• Amid the rapid development of Asia, particularly the Chinese mainland, Hong Kong's intermediary role has been somewhat affected, and Hong Kong traders are faced with intensifying competition.
• In response, they are changing their business model by extending the value chain and building flexibility through the dispersion of sourcing/manufacturing activities.
• With an average of just 36 suppliers in four countries, there is much room for Hong Kong's trading companies to expand their sourcing/manufacturing network.
• Only by optimising the supply chain, as well as rendering more and better value-added services to overseas buyers, can Hong Kong traders maintain their lead over competitors.

As the largest economic sector, trading constitutes directly over 20% of Hong Kong's GDP, compared with just around 10% in 1980. The importance of the trading sector is also reflected in the increasing openness of the Hong Kong economy. Hong Kong's merchandise trade as a percentage of GDP is over 340%, vis-à-vis 150% in 1980, as well as the world's average of around 50%, according to the latest figures complied by the World Bank.

Since the late 1970s, the majority of Hong Kong manufacturers have set up production facilities offshore, mainly on the Chinese mainland amid its open door policy. In the wake of this relocation trend, many of these manufacturers have become traders, and the role of their Hong Kong offices has shifted towards quality control, sales, finance and accounts, production management and logistics support. This skew towards higher value-added activities has helped them sharpen their competitive edges, in turn sustaining Hong Kong's role as a trading centre in the region.

Amid the rapid development of Asia, particularly the mainland, however, Hong Kong's intermediary role has been somewhat affected. In general, Asian suppliers have gained more knowledge of undertaking overseas sales than before. Some of them have even established a presence in overseas countries, making direct sourcing more feasible and convenient to buyers. Now, more sourcing opportunities are available in other places of the mainland and other Asian economies, which may further undermine Hong Kong's role as a middleman.

Facing the challenges of disintermediation and increasing competition, Hong Kong's trading companies have responded by changing their business model. In contrast to what has been perceived as simply being an intermediary, many Hong Kong traders are establishing themselves as an integral part of the global supply chain. They have a much wider scope of responsibility than simple matchmaking for buyers and suppliers.

Compared to 10 years ago, 67% of our surveyed companies (which have engaged in trading business for more than 10 years) have increased quality control activities. More importantly, 62% of the respondents have stepped up sales and marketing efforts, whereas 58% have bolstered product design and development. Hong Kong companies, in general, have moved up the value chain by extending their business focus from OEM to ODM and OBM.

While increasing their value added, Hong Kong's trading companies have also expanded their procurement activities. Survey results show that Hong Kong's trading companies, on average, source/manufacture in four countries from 36 suppliers. Although Hong Kong's trading companies still maintain most of their sourcing and/or manufacturing operations in Guangdong, they have been seeking opportunities in other parts of the mainland and elsewhere in Asia.

During the process of expanding procurement activities, trading companies tend to specialise. By doing so, they have better knowledge of their product lines and suppliers, and can offer personalised services. Yet, as long as they can manage, they would try to develop new but mostly related products. In most cases, Hong Kong's trading companies start with one industry, but may also look into the possibility of branching-out into other mostly related industries.

Asked what the likely difficulties of developing trading business would be, respondents said keen competition is the most significant, followed by problems arising from industry concentration, the diminishing intermediary role of Hong Kong's trading sector, lack of talent with relevant industrial knowledge, changes in policies/regulations and financial constraints.

For now, overseas buyers generally appreciate the performance of Hong Kong's trading companies. But in the face of intensifying competition and industry concentration, in tandem with the threat of disintermediation, Hong Kong traders should strive to further strengthen their competitive edges. They should continue extend the value chain, not least by engaging in ODM and OBM, and widening their range of products.

In view of the proliferation of new production sites on the mainland and elsewhere in the region, they are further required to set up production or strengthen their sourcing connections there, as the business environment in the PRD has become particularly challenging. With a fairly flimsy sourcing network, there is much room for Hong Kong's trading companies to broaden and diversify their sources. In all, only by optimising the supply chain, as well as rendering more and better value-added services to overseas buyers, can Hong Kong's trading companies maintain their lead over competitors, and help Hong Kong prop up its role as a trading centre.

I. Importance of Trading

Undoubtedly, the trading sector has played a very important role in the economic development of Hong Kong. As the largest sector of the Hong Kong economy, the trading sector directly generated value added of HK$305 billion in 2006, equivalent to 22% of Hong Kong's GDP, compared with just around 10% in 1980. There are now some 97,000 companies in Hong Kong engaged in trading business, employing 520,000 people, or one-fifth of total employment.

The importance of the trading sector is also reflected in the increasing openness of the Hong Kong economy. Hong Kong's merchandise trade as a percentage of GDP is now over 340%, vis-à-vis 150% in 1980, as well as the world's average of around 50%, according to the latest figures compiled by the World Bank.

However, the development of Hong Kong's trading sector does not refer only to the larger size of merchandise trade, but also a change in its role. In the 1980-90s, traders in Hong Kong served mainly as middlemen, striving to match overseas demands with supplies from the Chinese mainland. Then, following the opening up of the Chinese mainland, this intermediary role has been diminishing. Facing the challenges, Hong Kong's trading companies have responded quickly by increasing value added of their services and better supply chain management.

In this report, we shall present readers an overview of how the role of Hong Kong's trading companies has evolved in the past decade, discuss how they have responded to the challenges of disintermediation, and re-examine Hong Kong's role as a provider of quality services, supplemented with findings from surveys and interviews with Hong Kong traders.

II. Traditional Model and Rising Challenges

Role as a Middleman

In the late 1970s, both escalating labour and land costs made Hong Kong an expensive place to manufacture with fierce competition coming from other Asian tigers (South Korea, Singapore and Taiwan). Coincidentally, the Open Door Policy of China provided a relief to Hong Kong manufacturers. To reduce operation costs and stay competitive, the majority of Hong Kong manufacturers set up production facilities offshore, mainly on the Chinese mainland. In the wake of this relocation trend, many of these manufacturing companies in Hong Kong were reclassified as import-export establishments.

Meanwhile, the role of their Hong Kong offices has shifted towards quality control, sales, finance and accounts, production management and logistics support. This skew towards higher value-added activities has helped Hong Kong's trading companies sharpen their competitive edge, while expanding production capacity through relocation. While production on the Chinese mainland has been facilitated by an efficient network of supporting industries and services, the competitiveness of Hong Kong exports in terms of productivity, quality, reliability and delivery has been greatly enhanced.

Against this background, Hong Kong has been able to sustain its role as a trading centre in the region. Especially during the early stage of China's opening up, mainland suppliers did not know much about international trade. Due to language and information barriers, most overseas buyers were not familiar with the mainland either. That was why Hong Kong could play the role as a middleman. Besides, overseas buyers had to rely on Hong Kong companies to perform quality control for the goods produced on the mainland, and finished products also had to be re-exported through Hong Kong because of the backward ports and related infrastructural facilities on the mainland.

Threat of Disintermediation

Amid the rapid development of Asia, especially the Chinese mainland following its WTO accession in 2001, Hong Kong's intermediary role has been somewhat affected. In particular, foreign trade and business regulations of many Asian economies have been liberalised, and the business environment has generally improved. Not surprisingly, for instance, some large retailers or manufacturers, such as Wal-mart or Dell, have already set up offices and production lines on the mainland, directly engaging in production or sourcing activities. Although other smaller importers may still source China-made goods from Hong Kong, Hong Kong's role as solely an intermediary is greatly affected.

With rising export opportunities, Asian suppliers have also gained more knowledge of undertaking overseas sales than before. In addition to being more competent in international trade, some suppliers have even established a presence in overseas countries, making direct sourcing more feasible and convenient to buyers. To make matters worse, production or sourcing activities in Asia were previously more centralised in the southern part of China. Now, more sourcing opportunities are available in other places of the mainland and other Asian economies, which may further undermine Hong Kong's role as a middleman.

III. Evolution of Trading Activities

Current Model - Supply Chain Management

Facing the challenges of disintermediation and increasing competition, Hong Kong's trading companies, not least the larger ones, have responded by changing their business model. In contrast to what has been perceived as simply being an intermediary, many Hong Kong traders are establishing themselves as an integral part of the global supply chain. They have a much wider scope of responsibility than simple matchmaking for buyers and suppliers. In addition to providing support services such as marketing, orders processing, materials sourcing, product design and development, and quality control here in Hong Kong, they oversee the whole process of value creation, from sourcing or manufacturing to the point products get into the hands of the buyers.

It is apparent that big companies like Li & Fung are able not just to better build their supply chains, but build competencies in network orchestration, which involves the development and management of both a network of a large number of suppliers, as well as specific supply chains inside the network.

However, the business model adopted by large corporations may not be applicable for smaller companies, given their limited financial resources and management expertise. To find out how the business activities of Hong Kong's trading companies, in general, have evolved over time, the HKTDC conducted a survey study by sending questionnaires to local traders in HKTDC's database.

A total of 2,230 valid replies were received, with 38% from traders and 62% from manufacturers-cum-traders. About two-thirds of respondents have engaged in trading business for 10 years or more. In terms of company size, 40% of the respondents handled goods worth less than HK$10 million, 50% between HK$10 million and HK$100 million, and the remaining 10% over HK$100 million. Corresponding to the structure of the trading companies in Hong Kong, the majority of respondents are small and medium-sized enterprises.

Changes in Business Activities

In order to build better supply chains, Hong Kong's trading companies have changed and expanded their business activities, or, specifically, are strengthening their services of higher value added, so as to differentiate themselves from other suppliers competing solely on cost.

Compared to 10 years ago, 67% of our surveyed companies (which have engaged in trading business for more than 10 years) have increased their quality control activities amid intensifying competition and rising product safety concerns. More importantly, 62% of the respondents have stepped up sales and marketing efforts over the past 10 years, whereas 58% have bolstered product design and development.

Respondents have also increased their procurement and production activities. There were 51% of our surveyed companies which have increased product procurement activities, while another 49% have increased raw materials procurement activities. In the meantime, only 41% of surveyed companies have increased their own production activities.

It is worth noting that half of the surveyed companies have increasingly assumed corporate social responsibilities (CSR). CSR refers to, besides making a profit, what corporations should do to take care of others in society, including their customers, suppliers, employees, shareholders, communities and other stakeholders, as well as the environment. CSR is a growing trend, particularly in Hong Kong's major markets such as the US and the EU. Still, there were a quarter of respondents who have reduced their CSR activities, or never been involved in any CSR.

Extending the Value Chain

In line with increasing activities in sales and marketing and product design and development, Hong Kong's trading companies are extending their business focus from original equipment manufacturing (OEM) to original design manufacturing (ODM) and brand development (OBM), which involve supporting activities beyond what are required for subcontract manufacturing.

In most cases, trading companies were engaged only in OEM business in the 1980s and later diversified into ODM and even OBM. With expertise in the manufacturing process, Hong Kong companies may find it easier to master prototype creation, detailed product design and development of product concepts, the core activities of ODM, than product development, brand building, marketing and distribution, the core activities of OBM.

While engaging in ODM and OBM, most of them have still maintained their OEM businesses despite their ODM or OBM businesses being already well developed. There are a few reasons behind such a business decision. First, as both ODM and OBM also involve production, by expanding the scale of operation, companies which have already engaged in OEM can enjoy economies of scale. Second, although the profit margins of ODM and OBM businesses are higher, the associated risks are also higher. By engaging also in their well-developed OEM businesses, companies can diversify the risk of their business portfolio.

However, the most important reason for Hong Kong companies to maintain their OEM business is that they are still very competitive in activities in the middle part of the value chain, i.e. quality control, materials sourcing, logistics arrangement, etc, despite that their costs of production are not the lowest among competitors.

Dispersed Manufacturing/Sourcing

While increasing their value added, Hong Kong's trading companies are also expanding their procurement activities. Survey results show that Hong Kong's trading companies, on average, source/manufacture in four countries from 36 suppliers. Although Hong Kong's trading companies still maintain most of their sourcing and/or manufacturing operations in Guangdong, they have been seeking opportunities in other parts of the mainland and elsewhere in Asia, as the production environment has become increasingly difficult on the mainland, particularly the PRD, where labour shortages are widespread and wage increases are rampant.

Diversification of sourcing/production operations allows the trading firms to exploit the comparative advantages of other locations, such as low-cost labour and material inputs, bypass protectionist measures, and take advantage of trade preferences offered by developed economies to some developing economies. For example, Laos is granted duty-free and quota-free market access to certain developed countries such as the US and the EU.

Besides, given the ability to source and produce in various places, Hong Kong's trading companies are flexible and responsive to changes in the business environment in general and the specific requirements of their clients in particular. For instance, they will be able to react to urgent orders or reconfigure sourcing patterns and strategies frequently, while ensuring that the stipulated quality standards and delivery deadlines are met.

Product/Industry Specialisation

During the process of expanding procurement activities, trading companies tend to specialise. Instead of trading a wide variety of products, they are inclined to trim down the number of products they trade so as to direct more resources for developing their expertise in specific products. This is particularly the case for smaller traders. By doing so, they have better knowledge of their product lines and suppliers, and can offer personalised services. Otherwise they can hardly compete with their larger counterparts. On the other hand, as long as they can manage, Hong Kong's trading companies are keen on new product development. They usually develop products related to those they have been doing well in as they have already accumulated relevant experience, or sometimes because there is demand from their existing buyers.

In most cases, Hong Kong's trading companies start with one industry. As mentioned, they usually develop related products which are in the same industry. However, there are also cases of branching out into other mostly related industries. For one thing, there may be limited potential for further growth of a particular industry. Then, they will have to find some other way out. For instance, owing to the increasing trend of incorporating electronic components in traditional products, such as toys, trading companies in the electronic industry may also look into the possibilities of developing electronic toys. On occasions, they may even be compelled to branch out into other non-related industries, which pose the highest business risks. On the whole, survey results indicated that Hong Kong's trading companies, on average, handle 49 products from four industries.

Strengthening Quality Control

Hong Kong's trading companies are well known for their quality assurance service, an edge over their competitors, especially indigenous mainland suppliers, which usually compete on costs. In the old days, Hong Kong traders had their goods produced on the mainland shipped to Hong Kong for quality checking. Now, most of them find it easier to manage if products are checked somewhere close to the production base. When importers' requirements are higher, the quality control process becomes more sophisticated.

As a way to guarantee product quality, importers may ask suppliers to have their products certified by quality assurance bodies to ensure compliance with internationally recognised standards. Besides, exporters are making use of statistical knowledge to improve the standard and accuracy of checking. Exporters are also keeping track of their suppliers' quality, setting up and maintaining their own quality control system.

If anything, some recent issues have accentuated the importance of quality control. Since the summer of 2007, there have been high profile product recalls and safety alerts involving Chinese-made products from mature markets such as the US and the EU. In particular, defective and tainted toys and other children's products have become a major issue amid claims of lax safety standards in some of the Chinese factories supplying the US and the EU. As a result, Hong Kong's overseas markets have tightened their requirements, and Hong Kong traders are required to further enhance their quality control. Indeed, quality and safety are not only crucial to children's products, but also other products like food and related items.

CSR

While growing quality concern has increasingly affected the operations of Hong Kong traders, international labour issues continue to grow in their importance. This development is based on the recognition that the pace of globalisation has outstripped the existing mechanisms for regulating labour rights around the world. At the same time, public awareness about CSR has grown exponentially in the US, attracting mounting attention from the news media, labour groups, non-governmental organisations (NGOs) and the government. This has forced companies to critically examine the working conditions of labour at their suppliers' factories.

In the mid-1990s, the principal labour issues facing US companies, including such brands as Nike, Liz Claiborne and Gap, were the alleged sweatshop practices in suppliers' factories. In response to protests and boycotts, US companies began to demand their overseas suppliers to comply with a number of regulations and standards, such as labour laws and workplace regulations, forced and child labour, harassment and abuse, compensation and benefits, hours of work, discrimination, health and safety standards, freedom of association, environmental standards, customs compliance and counter-narcotics.

On the other hand, a variety of organisations and initiatives has been responding to the resulting proliferation of CSR-related reporting standards by attempting to set up standards which assist importers in selecting suppliers' rule of thumb. Hong Kong exporters, realising such a trend, have been putting more efforts on assisting their buyers to perform CSR responsibilities, which serves to be another type of value-added service for their buyers.

IV. Prospects

As noted, compared to 10 years ago, trading companies in Hong Kong have performed more quality control, sales and marketing, and product design and development. When asked what activities they would engage in more over the next three years, sales and marketing, quality control and product design and development still topped the lists. Around 70% of surveyed companies said they would increase their sales and marketing efforts and quality control in the coming three years. Sixty-two percent said they would enhance product design and development. In the meantime, 53% and 48% indicated they would increase product procurement and raw materials procurement respectively, while 49% would strengthen their CSR efforts. The results show that the trend of Hong Kong's trading business in the medium term will still be towards higher value added and dispersed manufacturing/sourcing activities in the supply chain.

On business development strategies, a majority of the surveyed companies (64%) revealed that they would expand their sourcing base on the Chinese mainland. Rather than a sourcing or production base, some others (47%) considered the Chinese mainland as a market, where they would establish a presence or expand their current presence. In contrast, fewer respondents appeared to be interested in overseas markets, with 27% and 26% of our surveyed companies planning to expand the sourcing base overseas and establish a presence or expand the current presence in overseas markets, respectively. This is completely justified, as Hong Kong companies are generally more familiar with the mainland, which provides lots more of business opportunities than the overseas markets.

Meanwhile, consistent with the global trend, 46% of the respondents said they would increase the use of the Internet in developing their business. In terms of developing new products, 45% said they would develop related products, while 20% would develop non-related products. There were relatively fewer companies trying to expand into other industries. Still, 23% and 13% of surveyed companies said they were going to expand into related and non-related industries, respectively.

Asked what the likely difficulties of developing trading business would be, respondents said keen competition was the most significant (rated 4.34 out of 5), followed by problems arising from industry concentration (3.88). The diminishing intermediary role of Hong Kong's trading sector (3.62), lack of talent with relevant industrial knowledge (3.57), changes in policies/regulations (3.52) and financial constraints (3.45) were the next significant difficulties.

Despite all the difficulties and challenges facing Hong Kong's trading companies, the respondents are broadly optimistic on the trade prospects. Not surprisingly, the Chinese mainland is considered the most promising market. Fifty-six percent of them believed the mainland market would expand in the next three years and 29% thought it would remain unchanged. The remaining 15% believed the mainland market would contract, or that they had no business activities, nor any interest to develop in the future.

For the US, the EU and Japan, there were 49% of respondents expecting market expansion there, while 28% anticipated stable prospects. The remaining 23% believed these markets would contract, or that they had no business activities, nor any interest to develop in the future. Lastly, other markets, mainly emerging markets, have remained new to Hong Kong's trading companies. Thus, proportionally fewer of our respondents (64%) were either upbeat or neutral on the outlook of regions other than the mainland and the major mature markets.

V. Conclusions and Recommendations

Hong Kong's Role as a Trading Centre

Having reviewed the changing business model of Hong Kong's trading companies, it is evident that Hong Kong has been able to sustain its role as a trading centre. But the challenges facing Hong Kong are very real. More and more Asian economies, particularly the Chinese mainland, are clamouring for a bigger slice of the pie. By all means, enhancement of the trading capabilities of these economies, albeit unlikely to create a serious threat to Hong Kong traders and manufacturers in the near term, will increasingly facilitate direct sourcing from mainland cities, probably eroding Hong Kong's role as a trading centre.

Hong Kong, indeed, has a dual role to play. On the one hand, Hong Kong is home to some 15,000 manufacturing companies, which usually undertake trading activities as well. Their manufacturing activities are propped up by around 55,000 factories on the mainland, the majority of which are in the PRD. These manufacturing firms invariably maintain their headquarters in Hong Kong to control and coordinate various trade-supporting services, including sales, marketing, finance and administration. The competitiveness of Hong Kong manufacturers will directly affect Hong Kong's overall attractiveness to overseas buyers. Should Hong Kong manufacturers be able to remain sufficiently competitive to deliver what overseas buyers ask for, the advantage of Hong Kong as a trading centre will be strengthened.

Hong Kong, on the other hand, assumes an intermediary role. There are now almost 97,000 import/export companies in Hong Kong. Many have been working on behalf of mainland companies, which may lack the appropriate export experience and overseas sales network to promote their products. Meanwhile, Hong Kong trading firms help overseas buyers source appropriate merchandise of the best quality and price. Some provide a full range of supply chain management for their clients, covering product development, raw material sourcing, production planning, factory sourcing, manufacturing control, quality assurance export documentation and shipping consolidation. The existence and prosperity of trading firms will definitely support Hong Kong's lead as a trading centre.

On the demand side, many overseas buyers still do not have the necessary experience and expertise in direct sourcing from the Asian region in general and the Chinese mainland in particular, and they will tend to be more reliant on Hong Kong companies for sourcing products. Such dependence, especially for small-and-medium importers, will not easily fade. But if the competitiveness of Hong Kong suppliers, whether manufacturing or trading companies, is not adequately sharpened, the risk of direct sourcing by overseas buyers will certainly increase. Should overseas buyers decide to bypass Hong Kong companies to buy directly from other regional suppliers as a consequence, Hong Kong's status as a trading centre will be eroded.

Strengthening Supply Chain Management: A Viable Solution

It is apparent that whether Hong Kong can sustain its role as trading centre will, to an extent, depend on the ability of Hong Kong traders to strengthen their competitive edges. In general, overseas buyers appreciate the competitiveness of Hong Kong traders, and are satisfied with the services they offer. Overseas buyers also consider Hong Kong's business environment as competitive, which underpins Hong Kong's status as a trading centre. But they have some concerns about the future status of Hong Kong as a trading hub, especially over the longer term.

Not surprisingly, the major concern of overseas buyers is the increased competitiveness of mainland and some other regional suppliers. To many overseas buyers, sourcing products from Hong Kong appears somewhat expensive compared with sourcing from, for example, indigenous mainland manufacturers. They pay a higher price premium with regard to the quality of services offered by Hong Kong companies, thus saving the trouble of locating the right suppliers on the mainland and the attendant business risks. Simply put, the benefits of keeping the procurement through Hong Kong outweigh the costs.

Nonetheless, overseas buyers also contend that the improvement of the services of indigenous mainland companies and other regional suppliers may over time reduce the competitive edges enjoyed by Hong Kong traders. From a macro view, there is no escaping from the need to strengthen Hong Kong's business environment as well as the competitiveness of its trading sector so as to maintain Hong Kong's status as a trading hub in the region.

For now, overseas buyers generally appreciate the performance of Hong Kong traders. But in the face of intensifying competition and industry concentration, in tandem with the threat of disintermediation, Hong Kong traders should strive to further strengthen their competitive edge. They should continue to extend the value chain, not least by engaging in ODM and OBM, and widening their range of products. Furthermore, they should increase the use of Internet, tighten quality control, perform CSR activities, and conduct more business with the mainland.

In view of the proliferation of new production sites on the mainland and elsewhere in the region, they are further required to set up production or strengthen their sourcing connections there, as the business environment in the PRD has become particularly challenging. By broadening and diversifying sources, Hong Kong traders will be better positioned to exploit the comparative advantages of different manufacturing bases, and build flexibility through the dispersion of sourcing/manufacturing activities. With an average of just 36 suppliers in four countries, there is much room for Hong Kong's trading companies to expand their sourcing/manufacturing network. In all, only by optimising the supply chain, as well as rendering more and better value-added services to overseas buyers, can Hong Kong traders maintain their lead over mainland and other regional suppliers, and help sustain Hong Kong's role as a trading centre.