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LEGO: Moving into Asia1+2

The Asian expansion

To maintain the growth that the Danish toy manufacturer, LEGO, has experienced over the past 10

years, LEGO wants to move further into the ASIAN and, in particular, the Chinese market.

To meet the Chinese challenge, the CEO, Jørgen Vig Knudstorp, considers a number of alternative

designs for the organization. Lego China could be an independent division or it could be integrated

into the global functional structure. Given that China is different, what leadership style would be

appropriate; what incentives will work well; how is information shared or not; can the existing IT

system be extended to China or is a new approach required? Jorgen wants to know his alternatives

and provide a well-considered answer for his Chinese challenge.

In September 2014, the LEGO group reported an 11% increase in revenues for the first six months

of the year. Compared to the previous year, the revenues increased from DKK 10.4 billion to

DKK11.5 billion (2.01 billion Dollars). LEGO Group thereby took the top spot as the biggest toy

manufacturer in the world, surpassing the American toy manufacturer, Mattel, Inc., who reported

net sales of 2 billion Dollars in the same period.

Although Asia has generally been a relatively small market for the LEGO Group, contributing

about 10 per cent of revenues in 20133, it is a region with very high growth in sales. In the first half

of 2013 alone, the sales to consumers in Asia rose by more than 35 % compared with a 4 % growth

in North America, and an 8 % growth in Europe. Much of the growth in the Asian market came

from a 70 % sales increase in China - one of the world’s fastest growing economies.

As early as in 2012, The LEGO Group management stated that “the Asian markets would be their

focus areas in the following years”4. This was further supported in 2013, when the LEGO Group

1 The case was developed and written by Mathias Pihl, Richard M. Burton, Børge Obel and Dorthe Døjbak Håkonsson 2 The case has been written as a basis for class discussion. The case cannot be used as an endorsement for organizing the LEGO group or illustration of effective or ineffective management. 3 ”Lego to Boost China Sales With Local Factories Supplying to Asia”, Pooja Thakur, www.bloomberg.com 4 Annual Report 2012, LEGO Group

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announced their plans to build a new factory in Jiaxing, China, about 100 km from Shanghai. The

new factory is expected to be ready for operation in 2017 and will employ approximately 2.000

people. It will produce solely for the Asian market and will be part of the LEGO Group’s strategy to

place production close to its markets. This factory is expected to supply approximately 70-80 % of

LEGO products sold in Asia in 2017. At the moment, LEGO sets in China cost about twice as much

as in the U.S. due to import and distribution cost, but the new factory is expected to decrease the

price by about 20 %.

The new factory will be located close to the LEGO Group’s new main office in Shanghai, which

was inaugurated in 2014. Jørgen Vig Knudstorp has said that;

“The new main office in Shanghai, our current main office in Singapore, and the establishment of

our own manufacturing here in China, are all testaments to our firm commitment to establish a

solid presence in China and Asia”5.

“The Jiaxing factory decision” has been made. However, the China Lego organization is not yet

set, and there remain many questions for Jørgen Vig Knudstorp and challenges for LEGO.

The reason for the new office is mainly LEGO’s desire to develop a better understanding of the

Chinese culture and become better suited to do business in the country. A better understanding of

the culture will lead to a better understanding of the taste of the Chinese children. This knowledge

will help the company develop new products for Asia’s rapidly growing middle class.

The LEGO Group’s commitment to the Asian market is reflected not only in the opening of new

offices and factories, but also in the changes made in its governance. At the LEGO Group’s General

Assembly in 2013, Jan Nielsen was elected member of the board of LEGO. Nielsen had since 2011

been living in Hong Kong, working as a partner for Blackstone and been responsible for expanding

Blackstone’s presence in Asia. His experience and knowledge of the region fit very well with

LEGO’s strategy of making Asia a new core market. He was previously Member of the Board for

Merlin Entertainments Group, owned by Blackstone. He has also managed visitor attractions and

supplied the LEGOLAND theme parks with knowledge of the LEGO brand (LEGO’s parent

company owns 30% of Merlin).

5 ”New office in Shanghai reinforces LEGO Group commitment to Asia”, Roar Rude Trangbæk, www.lego.com

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The history of the LEGO Group

The LEGO Group was founded in the Danish town of Billund in 1932 by carpenter Ole Kirk

Kristiansen who began producing wooden toys. The name “LEGO” is an abbreviation of the Danish

phrase “leg godt” meaning “play well”. It was later realized that the word means “I put together” in

Latin, fitting perfectly to the products that the LEGO Group would later be known for.

In 1946, Kristiansen spent his revenue from the past two years on a plastic injection-molding

machine with the intention of expanding production to plastic toys6. Three years later, the LEGO

Group began producing their first Automatic Binding Bricks, which were inspired by classic

wooden building blocks. The bricks were made in plastic and with studs that made it possible to

snap the bricks together. After experimenting with different designs through the years, the modern

LEGO stud-and-tube coupling system was finally patented in 1958.

The LEGO Group completely stopped the production of wooden toys in 1960, focusing solely on

the LEGO plastic brick. The following years were spent on developing new products and expanding

to new markets, laying the foundation of success. The company grew from 140 employees in

Billund in 1958, to a total of 2.500 employees in 1976.

In 1977, Kjeld Kirk Kristiansen, the grandson of Ole Kirk Kristiansen, joined the LEGO Group

management. A year later, he presented his “System within a System” development model, which

split production into product ranges and lines. In 1978, they initiated the production of the iconic

LEGO mini figure, which introduced the Moving LEGO. The popularity of LEGO surged the

following 15 years, with an increase in revenues from 142 million dollars in 1978 to more than 1.2

billion dollars in 19937 and 8.880 employees worldwide in 1994. This is, however, about the time

when the problems first started for the LEGO Group.

The competition in the toy market began to increase with the arrival of cheaper, Chinese-produced

toys. The LEGO Group started adding more varieties to its product lines with little effect on the

total sales, but with significant increases in the cost of production and distribution.

The 90’s also saw the rise of the relatively new market of video games and computer games, which

drew the attention of many young children. Kids began, at an earlier age, to spend more time

6 ”Building success: how thinking ’inside the brick’ saved Lego”; David Robertson, October 10, 2013 7 ”Building success: how thinking ’inside the brick’ saved Lego”; David Robertson, October 10, 2013

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playing video games in stead of playing with traditional toys; this posed a threat to the revenues for

all toy companies, including LEGO.

From Crisis to Success

Things weren’t looking very good for the LEGO Group in 2003. The company reported a pre-tax

loss of 1.5 billion Danish kroner (0.25 billion Dollars) for the year, compared with a pre-tax profit

of 0.617 billion Danish kroner (0.10 billion Dollars) in 20028.

The great fall in earnings could largely be ascribed to a 26 % fall in net sales, from 11.426 billion

Danish kroner in 2002 to 8.433 billion Danish kroner in 20039.

During these years, the LEGO Group had been able to keep its head above water largely from high

sales of products lines such as Bionicle, LEGO®, Star Wars, and LEGO Harry Potter, the latter two

product lines were produced through licensing agreements with Lucas film Ltd. and Warner

Brothers, respectively. With no new movie releases, neither in the Star Wars series nor the Harry

Potter series, the sales of these two product lines fell sharply, accounting for more than 50% of the

total fall in sales10.

In 2002, the LEGO Group had replaced the well-known LEGO DUPLO brand with a new product

line aimed at pre-school children, named LEGO EXPLORE. The new product line was not well

received by customers with a fall in sales of pre-school systems by 37 %. In 2002, The LEGO

Group also launched the Galidor product line in the United States. These products were based on

the science-fiction TV-series of the same name, which were partly funded by the LEGO Group. The

Galidor products were the LEGO Groups attempt to launch their own line of action figures. With

practically no resemblance to the traditional LEGO figures, consumers showed very little interest in

the products line – a huge failure and canceled shortly after. Unfortunately for LEGO, Galidor was

not the only failed product line in that period. Other product lines, that did not meet expectations,

include: Znap (1998-1999), Primo (1995-1999) and Jack Stone (2001-2003).

8 Annual Report 2006, LEGO Group 9 Annual Report 2003, LEGO Group 10 Annual Report 2003, LEGO Group

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In 2004, CEO Kjeld Kirk Kristiansen decided to step down and was replaced by Vice President of

Strategic Development, Jørgen Vig Knudstorp. Knudstorp was a former McKinsey consultant and

had been working at LEGO since 2001. At the age of 34, he suddenly went from managing 6-8

people to managing the LEGO Group with approximately 10.000 employees11.

After the disastrous result of 2003, the LEGO Group knew that they had to make some big changes

in their organization.

Turnaround

Only after the announcement of Jørgen Vig Knudstorp as CEO, in 2004, did the LEGO Group start

to see a consistent growth in profits. In early 2004, they launched a new Action Plan that would be

the foundation of their return to a profitable and well-driven firm. The Action Plan contained three

central elements:

“Set clear direction for the LEGO Group and fundamentally change the way to do business”

“Restore competitiveness by focusing on customers, and in particular the LEGO group’s

profitability”

“Reduce the level of risk by right sizing activities, cost base and assets to a lower revenue

base”12

As part of the Action Plan, the LEGO Group decided to improve its liquidity and financial base by

selling off the LEGOLAND theme parks. This decision was part of a plan to return the LEGO

Group’s focus on its core competencies and the classic LEGO brick. In order to focus on reducing

the time spent on developing new LEGO products, the LEGO Group transferred projects such as

electronic games and movie-production to licensed partners. Previously, LEGO would spend up to

24 months from the idea of a new product to the finished product was ready for retail. They realized

that this was too long in a toy market that was rapidly changing, and decided to set a target for

development time of 12 months for its products. These organizational changes were part of a series

of initiatives meant to cut costs and improve the way that the LEGO Group did business, which also

meant a reduction in workforce by approximately 1.000 employees.

11 http://www.au.dk/en/annualcelebration/annual-celebration-2014/the-aarhus-university-distinguished-alumnus/ 12 Annual Report 2004, LEGO Group

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The Action Plan would, in LEGO’s own words;

“…produce a smaller, but financially stronger and more streamlined Group, ready to deal with a

low-growth industry and product category”13.

It also brought about a change in the organizational structure and leadership of the LEGO Group.

The number of market areas was reduced from three to two while the leadership team went from

nine to six people, consisting of Knudstorp (CEO) and Jesper Ovesen (CFO) and four department

heads. The purpose of this restructuring was to create a simpler and customer-oriented organization.

The geographical distribution of LEGO was affected by the Action Plan. In 2005, to increase

efficiency and decrease costs, the leadership team decided to move production from Switzerland to

the Eastern Europe and to centralize their European distribution centers in the Czech Republic. For

the same reason, the production of certain product lines, for example Bionicle and DUPLO (which

had been reinstalled in 2004), was outsourced to other firms. Then in 2006, the LEGO Group also

decided to close down their factory in the US, moving production for the American market to

Mexico, where the cost of production was lower.

Communicating with fans

One of the three fundamental parts of the Action Plan 2004 was a greater focus on customers. The

FIRST LEGO League arranged robots building competitions using the LEGO Mindstorms

products. The LEGO Club. which communicated with its members through a website and a

members’ magazine, launched the LEGOfactory.com website in 2004 and the LEGO Ambassador

program in 2005. These two new initiatives marked a more mutual communication between the

LEGO Group and its customers. Through the LEGOfactory.com website, LEGO fans could share

their designs with each other, and even build 3-D LEGO models using a special software

application. A few of the best LEGO models would then get the opportunity to be mass produced

and sold, awarding the designer with a 5% royalty on each set sold.

Although the original target group of the LEGO products was children, the LEGO Group also noted

that there was a growing number of adult LEGO fans. These enthusiasts called themselves

“AFOL’s” (Adult Fans of LEGO), and were sharing new ideas and designs with each other through

the Internet. To get in better contact with these people and exchange thoughts and ideas, the LEGO 13 Annual Report 2004, LEGO Group

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Group came up with its worldwide LEGO Ambassador program to communicate with

representatives (ambassadors) of the different AFOL communities from all around the planet. These

ambassadors would then provide the LEGO Group with feedback on the current products and

possible concepts for new LEGO sets.

Restructuring for new challenges

In 2011, the LEGO Group announced its first big restructuring since 2005. the LEGO Group had

been making changes in its organization to deal with the heavy losses it was experiencing, but

things were different now. The number of employees had almost tripled from 3.500 to 10.000 while

revenue had increased from 6.300 billion Kroner to over 16.000 billion Kroner. It was time to

discard the old structure and adopt a new one that was better suited for dealing with the current

challenges and opportunities of the LEGO Group, or as CEO Jørgen Vig Knudstorp formulated it;

“While our current set up has successfully led to the past years’ superior performance it is now

timely to adapt our organization to tackle key challenges and prevent that our vigorous growth

creates complicatedness and an unhealthy culture where productivity and thus competitiveness is

reduced,“14

The most noticeable change was the expansion of Corporate Management from 6 people to a team

of 22 members. The plan was to reduce the number of layers in the organization, in order to make

decision making simple and fast as well as increasing the communication and collaboration between

business units. This would also be made possible by empowering the members of Corporate

Management and enabling them to make critical decisions, about which Knudstorp said :

“We are not merely putting people into new boxes. This is a lifestyle change, where we ask the

entire organization and thus all employees to take a step up. The move will simplify the structure of

the company and empower business units in order for us to respond faster and collaborate better to

increase innovative solutions to new challenges,”15

The restructuring also brought about a change in the organizational structure. While there was an

increase in the size of Corporate Management, the number of business areas was reduced from five

14 “LEGO Group expands top management”, Roar Rude Trangbæk, www.lego.com 15 “LEGO Group expands top management”, Roar Rude Trangbæk, www.lego.com

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to three. Previously, the LEGO Group consisted of Global Supply Chain, Markets & Product,

Community, Education & Direct, Corporate Center and Corporate Finance. Now the LEGO Group

centered its business on Operations (production, packaging, and distribution), Marketing (sales,

marketing operations, and product development) and Business Enabling (responsible for supporting

the overall business)16. According to the LEGO Group, the new structure would leave the

organization more adaptive and capable of experimenting and learning “…in a systematic,

disciplined creativity…”

About a year later, in 2012, the LEGO Group announced a change in top management, as former

President of Global Braun (a subsidiary of P&G), John Goodwin took the place as LEGO Groups

new CFO. Goodwin’s experience in international management and leadership in a global

organization was decisive for his appointment as new CFO17.

The large growth in revenues could partly be attributed to the huge success of The LEGO Movie, a

computer animated film based on the LEGO mini figures and building bricks produced by Warner

Animation Group, the animation division of Warner Bros. The movie was a hit among both viewers

and critics, and was followed by the release of a new well-received product line featuring the

characters, buildings, and vehicles from the movie.

Even though the story of the LEGO Group seems like a story of success, all the expansions and

streamlining may finally be taking its toll on the employees. Measures of the satisfaction of the

employees fell from around 2011 to 201318. The employees say that they feel stressed and that they

are under a constant pressure for improving and meeting expectations. Some fear that the LEGO

Group might risk losing their healthy work culture in their hunt for market share and profit.

China as the basis for continued growth

The previous yeas of success have, to some extent, saturated the traditional markets. To continue

growth, the LEGO Group could develop new types of toys to extend its current markets or go to

new markets. The development of new types of toys has been tried before with little success. The

16 See exhibit 3 17 ”LEGO Group appoints John Goodwin as CFO”, lego.com 18 ”Lego-ansatte presset af den økonomiske succes”, Lone Andersen, finans.dk

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LEGO Group therefore found that continued growth should be found in Asia and in particular in the

Chinese markets.

”Asia is not a supply base, it’s a market, and a growing market. The urbanization where 500

million people are going to become members of a middle class that will look to great schools, great

infrastructure but also play as an important part of childhood” said CEO Joergen Vig Knudstorp19

China, in particular, could be a The LEGO Group hotbed. The company’s famed ability to help kids

express their creativity could strike a chord with newly-affluent parents seeking every possible

advantage for their kids.

"We are now significantly putting the flag on the Chinese market and in the society. We want to be

part of the modernization of China." Knudstorp said.20

The plant, in the city of Jiaxing, 100 kilometers from Shanghai, will be the company's third-largest

plant worldwide, employing 1,500 workers when it is fully operational by 2017. It will cover an

area of 315,000 square meters with the establishment of molding, decoration and packaging

facilities. At the site there is room for further expansion.

The LEGO Group will also set up a distribution center in Shanghai for the Asia markets. Some of

the output of the Jiaxing factory will be exported to other markets including Japan and South Korea.

The Jiaxing facility will be built to the same global standard as all the LEGO Group factories in the

world and will not deliberately produce cheaper products to attract more mainland consumers21.

The rising middle-class in China could be a key driver for the LEGO Group's global business as the

number of middle-class consumers on the mainland is estimated to reach 400 million by 2020.

Questions:

Evaluate the organizational changes that were made in 2011: Did the changes make sense in

terms of the challenges at that time? In terms of the multi contingency diamond model did The

19 http://qz.com/131355/lego-looks-to-expand-in-china-the-land-of-lego-knock-offs/ 20 http://www.scmp.com/business/companies/article/1498472/lego-builds-presence-china-toy-market 21 http://www.scmp.com/business/companies/article/1498472/lego-builds-presence-china-toy-market

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LEGO Group find a fit solution? How well did the implemented solution work? What would

you have done differently?

Will the expansion into Asia and in particular into China require changes in the organizational

design of the LEGO Group? What is the environment in China? What is the culture? What is

the leadership style? Is it compatible with the Danish style? Will the Danish incentive scheme

work in China for Chinese managers and workers? What is the organizational climate for the

average Chinese firm? How will LEGO China deal with suppliers?

Review the challenges for Jørgen Vig Knudstorp as outlined in the beginning of the Lego case

and provide advice to Knudstorp on what LEGO should do.

There is additional information on the LEGO Group in Burton, Obel and Håkonsson (2015).

Additionally, you may search for additional public information about Lego on the web and other

sources.

Burton, R. M., Obel, B., & Håkonsson D. (2015). Organizational design: A step-by-step approach.

Cambridge University Press. Third edition.

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Timeline

The early days:

1932: The LEGO company is founded

1949: The first “Automatic Binding Bricks” are ready for the market

1958: The well-known LEGO brick is patented

1968: The first LEGOLAND theme park opens in Billund, Denmark

1978: The first LEGO mini figures are launched

1979: Kjeld Kirk Kristiansen, grandson of Ole Kirk Christiansen, becomes CEO of the company

1993: LEGO starts producing children’s clothing under license by the clothing company Kabooki

1997: The first LEGO video game, LEGO Island, is released

2002: LEGO make a partnership with the production and distribution company Miramax, to

develop and distribute three movies based on the Bionicle product line

The crisis:

2003: LEGO Group reports a pre-tax loss of 1.5 billion Danish kroner (0.25 billion Dollars)

2004: Kjeld Kirk Kristiansen steps down as CEO, and is replaced by Jørgen Vig Knudstorp

Turn around:

2004: Introducing the Action Plan

2005: Outsourcing and streamlining the production

2005: Selling off majority holding in LEGOLAND

Building on the success

2011: LEGO announces a new organizational Structure

2013: LEGO Group announces their plans to build a LEGO factory in China

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2014: LEGO Group becomes the world’s largest toy manufacturer, after taking the spot from

Mattel, Inc.

Exhibit 1: Financial data for LEGO Group. Source: LEGO Group Annual Reports 2007-2013

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Exhibit 2: Net profit of LEGO Group. Source: LEGO Group Annual Reports 2004-2013

-3000

-2000

-1000

0

1000

2000

3000

4000

5000

6000

7000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

mD

KK

LEGO Group net profit

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Exhibit 3: LEGO Group organizational chart. Source: The LEGO Group, A short

presentation 2014

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Exhibit 4: A LEGO brick. Source: lego.com

Exhibit 5: A LEGO mini figure. Source: http://www.ibrickcity.com/lego-60016-city-tank-

truck/