For this post, I am sharing with you the individual paper that I wrote for my Global Operations and Supply Chain Management class in IE Business School. The instruction from the professor was "to scan the recent press, to select a news message and prepare a written analysis and interpretation of what had happened".
What follows is the paper on Lego that I wrote. Happy reading!
 |
| Who doesn't love Lego? |
For
close to 70 years, Lego experienced steady growth. In 1998, the company started
losing money due to a series of unsuccessful diversification efforts (apparel,
theme parks and video games to name a few). By 2003, sales had dropped by 35
percent in the US and 29 percent worldwide, culminating a year later in the
biggest loss in the company’s history: £217 million.[1]
This prompted the company to embark on a restructuring program, one that would
see: 1) Kjeld Kirk Kristiansen, grandson of the man who invented the iconic
Lego block, step down as CEO and be replaced by Jorgen Vig Knudstorp; 2) Lego
selling off parts of the business that it deemed to be non-essential to the
core product including properties in the US, South Korea and Australia, its
four Legoland amusement parks, and its videogames development division; and 3) Lego
deciding to offshore and outsource majority of its production to Flextronics, a
large Singaporean electronics manufacturing services provider.
The
third item, which was announced in June 2006, was deemed by Lego to be the
“last major step in our process of restructuring of the group’s supply chain.”[2] The
outsourcing was seen at the time by Lego as a step to improve competitiveness
through cost reduction: “In the course of the last decade, competition on the
toy market has, however, intensified considerably, and the need for cost
reductions has increased in order to ensure future profitability.”[3]
However, just two years later, on July 2008, it was announced that Lego would
end the partnership and bring back production in-house. The partnership was
considered valuable but complicated by Iqbal
Padda, Lego’s Executive Vice President for Global Supply Chain:
“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 set up ourselves.”[4]
This
surprising turn of events would appear to show that Lego was too hasty in its
initial decision to outsource production. What could have promoted this
turnaround within Lego and what lessons can be learned from this piece of news?
Looking
deeper at the situation, the decision to outsource was actually the last step
in the process to restructure Lego’s supply chain. Lego actually were facing
several problems including: 1) majority of its production centers were located
in high-cost countries; 2) having a complex product portfolio; 3) poor in-house
supply chain that had problems in sourcing, manufacturing and distribution.
To
me, the main problem of Lego appeared to be that it had not evolved its supply
chain to match with the times. In the past, the toy industry was much simpler.
There was less competition for the attention (and dollars) of kids, toy
retailing was focused on smaller toy stores instead of larger chains and
discount stores and Lego products were simpler and less complex. As competition
grew in the form of more kinds of toys and also other non-traditional toys like
video games, Lego ventured into creating more product lines and more complex playsets,
including venturing into licensing of highly seasonal characters like Star
Wars. However, Lego did not adapt its supply chain and its lead engineers and designers
continued to add more and more product components to its production lines. This
meant that Lego had to invest heavily in creating more molds and as more and
more components entered the chain, it became more and more difficult to
forecast demand. This resulted in Lego keeping more and more stock, which quickly
became a costly and unprofitable exercise.
Lego
also dealt with a lot of suppliers, more than 11,000 in all.[5]
There was very few procurement procedures in place which meant engineers each
used their own preferred set of suppliers whenever new products or projects
were being developed. The same problem existed in manufacturing where each
production team operated like an independent toy shop. This independent spirit
was borne by Lego’s desire to push for more innovation. However, it made it
difficult to leverage Lego’s size and enjoy economies of scale.
Lego
was also ill equipped to properly handle the shift from retailing at small toy
stores to larger chains like Walmart and Toys R Us. With decentralized
distribution and poor forecasting in place, Lego could not properly fill orders
with these large retailers and eventually lost space to competitors who could
meet the stricter and shorter lead times required. Lego had also always kept to
the principle of keeping its manufacturing centers close to its main markets.
While other toy manufacturers had begun outsourcing manufacturing to Asia,
especially to China, Lego had resisted for this strategic reason. This,
however, meant higher fixed costs and higher capital requirements for
expansion.
To
address these problems, Lego tightened control of several elements of the
supply chain. They began by limiting the number of new components that entered
the production process. This was done mainly by challenging engineers and
designers to look for creative ways to reuse existing components. The goal was
to eventually reduce the number of new components being produced. Also, a
program was put into place to make sourcing of materials more strategic. The
roster of suppliers was narrowed resulting in the stabilization of prices.
Lego
also looked to standardize and improve their distribution. Where in the past,
they were very flexible even towards the smaller retailers (for instance they
allowed orders that consisted of less than a full carton which resulted in
labor intensive “pick packing” at distribution centers), now they had put into
place stricter rules on the level of servicing that retailers got with the
greatest focus being given to only the largest retailers. This helped to drive
down cost of distribution and provided a more reliable overview of demand. With
the reduced complexity, it helped relieve some pressure from the supply chain.
Distribution was also centralized, for instance, Lego’s five European
distribution facilities (scattered across Germany, France and Denmark) were
centralized in Prague. The operation was also outsourced to DHL.
On
the manufacturing front, Lego looked to shift production facilities from
Denmark and Switzerland, to lower cost countries. However, Lego wanted to
maintain proximity to their main markets of Europe and the United States. As
such, European manufacturing was moved to Czech Republic and Hungary, while US
manufacturing was moved from Enfield (USA) to Mexico.
This
lay the ground work for the final step: outsourcing production. Flextronics was
selected as a partner and over the next few months, control of the
manufacturing facilities was handed over to them. However, Lego still wanted to
retain control over two essential parts, molding and packing which was retained
in Billund, Denmark. The goal of outsourcing was for Lego to be able to reduce
costs and at the same time learn from Flextronics expertise in reducing
complexity and improving organization in general.
On
paper, the partnership should have worked. It had worked well for other toy
manufacturers. Why did Lego terminate the partnership? One reason is that
Flextronics was a company that specialized in producing more functional
products. Its supply chains were geared more towards achieving maximum
efficiency and economies of scale. This was not very well suited for the toy
industry where products were highly innovative and seasonal. Toy seasonality
skewed heavily towards the peak holiday period with products only having a
lifespan of 16 to 18 months. Demand also fluctuated heavily. Lego needed a
supply chain partner that had expertise in being flexible and market-responsive
which was not exactly what Flextronics were capable of.
Another
reason is that it was much more difficult to shift competencies to Flextronics
than previously expected. Flextronics had a lot of expertise as a manufacturer
of electronics, but little as a manufacturer of toys. The great demands brought
about by increased competition and the changing landscape put a great deal of
pressure to make the transition speedy and hassle free, something that did not
happen.
Lastly,
all of this happened within the same period as the toy recalls that were
occurring at rivals such as Mattel. Although Lego had deliberately avoided
China for strategic reasons, outsourcing of production meant relinquishing
control. As we have seen at Mattel, even the most reliable and trustworthy of
partners can let you down. Theoretically, retaining control would also enable
Lego to become much more flexible and adaptable to market changes. Information
would also flow freely since there would be no fear of information and designs
being leaked to competitors.
Looking
at Lego’s annual report for 2007 sheds some more light as to why the
partnership did not work: “In the course of 2006 and 2007, the outsourcing
turned out to be more cost-consuming and more complicated than anticipated at
the adoption of the plan. This is seen in, for example, a higher need for IT
integration between the parties than expected.”[6]
Taking the statement into account, it becomes more apparent to me that the
outsourcing activity was done without properly taking into account the greater
company strategy. It appears that outsourcing was done mainly for the cost-savings
it would generate. When this did not materialize or meet expectations, Lego
quickly decided to return manufacturing into the fold.
I
think Lego is a peculiar case where insourcing manufacturing made more sense
than outsourcing it. It has to do with the strategic fit that insourcing had
with Lego’s fine-tuned and improved supply chain and the overall business
culture that pushed for creativity and innovation. Lego believed that
insourcing would prove to be much more flexible and responsive to Lego’s
innovative product line. It would also afford Lego more control over the
process which meant greater efficiency. Although insourcing may not be the right
answer for other companies, the lessons learned from Lego’s situation,
particularly how they were able to learn from their mistakes and turn around
the business by adapting their supply chain to the changing landscape, are
lessons that can and should be applied elsewhere.
[1] Delingpole,
James. “When Lego Lost Its Head”. Daily Mail. 18 December 2009. http://www.dailymail.co.uk/home/moslive/article-1234465/When-Lego-lost-head--toy-story-got-happy-ending.html. Last
accessed on 14 July 2014.
[2] Olson,
Parmy. “Billionaire’s Lego Farms Out To Flextronics”. Forbes. 20 June 2006. http://www.forbes.com/2006/06/20/lego-group-restructuring-cx_po_0620autofacescan05.html. Last
accessed on 14 July 2014.
[3] Lego Annual
Report 2006.
[4] Lego
Corporate Website. 1 July 2008. http://aboutus.lego.com/sv-se/news-room/2008/july/lego-group-changing-production-set-up/. Last
accessed on 15 July 2014.
[5] Oliver,
Keith. “Rebuilding Lego, Brick by Brick”. Strategy + Business. 29 August 2007. http://www.strategy-business.com/article/07306?pg=all. Last
accessed 14 July 2014.
[6] Lego Annual
Report 2007.