Innovation Under Constraint: Constructing a Turnaround at Lego

Lego has been helping children piece together dreams and develop imaginations for decades, becoming one of the world’s most popular brands in the process. But the company lost its way in the 1990s and has stood on the brink of bankruptcy a few times since. Professor Jan Rivkin discusses his case study of Lego and how it innovates to meet the changing needs of young users in the digital age.

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Podcast Transcript

Edited for length and clarity.

Brian Kenny: According to Time magazine, just six Lego blocks can be combined in 103 million ways. The name Lego comes from two Danish words that mean "play well," and so they have —the colorful building blocks have remained a top seller since hitting stores shelves in 1949, flexing and adapting in an ever-changing landscape of toys. Today, we'll hear from Professor Jan Rivkin about his case entitled Lego: The Crisis, co-written with Stefan Thomke and Daniela Beyersdorfer. I'm your host, Brian Kenny, and you're listening to Cold Call.

Professor Rivkin is an expert in business strategy whose teaching and research examines the interactions across functional and product boundaries within a firm, and that sounds perfectly suited to our conversation today. Jan, welcome.

Jan Rivkin: Thank you, Brian. It's a pleasure to be here.

Kenny: I can't imagine there are many people who don't know the name Lego. Probably, most didn't know that it means "play well," which I think is a great little insight that comes from the case. And the Latin translation of that is?

Rivkin: “I assemble.”

Kenny: So, just start us off by telling us how does the case begin? Where do we start?

Rivkin: Sure, as the curtain rises on the case in 2004, Lego stands on the brink of bankruptcy. It looks certain that this iconic toymaker will be taken over by Hasbro, or Mattel, or some other large company, or maybe a private equity shop that will break it down into pieces, and Jorn vig Knudstorp, a fresh-faced 36-year-old has just been given the helm of the company, and he has one last shot to save the company. It is do or die.

Kenny: What prompted you to write this case? You played with Legos as a child, I assume, as many of us did.

Rivkin: I played as a child and I played with my kids, and sometimes I still play with them. Sometimes I share with the kids as well. My co-author on this case is Stefan Thomke and Stefan and I had the opportunity to get to know the Lego executives. We were interested in the company for a while, and they were interested in Harvard Business School, as well. So, we had an exchange with their CEO, and with the head of North America, and one of our alums who works at Lego, and they were interested in perhaps understanding more about what they might learn from Harvard Business School. They invited us out first to their North American headquarters in Connecticut, and then onward to the headquarters in Denmark.

Kenny: What was that like? Did you get to see behind the scenes as they make these, the bricks?

Rivkin: It was magnificent going into the Lego factory. Imagine a half-kilometer-long factory filled with injection molding machines, every few seconds churning out new Lego bricks. It was like going into Willy Wonka's factory. I kept looking for the oompa loompas.

Kenny: That's great. Many people probably don't realize that Lego is part of an enormous, ever-changing toy industry. Can you talk about the landscape that the case takes place in?

Rivkin: Yes, that is one of the first things the students discuss when we teach this case. They're looking at Lego on the brink of bankruptcy and asking, "Is this an industry problem? Is it a problem with the company's position? Is it somehow a change in the industry that has undermined the company's position?” And I don't want to ruin the case discussion, but I will say that not all is well in toyland as the case opens There are changes in the customers. There is a threat of substitution. There are threats of new entry. Kids’ play habits are changing in ways that make the industry as a whole more challenging, but also in ways that particularly undermine the Lego value proposition.

Kenny: Which is?

Rivkin: It’s an interesting question. For Lego, there's a combination of construction and play and education, as well. The company views itself as not simply being a toymaker. They realize, of course, kids love their product and they are making toys, but they also think of themselves in terms of making a difference in the creativity and imagination of children.

Kenny: Can you talk about the origins of the company? It goes way back, 1916, Ole Christiansen.

Rivkin: If ever there were a company with humble origins, it would be Lego. It starts with Ole Christiansen in 1916. He's a carpenter, opens a wood-working shop in rural Denmark. It is not until the 1930's when he actually adds toys. He starts with furniture and household products and his son, Gottfried, is actually the one who gets them in, first into plastic in the late 1940's. Legend has it that he was on a ship traveling with a purchasing agent for department stores and other stores and this agent complained that there was no systematic way of thinking about toys. The toys departments were a mess in stores. That got Gottfried thinking about a system of play which is what led to the Lego system.

Kenny: Break down the system for us.

Rivkin: It all goes back to the brick. Because each brick is interlocking with each other, and because the bricks have been the same sizes since, I believe, the 1950s, each brick can combine with others in many, many ways. As you mentioned at the outset, very quickly, with a handful of bricks, you've got an astronomical number of ways to make a toy.

Kenny: They stuck with their original model for a long time. Change was hard to come by. I loved the insight that it took 15 years to introduce a green brick into the mix.

Rivkin: The family owners were very resistant to any sort of change.

Kenny: Talk about the culture of the company as they grew and expanded and really came into their own.

Rivkin: Going into, say, the 1990s, the company had decades of success. They literally had to limit how quickly they wanted to grow and it was a culture of investment in new products, but really not so much discipline around thinking about how they would react to the future if the market were to change. There was an assumption that they would grow at a pace that they dictated, and the market would buy as many Lego bricks as they could produce. But then, market conditions started to turn in the 1990s, the early 1990s. There was a decline in birth rates in their core markets in Europe and North America. There was a change in the retail situation as mom-and-pop stores gave way to discount retailers who started to charge lower and lower prices for toys, including Legos. The big players like Hasbro and Mattel pushed production to the Far East while Lego was still very much a Danish company. Kids’ play habits changed. Kids had less time for structured play, they were more attracted toward electronic products, their attention spans seemed to have gotten smaller, and all of these things probably made it hard for any traditional toymaker, but particularly for Lego.

Kenny: So, Lego chose to respond in some interesting ways. When they started to face these challenges, they began to extend the brand into different lines of business.

Rivkin: What is really helpful from a teaching perspective about the Lego story is there were actually two efforts to turn around the company prior to the one in 2004. Moreover, each of those efforts, on their face, had some things about it that made sense. The first effort, starting around 1993, was to extend the brand of the products. They looked to other companies with great brands like Disney, and said, "Look, Disney is in so many things. The product line we're currently in seems to have stagnated. What makes sense? Let's take that core asset of the brand and expand into diversity of products." So, they opened amusement parks. They started making video game software, children's clothing, wristwatches. Moreover, in the bricks themselves, they responded to children apparently having less time to play by making it easier to get through the stage of constructing the products and get more quickly to the stage where you play with it. On the surface, these things all made sense. But, in fact, they led to disastrous outcomes. So, a key part of the class discussion is to understand why these things, that on their surface look reasonable, backfired in this context.

The second attempt at a turnaround was bringing in a mister fix-it who did many of the things that you would expect someone to do, right? The restructuring of the organizations bringing in a series of layoffs, streamlining production, producing layers, moving managers around more often, moving design centers out of sleepy old Billund in Denmark into London, Milan, and San Francisco, consolidating the sales force. They start to sell directly to customers. Take that last move, selling directly. It kind of makes sense, right? The retail situation is getting tougher. The mom-and-pop stores are going out of business. You're having to sell through the Walmarts of the world. Surely, it makes sense to go direct to the customer.

Kenny: You've got other brands that have done it. Apple has made that move. Disney has made that move.

Rivkin: Yeah, and once again, this turns deeply, deeply south and so the case discussion centers on why do these things that, on their surface, seem to make some sense, not make sense in this context?

The last part of the case discussion has students struggle to put together a plan to turn the company around. They are put in the position of Jorn, and asked what would they do, and they've got to make decisions about every single function of the company. How will the product line change? How will marketing change? How will sales change? How will they approach their retail partners differently? How might they manufacture differently? To do all that, they'll have to change how they prefer inputs, how they hire people, who they hire, how they train them, and how they manage the company. So, it really is a challenge to come up with an integrated strategic option that will respond to the challenges in the marketplace, will make use of what is unique about Lego, and will avoid the mistakes that the previous two efforts, which seemed sensible, fell into.

Kenny: So, you put the students to work on that. Do you find that there are any students that you have in class who are unfamiliar with Legos?

Rivkin: I cannot remember ever having the student who did not know Lego. Right now, they calculate they serve roughly 80 million children, which is only a small fraction of the world's population of children. But I think among the students, among the children who wind up coming to our business school, we've got a large share who are Lego fans.

Kenny: That's good, so they all feel a connection to the case and so forth.

Rivkin: They do, and we try to reinforce it. Have I shown you the Lego Baker Library?

Kenny: I've seen that; I've seen it in your office. Describe that for our listeners.

Rivkin: The designers at Lego were very, very gracious. Near the end of the case-writing process, they sent to us a Lego model of Baker Library [at Harvard Business School]. It is remarkably detailed. There are features of the library that I had not noticed in walking by the library for two decades until I saw it on the model.

Kenny: We might have to put some pictures of that on the podcast website.

Rivkin: I would be delighted to share my model. At some point, it will be bequeathed to Baker Library itself.

Kenny: Be really careful, I guess. Don't bump into that either; you don't want to take down a wing of the library inadvertently.

Rivkin: So, it turns out that the model is, in fact, glued together.

Kenny: They didn't trust you.

Rivkin: The other thing, you know, I'll share with you, Brian, is (I don't think he'd mind) it turns out that the executives of Lego have unique business cards. They are Lego mini-figures that look like them. And have their names and contact information on the mini-figure itself.

Kenny: That's fabulous. That's great branding, carrying it all the way through.

Rivkin: It is.

Kenny: Can you talk a little bit about the way that Lego, as a culture, manages innovation? People familiar with the toys might just say, “Well these things haven't changed forever. It's the same toy.” You mentioned the system and how it works, but in fact there's a strong innovation engine within Lego.

Rivkin: It is innovation within certain constraints. Each year, roughly 60 percent of Lego sales come from products that are brand new. On the other hand, zero percent of their products, roughly, come from components, or pieces, that are brand new, right, they're the same bricks. And so they need an innovation system that allows them to innovate within the constraints of using the same things. They're also very careful to separate out different types of innovation. They have a very small group that thinks about brand new, out-of-the-box things, but they've got a larger group which thinks about, “Wow, will we create the next Lego brick-based product for our core customer?” They also have engaged in a bit of open innovation. There are large numbers of adult fans of Legos, so called AFOL, adult fans of Lego, who because they love the product, are innovating with the product all the time, and they've got a system by which they reach out to those users of Legos to bring in new innovations. If people are innovating with your products, you know, voluntarily, you'd be nuts not to learn from that innovation.

Kenny: So, the future is bright. They continue to be, by the way, one of the top-selling toys. In fact, on eBay, they were among the top 10 toys that people are reselling consistently.

Rivkin: After the turnaround, their returns skyrocketed quickly, above one 100 percent return invested capital, and they've seen very rapid growth, which continues to this day, so far.

Kenny: You can find this case in the HBS Case Collection at HBR.org. I'm Brian Kenny and you're listening to Cold Call, the official podcast of Harvard Business School.

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Podcast Transcript

Edited for length and clarity.

Brian Kenny: According to Time magazine, just six Lego blocks can be combined in 103 million ways. The name Lego comes from two Danish words that mean "play well," and so they have —the colorful building blocks have remained a top seller since hitting stores shelves in 1949, flexing and adapting in an ever-changing landscape of toys. Today, we'll hear from Professor Jan Rivkin about his case entitled Lego: The Crisis, co-written with Stefan Thomke and Daniela Beyersdorfer. I'm your host, Brian Kenny, and you're listening to Cold Call.

Professor Rivkin is an expert in business strategy whose teaching and research examines the interactions across functional and product boundaries within a firm, and that sounds perfectly suited to our conversation today. Jan, welcome.

Jan Rivkin: Thank you, Brian. It's a pleasure to be here.

Kenny: I can't imagine there are many people who don't know the name Lego. Probably, most didn't know that it means "play well," which I think is a great little insight that comes from the case. And the Latin translation of that is?

Rivkin: “I assemble.”

Kenny: So, just start us off by telling us how does the case begin? Where do we start?

Rivkin: Sure, as the curtain rises on the case in 2004, Lego stands on the brink of bankruptcy. It looks certain that this iconic toymaker will be taken over by Hasbro, or Mattel, or some other large company, or maybe a private equity shop that will break it down into pieces, and Jorn vig Knudstorp, a fresh-faced 36-year-old has just been given the helm of the company, and he has one last shot to save the company. It is do or die.

Kenny: What prompted you to write this case? You played with Legos as a child, I assume, as many of us did.

Rivkin: I played as a child and I played with my kids, and sometimes I still play with them. Sometimes I share with the kids as well. My co-author on this case is Stefan Thomke and Stefan and I had the opportunity to get to know the Lego executives. We were interested in the company for a while, and they were interested in Harvard Business School, as well. So, we had an exchange with their CEO, and with the head of North America, and one of our alums who works at Lego, and they were interested in perhaps understanding more about what they might learn from Harvard Business School. They invited us out first to their North American headquarters in Connecticut, and then onward to the headquarters in Denmark.

Kenny: What was that like? Did you get to see behind the scenes as they make these, the bricks?

Rivkin: It was magnificent going into the Lego factory. Imagine a half-kilometer-long factory filled with injection molding machines, every few seconds churning out new Lego bricks. It was like going into Willy Wonka's factory. I kept looking for the oompa loompas.

Kenny: That's great. Many people probably don't realize that Lego is part of an enormous, ever-changing toy industry. Can you talk about the landscape that the case takes place in?

Rivkin: Yes, that is one of the first things the students discuss when we teach this case. They're looking at Lego on the brink of bankruptcy and asking, "Is this an industry problem? Is it a problem with the company's position? Is it somehow a change in the industry that has undermined the company's position?” And I don't want to ruin the case discussion, but I will say that not all is well in toyland as the case opens There are changes in the customers. There is a threat of substitution. There are threats of new entry. Kids’ play habits are changing in ways that make the industry as a whole more challenging, but also in ways that particularly undermine the Lego value proposition.

Kenny: Which is?

Rivkin: It’s an interesting question. For Lego, there's a combination of construction and play and education, as well. The company views itself as not simply being a toymaker. They realize, of course, kids love their product and they are making toys, but they also think of themselves in terms of making a difference in the creativity and imagination of children.

Kenny: Can you talk about the origins of the company? It goes way back, 1916, Ole Christiansen.

Rivkin: If ever there were a company with humble origins, it would be Lego. It starts with Ole Christiansen in 1916. He's a carpenter, opens a wood-working shop in rural Denmark. It is not until the 1930's when he actually adds toys. He starts with furniture and household products and his son, Gottfried, is actually the one who gets them in, first into plastic in the late 1940's. Legend has it that he was on a ship traveling with a purchasing agent for department stores and other stores and this agent complained that there was no systematic way of thinking about toys. The toys departments were a mess in stores. That got Gottfried thinking about a system of play which is what led to the Lego system.

Kenny: Break down the system for us.

Rivkin: It all goes back to the brick. Because each brick is interlocking with each other, and because the bricks have been the same sizes since, I believe, the 1950s, each brick can combine with others in many, many ways. As you mentioned at the outset, very quickly, with a handful of bricks, you've got an astronomical number of ways to make a toy.

Kenny: They stuck with their original model for a long time. Change was hard to come by. I loved the insight that it took 15 years to introduce a green brick into the mix.

Rivkin: The family owners were very resistant to any sort of change.

Kenny: Talk about the culture of the company as they grew and expanded and really came into their own.

Rivkin: Going into, say, the 1990s, the company had decades of success. They literally had to limit how quickly they wanted to grow and it was a culture of investment in new products, but really not so much discipline around thinking about how they would react to the future if the market were to change. There was an assumption that they would grow at a pace that they dictated, and the market would buy as many Lego bricks as they could produce. But then, market conditions started to turn in the 1990s, the early 1990s. There was a decline in birth rates in their core markets in Europe and North America. There was a change in the retail situation as mom-and-pop stores gave way to discount retailers who started to charge lower and lower prices for toys, including Legos. The big players like Hasbro and Mattel pushed production to the Far East while Lego was still very much a Danish company. Kids’ play habits changed. Kids had less time for structured play, they were more attracted toward electronic products, their attention spans seemed to have gotten smaller, and all of these things probably made it hard for any traditional toymaker, but particularly for Lego.

Kenny: So, Lego chose to respond in some interesting ways. When they started to face these challenges, they began to extend the brand into different lines of business.

Rivkin: What is really helpful from a teaching perspective about the Lego story is there were actually two efforts to turn around the company prior to the one in 2004. Moreover, each of those efforts, on their face, had some things about it that made sense. The first effort, starting around 1993, was to extend the brand of the products. They looked to other companies with great brands like Disney, and said, "Look, Disney is in so many things. The product line we're currently in seems to have stagnated. What makes sense? Let's take that core asset of the brand and expand into diversity of products." So, they opened amusement parks. They started making video game software, children's clothing, wristwatches. Moreover, in the bricks themselves, they responded to children apparently having less time to play by making it easier to get through the stage of constructing the products and get more quickly to the stage where you play with it. On the surface, these things all made sense. But, in fact, they led to disastrous outcomes. So, a key part of the class discussion is to understand why these things, that on their surface look reasonable, backfired in this context.

The second attempt at a turnaround was bringing in a mister fix-it who did many of the things that you would expect someone to do, right? The restructuring of the organizations bringing in a series of layoffs, streamlining production, producing layers, moving managers around more often, moving design centers out of sleepy old Billund in Denmark into London, Milan, and San Francisco, consolidating the sales force. They start to sell directly to customers. Take that last move, selling directly. It kind of makes sense, right? The retail situation is getting tougher. The mom-and-pop stores are going out of business. You're having to sell through the Walmarts of the world. Surely, it makes sense to go direct to the customer.

Kenny: You've got other brands that have done it. Apple has made that move. Disney has made that move.

Rivkin: Yeah, and once again, this turns deeply, deeply south and so the case discussion centers on why do these things that, on their surface, seem to make some sense, not make sense in this context?

The last part of the case discussion has students struggle to put together a plan to turn the company around. They are put in the position of Jorn, and asked what would they do, and they've got to make decisions about every single function of the company. How will the product line change? How will marketing change? How will sales change? How will they approach their retail partners differently? How might they manufacture differently? To do all that, they'll have to change how they prefer inputs, how they hire people, who they hire, how they train them, and how they manage the company. So, it really is a challenge to come up with an integrated strategic option that will respond to the challenges in the marketplace, will make use of what is unique about Lego, and will avoid the mistakes that the previous two efforts, which seemed sensible, fell into.

Kenny: So, you put the students to work on that. Do you find that there are any students that you have in class who are unfamiliar with Legos?

Rivkin: I cannot remember ever having the student who did not know Lego. Right now, they calculate they serve roughly 80 million children, which is only a small fraction of the world's population of children. But I think among the students, among the children who wind up coming to our business school, we've got a large share who are Lego fans.

Kenny: That's good, so they all feel a connection to the case and so forth.

Rivkin: They do, and we try to reinforce it. Have I shown you the Lego Baker Library?

Kenny: I've seen that; I've seen it in your office. Describe that for our listeners.

Rivkin: The designers at Lego were very, very gracious. Near the end of the case-writing process, they sent to us a Lego model of Baker Library [at Harvard Business School]. It is remarkably detailed. There are features of the library that I had not noticed in walking by the library for two decades until I saw it on the model.

Kenny: We might have to put some pictures of that on the podcast website.

Rivkin: I would be delighted to share my model. At some point, it will be bequeathed to Baker Library itself.

Kenny: Be really careful, I guess. Don't bump into that either; you don't want to take down a wing of the library inadvertently.

Rivkin: So, it turns out that the model is, in fact, glued together.

Kenny: They didn't trust you.

Rivkin: The other thing, you know, I'll share with you, Brian, is (I don't think he'd mind) it turns out that the executives of Lego have unique business cards. They are Lego mini-figures that look like them. And have their names and contact information on the mini-figure itself.

Kenny: That's fabulous. That's great branding, carrying it all the way through.

Rivkin: It is.

Kenny: Can you talk a little bit about the way that Lego, as a culture, manages innovation? People familiar with the toys might just say, “Well these things haven't changed forever. It's the same toy.” You mentioned the system and how it works, but in fact there's a strong innovation engine within Lego.

Rivkin: It is innovation within certain constraints. Each year, roughly 60 percent of Lego sales come from products that are brand new. On the other hand, zero percent of their products, roughly, come from components, or pieces, that are brand new, right, they're the same bricks. And so they need an innovation system that allows them to innovate within the constraints of using the same things. They're also very careful to separate out different types of innovation. They have a very small group that thinks about brand new, out-of-the-box things, but they've got a larger group which thinks about, “Wow, will we create the next Lego brick-based product for our core customer?” They also have engaged in a bit of open innovation. There are large numbers of adult fans of Legos, so called AFOL, adult fans of Lego, who because they love the product, are innovating with the product all the time, and they've got a system by which they reach out to those users of Legos to bring in new innovations. If people are innovating with your products, you know, voluntarily, you'd be nuts not to learn from that innovation.

Kenny: So, the future is bright. They continue to be, by the way, one of the top-selling toys. In fact, on eBay, they were among the top 10 toys that people are reselling consistently.

Rivkin: After the turnaround, their returns skyrocketed quickly, above one 100 percent return invested capital, and they've seen very rapid growth, which continues to this day, so far.

Kenny: You can find this case in the HBS Case Collection at HBR.org. I'm Brian Kenny and you're listening to Cold Call, the official podcast of Harvard Business School.

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