At The LEGO Group, “Everything is awesome!” The aptly titled theme song for the company’s 2014 Blockbuster film, The LEGO Movie, captures the success of a multi-year operational re-alignment that has reaped tremendous financial dividends for the once struggling, globally recognized toy brand. Helped in part by Blockbuster films and headline capturing partnerships with the likes of Star Wars that sustain a strong brand awareness, the secret sauce of LEGO’s financial turnaround has been successfully tweaking its operating model to meet changing business model pressures.
Just over 10 years ago, LEGO found itself on the brink of bankruptcy. Faced with increasing competition from a globalizing economy, video game entrants and mass adoption of the internet, LEGO implemented several poorly prescribed innovation strategies. One such strategy was the hiring of a team of leading young European designers with no toy making expertise. The result was a severe escalation in number of parts (blocks), climbing rapidly from 6,000 to over 12,000 and causing a nightmare for logistics, storage, and infrastructure expansion with no corresponding gain in sales.
“Innovative” technologically advanced products, like Galidor (above) did not meet the ethos of the LEGO brand and cost more to produce than they were being sold for.
Beginning in 2004, under the new leadership of Jørgen Vig Knudstorp, LEGO went to work to combat evolving business competition, implementing a host of operational improvements that have allowed its business to flourish:
Streamlined product line: Back to the basics. LEGO introduces new products every year, but is mindful of the costs of this innovation. The leadership team reduced the number of different LEGO bricks produced, eliminating those that were costly to source, standardizing their design, and thus increasing the team’s ability to react more quickly to consumer trends. Additionally, the company decided to sell off non-core, underperforming business lines. Lesson learned: focus on core competencies, and do not be afraid to shut down operations of unprofitable businesses.
Innovation within reason: LEGO prides itself on creating unique ways to tap into the needs of its customer through advances in field research and design thinking. In an environment where mistakes can be made cheaply and there are no cost or feasibility constraints, a team called the Future Lab is tasked with generating interesting concepts for the company, even though many of them never end up getting launched. Yet, after the idea generation phase, the company ensures that costs of innovation are clear to designers. LEGO has devised rules regarding the creation of new colors, shapes and ordering of new materials. Lesson learned: no boundaries should be placed on idea generation, but strict guidelines limit the chances of creating loss leading toys.
(R&D expenses have moved in-line with Revenues & Profitability)
Small number of suppliers: LEGO strategically chooses to work with a narrower set of suppliers to stabilize pricing. Previously, engineers had one-off relationships with suppliers, ordering specified products from various vendors and leaving tremendous, costly waste in the system.
Focus on large retailers: Cutting out distribution to some of the smaller retailers, the company is able to reduce fulfillment costs and eliminate orders that consist of less than a full carton of bricks. Additionally, the company works closely with large retailers on demand forecasting, inventory management and product customization.
Lesson learned: create financial advantages from scale that improve margins and put pricing pressure on competition.
Proximity of manufacturing facilities: LEGO has built its manufacturing facilities close to core markets allowing LEGO to get products to shelves faster and respond quickly to last minute demands. The company currently has factories in Mexico, Hungary, Czech Republic, and Denmark and is building a facility in China. Lesson learned: use size and financial might to create physical barriers to entry for early stage competitors.
LEGO’s business model had historically been guided by two principles: capacity for innovation and commitment to quality. Ironically, a focus on innovation and quality at no costs actually led to mismanagement of the operating model and a huge drop in profit for the company. As described above, LEGO’s current operating model is set up to create unique competitive advantages that have been critical in enabling LEGO to turn around its financial performance.
Yet despite LEGO’s remarkable turnaround, constant evaluation of operating and business model efficiencies is required. LEGO recently announced that it had failed to foresee a jump in demand in Europe and, as a result, may not be able to meet all orders around Christmas time. Until existing factories are expanded and new factories are built, the company must focus on improving its customer demand forecasting capabilities. Under the current operating model, the company’s sales team meets monthly to adjust order estimates for the coming month based on sales in the prior month – a system that could require analytical improvement. However, as proven by its commitment to adjust operating tactics to meet business model goals, LEGO will likely address this flaw so that “everything remains awesome” for the company in 2016 and beyond.