XU LING-LING OF LIANHUA SUPERMARKET
Interview by Abe De Ramos

Xu Ling-Ling has been working in the consumer sector in China for 30 years, starting as a 17-year-old supervisor at a tobacco-and-wine store in 1975. She was appointed head of finance of a food-and-beverage company in 1983, four years before she even completed her undergraduate degree in accounting. Since then, Xu has risen to become the CFO of Lianhua Supermarket, the largest operator of supermarkets, hypermarkets, and convenience stores in China, with more than 3,700 stores and revenues in excess of 14 bn renminbi (US$1.8 bn) in 2005. Its current store network is a gargantuan leap from the ten supermarkets Lianhua owned in Shanghai in 1996, when Xu joined the company as an internal auditor. Since her promotion to CFO the following year, Xu has been at the forefront of Lianhua’s mergers and acquisitions, a growth strategy she says the company will pursue in the next five years. That could be the only way Lianhua can survive the predatory retail sector in China, where local and foreign players from Wu-Mart to Wal-Mart are scrambling to acquire stores to capture this market of 1.3 bn people. As Xu asserts, Lianhua is engaged in “a battle of giants”.

How did the company start, and how did it grow to where it is now?

Lianhua was established in 1991. It recorded a loss in the first four years because the market was not mature and investors lacked understanding of the industry. In 1996, we adjusted our strategy. Until then, we only had supermarkets, but after studying market trends, we expanded into other models. We opened convenience stores in 1997, and hypermarkets in 2001. These models enable us to meet different customer needs. We also expanded our business to cities near Shanghai and the rest of eastern China. Now, we’re mainly focused on the eastern area, but with stores in the other major cities of China.

How did you manage your growth from ten stores in 1996 to more than 3,700 today?

Financial engineering has driven our growth over 15 years. In 1996, we were restructured from a wholly state-owned into a limited-liability company by bringing in two investors. We became market-oriented, and we pursued an acquisition strategy. Because the retail sector in Shanghai was very fragmented, our acquisitions entailed setting up a lot of joint-venture companies, in which we kept controlling stakes so we could develop our business in a centralized way. From 1999, foreign retailers began to enter China, so we acquired even more medium- and small-sized companies. One good example was in 2002 when we bought the largest supermarket in Zhejiang, which allowed us to take the leading position in that province. So through M&A, we gained new markets, network and sales scale, and new talents.

Among supermarkets, hypermarkets, and convenience stores, which do you think would be your most dominant operation in the future?

There’s no specific answer to that, because different formats will be used under different market conditions. Hypermarkets don’t have a big need for supporting systems, whereas if you want to develop convenience stores and supermarkets, you need to first set up a distribution system, among other prerequisites. Going forward, we view hypermarkets as our first step if we want to develop in places we have not entered before. In eastern China, we will develop these three formats at the same time.

And among the three, which offers the fastest and highest return on investment?

Since our supermarket business started earlier and has reached a comparatively mature stage, it has become the major profit contributor to the company (77%). The payoff from hypermarkets is still comparatively low because it is still at an early stage of growth, but this format has a promising future and once it has reached a mature stage, we’re confident it will become our new profit driver. Convenience stores can be an additional contributor – we believe they will have much influence on expanding the network and promoting the image of the company. We will continue to develop them over the long term.

As you grow, how do you profitably manage your inventory?

We do this in a number of ways. Because our focus is still eastern China and a few major cities, we still centralize our inventory management, putting a lot of emphasis on our information network. Every point-of-sale machine is connected to headquarters; we receive their sales information in real time so we’re aware of their performance. In practice, overall management is divided into regions and areas, for better control. We also have an individual-merchandise management system; we know very well about individual-product inventory changes through the barcode. We use these data to weed out products that don’t sell well, and to adjust our product mix according to consumers’ purchase attitudes. The headquarters, together with the internal audit department, checks the inventory in each store on an irregular basis to ensure it follows the correct inventory.

Can you give me some examples of foreign practices that you have adopted in China?

Lianhua as a company is keen on learning from outsiders. When Lianhua changed its ownership structure in 1996, one of our shareholders was Mitsubishi of Japan, and we visited the stores of Japanese retail chains to learn from their management practices; we even sought tutorship from them on how to develop a distribution system. From 1996, we also built up a partnership with Carrefour from France, and we are learning from them about management theories and methods for hypermarkets. Thirdly, we engage international consulting companies on advanced retail-management strategies. We feel we still need to strengthen our consumer-demand analysis.

Having a lot of joint ventures but still running a centralized operation, what is the finance structure of the company?

From an organizational perspective, headquarters appoints all accounting managers and directors of the JV companies. They are evaluated and trained to ensure that control is implemented thoroughly, because we have integrated all the stores and networks into one financial-management system, and unified the accounting standards and operating criteria. Internally, our company operates like a corporate bank. We have a cash-reserve quota for each business depending on its needs, and excess cash balances go to the headquarters’ account. We also have internal costs, so every loan to a business has its interest, and every deposit has its yield.

Some analysts were unsatisfied with your first-half performance, thinking you are expanding at the expense of profits.

Our interim result still showed an upward trend in net profit. (Operating profit declined 4%.) Having said that, the hypermarket business did come under pressure as a result of our acquisition costs. We added 40 stores last year, and they will be very valuable to us in the future as most of our foreign competitors have also entered this segment. In the second half of last year, we spent a lot on promotions, which brought down our gross margin, but we saw the benefits in the first half, when our profitability improved, also due to adjustments in our merchandise mix and pricing policy. We acknowledge that the speed of development should be controlled, but we think that under the current circumstances of fierce competition, we cannot just let opportunities go. We just need to be selective in our expansion.

What does that mean in terms of your future acquisitions?

We will still push ahead with M&A growth, however the target company should be in the top three in its local market or city. It must have its own reputation, on top of having a good network in good locations. Secondly, its business model should be compatible with ours. Thirdly, it should have a good team, and lastly the price should be reasonable. In some future purchases, we may decide not to buy a target as a whole, but select only its good assets.

Is winning the retail game in China really just a matter of network and scale?

This is a competition among giants. Foreign retailers are accelerating their growth in China through M&A, so there is a scramble for good stores in good locations. Competition for consumers is also fierce. As a local retailer, we know the habits of our customers and have very good relations at the government level. These are our strengths. We also believe that our brand reputation has been well established, and that our centralized management helps us to maintain our lead. Having said that, we want to see profitability in each of our stores, so we need to better manage their merchandise mix. We need to improve our supply chain so that goods arrive on time. We also need to train our staff at all levels.

Since you are competing with foreign retailers, how is your relationship with Carrefour?

Our relationship with Carrefour is pleasant and healthy, and we will sustain this good relationship according to the contract. We are now on the tenth year of our 25-year JV contract, which covers the hypermarket business in Shanghai. Our other partnership with Carrefour, the discount retailer DIA, is under negotiations to find the best way for DIA to develop in China. DIA is very successful in Europe, but as it has just entered China, it may still need to get used to the market, and perhaps it needs a very long time to develop. Hence, we are reconsidering this relationship. We clearly want to settle the issue in a good way.

Are you worried by the aggressive expansion of foreign retailers, in particular Wal-Mart?

Competition is unavoidable. What we can do is to build on our own strengths. We know how to face competition, having acquired advanced management skills. The biggest competitor of Lianhua is itself. If we can correctly identify the opportunities and risks in this market, we can outline the right strategies and use the local advantages to enhance operational capability.

So what in your view are the biggest risks the company is facing, and how can the finance function mitigate these risks?

Our first risk is the effectiveness of our investments. We need to do more market research and strengthen our investment-feasibility analysis. The second is customer loss due to fierce competition. We can respond to this by improving our analysis of our customer-management systems, improving our customer-loyalty programs and after-sale services. Talent retention is a also risk. We need to perfect our incentive scheme and enhance our staff training.

How are you funding the growth of Lianhua?

We arrange financing from the capital market and banks, but our priority is to maintain a strong internal cash flow through efficient operations. We take advantage of our centralized management to control the funds of our subsidiaries.

Other than M&A, where does your cash go?

As the property market is booming, we will purchase some properties in certain areas.

Where do you see China’s retail industry, and Lianhua, five years from now?

In three to five years, the powerful local and foreign retailers will still adopt M&A as a development strategy. Franchising will be extended to second- and third-tier cities, and the model of supermarket plus department store will be adopted. In five years, Lianhua will continue to expand and maintain our leading position in eastern China, and extend our business to second- and third-tier cities as well.