China

Retail Sherpa Li & Fung Grapples With Client Loss

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Last year, 41-year-old Spencer Fung became chief executive of one of the world’s biggest factory middlemen, tasked with reversing the sliding fortunes of the company co-founded by his great grandfather more than a century before.

For decades, that company, Li & Fung Ltd., has been the go-to helper for Western brands that don’t have the expertise to navigate the supply chain in China, Vietnam, Bangladesh and other low-cost countries. Connecting Tommy Hilfiger, Abercrombie & Fitch, Aéropostale and other brands with manufacturers in emerging markets, Li & Fung greatly expanded between 2006 and 2011, as revenue more than doubled to $20 billion and its head count tripled to almost 30,000 employees.

But Li & Fung profit has fallen 21% since 2011. Shares have plunged 70% from their 2011 peak, and the company has lost business from important clients including Wal-Mart Stores Inc. and Kate Spade & Co.

As Mr. Fung took the reins, the company spun off some money-losing businesses, including ones that owned clothing brands or managed licenses for brands like Disney and Nintendo, and cut back on acquisitions. Li & Fung has also expanded client services like factory inspection, logistics and distribution, and outlined plans to enter low-cost markets such as Myanmar.

Yet 10 months after Mr. Fung took over, Li & Fung’s decline has accelerated, with profits falling 12% to $539 million and revenue largely flat at $19.3 billion last year. On a March conference call with analysts, the company said its profit target for 2016 was now unrealistic.

Mr. Fung, however, is confident that Li & Fung’s prospects are bright. “We’ve invested for the short, medium and long term to generate growth,” he told analysts in March.

The struggles of Li & Fung reflect what industry insiders say is a sea change in how international brands manage their global supply chains, as factors from technological advances to e-commerce threaten the role of middlemen. Specifically, the rise of online sites that connect Asian manufacturers with buyers overseas has made it easier for Li & Fung’s clients to contract with suppliers directly.

Founded in 1906 as a porcelain and jade trader, the Hong Kong-based company began to take its current shape in the 1970s when Spencer Fung’s father and uncle, Harvard graduates, introduced Western management practices and expanded into design, marketing and transportation, catering to the West’s demand for cheap goods.

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But now, some brands are increasingly dealing with suppliers themselves, since they are under pressure to cut costs and take more control over their supply chains.

Wal-Mart Stores is taking back much of the business it outsourced to Li & Fung as the retailer moves to buy more of its products directly from factories, according to people familiar with the matter. Some of this pullback is happening in the next few months, and Wal-Mart says it will work with Li & Fung to ensure a “smooth transition.” Wal-Mart continues to work with Li & Fung in other capacities, including connecting with factories and acquiring finished goods, according to one person.

Another major Li & Fung client, Kate Spade, said in May that it was taking in-house the sourcing of its accessories starting in spring 2016. Kate Spade will continue to rely on Li & Fung to supply its clothing and to inspect its products.

Li & Fung says while it doesn’t typically comment on its customers, its relationship with Wal-Mart is strong. The company says it doesn’t see a growing trend toward retailers working directly with factories and cutting out the middleman.

“We see it both ways, that retailers are doing more direct sourcing and retailers are outsourcing to us,” said Mr. Fung, the CEO, at a shareholders’ meeting Thursday.

The extent to which companies need a middleman is a constant subject of debate. For instance, some brands are paying more attention to the welfare and safety of workers at suppliers, following high-profile tragedies in recent years such as suicides at iPhone assembler Foxconn, and Bangladesh factory disasters that have killed more than 1,000 people. Relying less on a middleman, some argue, improves transparency for a brand as it deals with factories directly. Others might prefer to pay Li & Fung to vet the facilities.

The head of Asia sourcing for an Australian sports brand, who asked that he and his company remain unnamed, says he sources some products through Li & Fung, but has always contracted the majority directly from suppliers since that permits better relationship-handling and quality control.

Chinese factories supplied as much as 70% of the Australian company’s products in 2011, but only 42% now, as it buys from cheaper countries such as Indonesia, Vietnam, Bangladesh and India, he said. E-commerce is also increasing costs, he said, because it results in lots of smaller orders that don’t take advantage of economies of scale.

The global supply-chain landscape is “getting more and more complex every day,” Mr. Fung said on the March call, though he argued that would ultimately drive more customers his way.

Li & Fung has responded by contracting with more factories in cheaper locales. About half of the products it sources for clients now come from China, down significantly from previous years, said Marc Compagnon, president of Li & Fung’s main global sourcing business, at a March sourcing conference in Hong Kong. In its 2013 annual report, Li & Fung said it was in a “pole position” to help customers and suppliers cope with shifts in labor-intensive manufacturing.

The company in 2009 tried to trim costs in its U.S.-based product-design and marketing business by training employees to do the work more cheaply in China. There were struggles between the two operations, and by 2012, as business declined, many of the 100-plus employees in that program had been laid off, said Sylvia Lam, one of the laid-off workers.

Li & Fung declined to comment on the program.

Efforts to set up shop in Myanmar, meanwhile, have dragged on longer than expected. Last August the company said it was about to set up an office there. Then, in March, Mr. Compagnon said Li & Fung was looking to source from Myanmar and Africa, but was moving carefully since “we want to make sure our supply chain is sustainable from day one.” This month, it said it is still in the process of opening an office in Myanmar. To scale up in Myanmar, Li & Fung needs more than just low-wage workers and factories; it needs the logistical support to bring in the raw materials and transport the finished goods directly to the West, according to industry experts.

Write to Wayne Ma at wayne.ma@wsj.com and Kathy Chu at kathy.chu@wsj.com

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