The Lego Group-adopting a strategic approach PDF

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CASE STUDY The LEGO Group: adopting a strategic approach Anders Bille Jensen

The LEGO Group had historically been a successful, family-led, innovative and high-growth company in the global toy industry. However, the company hit some hard times in the 1990s and early 2000s. Following a successful turnaround the company is now on a growth trajectory, requiring ongoing efforts involving many aspects of strategic management. ●

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‘We are again able to present a result which exceeds our imagination.’

Source: Dorling Kindersley

Playing is part of everybody’s childhood. It is fun, educational and important for the development of our individual physical, intellectual and social skills and competences. There are many ways to play, and companies in the global toy industry compete fi ercely and must constantly change to gain and maintain the interest of children and their parents. It was therefore a pleasure for Jørgen Vig Knudstorp,1 CEO of the LEGO Group, when he announced the results for 2012:

Sales amounted to DKK23.4 billion (£2.64bn; $4.04bn; €3.14bn), 2 an increase of 25%, and net profi ts were DKK5.6 billion, up by 35% (see Table 1). In addition, the LEGO Group improved its market share to 8.6%, ranking it third in the global toy market. Sustaining and managing growth remains a key strategic challenge for the 80-yearold LEGO Group. gripping pieces made it possible to build more stable and bigger constructions than before. The public was reluctant to accept them at first, preferring more traditional wooden The LEGO brick – a major factor in the expansion toys than plastic (then a new material). However, the LEGO of the LEGO Group bricks gained in popularity and the basic bricks were supThe company was founded in 1932 in the village of plemented with figures and technical features, such as Billund, Denmark, by Ole Kirk Christiansen. Wooden toys small electronic engines, which extended the playing quickly became the best-selling item, and the company opportunities. The fi rst LEGOLAND theme park was estabtook the name ‘LEGO’ – a conjunction of the Danish words lished in 1968 in Billund. Internationally, the LEGO Group ‘LEg GOdt’ (‘play well’). In 1949 the company started began to grow and the number of employees increased producing early versions of the well-known LEGO plastic from just 65 in 1950 to 1000 in 1970. Even during the bricks. In 1958 the current interlocking principle with economically diffi cult environment of the 1970s and studs and tubes was invented and patented. The tightly 1980s, the LEGO Group continued to be successful by This case study was prepared by Anders Bille Jensen, University of Southern Denmark. It is intended as a basis for class discussion, not as an illustration of good or bad practice. © Anders Bille Jensen 2013. Not to be reproduced or quoted without permission. Thanks to the LEGO Group for contributing to this case. This case has been written based on multiple sources, including literature, TV/radio interviews, the LEGO Group website, internet searches and, not least, interviews with key people at the LEGO Group. Financial figures are based on material from the company’s website, including annual reports, press releases and company history. LEGO and the LEGO logo are trademarks of the LEGO group.

545

THE LEGO GROUP

Table 1 Key financial figures, 2003–12 Financial highlights in Mn DKK Consolidated income statement Revenue Expenses Operating profit Financial income and expenses Restructuring costs, impairment 1 Profit before tax Net profit for the year Consolidated balance sheet Total assets Net assets, discontinuing activities 2 Equity Liabilities Cash flow statement Cash flows from operating activities Investments 3 Cash flows from financing activities Total cash flows Employees Employees, continuing activities Employees, discontinuing activities4 Financial ratios (%) Gross margin Operating margin Net profit margin Return on equity (ROE) Return on invested capital 1 Equity ratio 4

2012

2011

2010

2009

2008

2007

23,405 18,731 16,014 11,661 9,526 8,027 (15,453) (13,065) (10,899) (8,659) (7,522) (6,556) 7,952 5,666 4,973 2,902 2,100 1,471 (430) (124) (84) (15) (248) (35) (22) 7,522 5,542 4,889 2,887 1,852 1,414 5,613 4,160 3,718 2,204 1,352 1,028

2006

2005

2004

7,798 7,027 6,295 (6,393) (6,605) (6,394) 1,405 423 (99) (44) (51) (75) (80) (43) (813) 1,281 329 (987) 1,290 214 (1,800)

2003 6,770 (7,919) (1,148) 88 (455) (1,515) (888)

16,352

12,904

10,972

7,788

6,496

6,009

6,907

7,058

5,160 8,785 1,367 404 2,344 5,160 6,441

9,864 6,488

6,975 5,929

5,473 5,499

3,291 4,497

2,066 4,430

1,679 4,330

1,191 5,716

563 6,495

6,220 1,787 (4,535) (88)

3,828 1,580 (2,519) (233)

3,744 1,200 (3,477) (671)

2,712 1,954 1,258 443 (906) (1,682) 558 128

1,033 399 (467) 592

1,157 316 597 1,925

587 237 (656) 1,570

720 285 (70) 443

989 653 (205) (541)

10,400

9,374

8,365

7,286

5,388

4,199

4,908

5,302 1,322

5,603 1,029

6,535 1,160

71.1 34.0 24.0 66.7 40.2 60.3

70.5 30.2 22.2 66.8 133.4 54.1

72.4 31.1 23.2 84.8 161.2 49.9

70.3 24.9 18.9 82.3 139.5 42.3

66.8 22.0 14.2 72.2 101.8 31.8

65.0 18.1 12.8 71.6 69.7 27.9

64.9 17.0 16.5 147.1 63.6 17.2

58.0 5.4 3.0 44.2 16.2 8.0

57.9 (14.5) (28.6) (131.0) (2.0) 5.9

54.3 (23.7) (13.1) (28.1) (13.5) 26.7

All figures in million DKK Source: Excerpts from highlights in the annual reports 2012 and 2007. Figures have not been reported completely consistently and may not be fully comparable due to omission of specific items and changes in accounting practices 1 2 3 4

Restructuring and impairment costs related to actions taken during the crisis years Including investments in property, plant, equipment and intangible assets LEGOLAND Park employees Excluding a subordinate loan provided by the owners

graduate degree from a business school. After gaining experience in the Swiss subsidiary, Kjeld took over as CEO in 1978 while Godtfred continued serving on the board and remained passionate about the development of the company and its products until his death in 1995. Under Kjeld’s leadership the LEGO brand had become established as a unique and iconic brand. Success had been built on a combination of effective leadership, innovative products and A family-run company international growth. In 1996 the company received the This development was driven by the family from the early IMD ‘Distinguished Family Business Award’. years until the late 1990s. When Ole, the founder, died in 1958 the company was taken over by his son, Godtfred. A difficult time As a junior Vice President, Godtfred had been one of the main driving forces behind the growth of the company for In the mid-1990s Kjeld was planning for the future. some years. Third-generation Kjeld was the first to hold a Growth in electronic toys and changes in playing habits introducing innovative products (e.g. LEGO TECHNIC, and new play themes like LEGO Castle, LEGO Space and LEGO Cowboys). It also took its first steps into new markets, notably the USA, South America and Asia. In 1985 the company employed 5000 people (3000 in Billund). Successful development continued into the early 1990s.

546

THE LEGO GROUP

were a concern. Would kids stop playing with traditional toys? There were, however, also a lot of opportunities which could be based on the existing strong position of the group. Kjeld was also keen on combining initiatives with a new, decentralised management structure, which could take the LEGO Group into the future. In 1995, major new 10-year objectives were set, plans were made, resources allocated and initiatives were launched. The overall objectives were to become the bestknown brand among families with children, to grow sales by 100–200% over a 10-year period, and to establish three or four LEGOLAND parks. The brand would be expanded by entering into alliances with partners in related areas such as fi lms, clothing and games. A new and more decentralised management style was also introduced to strengthen the management of the organisation and make it less dependent on Kjeld. Over the next few years, a number of senior and long-serving managers left, as they disagreed with the new management style and/or with the new strategy. Conversely, new managers and specialists were hired to support the new strategy. The whole expansion plan proved to be too ambitious and resulted in significant problems for the company. Profitability declined and eventually turned into losses; debt increased to a level that threatened the autonomy of the company. The company was facing a crisis. Kjeld realised that the LEGO Group was facing problems which were unfamiliar to the company and its current management. He stepped back and an external chief operating offi cer (COO) was hired. The performance and results of the company continued to fluctuate, showing no consistent development. Kjeld stepped in again at the beginning of 2004 and the COO left the company. At that time, however, outsiders began to question who was running the business: the family, the new managers, or – worst case – the banks? Late that year, Kjeld handed over the CEO position to Jørgen Vig Knudstorp (‘Jørgen’), then a 35-year-old executive Vice President. His relatively young age and his background caused some discussion in the press. However, he had a good track record. Jørgen holds a BA in Economics and a PhD from the University of Aarhus (Denmark). He worked at McKinsey & Co. as a Management Consultant (1998–2001) before joining the LEGO Group as Director, Strategic Development. He was promoted to become Senior Vice President, Corporate Affairs.3 Would he be able to handle the task or would he fail?

Back on track and creating the basic recipe of growth

Table 1 ). The development has been based on a number of interacting and mutually supporting initiatives. Focus on the core business and improvement of the capital structure As a privately owned business the LEGO Group must be able to finance its own activities and service its debt. During the crisis the LEGOLAND parks were (partly) divested, which reduced the debt burden. In addition to these structural initiatives an important element has been the rebirth of the traditional business. The combined effect of debt reduction, growth and improving profitability has resulted in a strong fi nancial position which is clearly seen from the equity ratio,4 which – after paying out dividends – has been doubled since 2008. Focus on sales and distribution As with many other manufacturing companies, the LEGO Group is dependent on retailers. Having attractive brands and products (for end customers) is crucial for leveraging bargaining power towards distribution partners. This dimension is increasingly important as retailers are expanding and consolidating on a global scale. Such partners are big companies such as Toys R Us with turnover in the region of $14 billion, and Wal-mart with sales in the region of $450 billion. Good relations are also important in order to align expectations, obtain market information and finetune sales in both the short and the long run. The LEGO Group actively involves major retailers in the planning of the future product portfolio. As a recent development, direct sales through online channels and brand retail stores have increased to 10% of sales. Focus on cost, quality and supply chain The toy market is highly seasonal with peak sales in the second half of the year (Christmas), which makes production planning a challenge. Many toy manufacturers spend the first half of the year building up stocks of finished goods which are then sold and distributed in the latter half of the year. This is a challenge, as the specifi c composition of the sales is difficult to predict. During the crisis years, the LEGO Group tried to outsource production of the bricks in order to save costs. This soon proved to be a mistake, as quick market feedback, flexibility and fast adjustments in the supply chain were lost as external sourcing partners could not cope. Simultaneously maintaining quality and having an ability to respond to short-term changes in demand are key success factors.

Focus on innovation The LEGO Group became profi table again in 2005 and To stay ahead of the competition and align with changes began a growth journey which has been going on since in children’s playing habits, differences between markets then. Profitability has also increased signifi cantly (see and segments (e.g. boy/girl, geographies and cultures) and

THE LEGO GROUP

technological innovation, a continuous flow of new products is needed. Such products are both classic LEGO products but also launches based on current themes such as new movies. This strategy has paid off as up to 60% of annual sales are from product innovations, most recently ‘Ninjago’ and ‘LEGO Friends’, in addition to product renewals within the ‘LEGO StarWars’ and ‘LEGO City’ assortment. Approximately 160 employees are dedicated to development. The LEGO Group has been very successful in including users through open innovation processes. LEGO users – of all ages and all over the world – are encouraged to add new models based on their own ideas. These proposals are then evaluated by the management and ranked in user panels. The most successful ones are included in the assortment. A new line of products, LEGO Architecture, was initiated by a user interested in constructing famous buildings in LEGO. Further, the LEGO Group won 4 out of 12 awards at the Toy Fair 2013. The combined innovation effort is important to ensure interest from users, high levels of turnover in retail outlets and staying ahead of competitors.

547

Future challenges

Jørgen does not perceive the current, successful position as a final destination, but rather as a starting point for taking on new initiatives to ensure continuous improvements and sustained growth. As the LEGO group is a highly focused company, there are no other product ranges to compensate for any failures. Keeping up performance and growth remains a priority. Just a few years ago many decisions were strongly influenced by fi nancial necessity. Today the LEGO Group has a strong financial position, strong growth and more options than it has had for years. The context of the decisions has changed dramatically, but they are still very important for the future development of the company. Jørgen is thinking about what should guide his strategic decisions. One lesson from the last decade stands out: the LEGO Group has developed a new understanding of its roots, its successes and its failures. The company has decided to stay close to construction toys and develop in this area, applying the ‘obviously LEGO, but never seen before’ principle, refl ecting newness but also a natural recognition and fi t with the LEGO brand. This understanding can only be helpful to a certain Focus on the brand and brick quality Over the years, the LEGO Group has focused on brand extent – multiple markets, products and organisational building and product quality to compensate for the expira- entities require a more fine-grained and systematic tion of patents. At the core of this strategy has been an approach. As Jørgen adds: accumulated knowledge about plastics and production technologies. The results are superior gripping power of ‘The LEGO brick will continue to be our foundation. the bricks and leadership in non-poisonous plastics which In some markets we don’t have a huge presence yet, imitators have not yet been able to achieve. Direct imitation and there our goal is to increase market share by raising and compatible bricks are therefore more a threat to the awareness and attracting new audiences to our prodbrand (as consumers may take inferior imitations for LEGO ucts. Whereas in other markets, for example Germany, products), rather than direct sales threats. we already have a high market share so to increase Not everything, however, has been successful. Entering that we need to cater for new target groups with new the digital scene has been a challenge. A major initiative products.’ – an online multi-player game – called ‘LEGO Universe’, in which players could build, create and play together Taking the refl ections a step further, some of the LEGO via the internet, was launched in 2010 after several Group’s potential strategic challenges are as follows. postponements. It was not very successful and had to be withdrawn again. Other games, however, have sold in Geographical scope and market presence millions. It remains a priority for LEGO to provide offerings Balancing existing and new/high-growth markets remains that facilitate children’s options of moving between the a challenge despite the recent growth taking place in a digital world and the physical construction bricks when broad range of markets. LEGO’s big markets are well estabplaying. lished, but to a certain degree are mature and stagnant The LEGO Group’s overall development, so far, has been markets. Still, doubling the market share in the USA would successful. In a stagnant toy market – some geographical mean signifi cant growth. The Asian region accounts for regions are even declining – the Group has been able to grow approximately 10% of the total sales, and market shares sales from DKK7 billion in 2005 to more than DKK23 billion range from 3 to 25%. Asia and South America require in 2012.5 Product lines include pre-school, traditional bricks, ongoing investments in local organisations and facilities, as play themes, licensed products, robots, games and educa- these are markets where the LEGO Group has only limited tional products. As a result the LEGO Group has an estimated knowledge. Taking the uncertainty in the global market 8.6% share of the global toy market (up from 4.8% in 2008), into consideration, are the speed of growth and the balance ranking it as number three in the market. of markets optimal?

548

THE LEGO GROUP

Handling the growth Further expansion of production in existing and new facilities spread over the world requires significant funds. With a healthy cash fl ow and a good equity ratio, the financial situation is currently not a major concern. However, maintaining a high and successful level of innovation, building capacity and hiring more than 1000 new employees (in 2013 alone) require significant organisational resources and add to the complexity of the group, for example in maintaining quality levels, financial controls and compliance with local laws. Can the organisation cope with this growth? Where – and how – should it be strengthened? Girls – pursuing the growth opportunity Historically, LEGO has had a higher appeal to boys than girls. Over two decades the company has tried several times to adapt its products and communications to girls. After four years of preparation a breakthrough was achieved in 2012. LEGO Friends® (a product range specifi cally aimed at girls) has resulted in significant sales and demand above capacity. Apparently there is a large female market. How should this success be followed up? Navigating in the competitive arena The success of the LEGO Group has not gone unnoticed by its competitors. Recently Mattel and Mega Brands have decided to form a partnership. For girls they have created a ‘playing universe’ which combines the Barbie doll with bricks from Mega Bloks. For boys the combination is to apply the Hot Wheels brand from Mattel with bricks from Mega B...