New Rules of The Game
Confronted with Japanese trading giants like Mitsui, Mitsubishi and Itochu, Asia's smaller merchants are reinventing themselves as integral parts of the global supply chain
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By Neel Chowdhury/HONG KONG and SINGAPORE
Issue cover-dated January 24, 2002
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FROM THE RUGGED PLAINS of southern Bihar, one of India's poorest and most violent states, a profit margin is a distant glint in a trader's eye. Pockmarked by cavernous mines and labyrinthine tunnels, where labourers scour the soil with picks, shovels and plastic buckets, Bihar's mineral-rich earth offers up iron, alumina and coal to India and the rest of the world. But the landlocked and industrially backward state is also hundreds of miles from the nearest seaport, factory or commodity exchange and transporting its treasures to those places isn't easy.
But for a few plucky traders, who come to off-the-map places like these in search of cheap and coveted commodities, Bihar can be a gold mine. Richard Elman is one of them. Chairman and CEO of Hong Kong-based and Singapore-listed Noble Group, a 15-year-old trading company that deals in everything from cocoa to steel, 61-year-old Elman runs a pan-Asian operation that in 2000 generated a net profit of $21 million on total turnover of nearly $1.2 billion, despite working from a capital base that year that barely exceeded $100 million. More impressive, Noble's return on equity in 2000 stood at 20%, a margin centuries-old Japanese trading behemoths cannot achieve. In fiscal 2000-01, for instance, Japanese trading giant Mitsui chalked up $409 million in net profits on turnover exceeding $103 billion. But its return on equity hovered at roughly 6%, less than a third of Noble's.
How does Noble do it? Partly by reinventing the hallowed rules of the Asian trading game. The old Asian middlemen, either the solitary adventurer who greased palms and bargained without mercy in danger zones like Bihar, or the massive multinational like Mitsui, Mitsubishi or Itochu, which bought in tremendous volumes and traded on paper-thin margins, are both struggling to remain relevant. More imaginative criteria now measure the middleman's success: namely, the flexibility to wedge oneself into a product's supply chain and find ways to conjure up value, as Noble does so nimbly. "Nobody just buys and sells any more," as Elman puts it. "You've got to do something else."
The elaborate journey of Noble's Indian iron ore, worth roughly $1 million in its raw state, provides a glimpse into the industry's future. From Bihar's mines, Elman arranges for the iron ore to travel by train to a seaport near the Indian city of Bhubaneshwar. There, the iron ore is loaded onto a ship chartered by Noble, which charters roughly 400 ships a year. The ship's journey to the Chinese port of Qingdao, the first stop on the iron ore's long and complicated trip to its customer, will take 15 days and cost Noble more than $100,000.
At the Qingdao docks the iron ore leaves the hold of the ship and, simultaneously, the financial responsibility of Noble. Why? Elman has struck a deal with a state-owned steel mill in China to process the iron ore into steel. The terms are striking: For 60 days Elman has given all the iron ore to the Chinese mill-in this case, a typical money-bleeding, state-owned-enterprise-in return for $2 million worth of pig iron, billets and cold-rolled steel. Whatever excess iron ore is left over, the steel mill can keep for its own purposes.
For Noble, the advantages of the transaction are obvious: It transforms $1 million worth of iron ore into $2 million worth of steel at the stroke of a pen, without investing a penny. For the steel mill the deal is dicier: It must not only transport the iron ore from the docks of Qingdao to its mill in Shaanxi province, a journey of more than 1,000 kilometres, but the mill's managers are also betting global steel prices will remain lofty enough to justify the transaction. Admits Harindarpal "Harry" Banga, an executive director of Noble Group: "It doesn't always work out for them. Sometimes the end product is so cheap it doesn't cover their cost of production. But you just can't shut down these huge mills. Transactions keep carrying on regardless of price."
In this case, the iron ore is smoothly processed into steel that meets Noble's standards, and enough raw material is left to satisfy the Chinese steel mill's managers. Back the steel goes to Qingdao by train. So roughly two months after arriving in China, and more than two-and-a-half months after being coughed up from the mines of Bihar, the finished steel is reloaded onto another Noble-chartered ship to go to manufacturers in Japan, South Korea and Australia. Noble won't disclose how much it profited on this trade, but Banga says, "We collected a margin at five separate steps of this deal. So we can make five times the normal profit."
The middleman's new robes aren't exactly a natural fit for Elman. When Elman washed up in Tokyo in 1969, after a brief trip as a hippie in San Francisco, the middleman's job was simple: Spot a niche, charm your buyers and then scour Asia's darkest and dustiest corners to get your product. To Elman, business this way came naturally. A high-school drop-out who started as a self-described "coolie" at a scrap-metal yard in England, rising in his teens to yard manager, Elman knew his kingdom as a middleman lay in the knowledge gap between buyer and seller. "When I went out to India 30 years ago," he says, "I could tell the buyer and seller anything because their information was zero."
By the time Elman struck out on his own, founding Noble in Hong Kong in 1986 (Elman holds a 51% stake in the firm), the old Asian middleman's advantages were vanishing. To begin with, Asia's road, ports and airports were about to improve vastly, making the search for, and transport of, commodities far quicker and cheaper. No longer was it easy, therefore, for a middleman to keep his off-the-map product sources a secret.
Asian governments were also adopting globally uniform trade protocols, making a middleman's political connections less necessary. Last, but most important, the explosion of the Internet in Asia in the mid-to-late 1990s radically shrank the distance between buyer and seller, often to just a mouse click. "Everything became transparent," Elman explains. "You can't trade on lack of information anymore."
By the late 1990s the writing was on the wall for most Asian middlemen: Come up with more creative ways to add value, or get out. Hong Kong-based trading house Li & Fung is an instructive example of a middleman that successfully adapted to the new rules of the game. Traditionally a procurer of Asian textiles for Western clothing manufacturers, Li & Fung has in recent years become a one-stop shop for big Western retail stores like Abercrombie & Fitch and Esprit USA. From the design, tailoring and delivery of the clothes, Li & Fung manages the entire process on behalf of its clients.
"They just couldn't just sit around and do nothing," says Simon Lam, an analyst with Credit Suisse First Boston Securities in Hong Kong. "The current environment is too tough. So they've added more value in terms of their design and delivery services to maintain their operating margins."
Noble has followed Li & Fung's one-stop-shop strategy-but in the trickier realm of bulk commodities like steel, alumina, soya beans, grain and cocoa. Because it's not as simple to enhance the value of a shipment of Indonesian soya beans as it is to weave an Oxford shirt from a bolt of Pakistani cotton, Elman had to insert Noble into traditionally unexplored crevices of the supply chain. When a shipment of steel or grain is hoisted aboard one of Noble's ships, for example, a Noble subsidiary like Noble Finance or its risk-insurance arm, TradeVest Risk Services, offers to handle all the financing and insurance needs on behalf of the buyer.
Even more unusually, Noble often undertakes manufacturing jobs on behalf of its buyers, as it did in China with the Bihar-bought iron ore, or more recently for a European consumer-goods manufacturer with a craving for chocolate. Noble bought the cocoa from Sulawesi, processed it into chocolate bars at a nearby factory and then dispatched them to Switzerland on one of its Europe-bound vessels.
Finding such sweet spots in a customer's supply chain and then seizing them will be key to the new Asian middleman's future. "There's no question that the biggest potential source of operational efficiencies is not in the factory but in the linkages between the manufacturer and customer," says Ken Gibson, a Jakarta-based director with global management consultancy McKinsey & Co. "That is the challenge of the traditional Asian trader. He will die if he doesn't improve these linkages."
Elman the ex-hippie describes Noble's mission in similar-though more prosaic-terms. "We're the milkman," is how Elman puts it, drawing on a fond childhood memory. "When I was growing up in England you got the milk directly on your doorstep but you didn't know how it got there. The milk actually went through 40-50 different steps before it arrived on your doorstep. That's what we take care of."
Yet even as Noble has successfully adapted to the new rules, many older Asian middleman have not. In part, this is due to the growing need for scale in the trading business, which has effectively squeezed less nimble small to medium-sized traders out of the game. As trading in smaller volumes increasingly entails the agility and innovativeness of quasi-supply-chain managers like Noble, big Japanese trading houses like Mitsubishi, Mitsui and Itochu have largely receded to a domain where their dominance remains effectively unchallenged: The large-volume and low-margin industrial project. Because of their financial muscle and their almost incestuous links with Japanese manufacturers and banks, when it comes to large industrial projects like these, the Japanese behemoths possess advantages smaller trading operations could never secure.
A recent Black Sea gas-pipeline deal involving Mitsui is typical. The Black Sea project, a 760-kilometre undersea pipeline that will run from Russia to Turkey, will be largely financed by a syndicate of Japanese banks and built by a Japanese consortium assembled by Mitsui, and include such stalwart Mitsui partners as Nippon Steel, Kawasaki Steel and Sumitomo Metal. In return, Mitsui and its partners will source much of the steel required for the pipeline, an order amounting to some $1.8 billion.
Even so, money is only part of the problem facing the smaller trading shops; management is the tougher nut to crack. For most small to medium-sized Asian trading firms, the ubiquitous import-export shops that fill corporate registries in trading hubs like Hong Kong or Singapore simply don't possess the managerial talent to do anything but buy and sell. Says Milton Au, a Noble executive director who manages the firm's Singapore grain-trading division out of a leafy colonial bungalow: "In pure trading you don't need much managerial expertise. But the most important thing we need now is professional managers who know how to manage risk."
A CHANGING CULTURE
But not all traders in Asia fare so badly, not even the small companies that might seem automatically disadvantaged by the new rules of the game. Chris Baur, a recently minted Wharton MBA who returned to Singapore a few years ago, is carefully reinventing his family trading firm. The firm, which specializes in floor-covering products, has 50 employees spread across Europe, the Middle East and Asia. It's too small and capital-starved to become a manufacturer of flooring products in its own right, so the young heir faces a delicate task: How to change the trading culture of the firm from inside.
"My father followed a typical buy-and-sell model," Baur explains. "But when you're in a buying-and-selling culture, you can't attract people who can really think about processes and solutions. That's why I joined the firm. I'm the MBA. My father couldn't have done it on his own." Attracting more creative managers is Baur's hardest challenge, he says, as the company seeks to move closer to its buyers by taking on more logistical tasks. Adding lacquering to the floor products it imports, for example, is a small way to solidify its relationship with its buyers, for whom quality, not just price, is becoming more and more important. "I'm finding the transition very difficult," admits Baur. "You think as a hotshot MBA you can do it easily. But it's tough."
For his part, Elman has no doubts that the direction he's taking at Noble is not just opportunistic, but inevitable. "When I started out it was easy to make a living by trading in Asia if you just went to enough out-of-the-way places," he says, almost wistfully. "No more."
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