and more as a service company.

"Radio network and core networks are just part of the chain and there's little we can do about it," says Chan. "Where an operator can make a lot of difference is in the service network - content operation and design - so you can maximize [data traffic]." As such, SmarTone designed its data services - including e-mail, news and information, and text and picture messages - such that users are able to download or exchange data with as few clicks or scrolls on their keypads as possible. On the surface, it sounds like an elementary effort. But getting the interface right could be the basis of whether the measures SmarTone is taking to improve margins and generate profits will succeed.

Data services, for one, are more frequently used by business users and high-end consumers, and this is where SmarTone has focused its marketing. For example, the company has stopped bundling its service plans with monochrome handsets whose dark screens make it unappealing to input and read text messages, and are incapable of multimedia messaging (MMS). "Our competitors are still pushing outdated black-and-white handsets with no MMS," says Chan. "They can lock in customers, but they're limiting the ability of customers to use data services, and in effect, their own revenue potential."

Analysts at investment bank Lehman Brothers agree. "Rather than copying subsidies on low-end phones, SmarTone is promoting a HK$800 discount on the retail price of its high-end flagship terminal," they say in a December report, referring to a 3G-ready handset. For now, it is a sacrifice on margins, but the company "is sending out a strong message that SmarTone stands for premium service, and É attracts high-end users keen for data use and willing to spend on telecoms." For the year ending June 2004, investment bank Morgan Stanley expects SmarTone to increase its revenues from data services fivefold to HK$31 million. That should triple next year, and again in 2006, it says.

Another move SmarTone is taking is refusing to play the subscriber numbers game. Currently, Hong Kong has more mobile phone subscribers than it actually has people. That's because since the start of last year, some operators have been giving away one free SIM card, with at least HK$100 in credit, for every new subscriber they enlist. "We don't talk about customer numbers as such; we're after a better class of customers, and that means higher ARPU (average revenue per user)," says Chan.

As of end-June 2003, its blended ARPU rose 7 percent from a year ago to HK$183. Morgan Stanley expects the figure to inch up to HK$189 by June this year. (Comparative figures are unavailable, as other operators disclose only post-paid ARPU.) SmarTone's handset subsidies are also lower than competitors. "Management is clearly lifting its marketing skills," says Lehman Brothers, which projects SmarTone to increase growth of its subscriber base, currently about 1 million, from 16 percent last year to 19 percent by 2007.

Good Call

In Singapore, mobile phone provider MobileOne is also reaping the benefits of a customer-focused strategy to stay profitable despite the Lion City's prolonged economic slowdown. CFO Karen Kooi points to M1's churn rate - or the ratio of subscribers who terminate their subscriptions - to demonstrate this. Like Legend, the company had undertaken a comprehensive survey on usage trends. The result was a company-wide customer relationship management (CRM) program that Kooi credits for helping M1 achive a good rate of retention.

In 2003, M1 saw its average monthly churn rate fall to 1.8 percent, from 2.2 percent in 2002 and 2.3 percent in 2001. This helped M1 reduce its customer acquisition cost - the average cost of signing up one subscriber, which includes handset subsidies, marketing, and advertising - to S$156 in 2003 from S$183 in 2002. Currently, M1 has just above 1 million subscribers in a city of 4 million, making it a serious threat to state-run Singapore Telecom.

The company needs all the savings it can get, as it is about to roll out 3G services in the second half of the year. To this end, Kooi says the CRM program is constantly being enhanced, as it is on the forefront of its customer retention strategy. The program is powered by a software system that makes customer information accessible to all relevant "touch-points", or departments within M1, from finance to sales to call centers.

The program, among other things, tracks customer behavior and does two things vital to customer retention: churn prediction and delinquency prediction. "They help us understand our customers, which is why we have a whole suite of tailored retention offers," Kooi says. "We segment customers based on their needs, rather than their demographics."

The segmentation begins with market surveys and focus groups, and narrows down to customer profiles based on usage patterns and interface with M1 shops or call centers. "We know how they use their mobile phones, how much they spend, how often they pay, how long they have stayed with us, and if they want to churn, why they want to churn," says Kooi. By "we", she means everyone who has access to the CRM system, where all the information is stored on the customers' pages.

Kooi illustrates how the CRM system is used: "When we do our customer delinquency prediction, [the credit department] rates the customer accordingly, and that information is then put into the customer's record. When my CSO (customer service officer) deals with that customer, who might ask to hold off credit action, the CSO, without referring back to the credit control staff, can decide whether or not they can accede to that request. Likewise, when my credit action people want to go in and review a case, they would have a view of what has taken place between the CSO and the customer, and what action has been taken."

Similarly, when the profile shows a customer is about to churn, M1 then offers the subscriber a package tailored for their profile - say, an MMS package for those that heavily use picture messaging. How does M1 predict a churn? One obvious factor is when a customer inquires about when his or her handset contract is about to expire. "We have analyzed hundreds of factors, which we then narrowed down to the more relevant ones," she says. "We continue to monitor the accuracy of the prediction tools, and so far it's been proven to be quite accurate."

Along with customer retention, M1, like SmarTone, has shifted its focus to non-voice revenue, which currently accounts for 15 percent of its ARPU. This will help the company better market its 3G services, the core attraction of which is high-speed data transmission, including video clips. Overall, the company was able to increase its EBITDA margin from mobile services to 45 percent in 2003, from 42 percent in 2002.

Vertical Horizon

The need to respond to customer needs to command better margins is not lost on Wong Ngit Long, managing director at contract manufacturer Venture Corp. Wong knows the company, which specializes in networking equipment, printers, and computer peripherals, had to act as contract manufacturing became a cottage industry in the late 1990s. So from 2000 to 2002, he drove the company to change its business model to include not just contract manufacturing but also original design manufacturing (ODM) and vertical integration.

That means the company does not just offer manufacturing services, but now also a package of services from product design and prototyping, to fulfillment and reverse logistics (which, in turn, includes repair and maintenance, and disposal support). The transition was not all that difficult, says Wong, because Singapore has a sufficient supply of technical skills, which Venture has been building up over the years.

As such, Venture was able to combine both advanced skills with low-cost manufacturing. "In this industry, prices of products [required for production] always go down, so the strategy is to make sure that you can creatively improve your performance, double your performance with lower cost," says Wong.

The ODM business, which now accounts for 11 percent of revenues, allowed Venture to command higher prices. At the same time, Venture focused not on getting high-volume orders from multiple customers, but on getting low-volume, high-mix, orders. That means products with various applications, lot sizes and production processes. Wong hasn't turned Venture's back on high-volume orders, but says these products must require a high technical content. In short, Venture used the time of slowdown to focus on higher-value products that require advanced technical skills, which Venture already had.

"It's consistent with our overall growth strategy to expand on the value chain and expand on market segment," says Wong. "We want a more diversified growth, and we're one of the strongest companies not just in high-volume, but also in high-mix business." Wong has the figures to prove it. From 2000 to 2001, Venture's revenues were flat at S$1.4 billion, but profit after tax grew 34 percent, to S$134 million. In 2002, revenues grew 65 percent to S$2.37 billion, and profits another 34 percent to S$181 million.

That final set of figures slightly disappointed analysts, as it shows that profit growth lagged behind. Indeed, even with its new business model, Venture can only avert a potential margin erosion as competition catches up quickly. Citigroup Smith Barney analyst Pratik Gupta, in a report published in November, notes that Venture will register an EBIT margin of 7.2 percent in 2003, from 8.2 percent in 2002. That will stabilize to 7.1 percent in 2004 and 7 percent in 2005. Adds Sunil Gupta of Morgan Stanley: "The biggest concern regarding Venture has always been its ability to sustain high revenue and profit growth É We believe the margin compression trend will continue."

That only made Wong draw from the margin-enhancing strategies up his sleeves. In the second quarter of last year, Venture went into more lucrative areas such as automotive parts and medical equipment manufacturing. "We're upbeat about its forays into new high-margin segments," says Gupta of Citigroup. "Venture's strong - and growing - design skills across various segments with a premier customer base and high manufacturing efficiency in low-cost regions should enable strong growth prospects going forward."

Time to Evolve

Of course, no one can be sure how long those high margins will last, given the growing competition especially in the technology sector. Back at Legend, CFO Mary Ma is trying to address the issue. It's only a matter of time before competitors replicate Legend's product and distribution models. As such, the company's new thrust, while technology spending continues, is to capitalize on its brand by diversifying into products literally adjacent to its core computer products - consumer goods that require interface with computers such as MP3 players, digital cameras, and printers.

"We will be aggressive on revenue growth," says Ma. That kind of statement suggests sacrificing profits for market share, and indeed, Ma knows that the consumer products offer low margins. But Legend is thinking long-term; its goal now is to create brand affinity, and as conventional wisdom goes, brands command premiums. Also, Legend isn't making these products itself, but is outsourcing them. The reason? It doesn't want to invest in R&D on these products, because it wants to stay focused on its strength: computers. "We can't really apply the same strategy to every product, because that will dilute our strength," she says. And, of course, as her market survey showed, a little TLC with customers won't hurt. As Ma sums up: "The strategy for 2004 is push the core business, continue differentiating our products, and invest in customer relations."

Abe De Ramos is executive editor of CFO Asia.