Prepare a case study analysis of Case 12: “LEGO Group: An Outsourcing Journey” found in the Cases section of your digital book.
Closely adhere to the Case Study Analysis Template by clicking on the hyperlink. Please utilize this template format for this Assignment. Use titles and subtitles per the format for readability purposes.
Focus upon the idea of the company’s short-term objectives, and through internal and external analyses create functional tactics to support the company’s implementation and outsourcing proposition in order to help move LEGO Group forward. Be sure to include the SWOT analysis as shown in the Appendix of your paper (after the References page).
• Conduct a SWOT analysis on the case study company’s internal and external challenges.
• Create a case study analysis focusing on the company’s internal and external challenges through the development of short-term objectives.
• Design the functional tactics required for the company’s implementation and outsourcing proposition.
In this Assignment on conducting a SWOT analysis on the case study company’s internal and external challenges, you will engage in developing the following professional competency:
• Global awareness
For additional Assignment details see Rubric below Case 12: LEGO Group: An Outsourcing Journey
Marcus Møller Larsen
• 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
PhD Fellow Marcus Møller Larsen, Professor Torben Pedersen and Assistant Professor Dmitrij Slepniov wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.
• 3 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, the LEGO 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 LEGO Group earned DKK11.7 billion in revenues and DKK2.2 billion in profits, and had a workforce of approximately 7,000 employees around the world. 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).
Products and Markets
• 5 The LEGO brick was the company’s main product. 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 problem-solving, 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. 12-212-3
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 12-312-4basis. 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, 12-412-5where 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.
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 LEGO brick. 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; 12-512-6and 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 the LEGO 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.”
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 the LEGO sets, which over the years had grown highly elaborate. One LEGO senior director noted, “This excessive complexity of shapes and colors of LEGO 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 12-612-7distribution 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.
• 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. Assembling and post-packing were the most cost-intensive 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 12-712-8cost-saving rationale. With the majority of the production in high-cost countries, the management saw major potential for cutting costs by relocating production to low-cost 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 in-house, 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 LEGO Group’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. 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 Sony-Ericsson (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 12-812-9(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)