Saturday, April 14, 2007

Waiting for the Chinese Banquet

Brothers William and Victor Fung run Li & Fung, the venerable Chinese family trading house based in Hong Kong. The company, which employs 12,000 people and has offices in 44 countries, is on the cutting edge of global supply-chain management. Li & Fung has been the No. 1 performer in the Hong Kong Hang Seng index over the past 10 years, rising 25-fold. The Fungs recently spoke with BusinessWeek Editor-in-Chief Stephen B. Shepard, Asia Regional Manager Mark Clifford, and Asia Correspondent Frederik Balfour. Following are edited excerpts from their conversation.

Q: What is Li & Fung doing to take advantage of pending membership in the World Trade Organization for China?
Victor Fung:
We see huge opportunities in distribution. In China there's an east-west dilemma, with the population in the east and food in the west. We will [use] the expertise we have acquired over the past 20 years in supply-chain management worldwide and apply it to China.

William Fung: The first thing we can do is turn around all the factories we have organized for export and use them domestically. Right now we can't do that. [The factories] are licensed for exports only.

Q: How will Hong Kong benefit from China's admission to WTO?
There will be tremendous movement of goods in and out because of the opening of Chinese market. That will require an industry like supply-chain logistics to absorb a lot of labor, and that is our big story. About 85% of [Hong Kong's] economy is from services, compared with 33% in China. So Hong Kong will for a long time be able to remain the service center for China.

William: There is a whole aspect of logistics that is virtual and can go anywhere. The goods don't have to come to Hong Kong. At Li & Fung, we orchestrate the logistics. It's a knowledge-based industry, a service industry of virtual logistics. The ideal is [that] when a bottle of shampoo gets sold off the shelf at the supermarket in Hong Kong, then we start mixing the active ingredients [for a replacement bottle] in the Thai factory.

Q: How is global supply-chain management affecting trade flows?
One problem we have with trade flows is that all economies must attach country-of-origin [identifications] and can't accept that products are multi-origin. But parts are coming from all over the place. It says "Intel inside," but the monitor is probably Taiwanese, the memory is made in Penang or Singapore, and the PC is assembled in Taiwan or China. So what is it?

Q: What's your position on international labor issues?
The more sensible labor advocates in developing countries want the U.S. to take the lead, and we work for a lot of customers like that, [such as] Nike [and] Reebok. But paying $2 an hour when the rest of economy is getting $1 [may cause] graft in the recruitment [process], where people have to pay for a job in a Nike factory. So you can't have these big [pay] discrepancies. In 1995, we created the position of a chief compliance officer. Ethical sourcing is very important.

Q: What is the impact of China's entry to the WTO?
It will [have] a very big impact [on] the region and China itself, but not quite in the way the whole world has focused, which up until now is that China is going to be opening up. Yes, that's the big story, but [not the immediate story]. There isn't going to be a big surge from Day One. It will be over a three- to five-year period.

[Instead], what will happen is the flip side of the coin. China will enjoy the protection of the WTO trade rules. At the moment, Chinese products are subject to a lot of discriminatory trade practices. [Once] they are protected by [the] WTO, Chinese exports will become a lot more stable and competitive over time. The impact for China will be substantial.

Q: How about China's labor?
One of the key things that China has done in the past 20 years is to free up people so they can move around. That is a huge [development] in human rights terms. China was creating [an] opportunity to bring wealth into the interior as well as [mobilizing] labor by bringing [people] to the coast.

Q: How does this relate to Southeast Asia? Why does China seem to do everything so much cheaper?
The only country with any chance of having a long-term benefit [from] labor-intensive manufacturing is Indonesia. That's where the population is. Or countries with local advantage -- like Malaysia in latex or Philippines in wood.

Victor: Southeast Asian economies will be under pressure, but they have to respond in three ways. One, they have to join the parade to see what they can do in terms of balancing trade with the Chinese market. They don't think that way yet, only the Westerners do. Second, they now have to become faster, because they can't be cheaper. Third, concentrate on niches. For example, Thailand could be quite competitive in auto parts.

William: I think the political situation in Southeast Asia has got to improve 100%, otherwise the center of gravity in economics of Asia is moving north. It's almost inevitable because of the size of the market. For the first time, once China joins the WTO, developing countries will have a leader to focus on. Before that it was unipolar with the U.S., then bipolar with the European Union and the U.S. Now you will have a tripolar situation where China more or less represents the interests of the developing world.

Edited by Thane Peterson