Case 12: LEGO Group: An Outsourcing
Journey
Marcus Møller Larsen
Torben Pedersen
Dmitrij Slepniov
PROLOGUE
1 The last five years’ rather adventurous journey from 2004 to 2009
had taught the fifth-largest toy-maker in the world—the LEGO Group—
the importance of managing the global supply chain effectively. In
order to survive the largest internal financial crisis in the company’s
roughly 70 years of existence, resulting in a deficit of DKK1.8 billion in
2004, the management had, among many initiatives, decided to
offshore and outsource a major chunk of LEGO’s production to
Flextronics, a large Singaporean electronics manufacturing services
(EMS) provider. In this pursuit of rapid cost-cutting sourcing
advantages, the LEGO Group planned to license out as much as 80 per
cent of its production, besides closing down major parts of the
production in high-cost countries. Confident with the prospects of the
new partnership, the company signed a long-term contract with
Flextronics. “It has been important for us to find the right partner,”
argued Niels Duedahl, a LEGO vice-president, when announcing the
outsourcing collaboration, “and Flextronics is a very professional player
in the market with industry-leading plastics capabilities, the right
capacity and resources in terms of molding, assembly, packaging and
distribution. We know this from looking at the work Flextronics does for
other global companies.”1
2 This decision would eventually prove to have been too hasty,
however. Merely three years after the contracts were
signed, LEGO management announced that it would phase out the
entire sourcing collaboration with Flextronics. In July 2008, the
executive vice-president for the global supply chain, Iqbal Padda,
proclaimed in an official press release, “We have had an intensive and
very valuable cooperation with Flextronics on the relocation of major
parts of our production. As expected, this transition has been
complicated, but throughout the process we have maintained our high
quality level. Jointly we have now come to the conclusion that it is
more optimal for the LEGO Group to manage the global manufacturing
setup ourselves. With this decision the LEGO supply chain will be
developed faster through going for the best, leanest and highest
quality solution at all times.”2
This sudden change in its sourcing strategy posed LEGO management
with a number of caveats. Despite the bright forecasts, the
collaboration did not fulfill the initial expectations, and the company
needed to understand why this had happened. Secondly, what
could LEGO management have done differently? Arguably, with little
prior experience in outsourcing this large amount of production,
the LEGO Group had had a limited knowledge base to draw on to
manage a collaboration like this. Yet, with Flextronics’ size and
experience with original equipment manufacturers (OEMs), this, in
theory, should not have been a problem. Lastly, one could ponder
whether the unsuccessful collaboration with Flextronics had been a
necessary evil for the LEGO Group. LEGO management’s ability to
handle its global production network after the Flextronics collaboration
had surely changed, and aspects like standardization and
documentation had to a much larger extent become valued.
INTRODUCING THE LEGO GROUP: ONLY THE
BEST IS GOOD ENOUGH
4 The LEGO Group’s vision was to “inspire children to explore and
challenge their own creative potential.” Its motto, “Only the Best is
Good Enough,” had stuck with the company since 1932 when Ole Kirk
Christiansen, a Danish carpenter, established the company in the small
town of Billund in Jutland, Denmark, to manufacture his wooden toy
designs. As the company itself said, “It is LEGO philosophy that ‘good
play’ enriches a child’s life—and its subsequent adulthood. With this in
mind, theLEGO Group has developed and marketed a wide range of
products, all founded on the same basic philosophy of learning and
developing—through play.”3 With this simple idea, the company,
through its history, had grown into a major multinational corporation,
and, by 2009, was the world’s fifth-largest manufacturer of toys in
terms of sales. The same year, the LEGOGroup earned DKK11.7 billion
in revenues and DKK2.2 billion in profits, and had a workforce of
approximately 7,000 employees around the world (see Exhibit 1). Its
corporate management consisted, besides the chief executive officer
and the chief financial officer, of four executive vice-presidents with
respective business areas (markets and products; community,
education and direct; corporate centre; and global supply chain)
(see Exhibit 2).
Products and Markets
5 The LEGO brick was the company’s main product (see Exhibit 3).
The iconic brick with the unique principle of interlocking tubes offering
unlimited building possibilities was first introduced in 1958 and had
basically remained unchanged ever since. The underlying philosophy of
the brick was that it would stimulate creative and structured problemsolving, curiosity and imagination. In the company’s own words: “In the
hands of children, the products inspire the unique form of LEGO play
that is fun, creative, engaging, challenging—all at the same time ….
We strive to accomplish this by offering a range of high quality and fun
products centred around our building systems.”4 The simple yet
multifunctional and combinational structure of the brick (there were as
many as 915 million possible combinations to choose from with six
eight-stud LEGO bricks of the same color) had therefore been core to
the company’s history and success. In fact, the LEGO brick had been
rewarded the “Toy of the Century” designation by both Fortune
Magazine and the British Association of Toy Retailers.
EXHIBIT 1: The LEGO Group Financial
Figures
Source: The LEGO Group Annual Report, 2009.
6 To segment the products, however, a number of categories had been
created: First, “pre-school products” comprised products for the
youngest children, who had yet to start school. The LEGO DUPLO
products were examples of this category. Second, the “creative
building” category targeted sets or buckets of traditional LEGO bricks
without building instructions. Third, “play themes” products were the
products that had a particular story as their basis. This could be
themes such as airports, hospitals and racing tracks. The
classic LEGO City line and futuristic BIONICLE theme products were
examples of this category. Fourth, and related to the play themes, were
the “licensed products,” which were built up around movies or books
that the LEGO Group had acquired the rights for, such as Harry Potter,
Star Wars and Indiana Jones. Fifth, “MINDSTORM NXT” was a
programmable robot kit, where consumers could construct and
program robots to perform different tasks and operations. Sixth,
“LEGO Education” comprised products that had been specifically
developed for educational purposes. Last, in 2009 the LEGO Group
made its first move into the board game category with the launch of
the “LEGO Games” product line. The underlying logic of the entire
product portfolio was to reflect the fact that children grow older and
develop, and thus demand more challenging stimulation.
EXHIBIT 2: The LEGO Group Structure
Source: The LEGO Group Annual Report, 2009.
EXHIBIT 3: The LEGO Brick
Source: www.lego.com.
7 LEGO products were sold in more than 130 countries. The largest
single market was the United States, which in 2007 accounted for 30
per cent of the revenue in combination with Australia, New Zealand
and the United Kingdom. Central and Southern Europe represented 27
per cent, while Scandinavia, Benelux, Eastern Europe and Asia
represented 26.5 per cent.
Dealing with a Crisis
8 In 2004, radical changes took place within the LEGO organization as
a consequence of a major internal crisis that drew the company near
bankruptcy. The crisis, which could be traced back to the end of the
1990s, had accumulated with net losses worth DKK888 million and
DKK1.8 billion in 2003 and 2004, respectively. Sales had fallen by 30
per cent in 2003 and 40 per cent in 2004. These results had been the
most disappointing in the history of the company. On average, the toy
maker had made economic losses equivalent to DKK2.2 million per day
in the period from 1998 to 2004.
9 The reasons for the crisis had been many. The immediate
explanation was the company’s general loss of confidence in its core
product—the LEGObrick. With an initiative to create new engines of
growth and to address a decline in the traditional toy
market, LEGO had sought over the last decade to broaden its portfolio
into new, rather discrete areas, including computer games, television
and clothing. This act of diversification had resulted in vast complexity
and inefficiencies, as well as highly confused customers and
employees. For instance, with the surge of licensed products like Harry
Potter and Star Wars, the LEGO Group produced a range of unique
bricks for each single new product. The LEGO Group had at the time
roughly 11,000 suppliers—a number almost twice what Boeing used for
its planes. Unfavorable developments in the global toy market as well
as in the exchange rates of key currencies of important markets had
not made matters easier. As former chief executive officer Kjeld Kirk
Kristiansen argued, “We have been pursuing a strategy which was
based on growth, increase in market shares and growth by focusing on
totally new products. This strategy did not give the expected
results.”5 Moreover, he noted that “we shifted the focus from our actual
core product, which at the same time faced difficulties in a more
competitive and dynamic market.”6
10 In October 2004, Jørgen Vig Knudstorp was appointed as
Kristiansen’s successor. Kristiansen, who was the grandson of the
founder, Ole Kirk Christiansen, had been the president and CEO of
the LEGO Group since 1979. Knudstorp was only the second person
outside the founding family who held the position of CEO, and his
primary task was to steer the company back on track. “I don’t have
any miracle cure,” he explained as to how he would put an end to the
financial turmoil. “LEGO shall first and foremost drop its arrogance. We
have been too sacred with our own virtues, not open enough, and not
willing to listen to what other people say. We shall now listen to
customers and consumers; simply drop the sacredness. We must be
aggressive in the market; work closely with retailers; and
manage LEGO very tightly, also financially.”7 Accordingly, a strategy
titled “Shared Vision” was soon implemented, and was defined around
three core principles:
o • “Be the best at creating value for our customers and sales
channels.”
o • “Refocus on the value we offer our customers.”
o • “Increase operational excellence.”
11 After divesting its theme parks and receiving an extraordinary loan
from the founding family of 800 million DKK, the LEGO Group
embarked on the comprehensive strategy of right-sizing its activities,
its cost base and its many assets. In particular, careful scrutiny of the
organization made theLEGO Group aware of the fact that its ineffective
and inflexible supply chain was a key problem for the creation of a
sound business platform. The degree of organizational complexity on
multiple levels had basically undermined an otherwise sound business
platform. According to Knudstorp: “From my perspective, the supply
chain is a company’s circulation system. You have to fix it to keep the
blood flowing.”8
LEARNING FROM OFFSHORE OUTSOURCING: A
STORY IN THREE PARTS
1. Preparing for Outsourcing
12 A key revelation of the comprehensive analysis that was initiated in
2004 was that urgent transformations in all major areas of the supply
chain were needed. In the development function, the main focus was
to simplify theLEGO sets, which over the years had grown highly
elaborate. One LEGOsenior director noted, “This excessive complexity
of shapes and colors ofLEGO elements that was coming from the
development was badly hitting the supply chain.”9 A major challenge
was to ensure that the right components were constantly in stock.
Significant forecast errors and seasonal demand fluctuations coupled
with customers’ expectations of short delivery times resulted in large
stocks of many different components. The high numbers of
components also required heavy investment in molds. The decision
was therefore made to limit the growth in the number of product
components and then to gradually reduce it. This was not only
supposed to drive costs out of the supply chain, but was also to
prepare the company for the new scenarios of the outsourced
production set-up.
13 In the area of distribution, the analysis uncovered the need for
major changes in how the company approached its retailers.
Describing the situation, a senior director was quoted as saying, “It
was impossible to be efficient and manage the supply chain with the
level of flexibility we had towards all retailers, including the smallest
outlets. We clearly needed to put certain rules here.”10 To manage this,
clearly defined service policies were established. The new policies
distinguished explicitly between different approaches to the retailers
and helped the company to focus more on the large retail chains that
were increasingly gaining dominance in the toy market. This
immediately helped to drive down the cost of distribution, provided a
more reliable overview of demand and, along with reducing
complexity, took some pressure away from the supply chain. Moreover,
the company’s five European distribution facilities (Flensburg and
Hohenwestedt in Germany, Billund in Denmark, and Lyon and
Dunkerque in France) were all centralized in Jirny, 10 kilometres east of
Prague, Czech Republic. Occupying 51,000 square metres, the new
European distribution centre was in full operation at the beginning of
2007 and handled customers in Europe and distribution centres
throughout the world (except North America). The operation was
outsourced to DHL Solutions. In addition, the distribution
of LEGO products in the United States and Canada was outsourced to
Exel Inc., a contract logistics provider operating in Alliance, Texas.
EXHIBIT 4: Production Value Chain
Source: Authors’ own creation.
14 However, no matter how significant the problems were in product
development and distribution, sub-optimizing only those areas without
improving various aspects of the actual production could hardly bring
the company back on track. The LEGO Group’s production value chain
was divided into the following steps: the development of the molding
machine, molding, assembling, pre-packing and post-packing
(see Exhibit 4). Assembling and post-packing were the most costintensive parts of the value chain. Prior to the crisis, the company
owned and operated production plants in Denmark, the United States,
Switzerland, the Czech Republic and South Korea. Allocation of roles
and responsibilities to most of these factories followed a branding
strategy in which one of the Swiss factories only produced DUPLO toys
and another produced Technic products. Furthermore, the Danish
factory only manufactured LEGO System products, while the U.S.
facility predominately served American demands. The vast majority of
the production took place in the Danish and U.S. sites, while roughly
five to 10 per cent of the LEGO Group’s total production was
outsourced to Chinese contract manufacturers.
15 With the new strategic direction of achieving a lighter production
portfolio, however, the company started to look for external partners to
carry out a larger bulk of its production. There were two main strategic
rationales for this. First of all, there was the cost-saving rationale. With
the majority of the production in high-cost countries, the management
saw major potential for cutting costs by relocating production to lowcost countries. “We were basically turning the 50 year old idea that
Denmark and Switzerland were good countries for automatic
production upside down,” recalled Duedahl, a LEGO vice-president.
“The new mantra was: aggressive outsourcing to low-cost countries.”11
16 In spite of the fact that up to 95 per cent of global toy production
was located in China, the LEGO Group decided to avoid relocating
production facilities to Asia and instead emphasized proximity to its
main markets in Europe and the United States. Based on the fact that
the European market accounted for approximately 60 per cent of the
company’s sales, the Czech Republic and Hungary, two low-cost
Eastern European countries, fulfilled both the market proximity and
cost-saving criteria. These countries were supposed to accommodate
most of the capacity transferred from Denmark and Switzerland. In
addition, the decision was made to move the company’s U.S. plant in
Enfield to Mexico in order to supply the North American market, which
constituted approximately 30 per cent of the LEGO Group’s sales.
17 Secondly, with a production of approximately 24 billion bricks per
year, the LEGO Group rationalized sourcing through potential
economies of scale as well as the opportunity to drastically reduce
production complexity by targeting large subcontractors. Thus, besides
scaling down production in Denmark and closing sites in Switzerland
and Korea, it was decided that production should be outsourced to a
number of partners. These included Sonoco (a global manufacturer of
consumer and industrial packaging products and provider of packaging
services); Greiner (a global manufacturer of consumer and industrial
packaging products); Weldenhammer (packaging products and
services); 2B Pack (packaging products and services); and Flextronics
(an electronics manufacturing services company). While the Technic
and Bionicle product lines, to a large extent, were to be retained inhouse, the Duplo and System lines (characterized by their high-volume
production) were predominantly outsourced to Flextronics.
18 Flextronics, a leading multinational electronics manufacturing
services (EMS) provider based in Singapore, had a long history of
offering services to original equipment manufacturers (OEMs), and was
going to be the LEGOGroup’s largest partner in terms of production
undertaken. Flextronics was actually founded in 1969 in Silicon Valley,
California, and became in 1981 the first U.S. manufacturer to formally
start offshoring production by establishing a manufacturing facility in
Singapore. In 1990, however, the company moved its headquarters to
Singapore, and had since succeeded in building a network of
manufacturing facilities in 30 countries on four different continents. By
2009, Flextronics’ net sales were US$31 billion, and it had a workforce
of approximately 160,000 employees (see Exhibit 5). Flextronics’
major clients included large multinational companies like Cisco
Systems (consumer electronics products), Hewlett-Packard Company
(inkjet printers and storage devices), Microsoft Corporation (computer
peripherals and consumer electronics gaming products) and SonyEricsson (cellular phones). The company had focused its segments into
six core areas—automotive, computing, industrial, infrastructure,
medical, and mobile and consumer—and it operated with five business
units that consisted of “strategic technologies and augmented services
that are leveraged across all segments and customer product
categories to create scalability and to add flexibility and speed to our
segments.”12 The five business units were Multek (multi-layer printed
and flexible circuit boards, interconnected technologies and complex
display technologies); Vista Point Technologies (unique product
solutions for camera modules); Global Services (logistics, reverse
logistics and repair operations); FlexPower (design and manufacturing
of semi-custom and custom power supplies and battery chargers); and
Retail Technological Services (competitive and flexible field services for
customer operations) (see Exhibit 6 for Flextronics’ service model).
EXHIBIT 5: Flextronics in Brief
o • $31 billion in annual sales
o • 160,000+ employees worldwide
o • 120,000 employees in Asia (90,000 in China)
o • Operating in 30 countries
o • 27 million square feet of capacity (nine industrial parks)
o • Large customers: Casio, Cisco Systems, Dell, Eastman Kodak,
Ericsson, Hewlett-Packard, Microsoft, Motorola, Research in
Motion, Sony, Sony-Ericsson, Sun Microsystems, and Xerox.
Source: www.flextronics.com.
2. A Troubled Marriage
19 Following the decision to outsource major parts of production to
Flextronics, a contract with Flextronics was finalized in June 2006. This
was, according to the Danish company, a “brilliant idea,” as it locked
the prices over a long period and thus eliminated the risk of production
price fluctuations. In the period from 2004 to 2006, the following were
outsourced to Flextronics: parts of the production facilities’ capacity in
Denmark andSwitzerland were relocated to Flextronics’ plants in
Nyíregyháza and Sarvar, Hungary; the operating control of
the LEGO Group’s Kladno site in the Czech Republic was handed over
to Flextronics; and the Enfield plant in the United States was closed in
favour of using Flextronics’ newly opened site in Juárez, Mexico.
Throughout the transition phase, the LEGO Group was working
intensely towards reducing its in-house production capacity from 90 to
95 per cent to the set target of approximately 20 per cent. Actually,
the 20 per cent target had never been a strategic goal in itself. “It is
very difficult to give such an estimate,” a LEGO vice-president
explained. “Right from the beginning, the 80/20 per cent
[outsourcing/in-house] ratio was more a communication way. What we
have decided is that there are two competences that we need to keep
in-house in Billund; that is, molding and packing competences.
Whether it is 20 or 10 per cent of production it doesn’t matter; what
matters is that in the future we will still be able to do what we are
doing from the production point of view.”13
EXHIBIT 6: Flextronics’ Service Model
Source: www.flextronics.com
20 Flextronics had indeed been the LEGO Group’s preferred partner to
undertake this task. Because of Flextronics’ long history and vast
experience in standardizing and documenting work routines and
processes to move business activities from site to
site, LEGO management was convinced that Flextronics would excel in
reducing the complexity of theLEGO production and organization in
general. Knudtrup commented after ramping up the collaboration: “We
have come to know Flextronics as a very professional partner in
connection with the outsourcing of our DUPLO products, which has
taken place over the past year. They understand and appreciate the
unique values that LEGO products represent, not least the importance
of quality and safety which are fundamental to the good play
experience.”14 In an equal manner, Matt Ryan, executive vice-president
of Flextronics’ worldwide operations, stated that the relationship “is
characterized by intense supply chain collaboration that provides
strategic and efficient cost-savings to help improve the company’s
competitive market positioning. We are excited to expand our
partnership with theLEGO Group as this allows Flextronics further
market diversification and enhanced plastic molding capabilities in lowcost regions.”15 A large part of Flextronics’ motivation for getting into
business with the LEGO Group had thus been its interest in getting
more competencies and knowledge about plastics, which constituted
an important part of its electronics manufacturing activities.
21 However, the collaboration did not last for long. Despite LEGO’s
goal of optimizing its global supply chain, the outsourcing collaboration
was cancelled after merely three years. As became evident, the result
of attempting to manage and overcome the complexity of the
production network by outsourcing it to external providers was actually
only a more complex global manufacturing footprint. In particular, the
collaboration with Flextronics presented the LEGO Group with some
rather daunting and unexpected challenges. Considering the extreme
pace of the transition, it eventually turned out problematic for LEGO to
coordinate and control the increasingly global and complex network of
production facilities as well as to ensure a reliable and seamless
transfer of production knowledge between the two. For example, there
was the challenge of aligning the LEGOproducts’ seasonal fluctuations
and unpredictable demand with Flextronics’ business model. About 60
per cent of the LEGO production was made in the second half of the
year, the product had an average lifespan of 16 to 18 months, and the
demand uncertainty fluctuated with plus or minus 30 per cent.
The LEGO Group’s need for flexible and market-responsive business
solutions presented a strategic misfit with Flextronics’ more stable and
predictable operations in which economies o…
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