As one of the largest toy makers in the world, the LEGO Group has been riding high in America and Western Europe. To grow, however, LEGO recently faced a decision familiar to many other multinationals: should the company shift from manufacturing in a few sites in Europe and North America, and build a factory in a low-cost location in Asia?
Such a move over the next five to seven years would be full of risk, especially considering LEGO has had a checkered history of expansion—one such effort almost led to bankruptcy. So Harvard Business School Assistant Professor Anette Mikes knew she had a unique opportunity to study strategy in the making when she headed to the company's Denmark headquarters last year.
The case study The LEGO Group: Envisioning Risks in Asia, coauthored with HBS research associate Dominique Hamel, vividly details sitting in on the toy maker's scenario-planning meeting, where top execs tested whether the current business model was robust enough for the challenges lying ahead.
While LEGO has sold toys in Asia for three decades, there is serious potential to improve market share and maybe even outgrow North America and Western Europe, which together accounted for 72 percent of all LEGO sales in 2011.
"LEGO is a huge success story in Western Europe and America," Mikes says. "The question is will they be able to repeat this success story in Asia?"
The company is a fascinating business study for its extreme ups and downs. Founded in 1932 by Danish carpenter Ole Kirk Kristiansen, the family-owned company grew over the decades, moving from wooden toys to plastic "bricks," the building blocks of its construction sets. The products are designed around play themes such as urban landmarks, trains, and undersea exploration. LEGO also licenses properties from blockbuster films such as Star Wars and Harry Potter.
“It's really easy for them to be nimble and meet demand”
LEGO's ambition has at times exceeded its reach. By 2004, the company's overdiversification into theme parks, book publishing, and specialized toys sparked a colossal tumble. A recapitalization of the company led to a fairy-tale rebound as the group returned to selling its core building sets. LEGO earned $1.0 billion as sales approached $3.5 billion in 2011, and in 2012, it overtook Hasbro as the world's second-largest toy manufacturer.
What's The Scenario?
To sharpen its "Stepping Up in Asia" strategy, LEGO executives employed scenario planning as a key tool to weigh potential outcomes. The technique, which has been around since the 1960s, fell out of favor in recent decades. In his 1994 book, Rise and Fall of Strategic Planning, Henry Mintzberg argued that strategic planning techniques (such as scenario planning) do not work well for organizations because they typically fail to engage business managers and remain detached from everyday action.
But Mikes says the popularity of scenario planning is reemerging, as companies navigate the uncertainty in global markets and a diminishing control in their environments generally. For companies to "break through the illusion of certainty," she says, they must embrace imaginative, creative thinking to better prepare for the future, with scenario planning being one important tool to foster that.
While teaching the case, Mikes asked students to participate in their own scenario- planning exercise, deciding actions to take in Asia if they ran LEGO. Importantly, students had to figure out what to do with the scenarios they came up with. Would they bet on one of the scenarios? Would they exert influence to shape the environment? Or would they try to hedge?
"They had to imagine themselves making a decision," Mikes says. "I asked them to be the CEO: 'Now that these scenarios have been presented to you, what are you going to do next?' "
Assessing The Risks
Both the managers and the students had to consider areas of potential risk for LEGO in Asia, including:
Uncertainty of market growth forecasts. LEGO senior director John Kelley argues in the case that to supply the most optimistic sales forecasts in Asia, the company would need to build costly new capacity for warehousing, packing, and—possibly—molding. But what if demand never came despite the expense?
LEGO's director of strategic risk management, Hans Laessøe, pointed out the uncertainty of even short-term global demand forecasts. Out of the 20 themes launched by LEGO each year, it is likely that one will fall short of forecast by 50 percent while another sells twice what was expected. "We just don't know in advance which ones will be those two," he said.
On the plus side, LEGO's strength is flexible production. "If SKU2 is doing well but SKU7 is failing, all they need to do is repackage the bricks into the boxes of the one that's selling really well," Mikes says. "It's really easy for them to be nimble and meet demand."
The risks of product acceptance. LEGO's standard is to create global products, with 95 percent standardization and only 5 percent variation in its boxes, mainly in packaging—to suit local shoppers' tastes. The trick is to keep this high degree of standardization while creating new global themes with appeal in the various Asian markets.
Products that are big hits in the West are not always hits in Asia, Mikes says. Introducing more localized products coupled with licensing agreements linked to specific movie franchises might be an option, but an expensive one. The company also had to consider that "diminishing play time and the threat of a disruptive educational product innovation could be our biggest risk in Asia," as one LEGO executive put it.
Uncertainties of Asian retail. Many Asian countries lack a developed retail network. And while big chains like Walmart and Tesco are growing in China, the country still relies on many small retailers, few of which use common operations metrics such as margins and stock turnovers that drive LEGO's business model.
Senior distribution manager Asger Juncher Métais said the group should assume that all retailers want quick lead times and fast stock turnover, capabilities where LEGO is strong. The company can provide Asian retailers with a stock turn of six, while competitors could only offer three. However, LEGO offers a 30-35 percent margin to retailers, compared to competing brands offering 40-50 percent margins. What if local retailers wanted the higher margins and could care less about turnover?
Outsourcing risks. With limited real estate in Asia, many local retailers operate with low inventory and depend on LEGO for just-in-time delivery. The company could build molding factories in Asia to shorten lead times and improve efficiency, but pushing down production costs is not a primary driver for LEGO, which enjoys high margins on its products. The company's main priority is quick response to retailer demand. Outsourcing is another possibility, but a previous partnership with Flextronics was a poor match—LEGO eventually moved most production back in-house. Another option, Mikes says, is "they can build local warehouses, packing and distribution centers. Initially, they don't have to make a big commitment to a huge factory, although if demand exceeds forecasts, they may have to."
Time For Decisions
Back in the classroom, after engaging in scenario planning, the students decided that LEGO should put more resources on the ground in China, commit to localization efforts, and continue to introduce products like Ninjago that have global appeal. When Mikes followed up with LEGO, she realized that the managers "were largely moving in the same direction."
Mikes emphasizes that it's critical to understand what scenario planning can and can't do. While scenario planning can't forecast the future, the outcomes from its exercises help managers assign task forces around the necessary actions implied by the scenarios and create early warning indicators that can highlight the emergence of one scenario or another, giving the company a head start on the competition.
"Where we come out on this is that there are situations where scenarios can be useful," Mikes says. "But to make this a truly useful exercise there has to be real business engagement and follow-up. There can't just be stargazing and blue-sky thinking."
The company's recent history, she adds, makes it particularly cautious today.
"LEGO was burned very badly in the past," Mikes says. "They are humble enough to be wary of becoming complacent, as many successful companies do."