Cover story - Doraemon & Batman in Fairyland

Cover StoryEddie Lam is chief executive officermanaging a portfolio ofcompanies, the centrepiece ofwhich, Salland Enteprises, produces20 million pairs of shoes a year in Chinamostly for sale to the US. Lately he has beenassembling on the idea, since applied to hisown business, that shoemakers should alsomarket and sell shoes and, so too, he says,should makers of wallets, clothes, toys, andso on. Should he pursues to the end thisproposition, he will fundamentally alter thedominant business model of many HongKong manufacturers, which in his case hasbeen for 20 years since its inception dedicatedsolely to making shoes for shelves instores like K-Mart, Carrefour and Kids “R” Us.The business of the original equipmentmanufacturer (OEM) is, of course, still sound,steady, and profitable. But that is precisely thenature of the problem. And Mr Lam gestureswith the flat-down side of his palm, drawingan imaginary line of a sales chart that runs inone direction, horizontally. OEM sales havebeen flat in recent years. That being so, MrLam says, he must now distribute and retailshoes in China. “There, I have no languageproblem, no export duties, no import duties,no quotas. I have only a market.”Multi-store InterestAlthough other companies — Mirabell inshoes, VTech in children’s learning aids —have travelled down a similar path, the retailproposition that would let him eventuallycontrol the two ends of the product chainstill constitutes a leap of faith. To begin with,he needs to reconstruct and redirect the attentionof his group of companies away fromthe factory as the centre of business lifetowards, instead, a multi-store interest dispersedover the geography of China.After he completes the construction of thislogistical and distribution network — that is,he manages to bring the products to market— it will only create another problem. Howwill they sell?A number of options are open to him. Forexample, Mr Lam has registered a new trademarkcalled Kids Smart, which he has brandedinto his line of children’s shoes for the Chinamarket. But new brands lack immediate recognitionand there is no knowing when, ifever, they will help to propel the salesforward. This uncertainty is bad in the worldof fixed schedules, that is, factory production.It leaves in its wake a problem OEMs findmost dreadful: high unit cost coupled with,as is often the case, high inventory levels. Anobvious solution towards the uncertainty isto brand your products to a famous name orlogo so that it will bring a predictable levelof sales.In its past and present versions, Onlen Fairyland’sweb site (www.onlenint.com) has beenhost to a number of famous characters. There,on the electronic version of rolling greenplains, and beneath Onlen’s sun and star caricaturesand among the cast of multinationalcharacters are Mickey Mouse and Winnie thePooh from the US, Korea’s UniMinipet, Japan’sDoraemon and Hello Kitty. At one endof the page, Batman, under a tree, stands triumphantlywith arms folded. At the oppositeend, Ultraman has arms across the chest inits (or, “his”?) classic, hand raised, ready-tofirepose.Salland is Mr Lam’s factory arm producingan assortment of shoes including brandedlines for American retailers. Onlen is Mr Lam’sprimary vehicle in the China retail business.The first cartoon character to figure in hisretail business came in 1997 when Mr Lamreceived from Disney the trademark rights tomanufacture and to brand Mickey Mouse into“OEM saleshave been flat inrecent years.”Hello Kitty in Onlen Fairyland.2005/2 Hongkong Industrialist – 2005/2 Hongkong Industrialist – 13

Cover Storyvarious lines of footwearfor the Mainland. Most ofthe existing cartooncharacters were signedup during the past fouryears.Getting hold of thebrand is only the beginningof the problem:selling shoes. Sometrademark licenseescan’t sell enough inquantity to justify thecost of acquiring thebrands. Mr Lam recallsa trip to Beijing. “I sawa shop,” he says, “it wasfull of (branded) toys.Three months later itwas gone.”Then there are peculiarities in China’s retailmarket, which are different from that, say,in Hong Kong. Take cost structures. Staff costmay be low, according to one estimate, probablyno more 20 per cent of overheads. Butrents are high, taking up more than half theshare. Mr Lam’s initial task upon acquiring atrademark was to get going with hundredsof point of sales (POS) — typically a tiny,visible lot in a shopping arcade. The totalnumber today exceeds 2,000.Business ModelAlthough seemingly effective, this retailapproach incurs cost at multiple levels thatcompanies new to retail find an inhibitiveburden. In particular, for example, there isan assortment of upfront fees to set up a shop,no matter how small. Mr Lam’s answer to thepredicament was remarkably simple since hehad known for some time there had beenother factories which wanted retail space butwere discouraged by the cost. Mr Lam convincedtheir CEOs to join him so that theycould take up any space they wanted as asingle entity hosting an assortment ofproducts. Very quickly POS were springingup everywhere.There is a larger and a greater inference tobe drawn from this arrangement that is thegenus of Mr Lam’s new business model to-Eddie Lam: “In China I have no language problem, no export duties, no import problem.duties, no quotas. I have only a market.” ”wards retailing in China. If you went in as agroup to secure a shop lot selling variedproducts, could you not approach a trademarklicensor also as a group? The answer isa qualified yes.The reason why this should be so is largelyintuitive: licensee applicants as a group willbe better off than individually to influencethe negotiations and therefore its outcomeand the terms of a license contract. Does thismean that such negotiations will inevitablyclose on more favourable terms to the OEMs?And, will collective bargaining lead to lowerlicensing prices, in terms of either the annualor the unit product fee or both?The answers to both questions are neitherentirely obvious nor straightforward. For feesto be considered cheaper or the terms morefavourable is to assume the existence of asingle, fixed term, fixed quantity benchmark.But contracts are closed in different years,they are negotiated under differentcircumstances, and the quantitative and qualitativeclauses related to issues like salesvolume, product lines and, in particular, productspecifications are as varied as the numberof applicants seeking to brand not only onekind of product line but multiple product lineson top of the multitudes of specifications.Hello Kitty alone is branded on 20,000 productitems — from dolls and foot mats toGetting hold“of the brand isonly thebeginning of the2005/2 Hongkong Industrialist – 2005/2 Hongkong Industrialist – 15

Cover StoryIn China“alone, severalwatch supplierscarry the sametrademark.”sweets and window stickers, a range that bogglesthe mind because an item is the equivalentof one set of specifications and specificationstend to negate the purpose of classificationand definitions. In footwear alone,Salland Enteprises makesmen shoes, womenshoes, children shoes,flip-flops, sneakers,sporting shoes, leisureshoes. Take a productline, break up its classificationand you get, forinstance, jogging shoes,climbing shoes, walkingshoes, kungfu shoes. Becausekungfu shoes areconstituted differently inshape, feel, and materialingredients, it is possibleto re-class them entirely,such as shoes for Chinaand shoes for America.This product extravagancemay be product segmentationgone amok, but it isheaven sent to licensors. From a commercialstandpoint, it gives a licensor enormousflexibility to price its trademark, andbrand a single product line among multipleand competing applicants. In China alone,several watch suppliers carry the sametrademark, as do makers of wallets, hats, andso on. All this makes very tempting the ideaof comparing who has gotten the best deal,but the eventual answers to the same questionsconcerning licensing fees will disagreeamong different licensors. This is becauseeach of them, coming from dissimilar productionand cost backgrounds, will answerin divergent ways to the fundamental issue:Can they, or how muchcan they, return a profiton the licence?Not long ago OEMs inChina producing consumeritems would havebeen the last group ofpeople inside a productlifecycle to take up atrademark licence, letalone go into retailing.The common refrain is,what do they know aboutmarketing? Exclusiveagents, typicallyOnlen’s own brand, above. wholesalers ordistributors,therefore fittedthe distributionand marketingrole better thanOEMs. Seen inthat way, the decision by an OEM to accept aretailer’s role is profound in two ways. One,it carries not one or two but numeroustrademarks. Two, a single trademark is beingbranded not on a handful but on an array ofproduct lines. This is to say that a single brandis being carried simultaneously by manyOEMs, on varied products.The latter concept is known to marketersProducts covered, CN Codes 6401-64; Source: Eurostat2005/2 Hongkong Industrialist – 162005/2 Hongkong Industrialist –

Cover Storyas cross-product licensing, the issuance of asingle trademark or brand to multiple linesof products. The American Jeep, the equivalentof UK’s Land-Rover, is an internationaltrademark licensed to 60 companiesworldwide. The logo and name are brandedon products that have nothing to do with themotorised vehicle: bicycles, watches,footwear, strollers, radios, luggage andeyewear.In 2003, manufacturers paid US$5.8 billionin royalty fees to the US alone. Of the sum,60 per cent or US$3.5 billion are paid undertwo categories: characters from entertainment,television and movies, and trademarks orbrands.In 2004, VTech rolled out a new series ofits “V Smile” products, which is one of manylines of children’s electronic learning products(ELPs) that altogether account for almost21 per cent of the group’s most recent, totalrevenues. For years VTech had been underpressure to find ways to rejuvenate its revenuesand its bottom line profits from ELPsales (the reason, it seems, is that childrenwere switching to computers) or from its otherproduct category, cordless telephones. Anattempt made years earlier to introduce mobilephones was aborted. Then in 2003 orsome months before that VTech began buyinglicensing rights from companies likeWarner Brothers and Marvel Comics. Thepurchases were crowned in December 2003when it announced a deal with Disney ConsumerProducts for the rights to carry on itsELPs the characters such as Mickey Mouse,the Lion King, Winne the Pooh and an assortedother characters.Brand Synergy“This powerful brand synergy,” VTech saidwhen disclosing the licensing, “will providea major impetus to growth in revenues andprofitability for our ELP business and regainour market share in the US market.” And, theresults were almost immediate. In the firstsix months to September 2004, ELP sales rosealmost 67 per cent from the same period ayear earlier. This growth compares to lessthan 2 per cent in telecommunication productsand about 20 per cent in contractmanufacturing, the third most important componentof its businesses.Hutchison Harbour Ring, the toymaker ofthe Hutchison Whampoa group, has alsobegun buying trademarks. With a joint venturepartner called Global Brands Group, itestablished the company PMW agency andin early 2004 the latter acquired, a host ofnames (including Looney Tunes, Harry Potter,Matrix) from Warner. PMW has been givenexclusive agency on a portfolio of productsin China, Hong Kong and Macau.Another company that underscores this new“In 2003,manufacturerspaid US$5.8billion in royaltyfees to the USalone.”Source: Eurostat2005/2 Hongkong Industrialist – 2005/2 Hongkong Industrialist – 17

Cover StoryLeft: Customers in an Onlen store.Below: The contrasting pastel pink andheavy dark blue of Hello Kitty shoes: InChina, consumers prefer the dark colours.wave of brand acquisitionsis Li & Fung,a trader whichnow appears to beon the way to repositioningits OEM connections. In August 2003,the group acquired trademark rights to“design, manufacture and distribute” LeviStrauss Signature tops. Five months later, itwas the Royal Velvet brand for home textilesand décor. Another two months later in March2004, it announced it was finalising similarkinds of deals with Disney among others.Higher marginThe year 2003, William Fung, the groupmanaging director said at the time of Disneydeal, “was a year of important progress for Li& Fung. Leveraging on our strong position inthe supply chain we are building a highermarginbusiness model of licensing wellknownbrand names. This new businessmodel will augment our core sourcing businessand will be an important growth driverfor the group in our next Three-Year Plan2005-2007.”Li & Fung’s reasoning in its drive towardsthe new business model also reflects the basicconsideration among OEMs in their trademarkpursuits: high profit margins. Mr Lamsays that the figure in branded shoe sales isaround 30 per cent, compared to the industryaverage of 8 per cent in OEM shoeproduction.There is an essential difference in the strategiesadopted at, say, VTech or Li & Fung tothat adopted by Mr Lam. What his attemptsays is to take the paradigm in trademark licensinga step farther: one famous brand, mul-tiple product lines, a single point of sale. Thissounds amazingly like a fusion of specialty(children’s only products) and concept (onebrand) retailing, with the added differencethat it is run and stocked by OEMs.Mr Lam’s model unites groups of OEMs andtheir products under a single, overarchingretail and brand umbrella. This is an obviousattempt to lower the entry price and thereforelessen the commercial and costs risksfor factories entering a new, by-and-largeuntested market that is China. In anothermanner of speaking, the cross-product licensingstrategy coupled with brand store retailingattempts to spread the costs and hencethe associated risks among a number of OEMparticipants.OEM ReputationBut why only OEMs? The reasons areseveral. Most OEMs that Mr Lam is acquaintedwith already have a track record in producingbranded goods and producing them forhigh profile Western retailers. This reputationalone is a critical consideration. For one, itinspires confidence among licensors that theOEMs are able and willing to fulfill the termsof the licensing conditions. For another, it isthat they can deliver and deliver on time thestocks to product specifications.All this suggests that OEMs may have someintrinsic advantages over, say, general licenseeagents. Take licensees in Southeast Asia,for example. To overcome the higher ex-fac-A fusion of“concept andspecialityretailing.”2005/2 Hongkong Industrialist – 2005/2 Hongkong Industrialist – 19

Cover Story“The newbusiness wouldbe the spearheadof a restructuredgroup.”Production inside a Salland factory, Fujian.tory costs in their markets, they have turnedto production in China. Mr Lam is seeing thisopportunity emerging: licensees have askedfor quotations to produce shoes that carrythe same brand. Such a prospect is revealingin that the brand is preceding the conventionalreputation of OEMs as mere producers.So far contract manufacturing secured betweenone licensee and another is not significantin terms of revenue contributions, butthe opportunity is there. Where the OEMsare deficient, it is at the other, retail end ofthe product chain.This is where Mr Lam intends to thrust therole of Onlen Fairyland. He wants to openup and deepen the role, and he wants tocreate under its sun and star caricatures astore brand to reflect the position of a reputableretail house selling genuine, qualitychildren’s products. And, if all goes asplanned, the new business would be thespearhead of a restructured group, which MrLam hopes he is able to float in 2007 in theHong Kong stock exchange. He is calling theholding company Onlen International Corp.Within the past year, Onlen has establishedstores in Shenzhen, Guangzhou and Beijing— Shanghai is next — all dedicated to MrLam’s business model. Ten OEMs areparticipating, so the stores sell, aside fromshoes, hats, clothes, socks and bags. Thesestores are obviously blown up extensions ofthe POS, but there are key differences.Other than carrying multiple and usuallyunrelated product lines, the stores are biggerthan the POS. They were designed and meantto deliver an imagery thatis vivid and allconsuming,such as thepastel pink and the redthat are present in the Hello Kitty character.However, colours cause problems associatedwith cultural preferences. Among MainlandChinese, navy blue and black are preferredover pastel since, they argue, dark coloursmake dirt less evident. As a result, and withthe agreement of the licensor Sanrio, dashesof black line some Hello Kitty shoes. Theseissues are minor, and the stores are proceedingto accomplish their intended purpose: deliveringawe, colours everywhere, and shelvesupon shelves stuffed full of diverse productspackaged under a unified brand theme.Marketing TechniquesIt is still early days to conclude how thebusiness model will look like in the long run.So far the goods are moving, according to MrLam, and the profit margins are within thedesired range. Onlen’s POS and its brandtheme stores are already contributing a 30per cent share to total revenues, currently atabout US$30 million a year. Mr Lam still needsto perfect his marketing techniques, whichhe says too many Hong Kong companies,especially manufacturers, have ignored. Perhapsthere was never a pressing need before,he says, but there is now.Given the state of the China market, saysMr Lam, it isn’t too late yet to experimentand drive his business model forward. Henotes, by way of illustrating, that China’s twolargest foreign retailers, Wal-Mart andCarrefour, are still far away from the idealisedversions found in their more maturedoperations in Europe and America. The rangeamong some of their products is incomplete.Some stocks look suspiciously like “jump offthe building goods” — the Hong Kong industryeuphemism for products picked up atbelow costs from a manufacturer’sexcess inventory or goodscast off after an aborted contract.All this is also to say that, becauseof the early state of China’sconsumerism, the marketdoes offer some allowances forerrors in retailing strategy.“Where in the world,” says MrLam, “can you find such amarket?”2005/2 Hongkong Industrialist – 202005/2 Hongkong Industrialist –