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of adjustments to its strategy had to be made? Was Chinese business logic helpful to building success in Japan? With the “filling the gap” positioning of Phenix in the Japanese market, how could Dongxiang break out of the mould of habitual practice? Chen Yihong and Kappa in China Private Chinese firm Dongxiang had emerged out of the early pioneering domestic sport company Li Ningiv. Li Ning, its eponymous founder, was regarded as China’s “prince of gymnastics” for his three gold medals in the 1984 Olympic Games. On retiring from sport, he established his own sportswear firm in 1990, and was joined by 33-year-old Chen Yihong a year later. Li Ning wanted to create a famous Chinese sports brand, and Chen Yihong was the best candidate to carry out his dream. Li Ning saw Chen as “a true businessman, with business acumen and a sense of responsibility.”4 Li Ning’s dream and Chen Yihong’s business talent led to a golden decade of development for Li Ning company.5 2001 sales were more than 700 million RMB, and Li Ning company became the Chinese market leader with a 29% share, chased by Nike with 19%. By 2002 it was time for 44 year old Chen Yihong to move on. For the previous 11 years he has laid the foundations for the Li-Ning brand, turning a dream into reality. Now Li Ning’s hope was to replace company veterans with younger and more creative people. Chen Yihong found a replacement CEO for the company, Zhang Zhiyong, and Li Ning himself went to study at Peking University. Chen Yihong considered his next move. At the same time Li Ning invited the consultancy Gallup to revisit company strategy. Gallup concluded that “at a certain stage of economic development the sports industry is dominated by international first-tier brands.” The impact of brand universality had a significant part to play in Chen Yihong’s decision. Following Chen Yihong’s advice, Li Ning acquired exclusive rights to the Italian brand Kappa in mainland China, and Beijing Dongxiang, the predecessor of the China Dongxiang Group, becomes its agent. Chen Yihong hoped to build a unique business model, markedly different to Li Ning’s, and also different from the simple agency model. Chen Yihong and the Dongxiang team looked to the Korean model and the concept of fashionable sportswear for inspiration. The plan was for the Kappa brand to establish its position in China, and develop a strong retail network, attracting a base of young trend-conscious consumers. In 2004, when Li Ning company listed on the stock market, Kappa was bringing in 5.6% of the company’s revenue6. Due to a precarious relationship with its agents, Li Ning company sold Dongxiang to Chen Yihong and his family. In March 2006, Dongxiang bought the rights to the Kappa brand in China from BasicNet Group. According to the agreement, from May 30, 2006, Dongxiang had total usage rights over the Kappa brand in mainland China and in Macauv, including control of marketing and development. The Kappa brand soared in the Chinese market. At a meeting in late 2005, it was found that orders far exceeded the expected 500 million RMB in value. Moreover, in the year before, annual sales for Kappa had been a mere 148 million RMB. Dongxiang CEO Qin Dazhong expected 2006 Fall orders to reach 800 billion RMB. Witnessing this growth story from the inside as the bank that had assisted in the Kappa deal, Morgan Stanley made a major investment in Dongxiang, acquired a 20% stake for 38 million USD in May 2006, making it the Chinese firm’s second largest investor. In 2007, Dongxiang sales grew 99.2% year-on-year to reach 1.71 billion RMB. The number of Kappa brand retail outlets mushroomed to 1,945, marking a 70.9% increase. Kappa had become one of China’s top three international sportswear brands. On October 10, 2007, Dongxiang successfully listed on the Main Board of the Hong Kong stock exchange.7 The closing price that day was 5.43 HKD, rising from

ivLi Ning: SEHK: 2331 v Macau Special Administrative Region or SAR

3.98 HKD (36.43%) on the issue price, and giving the company a value of 29.87 billion HKD. This was higher than Li Ning’s stock market value at the time8; and won Dongxiang the title of “sportswear industry stock market king.” Despite having been crowned “sportswear industry stock market king” just five years after being established, Dongxiang’s success had done little to settle Chen Yihong’s nerves. Instead, it just made him aware that the company had no room left to grow. By 2008, Dongxiang’s competitors were well positioned in the Chinese market. Sales for Nike, adidas (hereafter Adidas) and Li Ning, accounted for 19%, 15% and 11% of market share respectively.9 Annual gross profit margins in the same year were 45%, 48.7% and 48.1%.10 Due to stringent cost controls, the annual gross profit margin for Dongxiang was 58.5%.11 Chen Yihong hoped that high profit margins would help the company develop, yet this was no small challenge. Kappa had entered the Chinese market just as domestic demand was expanding. And this, coupled with Chen Yihong’s skills enabled the Kappa brand to grow rapidly. Chen Yihong said, “I was lucky. In the past six years, I managed to grab all of China best resources, human resources, brand resources, capital, market resources.”12 But he was also aware that since Dongxiang listed in 2007, the company had reached a bottleneck, “In general, all companies in the field are in the same situation, the supply chain is similar, the people are similar. We can put in extra effort, and make small gains, but from a bigger perspective this is ineffective, and we are at a bottleneck.”13 He predicted that “technology is no longer a barrier for any industry, whether clothing or automobiles. Competition exists on the level of culture, supply chain and technological process. In five to ten years the bottleneck will be difficult to overcome.”14 He hoped to see Dongxiang prosper in this next phrase, with the support of new resources. Japanese Phenix After Dongxiang’s annual meeting in Singapore in February 2008, Chen Yihong attended a meeting in Japan, and received a call from ORIX Corporation (hereafter Orix), a Tokyo-based financial services company. Orix invited Chen for a meeting. After Dongxiang had listed, Chen Yihong received invitations such as this regularly. The Japanese side came well prepared, and after congratulating Chen on the success of Dongxiang’s public listing, got straight to the point. Orix wanted to sell off sportswear company Phenix, and was scoping out Dongxiang’s interest. Phenix is a sporting apparel company with core operations in design, development and sales. Founded in 1952, its major brands include Phenix, a ski and outdoor sportswear brand with the highest market shares in Japan, and Kappa in football and sportswear. Phenix is also one of three Kappa brand owners, managing the Kappa brand in Japan.15 Phenix (originally established as Ohtori Co., Ltd) was established by Tajima Kazuo, as a wholesale sportswear business. In 1967, Phenix and German company Bogner entered into cooperation for technological development and launched the high quality ski-wear brand Bogner. The company was rebranded Phenix (after the legendary Phoenix) and its business was refocused away from wholesale towards manufacturing. In 1972 Tajima Kazuhiko, a son of Tajima Kazuo, became president and chief representative director and set up the Phenix R&D laboratory,16 shifting the company focus towards brand development. In the late 1960s, when the Japanese economy was booming, customer demand for ski-wear and winter sports was growing alongside it. Phenix, with its manufacturing and R&D capabilities in ski-wear was set to benefit. In 1976, Phenix expanded in the Japanese ski-wear market, and started manufacturing feather-based wear in Shanghai. It was one of the first attempts at internationalization by a Japanese company. Besides, Phenix was the first Japanese brand selling feather-based ski-wear that looked fashionable and

were well made from quality material. In 1977, The Ski Association of Japan recognized the company as an official supplier.17 In 1983, Phenix and Italian company MCT (Maglificio Calzificio Torinese), entered into cooperation, and started selling Kappa clothes on the Japanese market. In that year Phenix sales exceeded 10 billion JPY. Almost ten years later, in 1992, Phenix signed a contract to become the official supplier to FIS (Federation Internationale de Ski),18 establishing its position on the international market. In 1994, Phenix established a joint venture company, Shanghai Fengda Garment Co., Ltd. In the same year, Phenix started diversifying, and opened a hotel, the Grand Phenix Okushiga in Nagano, one of the largest ski resorts in Japan. In 1995, Phenix set up a second joint venture, Shanghai Phenix Apparel Co., Ltd. in Shanghai.19 Until 1998, Phenix was a leader in ski-wear manufacturing in Japan. But when the Japanese asset price bubble burst, Phenix’s prospects also began to sink. As the economy was disintegrating in the 1990s, Japan entered its first depression since the Second World War. Business at Phenix was directly affected. Japan skier numbers peaked in 1993, and started dropping in 1996. As a result, ski resorts and ski manufacturers closed down one by one. Having prospered by riding the Japanese ski industry wave, Phenix was unable to survive this downturn. In the second half of the nineties, sales were at 30 billion JPY. In 2003, after the ski bubble had burst, sales were down to 20 billion JPY, dropping further year-on-year. Phenix’s hotel had become a real drain on its books, and a burden on the company. The real trigger of Phenix’s troubles was the bankruptcy of its main customer, Viva Sports Ltd. In August 2004, Viva filed for bankruptcy with 3.1 billion JPY debts. Phenix was one of its main shareholders, and the company’s financial situation affected Phenix directly. Soon after, on 30 August 2004, Phenix was forced to apply for support from the Industrial Revitalization Corporation of Japan (IRCJ).20 In December 2004, Orix took a 100% equity stake in Phenix for 495 million JPY, promising to rebuild and revitalize the company. Under Orix’s revitalization plans, all directors, including Kazuhiko Nishimura, would be replaced.21 Phenix’s debts were to be assisted to a total of 8.4 billion JPY.22 After Phenix was taken over, Orix sought to raise value via internal integration. However, sales kept dropping each year, and there was soon no way to cut additional costs. Phenix’s sales saw no improvement, and its February accounts showed 2.9 billion JPY in deficit, with its assets and liabilities statement showing 3.2 billion JPY in debts. By early 2008, Orix had decided to give up. Four years of trying Orix’s plan to revitalize Phenix had not worked. Firstly, the Japanese market was shrinking. Secondly, the 2008 Beijing Olympics was an opportunity bar none to develop in the Chinese market.23

Orix was looking to sell Phenix to a Chinese company, and had Dongxiang in its sights. Acquiring an International or Domestic Brand Since Chen Yihong had been seeking to gain external resources for a long time, he immediately agreed to the offer, despite full awareness of the risks. Orix offered a choice. The first option was that the acquirer would pay several million dollars for the Kappa brand, and that Orix would declare Phenix bankrupt. The second was that the acquirer would pay nothing, but would have to ensure the continuation of Phenix’s business operations. Chen Yihong was very clear about Orix’s proposal. “It was a question of whether it made sense to just buy a brand or to buy a whole company. Buying a brand needed money, but would save the cost of employment. Acquiring the whole company would give us a brand but would require us to provide for the personnel.”24 Chen Yihong quickly decided to buy the company, not just the brand. He saw Phenix as the long awaited opportunity to make a breakthrough. He looked back over his 20 years of business experience, when he

continuously sought opportunities with no results. This experience had always pushed him towards novel solutions. “I had used up all the resources I could find in China, which meant that we were operating at the highest standard possible. Now we faced a bottleneck. The only option was to go global to find better resources”25 But when talking over his decision with members of the board, Chen Yihong faced resistance from some shareholders. Chen Yihong explained the reason he met with such opposition: board members simply hoped to acquire a domestic brand, rather than a Japanese company. In the year when Dongxiang was listed, acquisitions were quite common in the clothing industry on the China mainland. One of the more eye-catching involved China’s largest retailer of ladies’ footwear, Hong Kong Stock Exchange-listed Belle Internationalvi. In the early 1970s, Belle was just a simple shoe shop in Hong Kong. In its early days, the company was just small fry in the Hong Kong shoe supply network. In 1998, Belle International introduced the Staccato brand, a new style for the Hong Kong market, and established the Staccato Footwear company, starting a retail business in 2004. Starting with this expansion, by the end of 2006, the company had 3,828 retail outlets (excluding 35 in Hong Kong, Macau and USA), across 150 cities in 30 provinces. Turnover increased by 260.2% to 6,238.5 million RMB in 2006 from 1,731.8 million RMB. Profit after taxation increased by 315.8% to 976.6 million RMB in 2006 from 234.9 million RMB in 2005.26 In May 2007, Belle International was the first biggest women’s shoe retailer listed in Hong Kong. “Its H-shares were 60 times oversubscribed on the first day of the IPO, with the international tranche 10 times oversubscribed”27 “giving the company a market value of 67 billion HKD (8.6 billion USD).”28 After its public listing, Belle International raised capital reaching 9.95 billion HKD, and moved from the industrial to the capital market, from the industrial economy to a fast growing capital economy, helping it to consolidate its market share.29 After Belle International’s public listing, the Hong Kong and domestic shoe retail market were shaken by a series of acquisitions. In August 2007, Belle International “acquired an 85% interest in the Fila trademarks in the mainland, Hong Kong and Macau markets, together with certain related businesses, and a 100% interest in Fila Marketing (Hong Kong) Limited” for a cash consideration of 48,000,000 USD. In October 2007, Belle International acquired total equity interests in Ossia Marketing (HK) Company Limited and Ossia International (HK) Limited, principally engaged in the distribution and retail sales of footwear products in Hong Kong, Macau and the PRC, mainly under the brand name of Millie, at the initial consideration of 600,000,000 HKD (equivalent to 559,600,000 RMB).. In November 2007, Belle entered into a series of agreements with Jiangsu Senda Group Co., Ltd. Belle acquired interests in certain assets, businesses and companies from Senda. Senda principally was engaged in the manufacturing and retail sales of men’s and ladies’ footwear products in mainland China. The aggregate consideration for the acquisition amounted to approximately 1,650,000,000 RMB.30 Five days later Belle acquired Shanghai Yongxu, Senda shoe equipment manufacturer, for 563 million RMB. In May 2008, Belle International acquired “all of the issued and to be issued shares in the share capital, and for the cancellation of all the outstanding share options, of Mirabell International Holdings Limited. Total consideration for the acquisition was 1,615,656,000 HKD (equivalent to 1,475,950,000 RMB).”31 This series of acquisitions rapidly expanded Belle International’s scope on the international market. By the end of 2007, Belle managed 6,090 outlets in mainland China and 53 in Hong Kongvii, Macau and USA. During the year, the company recorded revenue and profits of “11,671.9 RMB million and 1,979.1 million RMB respectively, achieving a growth rate of 87.1% and 102.7% respectively.”32 viBelle: SEHK: 1880 vii Hong Kong Special Administrative Region (SAR)

Investors including Morgan Stanley’s two subsidiaries MS Shoe Limited (MSI) and MS Shoe II Limited (MSII), and CDH Retail Limited (CDH) Investments’ CDH fund would have been delighted by these successes.33 In October 2007, just after listing, Dongxiang was thinking of its strategy and considering how best to use its new capital. Belle International had proved itself capable of pulling off successful acquisitions of domestic brands. Chen Yihong said that Morgan Stanley hoped for a domestic acquisition, so that just like in the case of Belle International, market share increases could be made swiftly. But since acquiring Kappa, Chen Yihong gained confidence and made it clear that he did not want involvement in other domestic companies. Since the company’s establishment, Chen Yihong had it in his sights to operate high-end international brands. Insiders speculated that Chen Yihong and Li Ning, working together for 14 years, and then separating peacefully, had an agreement to focus on different types of brand operation: Li Ning on domestic brands and Dongxiang on international ones. Such a deal, if it existed, was only informal, and naturally investors would not have known about it. Phenix’s Acquisition In Spring 2008, Sun Jianjun, in charge of M&A strategy at Dongxiang, went to Japan to investigate the situation at Phenix. Prior to joining Dongxiang, Sun Jianjun had worked for Beijing Shunmei Garment Co., Ltd. as a workshop supervisor responsible for marketing, and had then been promoted to deputy head of finance. He had also been marketing director of Beijing Li Ning Sports Goods Co., Ltd., general manager of Shanghai Edo Sports Company Limited and executive director of Renhe Oriental Investment Company. Sun joined Dongxiang in April 2008 and was put in charge of turning Phenix around.34 With almost 20 years of experience in the industry, including at Li Ning company, he was an equal to leaders in Nike, Adidas and other major competitors. When the Phenix acquisition was first mooted, Chen Yihong had sought out Sun Jianjun to take charge. The report Sun Jianjun brought back from Japan satisfied Dongxiang’s management team. According to Sun, Phenix’s problems were readily solvable, the most tricky being high costs. The second problem was that sales channels were narrow, and compared with other brands, insufficient and limited. The third problem was product positioning. Phenix’s target segment was the professional middle classes, who had suffered most from Japan’s recent economic decline. Understanding that situation led Sun Jianjun to the conclusion that this company was the best opportunity for Dongxiang. In his opinion, changing things at Phenix was not hard. The first goal was to re-position the brand. Sun Jianjun thought the current customer focus on ski-wear was too narrow. According to Dongxiang’s estimation, the Japanese ski-wear market was worth around 9 billion JPY. He hoped to use Phenix’s technology and research to become a general outdoor lifestyle brand, with a market value of hundreds of billions JPY. The second goal was to cut costs by reducing supply chain links. The third point was to re-model channel control in Japan, and create new channels. Qin Dazhong, the then CEO, after detailed analysis of the Phenix system, thought that after the acquisition Dongxiang would be in control, and would be able to change the situation at Phenix. He calculated the following: In 2007, Phenix created 100 million USD sales revenues, a very substantial sum. That was a gross profit ratio of 37.5%, which was 23% less than that of Dongxiang. If Phenix’s gross profit ratio could be boosted by 10%, Phenix would start making a profit. According to Qin Dazhong’s prediction, if the manufacturing department was transferred from Japan to China, this would be feasible. If Chen Yihong had been uneasy about the value of his Japanese acquisition beforehand, following his team’s research visit, he had renewed confidence in his plan.

Morgan Stanley’s attitude was less positive however. Morgan Stanley did not want to have to pay for the consequence of the offloading of a failing company onto one of its portfolio companies. Chen Yihong understood each side’s position: “The investor thought it was a risky company, but we in the business might disagree about the degree of risk.” While Chen Yihong thought Phenix would move Dongxiang five to ten years ahead of its competitors. Morgan Stanley felt that a company with losses of 15 million USD the previous year would seriously affect Dongxiang’s profits and share price. “That’s normal. You need to understand how the capital markets work, but you also have to understand the business person’s logic. While investors can have a short term perspective, business leaders must look to the long term.”35 If the stock price would be affected, Morgan Stanley's withdrawal would put Dongxiang on the back foot. The acquisition idea met with the support of the Dongxiang team. No matter if judged from the angle of multi-brand strategy or from the angle of strengthening R&D, Chen Yihong thought this acquisition was a long-term project, calling it a “milestone.” Finally Chen Yihong was able to persuade the Board of Directors to accept the acquisition. On April 30, 2008, Dongxiang acquired an overwhelming majority equity interest in Phenix for the price of one Yen. Upon acquisition, 91% of Phenix was to be held by Dongxiang, and 9% by Orix. “Subsequently, Dongxiang and Orix will subscribe for 71,399,999 and 9,000,000 newly issued shares of Phenix respectively at a consideration of 499,799,993 JPY (equivalent to approximately 38,438,761 HKD) and 63,000,000 JPY (equivalent to approximately 4,845,222 HKD).” “In addition, Dongxiang will acquire the benefit of the Sale Loan (including principal amount and interest thereof) of Orix to Phenix amounting to approximately 5,937,000,000 JPY (equivalent to approximately 456,604,499 HKD) at a consideration of 1 JPY (equivalent to approximately 0.0769 HKD).”36 According to Chen Yihong, around the time Dongxiang was considering doing a deal with Orix, another Chinese company also showed interest, and missed out. Orix had started talks with both companies, but while the other company was hesitating, Chen Yihong made his decision in just a week. It took just 40 days from the day the deal was confirmed until the day of acquisition. Chen Yihong was very pleased. However, on May 7, Morgan Stanley disposed of 50% of its shares in Dongxiang. After the acquisition, Chen Yihong felt he had bought a company that was really a “good deal.” He found that at Phenix the placement of every tiny button was the result of precise digital technology and accompanied by strict procedures. “Every detail, every seemingly insignificant thing, takes so much effort. That is the mark of a product from a great industrial country.” That brought out Chen Yihong’s frustration with the situation at home. Having worked in the industry for 20 years he remarked, “We Chinese think it is all about the design, and that the designer will sort out all the problems. This is completely wrong.” Regarding the value of Phenix to Dongxiang, Chen Yihong had great hopes. From his point of view, the most important value of integration was space to innovate. Phenix’s 300 workers and internal structure made up the core DNA of the company and this was where the true value of the company was to be found. The integration process needed to capture the source of the company’s creativity: its employees. Sun Jianjun, the new head of Phenix, described the integration objectives for Dongxiang as follows: First, resource integration: With Phenix’s strong design and R&D capabilities, it would bring value to Kappa brand technology and design. Second, the integrated supply chain strategy: this included allocating global resources to create a global supply chain, set up China as manufacturing centre and Japan as technological and design centre, aim at enlarging markets in Europe and USA. The key focus of this strategy is Japan. Third, brand strategy: The main goal was to become a global brand company. In early 2002, Chen Yihong decided he would set up an outstanding brand company. He described it as “triple model” of high risk, high investment and high profit, focusing on brand and business operations. Phenix comprised of four big brands, Phenix, Kappa, X-NIX and Inhabitant. Before the acquisition, brand development at Dongxiang

had been relatively slow. Chen Yihong hoped to change the positioning of these brands and replicate the success Kappa had had in China in the Japanese, European and US markets. To change Kappa’s strategy was the main focus of Phenix, but achieving such an idealistic goal meant overcoming a series of challenges. “Fitting In” Operations Setting about changing Phenix’s business practices was not easy. Sun Jianjun realized that the three main problems with Phenix were common to many Japanese small and medium sized companies at the time. High production costs were mainly due to the Japanese company’s numerous intermediate supply chain links based on the Japanese business model of “sōgō shōsha.”37 These are uniquely Japanese general trading companies that feature heavily in Japanese business philosophy. Dealing in general commerce, they supply large volumes of raw materials from large manufacturers or wholesalers to smaller distributors and retailers. They also act as an international sales force for SMEs that lack the ability to market and maintain distribution channels overseas. Pursuing vertical integration from upstream purchasing, design and manufacturing to downstream distribution, sogo shosha operate by subcontracting work to a wide range of businesses. This offers SMEs stability, rational profits and quality expertise but leaves them little room to negotiate. As SMEs operate on a small scale, they face high agency and manufacturing costs. Due to the Japanese retail monopoly, Phenix’s distributions channels were very narrow. Strong monopolies exist in sales, such as in the sport industry, which are mainly controlled by two big retailers, Alpen and Xebio. The other two channels, department and outlet stores are in control of Mitsubishi and Itochu. Therefore, many businesses must fit into position in order to survive. Retailers decide where they stand, their business method, including brand positioning, goods category, etc. This kind of business model results in SMEs becoming dependant on sogo shosha, even for aspects such as fabric innovation. Principles and customs that are deeply rooted in Japanese culture tend to restrict business creativity. Any SME that innovates risks risks breaking business customs, and being eliminated from the supply chain by the controlling sogo shosha. Such an environment clearly favors the strong. Phenix was already in a weak situation, with the ski industry in decline, major retailers going bankrupt and the financial crisis compounding the crisis. With big corporations controlling the market, Phenix was forced to “fit in” and was restrained from making any move to change the status quo. A Cultural Chasm between China and Japan At the beginning of the acquisition, Dongxiang management believed that applying Dongxiang’s practices to Phenix might solve a lot of the ski-wear company’s problems. For example, moving production to China might reduce costs created by the cosy relationship between sogo shosha and suppliers. But would it work if traditional trading channels were broken down and Dongxiang operations were set up to replace them? The first challenge came very shortly after the acquisition. A certain Osaka-based retailer declared bankruptcy, and the revitalization institution met to decide whether to help the retailer or not. Agreeing to help meant that the retailer would be relieved of his debts. Phenix and other brands were invited to vote, and Sun Jianjun voted against the motion to assist the retailer. In the event, out of several hundred attendees his was the only negative voice.

This, according to Sun Jianjun, signalled the biggest cause of cultural conflict between China and Japan. “The Japanese way of doing business has a high regard for people: if a company faces troubles, it will be helped out. It feels a bit like communism. But at a time of economic crisis this can drag down many companies. One significant company failure in the industry can bring down the whole industry, and cause long-lasting damage. Then only an invigorated economy can help.” The supply chain cost-cutting exercise inevitably resulted in conflict. After the acquisition, Dongxiang needed to terminate cooperation with two suppliers, as the company had decided to give up on some products and product categories. When Sun Jianjun discussed this termination of cooperation with different departments, he discovered that most people at Phenix were very much opposed to the termination. When finally he made up his mind, Japanese colleagues told him the truth. He was told that if Phenix stopped working with them, they would go bankrupt, as their survival depended on orders from Phenix. It was for this reason that Japanese companies avoided terminating cooperation with each other. For Sun Jianjun this came as a surprise. He decided to communicate with each link in the supply chain. He told Japanese employees, “A strong Phenix can help out many people. Do you want us all to go down with that company? Or should we let it perish first, save ourselves, and help other companies that have a better chance of survival?”viii In the end everyone agreed with Sun’s decision, but Sun still had the feeling that his anti-aid stance was held against him by the Japanese side. As it happened, the first attempt to help the Osaka retailer did not really improve its situation, and in the end it was forced to close down. The companies within the industry that had helped out went bankrupt one by one as business opportunities deteriorated. Despite this, business practices in Japan carried on as before. These conflicts at Phenix made new owner Dongxiang challenge Japanese business style and traditional ideas. In his professional experience Sun Jianjun had never came across such problems before. He had to explore options and find a way to break through the cultural barrier. Fortunately Chinese headquarters held its resolve that breaking through is the only way to bring about improvements in Phenix’s fortunes. Just like many overseas CEOs, Sun Jianjun encountered another challenge. How could it go about winning the support of its acquired company? First of all, as a new Chinese boss, he needed to come to terms with the Japanese culture of status, and confront resistance to change of the status quo, as well as some hostility towards China. As the first Chinese acquisitions in Japan had been presented quite negatively in the media, Japanese business people had built up considerable prejudice against the new class of Chinese owners and managers. In the first half of the year, Sun Jianjun spent much of his time communicating with employees at every level. To make a breakthrough, he had to fully understand Phenix and its business operations in Japan. But most importantly, Dongxiang needed to make the Japanese side comfortable with its intentions, past achievements and ability to save Phenix. The Japanese side needed to realise that support for Dongxiang from every employee at Phenix was vital. Sun Jianjun’s manner of communication was rare in Japan. Due to the strict hierarchical system, workers hardly ever got a chance to communicate directly with management. Sun Jianjun’s sincerity and goal for integration slowly won over employees and management. But every reform met with opposition, with Sun Jianjun facing particularly strong opposition from Phenix’s Kappa brand division. At the end of 2008, half a year after the acquisition, Chen Yihong received a visit from a senior Phenix executive in Beijing. This executive was a head of the Kappa product department under the Phenix umbrella, reporting to the head of Phenix, and one of the leaders of the company that had seen most value

viii Interview with Dongxiang executive

in its acquisition by Dongxiang. This unexpected visit had clear and specific purpose: to bring about Sun Jianjun’s dismissal from his post as the Chinese head of Phenix. The Japanese Kappa executive pointed to three problems with Sun Jianjun. First, he had broken away from the typical Japanese bonus system by giving high bonuses to outstanding sales departments, and this had provoked unrest among Phenix employees. Second, all bonuses were supposed to be given to heads of departments who would be responsible for distributing the bonuses to the workers. Sun Jianjun had himself given bonuses to some employees. Third, salary rises were normally decided by heads of departments, but Sun Jianjun had made some salary rises directly. The overall message was clear. Finally this Kappa departmental head said to Chen Yijong that if Sun Jianjun continued as head of Kappa in Japan, it would lead to mass resignations. Even if Kappa in Japan could not compare with Phenix, since the integration of Phenix by Dongxiang, were Kappa workers to all resign, the harm to Dongxiang could be well imagined. Chen Yihong response was very calm in the face of such an ultimatum. As Sun Jianjun recalled, Chen Yihong had first expressed gratitude to the Japanese executive for all his work. Second, he reassured those present that Dongxiang would be going to make reforms at Phenix no matter what. Thirdly, he highlighted his respect for the choices made by the executive. Sun Jianjun was not surprised by Chen Yihong’s reaction. There were a number of problems that they had expected to encounter before the integration, including breaking the usual Japanese codes of practise, and they had already exchanged views about these risks. As for the Kappa departmental head’s mass resignation threat, Sun Jianjun had already taken countermeasures to avoid adverse consequences. Various integration strategies that were designed to break down standard Japanese practices really started to get going after the threatened resignation incident. Breaking the Japanese Code of Practice Unexpectedly, the breakthrough came from Japanese Mitsui & Co. One of the six famous big sogo shosha, Mitsui had provided production, logistics, import and export services for Phenix prior to its acquisition, but had terminated all services post-acquisition. Sun Jianjun thought the reasons to that were quite complicated. He thought it was mainly because of differences in business culture and because Mitsui simply did not approve of some of Dongxiang’s initiatives such as reducing the number of suppliers. By doing so, Mitsui sent a strong signal to the Japanese business community that “Dongxiang does not comply with the Japanese code of business practice.” After Mitsui, problems with suppliers arose with increasing frequency. The supply chain was stymied by slow cooperation which soon turned into non-cooperation. In order to compensate for Mitsui’s withdrawal, Dongxiang purchased and delivered the necessary materials, and asked the factory to complete manufacturing. This part of the business was originally handled by Mitsui, so to Sun Jianjun’s surprise the supplier did not accept a cash payment. Sun Jianjun remarked that such a situation simply could have not happened in China. Before, Mitsui with its partners adopted a long term payment policy, but now the partner refused payment settled in cash. Later on, Sun Jianjun learned that Japanese sogo shosha culture value long term cooperation, and it is their business responsibility to ensure lasting partnerships. By comparison, trust in individual companies tends to be low, so even if they offer very good conditions, and great prices, suppliers may be reluctant to work with them. For Japanese companies, profits take second place to long term cooperation. Sun Jianjun realized that the integration of the supply chain and cost reduction presented major obstacles to success in Japan. Changing Japanese company and employees’ modes of thinking was the biggest challenge, far more than what Sun Jianjun had anticipated. Sun Jianjun had to convince Chinese

headquarters to give up duplicating the Chinese way of doing things on the Japanese market, and at the same time step by step make a change and breakthrough in the Japanese business model and culture. “If you had persistently thought of moving forward, you would face similar difficulties. From this perspective, an individual company can hardly rely on challenging norms to become integrated in Japan. But if such a company wants to become integrated in Japan, it will need to engage in cooperation and resource exchange, as only by doing so, can it generate compromise and trust between partners.”ix After Mitsui’s withdrawal, cooperation with suppliers stopped. Sun Jianjun sought out Itochu Corporation, another sogo shosha, under the flag of Dai-Ichi Kangyo Bank, hoping it would agree to take Mitsui’s place. Itochu agreed. Itochu had been one of the first companies to start trading with China. As early as 1972, the Chinese government had welcomed Itochu as a friendly trading company, the first such recognition given to a sogo shosha. After China’s reform and opening, Itochu paid great importance to expansion to China. Sun Jianjun thought Itochu had agreed to take the place of Mitsui for three reasons. First, it was its competitor. Second, since Dongxiang was willing to cooperate it means it was also willing to follow the Japanese business practice. Third, via Dongxiang Itochu would get access to the Chinese market. Sun Jianjun thought that this would be the great compromise in terms of resource sharing and benefits. After over a year of experience in Japan, Sun Jianjun realized that changes should be carried out, but not at the expense of stability. Cooperation of Phenix with Itochu cut down on intermediate links, and reduced costs, allowing Phenix to develop gradually. The timeframe for moving manufacturing and purchasing from Japan to China was extended to make the transition smoother. Some of the manufacturing processes would be kept in Japan, as China had not reached such advanced technological standards. Seven months after the acquisition, by the end of 2008, Phenix sales were over 312 million RMB, 9.4% of Dongxiang’s total sales. The Japanese segment’s gross profit margin was 40.7%, much lower than the gross profit marginf of the Chinese segment at 61%.38 Compared with the previous year, Phenix’s gross profit margin rose by 3.2%, which was moving step-by-step towards Qin Dazhong’s predicted 10%.x As for channel breakthrough, Sun Jianjun had found a good model: famous Japanese apparel company Uniqlo. One of the world’s top ten leisure brands, Uniqlo produced high quality low-cost casual clothes for all age groups. Just as the financial crisis of 2008 was causing global havoc, Uniqlo founder Tadashi Yanai started a round of aggressive brand expansion. His personal assets increased by 29%, from 4.7 billion USD to 6.1 billion USD, ranking him according to Forbes as the 76th richest man in the world in 2009.39 According to 2012 data, in 2011 Uniqlo ranked fourth in sales, with the first three places taken by Zara, H&M and Gap.40 In 2009, Uniqlo was fifth.41 Uniqlo, owned by Fast Retailing Co. Ltd., opened its first store in 1984. Established 37 years after H&M, and 9 years after Zara it is a junior member of the clothing industry, but its rapid development meant that it was now ahead of many traditional competitors. In Japan alone, Uniqlo controlled more than 800 stores, and globally it operated in 11 countries.42 After careful studying of Uniqlo business model, Chen Yihong discovered that 20 years earlier this company was also facing the same problems as his related to the control of sogo shosha over manufacturing, trading and distribution channels. The company founder, Tadashi Yanai had not only got

ix Interview with Dongxiang executive x Dongxiang internal documents

around these restrictions, but had also moved most of Uniqlo’s manufacturing to China. Already in 1998, 90% of Fast Retailing products came from the factories commissioned to produce for it in China, and the number of factories in Japan was cut from 140 to 40.43 Such a solution had shaken up the Japanese deeply-rooted business control model, many researchers therefore referred to Fast Retailing as an atypical Japanese company. Phenix’s Japanese channels include major sport shops, specialty sport shops, distributors, department stores, the internet as well as its own outlets and direct stores. When Phenix wanted to establish its first specialty store, its partners questioned Sun Jianjun, saying that he was taking the Uniqlo path. It was not exactly what Sun Jianjun wanted. Uniqlo produced in far higher quantity than Phenix, and Phenix couldn’t simply replicate the Uniqlo business model. Sun Jianjun was aware that he had to retain the traditional Japanese business model for a sufficient period of time, and launch branded stores at the same time. It would be disastrous if the new channels had not yet been built and the traditional channels had already been made unavailable to Phenix. So, Sun Jianjun explained his plan for Phenix to each co-operator: First, Phenix would not copy Uniqlo’s business model and would take a more traditional path. Second, establishing Phenix stores was about promoting and repositioning the brand. Besides, Nike, Adidas and other big sports brands also used the strategy of flagship stores. In August 2008, Kappa opened its first flagship store in Tokyo.44 By July 2011, Phenix had opened ten flagship stores across Japan.xi The integration process slowly began to bring in results. In 2010, sales in Japan accounted for 611.7 million RMB, a year-on-year increase of 7.8%. It accounted for 14.4% of Dongxiang’s total sales.45 The gross profit margin for the Japanese segment was 43.9%, and for the Chinese segment 62.4%, decreasing from 45.2% and 63.0% respectively from the previous year. In the Japanese market, this drop was mainly due to the impact of stock clearance, an increase in production costs resulting from rising raw material and labor costs as well as a higher discount provided for distributors and customers. In 2011, the Phenix brand was to be officially launched in China and was expected to expand rapidly. By the end of 2011 there were 18 stores in mainland China, in Beijing and first-tier cities in North and Northeast China. In June 2011, the Phenix store in the Wanliu Hualian Mall recorded over 510,000 RMB in sales in a three-day exhibition.46 Sun Jianjun realized that integrating the Japanese and Chinese parts of the supply chain would be hard. First, in China the stress was put on specialty store sales and strong brand autonomy, while in Japan the emphasis was on “fitting in” by using controlled channels and department stores. Second, consumer awareness was at a different level, with Japan about ten years ahead in terms of fashion and technological savvy. Even if the respective fashion senses were moving closer, they were still out of sync, with Japanese fashions not finding acceptance in China, while Chinese fashions were deemed out of date in Japan. Third, there was a big gap in clothing quality standards between two countries. All of this made integrated development hard to implement. In the process of integration, Sun Jianjun came to the conclusion that the biggest problem was “location differences.” He said, “knowledge, values, resources, principles, and costs differ widely. As soon as something leaves its place of origin, it becomes very hard to push for a sustained process.” In order to make advances in the integration process, Dongxiang hired a particular American consulting company to generate a new strategy. But Sun Jianjun thought that the benefits were minimal. The consulting company optimized the workflow system in Japan, and on the other hand proposed solutions on the Chinese side. The two sides had very different ways of working. Sun Jianjun gave the following

xi Interview with Dongxiang executive

example. Material was developed in the supply chain, and designer used this to develop their products. In China it worked differently. The design was made first and then the material was found in the market. For integration to work, procedures needed to change. Fortunately, prior to integration, Phenix had gained joint-venture experience with two companies in Shanghai. One of them had been a steady partner for 13 years, mostly on the manufacturing side. This cooperation faced many problems and differences too, but over time they had managed to make adjustments and find solutions. The plan was for one of the Shanghai joint-venture to become Dongxiang and Phenix’s sample center and participate in the restructuring of Dongxiang and Phenix’s operations, helping to reduce the massive gap between their respective operational flows. Dongxiang would send its managers for annual training in Japan. Chen Yihong hoped that this would help them understand technological processes and essence, which later could be incorporated into Dongxiang’s strategy. Three and a half years after Dongxiang’s acquisition of Phenix, Sun Jianjun was frank that no matter the level of success, Dongxiang still faced many challenges and uncertainties, and had to constantly renew its methods of integrating its Japanese subsidiary.

Attachments Table 1 Dongxiang: Five Year Financial Highlights (in millions RMB)

Source: China Dongxiang (Group) Co., Ltd. “Annual Report 2010”. China Dongxiang (Group) Co., Ltd., 2011. Print. Table 2 Dongxiang: Sales Analysed By Geographical Segments, Business Segments and Product Categories

Source: China Dongxiang (Group) Co., Ltd. “Annual Report 2010”. China Dongxiang (Group) Co., Ltd., 2011. Print. Table 3 Dongxiang: Key Financial Performance by Segment

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April 7, 2012. 22 IRCJ point. 3 stated: “Debt forgiveness of about ¥8.4 billion will be sought from financial institutions.” See IRCJ. “IRCJ Approves Application for Assistance for Phenix Co., Ltd.” cao.go.jp. IRCJ, April 30, 2004. Web. April 7, 2012. 23 Pls provide the detailed source. 24 Enterprise Netscape. “Phenix: Breaking Down The Door” (trans. from Phenix 突围之门). cn21.com.cn. CN21, February 11, 2009. Web. April 3, 2012. 25 Enterprise Netscape. “Phenix: Breaking Down The Door” (trans. from Phenix 突围之门). cn21.com.cn. CN21, February 11, 2009. Web. March 3, 2012. 26 Belle International Holdings Limited. “Global Offering”. Belle International Holdings Limited, 2007. Print. 27 Sinocast. “Mainland Shoe King Close to SEHK Debut”. highbeam.com. HB, May 15, 2007. Web. April 8, 2012. 28 Russell Flannery. “Belle IPO Makes Tangs Billionaires”. forbes.com. Forbes, May 23, 2007. Web. April 8, 2012. 29 Wu Jianguo. “How M&As Helped Belle Become Shoe King” (trans. from 资本并购组合拳成就“百丽”系鞋王). 5143.cn. China Apparel, February 25, 2010. Web. April 8, 2012. 30 Belle International Holdings Limited. “Annual Report 2007”. Belle International Holdings Limited, 2008. Print; Belle International Holdings Limited. “Discloseable Transactions: Acquisition Of Trademarks And Formation Of Joint Venture”. Belle International Holdings Limited, 2007. Print; Belle International Holdings Limited. “HKEx Filings: Acquisition of Companies And Assets”. Belle International Holdings Limited, December 6, 2007. Print 31 Belle International Holdings Limited. “Annual Report 2008”. Belle International Holdings Limited, 2009. Print. 32 Belle International Holdings Limited. “Annual Report 2007”. Belle International Holdings Limited, 2008. Print. 33 Belle International Holdings Limited. "Global Offering". Belle International Holdings Limited, 2007. Print. 34 China Dongxiang (Group) Co., Ltd. “About Us”. dxsport.com. China Dongxiang (Group) Co., Ltd., n.d. Web. April 9, 2012. 35Enterprise Netscape. “Phenix: Breaking Down The Door” (trans. from Phenix 突围之门). cn21.com.cn. CN21, February 11, 2009. Web. April 10, 2012. 36 Porda International (Finance) PR Co., Ltd. “China Dongxiang Announces Acquisition of Phenix Co., Ltd. Becoming the Owner of KAPPA Brand in Japan.Introduces Strong R&D Capabilities from Japan Taps the Ski-wear Market”. Porda International (Finance) PR Co., Ltd., 2008. Print. 37 Sōgō shōsha handles half of Japan's exports and two-thirds of its imports. The seven largest sōgō shōsha are Mitsubishi Corporation, Mitsui & Co., ITOCHU, Sumitomo Corporation, Marubeni, Toyota Tsusho and Sojitz. 38 China Dongxiang (Group) Co., Ltd. “Annual Report 2008”. China Dongxiang (Group) Co., Ltd., 2009. Print. 39 Forbes. “Japan’s Richest”.forbes.com. Forbes, May 7, 2008. Web. April 15, 2012; Forbes. “Japan’s Richest”.forbes.com. Forbes, February 18, 2009. Web. April 15, 2012. 40 Fast Retailing. “Industry Ranking”. fastretailing.com. Fast Retailing, February 8, 2012. Web. April 15, 2012. 41 Global Entrepreneur. “A Unique Japanese Company: Uniqlo”, gemag.com. Global Entrepreneur. July 2011. Web. May 3, 2012. 42 H&M as for November 30, 2011, had 2,472 stores globally, including franchise. ZARA, owned by Inditex, had 5,527 stores by end of 2011. UNIQLO of Fast Retailing had 2,088 stores, including franchines, as on August 31, 2011. Gap had 3,263 stores as for January, 28, 2012. See H&M. “Annual Report Part 2. H&M in Figures 2011.” H&M. 2012, Print; Inditex. “Press Releases: Inditex’s 2011 Net Sales Rose 10%”. inditex.com. Inditex, March 21, 2012. Web. April 16, 2012; Fast Retailing. “Annual Report 2011”. Fast Retailing. 2011, Print. Gap Inc. “Annual Report 2011”. Gap Inc. 2012. Print. 43 Takahide Yamaguchi and Hiroyuki Yoshida. “Fast Retailing: An Analysis of FDI and Supply Chain Management in Fashion Retailing”. henley.reading.ac.uk. Henley Business School, 2002. Web. April 16, 2012. 44 China Dongxiang (Group) Co., Ltd. “Annual Report 2008”. China Dongxiang (Group) Co., Ltd., 2009. Print. 45 In 2010 sales in China segment accounted for 85.7% with 3,649.9 million RMB in sales. See China Dongxiang (Group) Co., Ltd. “Annual Report 2010”. China Dongxiang (Group) Co., Ltd., 2011. Print.

46 China Dongxiang (Group) Co., Ltd. “Interim Results Announcement for The Six Months Ended 30 June 2011”. China Dongxiang (Group) Co., Ltd., 2011. Print.