Emily Lai BA 453. LEGO Case

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1 Emily Lai BA 453 LEGO Case With the loss of its patent, numerous threats from rivals, and recent lawsuits, the notorious building-block toy maker LEGOs, must find a way to sustain its competitive advantage and continue its heritage of success into the future. There are a few strategies the privately-owned company can take including creating an economically-priced product line, optimizing their inventory management and supply chain, continuing to secure license agreements, and creating relationships with schools. Although LEGOs has enjoyed a history of success, its legal challenges portrayed by the PESTEL (Appendix A) include its expiration of its patent and loss of its building-block trademark which have both diminished their competitive position. Due to these factors, big players in the toy industry such as Hasbro and MEGA Brands were able to create building blocks similar and even compatible to LEGO s. The barriers to entry in the building-block subset has lowered substantially and entering the buildingbrick toy market as a big company with economies of scale is attractive. With LEGO s being priced higher than their competitors, they may start losing market share especially with MEGA Brands already owning 25% of the North American market. Aside from an increase in substitutes for the building-block toys, consumers also have many other products their children can turn to from tablets, to smartphones, and other types making threat of substitutes very high (Appendix B). A strategy LEGOs can take is focusing on an integration positioning. In the past, they were using differentiation and had the ability to with their patent. Their product was unique, the blocks had the perfect clutch power, and could not be replicated or sold legally until Due to this, owning the manufacturing equipment, and having licensing deals with entertainment franchises, LEGO s enjoyed the ability to price their products relatively high while building a loyal customer base. Their past strategy also involved securing licensing deals and releasing new series and themes consistently; their biggest success in licensing was seen with the Star Wars kits. As seen in their strengths (Appendix C), LEGO had a strong brand image and won Toy of the Century, reflecting their successes in consistently being a recognized toy in past years. Today however, their competitive advantage is diminishing as they are easier to imitate and no longer meet the VRIO factor. Luckily, LEGOs has been vertically integrated for some time and has the ability to control their production giving them some management of their costs. As seen in their financials (Appendix D), LEGO has a huge gross margin that has continued to increase to 72.5% in the recent year of Together, by managing costs and optimizing operations, LEGOs can refocus on volume and being the biggest market share holder in the building-blocks sections, while having competitive pricing with its rivals. Although the gross margin of 72.5% is large, LEGOs seems to have many costs as their operating margin is 31.1% for 2010 (Appendix D). This vast gap is explained through labor costs, material costs, and production costs. A strength LEGOs has is their efficient leadership team that was formed in 2004; this team found ways to cut costs, enact cost-saving measures, and managing inventory more efficiently (Appendix C). Based on the financials and looking into the long-term, I believe LEGOs can go further by cutting down labor costs. In 2008 and 2009, LEGO s employee growth rate was over 10% more than their revenue growth rate (Appendix D). Also, many employees were spending time with smaller independent stores than larger retailers that were making two-thirds of the revenue. By keeping the two leveled, enacting merit systems and cutting less productive individuals or teams, LEGO can manage costs

2 and create a more motivating environment. Another cost they can continue to cut is production. Although they have increased production cycles, a potential future investment they may consider is using 3D printing which may be quicker, cheaper, and more efficient. Aside from labor and production, LEGOs can also invest in an inventory management or sales system that can pinpoint which kits sell best, and the geographic location of top sellers. This would enable them to cut out kits that won t make as much money, focus on their top selling product lines, and, or, distribute specific kits to a certain area that sells more than another. An addition to their software could be an ability to track the most popular LEGO pieces and forward this data to designers who are creating future kits, encouraging them to use pieces already in production. This would allow LEGOs to cut waste from pieces that are rare while saving costs and production time. All these are tied into the current leadership team s success in cutting down logistic suppliers to four and replacing smaller distribution centers with hubs located close to retailers. With the new changes in place and a better control on employees, inventory management, and production methods, LEGOs can continue cutting their costs down and improve their operating margin. With controlling and minimizing costs, LEGOs can then market their kits at a lower price making them more competitive to their rivals. In 1984, TYCO released a plastic brick product compatible with LEGOs that communicated the idea, If you can t tell the difference, why pay the difference. Luckily for LEGOs, their patent was still active at this time and they won the lawsuit. However, this shows an opportunity for cost-leadership in the building-brick toy market. With the patent expiration, other competitors have already entered the market, and LEGO must accept the need to competitively price as they are now imitable. A way LEGOs can leverage this is with their recent goals in managing costs already, and continuing to optimize their supply chain and inventory management as listed above. A pricing strategy LEGOs could take includes reducing pricing for their own themes such as LEGO Adventurers, or LEGO Iceplanet, while keeping prices the same for their seasonal licensed products. This would give the price-sensitive consumer the opportunity to purchase high quality LEGO sets for kids at a lower price, but also purchase seasonal entertainment themes that may become collectible in later years at a price no higher than before. This strategy would be feasible as parents grew up playing LEGOs themselves, making the product nostalgic and a recognized brand. Parents would be able to ensure their children also get the experience at a price relative to the other building-block options on the market. Since children go through phases of liking new stories, movies, and other entertainment, charging higher prices on licensed-kits would leverage the loss in margins for the regular themes as these would have a higher turnover and are only available for a seasonal period. With Disney s acquisition of Marvel, it may make it harder for LEGOs to be consistent with their licensed kits in the future. Disney now has more control over distributing license agreements and has a favorable history with Mattel. Hasbro s current license agreement with Marvel is set until One of LEGOs core competencies is the ability to innovate and consistently release new creative play themes, some of their most successful involving third-party license agreements. Their successful acquisition of many licensed rights also led them to new avenues for video games later leading to an online gaming platform. LEGOs must exercise this capability of license acquisitions in the future to stay competitive. To sustain their current relationship with Disney, LEGOs should prove financially that their current licensed kits are doing well. Since license agreements typically involve a large advance and a royalty, showing high volumes of sales would mean LEGOs can generate a large royalty on top of the advance paid. With Disney now having more control of licensing agreements, LEGOs should aim for long-term agreements for stability which would also allow them to release new innovative themed kits over the time period,

3 something they are successful at. To appear more attractive to the licensor, LEGOs could add a page on their interactive website asking parents and children what kits they d like to see in the future. For the most popular answers, LEGOs could use customer engagement to prove to the licensor that this specific theme would be popular. Also, as the original building-block brand and one that has been around for decades, LEGOs should argue for licensing deals specifically for building-block toys, while competitors like Hasbro and Mattel could use licenses for other types such as action figures or props. By proving the demand, and using their position as the original building-block company, LEGOs can look more attractive to future licensors. Mattel, Hasbro, and MEGA Brands are all very large players in the toy market and have a global presence. Mattel and Hasbro are the two largest manufacturers and have diversified type of toys beyond building-blocks. MEGA Brands on the other hand has been making the same products as LEGOs since 1984 and has successfully secured licensing agreements while expanding around the world. Since Hasbro and Mattel are so large and diversified in the type of product lines they offer, LEGOs has an advantage with their brand history, and ability to focus all resources and capital on making their one product, the building-block, the best. Before their patent expiration, LEGOs was VRIO and developed their core competency of brand reputation and loyalty over the years of releasing new sets. Parents recognize the LEGOs brand as they grew up playing with them as well, and this creates a generational cycle of them purchasing kits for their kids. By staying a household name and being known as the best and highest-quality building-block through nostalgic memories and past experiences, LEGOs can maintain their brand reputation and create loyalty for future generations. A way they can establish their brand in new generations today is partnering with the education system and schools. LEGOs could donate discontinued kits or release an education LEGO kit for preschool to first grade classrooms at a discount of retail. Similar to LEGO brick buckets made in the 80s, this education kit would be a bulk amount of the most popular pieces, and include a sheet of some examples models you could create. The bucket would include enough pieces for an average class of 20 to play and interact together. This strategy would give children hands-on experiences with LEGOs, challenge their creativity which goes along the company s values, and encourage them to want their own kits at home. It will align the brandaware parent with the now brand-aware child who gets to play with LEGOs every school day. Looking into the long-term, it would also continue LEGO s tradition and history by creating brand loyalty for the future when these children become parents. When these strategies come together, they allow LEGOs to have a competitive advantage over Hasbro, Mattel, and even the second largest building-brick rival, MEGA Brands. Continuing to optimize their inventory and supply chain will lower costs, enabling them price more competitively to their competitor s building-block toys. By showing demand and acquiring licensing agreements specifically for building-block toys, LEGOs can continue their core competency of creating new kits while helping the licensor make money. Lastly, by partnering with schools, LEGOs can achieve their mission of inspiring and developing children to think creatively while generating brand loyalty into the future.

4 Appendix Appendix A: PESTEL Political: The way politics plays a role in the toy industry is consistent with LEGO s competitors. A key difference however is that LEGO s must be considerate of the political stability within Denmark, and the European Union which is applicable to their company. Although they operate internationally, they are still a privately owned company from Denmark. Economic: A tactic LEGO s competitors have used in the past include marketing their substitutes as a cheaper version; this means LEGOs is seen as being higher priced and must be mindful of the current economic state and their consumer s price sensitivity. With more products becoming similar to LEGOs since their patent expiration in 1988, LEGO must find new ways to sustain a competitive advantage and create value for their customers. Social-Cultural: A key factor in LEGO s past success is their licensing deals with major entertainment characters such as Star Wars and Spiderman. They were able to create LEGO sets and video games themed after popular entertainment blockbusters. New movies and stories are out frequently and LEGO must constantly pivot and align with social-cultural trends in entertainment for children, while landing licensing deals with these companies. Technological: With new technologies and developments in the toy industry from video games, to tablets, and other handheld electronics, LEGO will see many other competitors outside the building block subset that can potentially take some of their market share. It may need to shift its gaming and video game platforms to smartphone and tablet apps to better capture both todays and the future market of gaming. Another shift in technology is production; with the rise of 3D printing, LEGOs may consider a new method of production that may potentially decrease costs. Environmental: LEGO s is related to many other themes and entertainment blockbusters and is seen as a staple toy to children and their parents. With business and consumer trends shifting to sustainability, it must be considerate of the plastic waste they create in their supply chain, their eco-friendliness, and their position on being a green company that cares about its customers, community, and other stakeholders. Legal: With LEGO s patent expiring in 1988, many other competitors have rose with similar or equivalent products, prompting LEGO to have a legal altercation. It s recent suit with MEGA Brands failed as the court ruled LEGO s brick trademark did not qualify. Furthermore, LEGO has no power in the courtroom to file a suit against its direct competitors who create equivalent building blocks due to their patent nolonger being active. This causes new challenges for the company as barriers to entry have lowered substantially since the expiration, prompting new players to enter the market.

5 Appendix B: Porter s Five Forces MEDIUM HIGH HIGH HIGH Threat of New Entrants: MEDIUM Although the threat of new entrants has increased for LEGOs with the expiration of their patent, a new entrant would need large operations and economies of scale to have a competitive advantage. LEGOs only has one product, plastic building-blocks but also has large distribution globally, their own production, and a loyal brand base. Due to this, the threat is high for existing toy companies to enter the building-block space such as Hasbro or MEGA Brands, but low for toy companies starting from scratch. Bargaining Powers of Suppliers: HIGH The bargaining power of suppliers is high due to LEGO s raw inputs coinciding with oil prices. Although LEGOs has equipment for a part of their production, oil is required to manufacture plastic and cost of materials may vary based on market oil prices. Bargaining Powers of Customers: HIGH With more substitutes and complements available to consumers now, LEGOs may be pressured as their revenue or market share may diminish due to other building-block sets available at a cheaper price. Although LEGOs is known for their history and quality, consumers may go with a cheaper option during times of financial hardship.

6 Threat of Substitutes: HIGH With the patent expiring, the threat of substitutes is very high. LEGOs has already suffered from imitators like TYCO in the past. Now, there is the threat of legal building-block toys and the ones made in Asia that sell for a lower price. Also, aside from building-blocks, parents and children have a vast variety of different types of toys to choose from. Appendix C: SWOT Strengths Strong brand reputation, leader in toy industry throughout a couple generations, creating sense of nostalgia Won Toy of the Century Efficient Leadership Team that optimized supply chain Successful acquisition of many licensed rights Innovative and engaging website, with four million visitors per month Consistent innovation and releasing new themes Weaknesses No intellectual property or patent (expired) One main product line: building blocks No main focus on operations: o No consideration by designers in production cost o No emphasis on cost management o Inefficient production schedules and use of machines o Extensive supply chain systems creating complexities and disadvantages Opportunities Move to smartphone/tablet app market Secure long-term licenses with Disney after their acquisition with Marvel Create new product lines beyond building blocks Create lower-cost product line options Become more environmentally friendly with plastic waste and overall brand image Look into 3D printing for potential cost reduction in production Secure relationships within education industry from schools to classrooms Expand in emerging markets such as China and India Create geographic specific cultural themes Threats Loss of LEGO brick trademark, losing apart of brand recognition MEGA Brands creating smaller-sized blocks compatible with LEGOs MEGA Brands securing licensing agreements with Marvel, Disney, and more Hasbro creating Kre-O, compatible blocks with LEGOs Disney s acquisition of Marvel creating more control over licensing agreements Mattel having long and favorable history with Disney Other smaller toy companies/brands that can create similar toys with building concepts or other substitutes

7

8 Appendix D: Financials Revenue $16,014,000 11,661,000 9,526,000 8,027,000 7,798,000 Revenue Growth 37.3% 22.4% 18.7% 2.9% Net Profit $3,718,000 2,204,000 1,352,000 1,028,000 1,290,000 Equity $5,473,000 3,291,000 2,066,000 1,679,000 1,191,000 Return on Equity 84.8% Average Return on % Invested Capital Gross Margin 72.5% Operating Margin 31.1% Net Profit Margin 23.2% Employees 8,365% 7,286 5,388 4,199 4,908 Employee Growth 17.8% % Key Takeaways: Revenue has grown substantially since 2006, with a consistent and increasing growth rate in recent years Synonymous with revenue, net profit has also been increasing steadily Equity and ROE have both increased, showing a good steady increase in return on shareholder s money Average return on invested capital has grown substantially and is over 100% beginning 2008, showing profitable returns on investment Gross margin is extremely high compared to operating and net profit margin showing many costs within operations and wages Employee growth fell substantially between 2006 and 2007, but jumped beyond revenue growth in both 2007 and 2008 Employee growth is now lower than revenue growth in 2010

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