July 10, 2014 5:55 pm

Lego: King of the castle

Focus on detail and digital expansion have helped the Danish toymaker thrive in a tough market, writes Richard Milne
'The Lego Movie'

No matter how hard Sam Johnson presses down on the spider, the creature known as Sparratus stays together. It was not always so.

In his earlier versions, the plastic spider could withstand the pressure applied by someone like himself, an adult Lego designer from England. But when he gave the prototype to children, things were a little different.

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“They picked it up by the legs! The crazy things kids do,” he says. “We had to make sure kids could push the body all the way down to the floor to put the figure in.”

Much of the six-month development of the $25 Sparratus’ Spider Stalker toy set was spent making sure the legs did not snap off. A solution for wooden floors did not work on carpets until Mr Johnson introduced bricks from more advanced Technic sets. “You can end up falling in love with a brick,” he says.

It is typical of the attention to detail that has propelled the Danish toymaker from the brink of financial collapse a decade ago to the most profitable company in the sector.

The Lego formula appears simple: take plastic costing less than $1 per kilogramme and transform it into sets based on Star Wars, Legends of Chima or The Hobbit retailing for about $75 per kg. But the company’s success – sales enjoyed compound annual growth of more than 20 per cent between 2008 and 2012 – is not just built on the humble plastic brick. It has branched out from toys into video games, board games and, most recently, film, with the highly successful The Lego Movie .

But as children spend more time playing on devices such as iPads and smartphones, Lego faces a big problem that has stalled rivals: can it keep up its stellar growth in an increasingly digital world of play, or will it be trapped by its own recent success?

“I think it’s a really critical question,” says David Robertson, a professor at the University of Pennsylvania’s Wharton School who has written a book on Lego, Brick by Brick . “They really need to find that next big thing. Lego has been pretty good at finding the next little thing but not the next big thing.”

The real problem for Lego was that it did so many experiments in such a short space of time that the capabilities didn’t follow quickly enough

A decade ago the privately owned company – still controlled by the founding Kristiansen family – was having trouble even knowing what the next little thing would be. When Jørgen Vig Knudstorp took over as chief executive in 2004, it was in deep crisis.

The former McKinsey consultant found a company that had lost faith in the brick, dumping its Duplo brand for toddlers and plumping for easier-to-build products such as a character called Jack Stone.

“The real problem for Lego was that it did so many experiments in such a short space of time that the capabilities didn’t follow quickly enough,” says Mr Knudstorp, sitting in his modest office filled with dozens of Lego sets in the Danish town of Billund.

Mr Knudstorp, 45, who retains a boyish air with his spiky hair and glasses, put in place a three-stage plan. The first two years were about survival: assets, such as the Legoland theme parks, were sold off and strict financial controls were introduced.

Once the bleeding stopped, he tried to make the company healthy again in 2006-07 by restructuring manufacturing. The final stage, begun in 2008, was a push for growth. Lego made a big effort in markets where it was under-represented: in the US, as well as emerging markets such as China, Russia and Brazil.

It also launched new product lines. Lego had always been preferred by boys, so it started the Friends range aimed at girls. Despite controversy, it was a big seller. Other successful homegrown launches were Ninjago, based on Japanese warriors, and Legends of Chima, featuring animals fighting in a magical land. Those successes were all the sweeter because Lego does not have to pay the royalty it does for third-party sets such as Star Wars or Harry Potter. It also has full control over the characters, what they look like and can do.

The result of these efforts was a company that made an operating profit of DKr8.3bn last year on sales of DKr25.4bn – up from DKr8bn in 2007 – from a product with global appeal. “Kids in Afghanistan and Jordan, kids in Boston, Beijing and Berlin, they have the same perception of the product. So what we’re dealing with here is one of these few companies in the world that are a bit like Airbus or Boeing or Coke or Pepsi or Apple or Samsung [and] have a global product assortment,” Mr Knudstorp says.

Yet he cautions that the challenges Lego faces today are very similar to the ones a decade ago. “I think one of my huge jobs over the next 20 years is to be able to adjust to globalisation and digitalisation and not be taken hostage by our past success, not being tied by earlier decisions which then limits your ability to adapt to what is required from the future.”

The one thing is that we never leave the physical brick. Our standpoint is that physical play is extremely important

One criticism made of Lego is that it has missed the chance to move decisively into the digital world. Minecraft, a highly popular Lego-like computer game in which players build or destroy virtual landscapes made of building blocks, was instead created by the Swedish start-up Mojang.

Some Lego executives privately regret that they failed to develop such a game but Mr Knudstorp praises Mojang, with whom the toymaker is developing several big Minecraft sets for release later this year. “What we’re finding is that if you are very good at writing books, you are not necessarily the best to turn that book into a great movie. You need somebody who makes movies . . . and in our case we need partners who can translate the physical Lego experience into the digital experience,” he says.

So Lego teamed up with TT Games, a British games developer, to make video games from Lego ranges such as Star Wars and Chima. Many became bestsellers and Lego has had success, too, with online games. It also partnered with Warner Bros to make The Lego Movie, which is the seventh-highest grossing film of the year, generating close to $500m globally.

Mr Knudstorp says Lego will never become a fully digital company: “The one thing is that we never leave the physical brick. Our standpoint is that physical play is extremely important. Then I see digital as an extra experience layer.”

He adds: “I guess we could be closer to a Nike, which is trying to obviously sell a very physical product like a sneaker or golfing equipment but may add an app that improves your golfing performance.”

That digital layer is making Lego’s product launches more complex. When The Lego Movie was released, it was not just the film: construction sets, a video game and a website in partnership with Google all launched at the same time. Such merchandising tie-ins have long been a lucrative part of film releases by Disney and DreamWorks.

“This movie signals they continue to want to expand from a construction toy to a content company. They can leverage that safe brand,” says Prof Robertson.

A sequel to The Lego Movie is set for 2017 but Mr Knudstorp is keen to take it slowly rather than rushing out films based on its various products.

Mr Knudstorp acknowledges that complexity is growing and says he has revamped Lego’s management structure precisely for that, stripping out a whole layer.

But he adds: “I have a little picture of 25 minifigures each turning Chinese plates on a bamboo stick. I show it to the guys and I say: ‘I know it’s difficult. That’s why we spent 20 years learning it and that’s why we are so difficult to imitate.’ So don’t be sorry that we do something that’s very hard to do. It’d be worse if we could only spin one plate.”

One concern today is that history may be repeating itself. Lego were in a mess at the end of the 1990s for several reasons that sound familiar. Prof Robertson points to examples, including a dizzying array of product launches and recruiting workers who lacked sufficient understanding of the company and its culture.

Some of those issues are now returning. Lego’s website lists 30 product ranges, while in February the company said it would focus on increasing staff in Connecticut, London, Shanghai and Singapore.

The big blue hair. That is a bit of a costly element to manufacture to be quite honest but it is also a very special element

Mr Knudstorp says: “I worry about it all the time but I think we are in a very different place.”

First, he points out that all Lego’s growth is self-financed, meaning the payback for investments is quick and a failure is not a disaster. The
Kristiansen family are committed owners.

Second, what he calls “health metrics” – such as customer and retailer satisfaction, shelf positioning, employee motivation – are at “a completely different level” compared with a decade ago. Finally, he says, underlying profitability is far better.

Alook at the recently released Simpsons house, based on the cartoon TV series, shows why. The $200 set includes minifigures of the en­tire family, including mother Marge with her distinctive blue beehive.

“The big blue hair. That is a bit of a costly element to manufacture to be quite honest but it is also a very special element,” he says. “So the designer is basically told: ‘You get that, but in the rest of the set we want to see a fairly standard execution’.” That means the designer needs to use bricks from other sets to keep costs down.

Prof Robertson says DKr1m ($182,600) is the “magic number” for bricks. If a single element – say a red brick with two rows of four studs – makes more than DKr1m in all the sets it is in, the profit rises almost exponentially over that sum; if it sells less than that, a loss is guaranteed.

Growth is slowing at Lego. Sales increased 10 per cent last year, down from the breakneck average of 20 per cent in the previous five years. That is still better than many rivals in a gloomy toy market. Mattel’s sales rose 1 per cent in 2013 while Hasbro’s fell slightly.

Sean McGowan, managing director of equity research at Needham, a New York investment bank and asset manager, praises Lego’s marriage of physical and online play, while cautioning that “brands can be deceptively vulnerable” in a maturing sector.

A character from 'Legends of Chima'

“Western markets are very mature, and Lego have been very successful by growing into other categories beyond basic bricks,” he says. “That expansion gets harder the bigger they get because the total industry isn’t growing.”

Yet Mr Knudstorp views the toy landscape optimistically. Children who play video games still want to play with physical Lego, even in countries that are hard to crack such as China. “I feel very confident about what we’re doing here and I feel I am speaking from a real position of strength,” he says.

“Of course I have to worry about where are the boundaries and are we pushing too much, but I feel we are very ambitious and balanced with where we’re standing.”

Design: From perfection to experimentation

When Lego decided to launch an online game, it spent years planning and perfecting Lego Universe until its launch in 2010. But the game quickly fell flat and was killed off 18 months later, at the cost of about 115 jobs.

Around the same time, Markus Persson, a Swedish games developer, put out a test version of a game that he had developed in his spare time. That game became Minecraft, which is the biggest-selling PC game in history.

Lego executives say they have learnt much from flops such as Universe. “What we have taken away from that is the need to be much more agile in digital propositions,” says John Goodwin, Lego finance director.

“Others put their games out in beta [an early development stage] and constantly reiterate it. That’s not part of our DNA. We have a tendency to want to have perfection by the time it gets into consumer hands.”

Now Lego’s approach to digital is more experimental and designed to get products out more quickly.

To coincide with The Lego Movie, it launched a website with Google called “Build with Chrome” where people can construct whatever they like using digital bricks.

Another example is the recently released Lego Fusion set. Launched in the US in June, they allow children to build two-dimensional models of buildings, castles, racing cars or beach resorts.

Jørgen Vig Knudstorp, Lego's chief executive

They then use an app to capture the model and import it into a 3D digital world where they can play with their own creations.

Ditte Bruun Pedersen, a senior Lego design manager, says: “In our research, we heard repeatedly from parents that they are constantly battling ‘zombie gaze’, the experience when their children are immersed in their device screens for large blocks of time.”

She adds that Fusion tries to give children the gameplay they enjoy with apps as well as reasons to return to the physical bricks.

Jørgen Vig Knudstorp, Lego’s chief executive, says he is happy with Lego’s digital positioning, especially with its video games, the website lego.com and as one of the top three most-watched brands on YouTube.

But he adds: “If you’re good at authoring books, you’re not necessarily good at writing a movie script. That’s our challenge.”

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