Brick by brick: How LEGO Rewrote the Rules of Innovation and Conquered the Global Toy Industry - BusinessNews Publishing (2014)
Part I. The Seven Truths of Innovation and the LEGO Group’s Decline
Chapter 3. Losing Control
The Scattered Remains of Runaway Innovation
We are on a burning platform.
—Jørgen Vig Knudstorp, June 2003 memo to the LEGO Group’s board of directors
IN THE EARLY MONTHS OF 2003, THE LEGO EMPIRE BEGAN TO crack. The previous year had started out strong, with the company on track to realize roughly 10 percent growth, largely due to the jaw-dropping success of the LEGO Star Wars and Harry Potter themed sets. In fact, some felt the company, for the first time since 1993, would exceed a profit of DKK 1 billion ($150 million). But as 2002 neared its end, the LEGO Group’s sales rapidly lost altitude. Christmas sales sank well below the company’s internal forecast. By February 2003, behemoth retailers such as Target and Walmart were choking on a backlog of unsold LEGO sets. LEGO inventory had ballooned by 40 percent at some outlets, to more than twice the amount of stock that’s considered acceptable.
With the company’s fiscal health dramatically deteriorating, its senior management assigned the recently hired Jørgen Vig Knudstorp, then the company’s head of strategic development, to diagnose the problem and report back to the board of directors.
With his rumpled hair, Harry Potter glasses, and boyish enthusiasm for all things LEGO, Knudstorp must have seemed, to some LEGO senior managers, even younger than his thirty-three years. Having joined LEGO just eighteen months earlier, he was still very much a newcomer in a place where it’s not uncommon to find brick-in-the-blood veterans of two, three, and sometimes even four decades. Despite his brief tenure, he had already become one of the LEGO Group’s more networked executives.
Knudstorp, a PhD who spent eighteen months as a trainee kindergarten teacher before switching to a business career, had come to LEGO by way of the Copenhagen branch of the global strategic consulting firm McKinsey & Company. In the late 1990s, hypercompetitive, athletic Danes dominated McKinsey’s Copenhagen office. A former colleague remembers Knudstorp as being different from others in the office—a genial, somewhat nerdy fellow who always sported the latest technological gizmo. He proved himself a capable consultant. But the firm’s macho, very traditional culture never fully embraced him, and he left after just two and a half years, a relatively short time even by McKinsey standards.
Knudstorp proved a better fit at the LEGO Group. Although he never consulted for LEGO while he was at McKinsey and had never visited the company prior to his arrival in September 2001, Knudstorp had grown up less than an hour’s drive from Billund. As a child, Knudstorp had not been allowed any electronic toys and so spent many hours with his LEGO sets. “I was keenly aware of LEGO’s heritage, so the call represented a kind of homecoming,” he recalled. “But what really made me think about joining LEGO was the company had gone through a rough patch. It seemed like it was back on track but still had some challenges ahead of it. From a professional angle, it was an exciting opportunity.”
Once ensconced at LEGO, Knudstorp became a kind of at-large strategist who roved throughout the company, taking on different assignments as new challenges arose: collaborating with the management team of LEGOLAND to improve the theme parks’ performance, developing an action plan for building out the company’s nascent line of retail stores, deconstructing its global supply chain and recommending improvements. Acting on his belief that “relationships are just as important as results,” Knudstorp formed many critical ties across what was then a heavily compartmentalized organization.
Within six months of arriving at LEGO, Knudstorp began reporting directly to the chief operating officer, Poul Plougmann. The theme park and LEGO store projects, in particular, frequently engaged him with Kjeld Kirk Kristiansen, the company’s president. As a result, he often delivered reports to the LEGO Group’s board of directors. To prepare his state-of-the-company analysis, Knudstorp drew heavily on his McKinsey training, which preaches that fact-finding is the first step toward problem solving. He spent several months sleuthing in every part of the LEGO organization, interviewing senior managers, front-line employees, and major retail customers on what was working and, more critically, what was failing.
The LEGO Group’s immediate problems were not so difficult to discern. In fact, they were plainly evident to many of the company’s executives. Buoyed by the over-the-top sales of LEGO Star Wars and Harry Potter kits in 2001 and the first half of 2002, retailers had doubled down on LEGO for the Christmas season. Trouble was, neither a Star Wars film nor a Harry Potter movie was scheduled for 2003, so kids weren’t primed for repeat offerings of LEGO Yoda and Chamber of Secrets sets. (And as we’ll see, sales of many other LEGO lines proved lackluster at best.)
Knudstorp believed the company’s dilemma was in no way due to a lack of innovation. Even though he was new to the company, he was well aware that LEGO had been delivering novel products for the past three years. But as he dug deeper into the LEGO Group’s sales results and its manufacturing, distribution, and advertising costs, he saw there was a shocking lack of profitable innovation. LEGO had plumped up its top line, but its bottom line had grown anorexic. All the creativity of the previous few years had generated a wealth of new products, but only a few were actually making money. To make matters worse, the LEGO Group’s management organization and systems, shaped by decades of success, were poorly equipped to handle a downturn.
LEGO was trapped in a painful double bind. Instead of pushing the new product lines that the company was advertising in early 2003, retailers were trying to unload their LEGO inventories from Christmas 2002. The result: robust sales of new LEGO sets never materialized, while retailers had to heavily discount their existing LEGO stock and watch their profits evaporate. Not surprisingly, they soon regarded LEGO as extraordinarily unappetizing. Adding to the LEGO Group’s misery, the U.S. dollar started to depreciate. Not only did LEGO lose sales in dollars, but it lost income due to the weak dollar. As the year progressed, the decline accelerated. “Our problems couldn’t be pinned to one failing product,” said Knudstorp. “It was the failing performance of nearly the entire LEGO portfolio.”
As Knudstorp dug deeper into the LEGO Group’s malaise, he found the company’s problems were far more systemic than a falling U.S. currency and a failed Christmas. First and foremost, the company’s management team, which consisted of twelve senior vice presidents who oversaw six market regions as well as such traditional functions as the direct-to-consumer business and the global supply chain, was “highly dysfunctional,” recalled Knudstorp. “They didn’t work together. They operated in silos.”
The chill from the executive suite often frosted the company’s retail partners, who regarded LEGO as aloof and largely uncaring. Knudstorp also found the company’s designers and developers chronically failed to grasp the business implications of their actions. And too many managers did a poor job of allocating responsibilities and carrying out decisions. Although there were clear lines of authority throughout LEGO, there was far too little accountability.
Equally troubling, the company’s ability to track its product inventory and produce a reasonably accurate financial forecast was shockingly poor, largely because the LEGO Group was organized as a loosely linked holding company, with every business unit keeping track of revenues and expenses in its own unique way.
Despite senior management’s difficulties in getting a timely sense of the LEGO Group’s inventories and cash flow, Knudstorp thoroughly vetted the company’s performance over the previous decade. He homed in on economic value added (EVA), where opportunity costs are deducted from revenues. A standard industry metric, EVA measures what the owners of a company could have made if they’d invested in risk-free government bonds instead of the business. Calculating the EVA is something of an academic exercise for companies that are owned by a large swath of shareholders. But for Kjeld Kirk Kristiansen, the leader of the LEGO Group’s owners and the guardian of the family fortune, EVA mattered.
Knudstorp’s finding was shocking. His analysis revealed that with the exception of 1998, the LEGO Group had steadily produced accounting profits from 1993 to 2002, yet the company had lost some $1.6 billion of economic value over the same period. In other words, the company’s owners would have been better off investing in no-risk, low-return government bonds than in LEGO. By backing LEGO, they had depleted their family fortune at the rate of almost half a million dollars per day, every day, for ten years.
Guided by former General Electric CEO Jack Welch’s axiom that a leader must “see things as they are, not as [you] wish them to be,” Knudstorp’s report on the LEGO Group’s performance was unflinching. His message to the company’s board of directors at its June meeting in Billund was unsparing. He summarized his analysis in a slide titled “What is the price of good management?”
And then he provided some answers. The LEGO Group’s immediate future looked even bleaker than its recent past. The company was on track to suffer a 30 percent drop in sales and bleed out $250 million in operating costs. It was running a negative cash flow of more than $160 million. By year’s end LEGO would likely default on its outstanding debt of nearly $800 million, and it lacked committed lines of credit. The forecast for 2004 looked every bit as ugly, if not worse, as the company’s net loss was expected to double.
“I [told them] we are on a burning platform,” recalled Knudstorp. “We need to take action, because the problem is not going away.”
As they took in Knudstorp’s report, more than a few directors found it difficult to shake off their surprise over the company’s predicament. Although they grudgingly accepted Knudstorp’s reading of the LEGO Group’s challenges for 2003, several directors pushed back forcefully against his forecast for 2004. The skeptics argued that although the losses meant they should strip out between $135 million and $155 million in operating costs, sales would rebound as soon as the U.S. currency crisis cleared and the next Star Wars movie hit the street. Exclaimed one director: “I don’t know where you’re getting this, that 2004 is going to be another difficult year. What are you building this on?” As Knudstorp walked out of the meeting, it occurred to him that he might well lose his job.
“I wasn’t deliberately trying to disagree with them,” he recalled. “I just felt that I would serve them best by telling them the truth as I saw it. Of course, they saw things differently. So I did think about whether that was the end of my time at the company.”
As the summer progressed, it became more and more apparent that LEGO would not easily reverse its declining fortunes. In an attempt to stabilize the company’s balance sheet, Kristiansen and Plougmann recruited Jesper Ovesen, the chief financial officer of Danske Bank, one of the largest banks in Scandinavia, to steer the LEGO Group’s financial operations.
Ovesen arrived in Billund on the first of November 2003, took a suite at the LEGOLAND hotel, and began a solitary dive into the company’s books. Although he has a boxer’s broad shoulders and expansive forehead, Ovesen possesses the mathematically inclined mind of a pencil-necked geek. He’s been known to remark, “Behind every product and person there’s a number, and that’s what I look for.” It wasn’t long before people at LEGO likened him to the characters in the sci-fi thriller The Matrix, who see the world as a vast, ceaselessly scrolling grid of computer code.
Ovesen was taken aback by what he found at LEGO—and what he couldn’t find. Since the company’s inception, the LEGO Group’s leaders had operated on the notion that if they consistently delivered great products for kids, profits would follow—a philosophy that might have served them well during the organization’s early years but ultimately left them without an overarching system for monitoring the company’s financials. LEGO also lacked a robust, up-to-the-minute accounting system that would alert managers when things went wrong.
“They had no control over their investments,” Ovesen later exclaimed, still amazed by the company’s lack of fiscal oversight. “They didn’t know where they made money. They didn’t know if they made money on the product side. They didn’t know product profitability. They did know the LEGOLAND parks were a cash drain, but they didn’t know why.”
Even by late 2003, the LEGO Group’s tangled corporate structure, where every country organization ran a separate P&L, continued to plague its performance. The company’s newly installed IT system for managing the company’s finances let executives see if the United States or Germany, for example, yielded profits. But the company still didn’t track which products made or lost money. LEGO lacked an activity-based costing system, so it had only a crude view of the costs it incurred to produce individual products and its returns on individual sets. If it had dug deep enough, LEGO could have figured out product profitability, despite its complex corporate structure. But it never felt compelled to do so. LEGO had been so successful for so many years, it never did the work to really understand what different sets cost.
Even so, it didn’t take a sophisticated financial analysis for Ovesen to see that in just the third quarter of 2003, the company’s total sales had gone into free fall, declining nearly $800 million compared to the previous year’s quarter. Toward the end of November, the LEGO Group’s board of directors gathered again in Billund. This time it was Ovesen who stood before them. His message was blunt: LEGO was indeed teetering on the edge of a financial abyss. “It was purely a financial disaster,” he exclaimed.
Ovesen is widely regarded as one of Europe’s most astute CFOs; it would have been exceedingly difficult to discount his assertion that LEGO was close to bankruptcy. Even the skeptics now had to confront what once had been unthinkable: if the company that produced the toy of the century didn’t find a way to reinvent itself, Kristiansen and his family might well have to break LEGO into pieces and sell it to save it.
For Knudstorp, Ovesen, and the board of directors, the company’s plight was shocking, not least because LEGO had always seemed so strong. The seventy-one-year-old icon of the toy world had endured the Great Depression, a brush with bankruptcy in its early days, the ravages of the Second World War, and the constantly shifting tastes of one of the world’s most demanding consumers—the seven-year-old boy. In 2003, the LEGO Group’s annual revenues were forecast to exceed $1 billion, making it the fifth-largest toy company in the world and the undisputed king of construction toys. LEGO products, ranging from the DUPLO line for preschoolers to the LEGO Technic line for teenagers, could be found in about 75 percent of American and 80 percent of European households with children. The LEGO brick was almost as ubiquitous as it is today. Yet the company was draining cash and destroying the owners’ wealth at an alarming rate. How could one of the world’s most beloved brands have been brought down so swiftly and so decisively?
Yes, its businesses were siloed and its designers were too far removed from the market. The LEGO Group’s brain trust had for years let climbing production and marketing costs cannibalize the company’s profits. And the company had wrongly bet that LEGO Star Wars would remain a blockbuster even without the release of a new Star Wars movie to help drive sales. But the full explanation for the LEGO Group’s steep decline resides in those seven innovation truths. Big, bold moves often come with the risk of a long-term slide, even when the early results are all rosy.
Individually, the seven truths have worked for other companies. Collectively, they almost pushed LEGO into bankruptcy. Following the seven truths boosted sales at LEGO but also led to skyrocketing costs. Because LEGO lacked an effective system for monitoring its innovations and swiftly alerting management when an initiative took a wrong turn, the company was caught off guard and couldn’t recover.
To better understand what happened, let’s revisit those seven truths.
Hire diverse and creative people. Although LEGO succeeded in recruiting blue-chip talent and deploying satellite offices throughout the world, the rapid expansion proved devilishly difficult to manage. New hires lacked a connection to the company’s DNA and an overarching vision of where Plougmann wanted to take LEGO; new designers lacked a feel for creating with the brick and for collaborating with their veteran counterparts in Billund. Consider the effort to develop the LEGO Explore line, which we discussed in Chapter Two. This was marketing chief Francesco Ciccolella’s attempt to replace the long-running DUPLO line, whose sales were stagnating, with an entirely new global brand for the preschool set. Through Explore, LEGO aimed to build a bigger presence in the U.S. market, which was clamoring for electronic toys that delivered some educational value.
“Explore was our favorite,” Plougmann asserted. “The idea was to regain strength in the toddler category by segmenting it into different themes and ages. The LEGO Explore system—the skill and knowledge it would bring to children—would make the single brick less important in the minds of mothers.”
Just as Kristiansen’s decision to license Star Wars had earlier proved the value of ceding a degree of decision-making autonomy to Peter Eio and his LEGO Americas team, Plougmann believed he’d reap similar gains by letting Ciccolella and his talented team of Milan-based designers take the lead in developing Explore. From the outset, the effort was fraught with a command-and-control management mind-set that hobbled creativity, as well as the near-total inability of the Milan- and Billund-based designers to work together.
In LEGO Explore, the Milan shop fashioned a line of electronic toys, some of which entirely omitted the brick. Although the Milan team created the concepts for the Explore line, a group of Billund-based designers was charged with developing the toys and preparing them for the market. More than a few of those designers were aghast when they received their design briefs.
“The heads of marketing and product development presented Explore in a big meeting, and it was not very well received at all,” recalled Allan Steen Larsen, one of the Billund designers who worked on the line. “First they took away the [DUPLO] rabbit logo that meant so much to our core markets. Second, all the values we were taught to communicate in the packaging and the products were completely thrown away.” Ciccolella gave the Milan team full design authority and told the Billund team to follow Milan’s lead. No dissent was tolerated. Said Larsen: “They told us not to come up with any objections. They didn’t exactly threaten to fire us, but that was definitely the message.”
Explore’s success in part depended on melding the Milan group’s creativity and design prowess with the Billund designers’ deep understanding of the LEGO play experience. Yet, remarkably, there was no attempt to coordinate the two departments’ development efforts. Larsen, who helped create the Explore Music Roller—a very un-LEGO-like concept developed in Milan—couldn’t recall a single meeting between his team and his counterparts in Milan. “We felt like we were being amputated” from the development of core preschool toys, he asserted.
If senior managers had defined Explore in such vivid terms that designers knew where they needed to take the line, the Billund and Milan teams might well have meshed and learned to collaborate effectively. But the company’s top managers remained divided over the Explore strategy and therefore couldn’t deliver a clear sense of direction to the line’s developers.
Plougmann and Ciccolella believed that LEGO Explore, because of its capacity to stimulate children’s development, held great promise. In the LEGO Group’s 2002 annual report, Plougmann declared that switching to Explore was “the right decision and it will prove itself in the long run.” But veteran LEGO executives led by Mads Nipper, who then headed up the company’s central Europe operations, argued that Explore was too radical a break from classic LEGO. Scuttling a beloved brand such as DUPLO would prove disastrous. An animated, energetic executive who can be strikingly candid, Nipper was not shy about voicing his distress. “DUPLO was the second-strongest toy brand in northern and central Europe after LEGO,” he later fumed. “And we in all our wisdom decided to kill it.”
On a winter’s day in 2002, the infighting boiled over. Nipper and the three other heads of the company’s largest markets got a call to report to a suite at the LEGOLAND hotel, a short walk from the company’s headquarters in Billund. LEGO staffers called it the “firing room.” If you were employed by LEGO and you were summoned there, chances are you’d be unemployed when you left.
For months, Nipper and the three executives had continued to press their case against Explore. Plougmann decided he’d heard enough. He instructed his lieutenants to gather the dissenters and deliver an ultimatum. Recalled Nipper: “All four of us were brought in and told that if we didn’t shut up and loyally support Explore, we would leave the company.”
Faced with a choice between supporting Explore or losing his job, Nipper relented. Nevertheless, when LEGO presented the Explore line to its key central European retailers, his misgivings resurfaced even more powerfully. The general manager of Idee+Spiel, one of Germany’s largest chains of specialty toy stores, was especially unimpressed by Explore. He approached Nipper and asked, “Are you sure you know what you’re doing?” Nipper found himself reprising Ciccolella’s argument that since DUPLO’s sales were stagnating, it was time to make a big break from the past.
“As I was talking,” he recalled, “it was just like eating something that you don’t like. When the people who knew the market exceptionally well explicitly expressed what I was feeling, I was no longer reasonably sure that we were on a disastrous course. I was 100 percent sure.”
In the end, the misgivings of Nipper and other executives proved prescient. LEGO Explore was such a striking departure from the brick-based toys that parents knew from their childhoods, it confused the market and ultimately decimated sales. Even worse was the decision to let Explore supplant DUPLO. Although DUPLO had struggled in recent years, its strong LEGO lineage nevertheless helped make it the second-best-selling toy brand in Europe. Nipper’s “very rough” estimate is that over its three-year lifetime, the Explore adventure cost LEGO at least DKK 500 million (about $65 million). “Explore was a smoking disaster,” he exclaimed. “Our least fine moment of all time.”
The LEGO Group’s new wave of designers can’t be blamed for the Explore debacle. Rather, the company’s leaders tripped up in three critical areas. First, they failed to ensure that the new hires’ skills were in sync with the company’s needs. Although LEGO recruited world-class developers who were celebrated for their work with graphics, animation, and 3-D moviemaking, far too few had mastered the craft of using the brick to create compelling play experiences.
Recalled Paal Smith-Meyer, who was one of the new wave of designers hired under Plougmann and now heads up the LEGO New Business Group: “[We all] wanted to be great industrial product designers, the next Philippe Starck”—the French designer famous for his sleek, organic renderings of everyday furniture and household items. “LEGO thought it was cool that we could draw well. But no one ever told us that for the company to make money, you have to be able to build it in LEGO.”
The company’s second misstep: the near-total lack of coordination between Explore’s Billund-based developers and the satellite team in Milan, which was not an isolated event. LEGO likewise never bothered to ensure that the developers at Zowie Intertainment, a company LEGO acquired in 1998, worked well with the Billund design teams.
One of the major products that LEGO planned to develop at Zowie was the KidPad, an electronic toy that allowed kids to play a computer game by moving physical pieces around in front of a camera. LEGO originally forecast that the KidPad would deliver DKK 500 million in first-year sales. In the end, the company failed to sell a single toy, as the KidPad never made it to market. Nor did any other toy concept produced by the Zowie unit. In 2001, three years after acquiring Zowie, LEGO shut the studio down and laid off most of its employees.
The company’s third mistake was to refuse to learn from those setbacks and take corrective action to reset its strategy and better deploy its new hires. After LEGO killed the KidPad effort in the fall of 2000, Ciccolella met with Smith-Meyer for a postmortem. “He said he only had a half hour,” remembered Smith-Meyer. “And when we finished, we would never talk about the project again. His attitude was, ‘Let’s move on. There’s nothing to see here.’ ” The result was that LEGO, by failing to learn from its reversals, was far more likely to repeat them.
Plougmann was certainly correct in concluding that to compete on a global stage, the company needed a globally diverse design culture. Diversity fosters creativity; when similar scrapes up against dissimilar, it can generate the creative spark that ignites white-hot innovation. For LEGO, problems arose when it failed to channel the new hires’ energy and inspiration. LEGO set off a chain reaction of human creativity but never contained it and managed it. The result was a cascade of runaway innovations that either bombed or imploded.
Head for blue-ocean markets. The urgency with which LEGO pursued uncontested, blue-ocean markets was in large part due to the fact that the brick appeared to be trapped in an increasingly crowded and bloodied red ocean. With the expiration of the last patents for the LEGO brick in the 1980s, sharks such as Tyco Toys and Mega Bloks tore into the LEGO Group’s market share with knockoff bricks sold at a steep discount to LEGO sets. At the same time, consultants were advising the company that the brick itself was passé.
“We had all these external experts telling us the LEGO brick is going to die,” said Smith-Meyer. “They said the twenty-first century is not about little square plastic blocks. It’s digital.”
According to the consultants, the LEGO Group’s future resided not in the brick but in exploiting the highly trusted, widely beloved LEGO brand. Their advice led to the strategy of pursuing an untapped, blue-ocean market in the digital arena by yoking the LEGO brand to the Spielberg brand. The result, of course, was the LEGO Studios Steven Spielberg MovieMaker.
The LEGO Group first launched its “movie studio in a box” solely in the United States in October 2000. The thrill of creating stop-motion animations with LEGO bricks proved to be a minor hit with American kids, though hardly a blockbuster. Buoyed by the kit’s reasonably successful sales of DKK 80 million (about $10 million) in just a three-month span, LEGO gave the Spielberg MovieMaker a splashy global launch in early 2001.
The idea was to leverage the MovieMaker’s success in the United States and grow it into a hot property the world over. Such a strategy was fully aligned with the LEGO Group’s stated ambition to become the world’s strongest brand among families with children by 2005. To achieve that goal, LEGO would have to double its annual sales by 2005. Thus, promising product lines such as MovieMaker had to find their blue ocean and quickly grow into big fish. LEGO, however, made the mistake of trying to grow the MovieMaker too soon and too fast.
Taking a page from the blue-ocean playbook, LEGO pushed to transform the MovieMaker product into a full-blown product line. First there came the MovieMaker kit with its bricks, minifigs, digital camera, and editing software for creating stop-motion animations. LEGO then followed up with nine additional MovieMaker kits that came with bricks for building movie sets but lacked the camera and software. The company’s intent was to create a platform that would entice kids to keep adding to their MovieMaker collection, even after they’d bought the more expensive kits with the camera. Trouble was, for those nine cameraless kits to sell well, they would have to deliver a great building experience. They didn’t. “Without the camera, they were really nothing special,” conceded John Sahlertz, the MovieMaker design lead.
The MovieMaker’s global launch also meant instructions and software had to be translated into thirteen languages. So LEGO went from raising the curtain on one MovieMaker set in the fall of 2000 to spinning off twenty-three different versions in early 2001. Although the MovieMaker performed reasonably well as a niche product in the United States, it was a bust as a worldwide product line. Because the cameraless kits lacked a clear and compelling value proposition, they never caught on. Retailers were forced to discount unsold boxes so as to clear out inventory. As is often the case with toys that hit the discount racks, the shift signaled the product’s demise.
Every innovation has its own cadence. Especially with new product concepts, marketers must balance out the inevitable ebb and flow of consumer demand. The MovieMaker line might well have succeeded had LEGO given the original set more time to grow before it rushed out all those add-on sets. But LEGO never got the pacing right. By rapidly ramping up the release of its sundry MovieMaker sets, it flooded the market and diluted the line’s value.
Hobbled by the LEGO Group’s weighty ambitions, the MovieMaker couldn’t complete its long swim to those wide-open, blue-ocean waters. The line went under in 2002 and never resurfaced. Even the combined power of the LEGO and Spielberg brands couldn’t save it from drowning.
As for the company’s other attempts to find a blue ocean—LEGO Explore and LEGO Education Centers—the huge losses from Explore greatly outweighed the meager gains from the Education Centers. Almost a quarter of the centers were unprofitable and were shut down in 2004, the same year Explore was shuttered.
Be customer driven. The LEGO Group’s ambitious push to pursue an entirely new set of consumers—the two-thirds of kids who told researchers they’d rather plug into an Xbox (and the like) than play with construction toys—led to that all-out effort to think beyond the brick and fan out in entirely new directions, not only with digital toys but also with physical toys that were easier to build with because they had bigger, chunkier pieces. Above all, LEGO set its sights on developing turn-on toys featuring amped-up, good-versus-evil story lines.
“In the design department, the new buzzwords were to make things edgier and darker,” said Smith-Meyer. “Boys wanted more aggression, more conflict.”
According to Plougmann, much of the pressure for a cool, character-driven product line that was less buildable but more playable came from the LEGO Group’s “very demanding” U.S. division. “The American market was becoming dominated by Walmart, Kmart, Toys ‘R’ Us, and Target,” he asserted. “We were told that if we didn’t do this stuff, we would lose shelf space.”
The result was the aforementioned Jack Stone, who came off as a younger, less threatening mash-up of the action heroes G.I. Joe and Batman. From a theoretical point of view, Jack Stone looked like a winner. Here was a “new kind of hero … ready to save the day,” as one TV commercial put it, for a toy market that was becoming increasingly dominated by story-driven concepts. And here, too, was a quick, snap-it-together toy for the majority of kids who’d rather put their free time into playing than into creating. But when Jack Stone hit the market in 2001, it proved to be a “terrible product,” according to executive vice president Mads Nipper. “To be quite frank about it … the [Jack Stone] fire truck is probably my number one disliked product of all time from LEGO.”
Jack Stone failed on three fronts. First, it couldn’t capture the imaginations of the majority of kids who were indifferent to construction toys. Jack was a wholly fabricated toy hero without any real history or context, so kids didn’t care about him. In 2001, U.S. kids sent action-packed toys such as Mattel’s Hot Wheels Cars and Fisher-Price’s Kawasaki Ninjas to the top of the bestseller lists. Jack Stone never even got an honorable mention. Second, the chunky pieces that made up the Jack Stone toys required expensive new injection molds for manufacturing the parts, making the toy unprofitable even in relatively high volumes. And third, the LEGO Group’s new hero alienated the company’s core fans. Parents who grew up with the brick couldn’t find any of the company’s classic play values—the “joy of building, pride of creation”—in that overgrown minifig. And on websites around the world, the influential AFOLs (adult fans of LEGO) bemoaned Jack Stone as further evidence of a damning trend: the “juniorization” of LEGO play themes, where the building experience is so unchallenging, it barely qualifies as LEGO.
The move toward radically simplifying the line was not an accident. Niels Milan Pedersen, the Galidor freelance designer who also worked on Jack Stone, recalled that he and his colleagues were explicitly instructed to prioritize action and play values above all else. “[Managers] told us the building experience wasn’t the main purpose any longer.”
In theory, Jack Stone should have worked. “All the research, all the rational arguments supported it,” said Nipper. “A larger and larger part of the toy market was and still is driven by stories, so we gave them a story context. And if we could make it easier for the boys who didn’t particularly fancy to build, why wouldn’t we do it?”
Despite the LEGO Group’s clean break with its past, poor sales forced the company to pull the Jack Stone line off the market just one year after the toy’s 2001 launch. Here was a case where the company’s internal compass put it on a course that diverged sharply from the fundamental principles—development, imagination, creativity—that constituted the classic LEGO play experience. Plougmann and his executive team quite rightly tested the outer edge of what kids and their parents would accept from LEGO, but the company clearly crossed a line. Jack Stone not only failed to capture a chunk of the two-thirds of kids who disliked construction toys but also turned off the core group of loyal LEGO consumers who did.
Practice disruptive innovation. By the late 1990s, there was the distinct sense among many in the LEGO community that with the rise of video games and Nintendo’s Game Boy—which by 1998 had sold more than sixty-four million units worldwide—digital play experiences were about to overtake the decidedly physical, tangible experience of building with the brick. The Darwin project, by aiming to create a unified database that rendered every LEGO element in high-quality 3-D, was the LEGO Group’s boldest bid to jump ahead of the trend and get to the digital future first.
No doubt Kristiansen’s enthusiastic backing of Darwin was in part due to his pure love of technology.* After all, he saw to it that LEGO, along with IBM, was the first company to cosponsor MIT’s Media Lab. Perhaps the grandson of the LEGO Group’s founder believed all those Silicon Graphics supercomputers, upon which the Darwin team was building its massive database, would revolutionize LEGO and help the company disrupt its own business model, just as the plastic injection molding machine had done a half century earlier. At the very least, Darwin promised to digitize LEGO.
To recap, the goal of the Darwin project was not only to create ultra-high-quality virtual versions of physical toys—where the LEGO logo, for example, would be perfectly etched onto each stud on a digital LEGO brick, just as it is on a physical brick—but to become a storehouse of digital LEGO elements that could be used for creating computer-animated building instructions, games, TV ads, cartoons, and even feature films.
Creating a computerized rendering of the entire universe of LEGO parts not only was a massive engineering challenge but also posed some fundamental questions about the nature of the LEGO play experience. Should a digital brick have the same constraints as a plastic brick? How should a minifig act in the digital world? A plastic minifig can’t bend its elbow to drink out of a glass—should a digital minifig be able to do so?
The Darwin team made enough progress on both the engineering and the philosophical fronts to underscore the project’s potential. Darwin contributed to both LEGO CyberMaster, a toy that merged computer gaming with robotics, and LEGO Island, the company’s very first software title. Sales of CyberMaster were mainly limited to Europe and Australia/New Zealand. But Island, which was released in the fall of 1997, went on to sell more than seven million copies worldwide and was named Family Game of the Year at the Interactive Achievement Awards in 1998. Despite those successes, in 1999 the LEGO Group shut the project down.
Darwin’s undoing was largely a matter of trying to do too much, too soon. It was a daunting mathematical task to begin with—representing complex shapes in three dimensions is extraordinarily difficult. That challenge was compounded by a lack of focus. Darwin tried to do everything for everybody, from creating digitized versions of specific toy lines to rendering the thousands of LEGO elements in 3-D. In the end, the Darwin team chose the wrong data model for reproducing the shapes of LEGO pieces, and the company was later forced to scrap all of Darwin’s work.
Darwin’s collapse was as much a management failure as it was a technological failure. Darwin was not widely loved, partly because the team enjoyed a separate-but-unequal status compared to the rest of the LEGO Group. Because the team worked in its own building on the outskirts of Billund, it was never integrated into the rest of the organization. The project’s founder drove a Porsche, a car that’s not often seen on Billund’s back roads. Rumors soon swirled that LEGO was lavishing luxury cars on Darwin’s hot-shot technologists to entice them to leave Boston and Silicon Valley for the company’s dreary hometown. Even if the rumors were untrue, the outward appearance of favoritism was all too real.
“Whatever we asked for in terms of money and people, we were given,” said Bjarne Tveskov, the leader of Darwin’s software operations. “It was just like, ‘Here’s another check.’ ”
But Darwin never got the two things it needed most from top management: a clear sense of direction and useful critiques that would keep the project on the right track. Darwin was home to Scandinavia’s largest computer graphics studio; its designers could don virtual-reality goggles and “play with the data” in a highly advanced, virtually collaborative workspace. But they never delivered the digital tools that other LEGO departments could utilize. Hence, the project enlisted few allies from other LEGO departments to its cause. Darwin was in need of a serious midflight correction, but it never got one.
“We didn’t have the proper feedback loops to get that reality check as we went along,” Tveskov asserted. “To be frank, there weren’t any software experts in top management, or anyone with a deep knowledge of digital technology. It’s hard to give qualified feedback if you don’t know it.”
In the end, Darwin lost out to a competing division, LEGO Media, which was set up in London in 1996. Christian Majgaard, who oversaw LEGO Media, took a very different approach to developing computer games and other online play experiences. Instead of doing all the technological heavy lifting in-house, Majgaard believed in collaborating with the best outside experts when the opportunity warranted it. That strategy proved to be more efficient and, for a time, more sustainable than Darwin’s go-it-alone approach. And so, in 1999, the LEGO Group quietly pulled the plug on Darwin. Its immodest bid to push back against the video game publishers and unleash some creative destruction on conventional toy companies instead hit an evolutionary dead end.
Foster open innovation—heed the wisdom of the crowd. In the first years of the past decade, the LEGO Group’s new-business mavens watched as a generation of Web 2.0 companies—YouTube, Facebook, Flickr—tapped into a seemingly bottomless reservoir of creativity by encouraging the masses to contribute to an online product or service. LEGO was far too cautious to open up its design studios to a crowd of outsiders, but it did make some modest moves toward harvesting the genius of its burgeoning fan community. Essentially, LEGO combined the technology of the crowdsourcing craze with the ethos of the design-it-yourself movement.
As we saw in Chapter Two, LEGO developed a computer-aided design program, dubbed LEGO Digital Designer, which let fans imagine and create their own LEGO kits using virtual 3-D bricks. They could then upload their dream models to the website of LEGO Factory, and LEGO workers would assemble the physical sets and ship them to their citizen designers. If other fans liked the designs, they, too, could order the bespoke sets from LEGO Factory. Here, then, was a case of mass customization on an individual basis.
LEGO originally conceived Factory as a DIY site for adult fans, who by some estimates accounted for 20 percent of the company’s sales. But after surveying users, LEGO marketers discovered Factory was also popular with the nine- and ten-year-old set. They re-branded Factory with a self-explanatory name, LEGO Design byMe, and watched as the service gave LEGO a far more personal connection with its legions of fans by letting them create one-of-a-kind kits. Design byMe could also be seen as an outgrowth of one of the company’s founding principles: authenticity. Rather than make only sets that conform to the company’s image of its consumers, LEGO had found a way to let people create sets that conform to their image of themselves. Design byMe let them invent sets that reflected who they were and who they aspired to be.
Although Design byMe let LEGO forge a more personal, more genuine bond with its fans, as a business, it failed to take off. At its peak, Design byMe had a conversion rate of less than 0.5 percent—for every two hundred visits to the site, less than one purchase was made. That rate was certainly weighed down by the service’s price tag. Although the design feature was free, the price for the custom sets was significantly higher than store-bought LEGO sets, as the bricks were costlier and LEGO had tacked on a $10 service fee for producing the custom-designed box and instructions.
Increasingly, the DIY effect gave the LEGO Group’s brain trust a migraine. LEGO fans, eager to show off their creations, might upload a LEGO Homer Simpson set and offer it for sale, exposing LEGO to lawsuits from Twentieth Century Fox, the owner of The Simpsons intellectual property. Another group of malicious fans tried to upload inappropriate content, such as detailed reconstructions of parts of the male anatomy.
Design byMe’s performance oscillated for many years, but the site never made money. Certainly it did not materially fuel the LEGO Group’s fall. But while Design byMe was a modest attempt to build a business by sourcing the crowd, the crowd never really responded, and the service was finally shut down in January 2012.
Explore the full spectrum of innovation. The LEGO Group’s effort to stretch into every genre of innovation—by conceiving decidedly un-LEGO-like products, as well as summoning new consumer experiences and services—should have advanced the company’s goal of doubling its annual sales by 2005. But as it turned out, the strategy very nearly dragged LEGO over a cliff.
On the product innovation side there was Galidor, the line of sci-fi action figures that dramatically broke from the classic LEGO building experience. To recap, Galidor featured its own building system, which entirely omitted the brick. And rather than spin Galidor off from a world-beating movie franchise, as it had done with Star Wars, LEGO opted to develop its own TV series to propagate the toy. A hot sci-fi show, combined with an utterly atypical character-driven theme from LEGO, just might capture some of the action figure craze that was sweeping the toy world.
Plougmann and Kristiansen were well aware that Galidor represented a significant risk. After all, just one in five action figure toys is a commercial success. But coming out of 2001, LEGO was reaping eye-popping sales from its Star Wars line. LEGO had also just released Bionicle, a best-selling line of buildable action figures based on an original work of science fiction, just like Galidor. Given the triumphs of Star Wars and Bionicle, LEGO bet that it could beat the odds with Galidor. “We had such a belief in ourselves,” recalled Jacob Kragh, Galidor’s development lead. “We thought we could walk on water.”
Kragh and his team ran the Galidor toy and its story line through numerous kid-centered focus groups; the boys’ enthusiasm for the concept led LEGO to conclude the line would triumph. What was unknown was whether the TV series would captivate kids. Hollywood producer Thomas Lynch, the series’ creator, had scored so many hit children’s programs that the New York Times dubbed him the “David E. Kelley of tween TV.” But Galidor: Defenders of the Outer Dimension, which aired on Fox Kids for two seasons, was an unmitigated mess, amounting to little more than a half-hour pitch for the toy line. “We were gobsmacked with disgust when we saw the first episode,” recalled Niels Milan Pedersen, one of Galidor’s designers. “It was terrible.”
Meanwhile, Andrew Black, who was then head of LEGO Americas, was so high on Galidor, he instructed his sales team to dramatically ratchet up the line’s forecast and front-load their sales channels with inventory. It was then that Kragh began to fear that he and his team had gotten the LEGO Group’s leaders a little too excited about Galidor’s potential. “We were very uncomfortable with the [increased forecasts],” he confessed. “We talked quite a bit about it [with upper management]. But we weren’t really heard. Besides, there was really no turning back at that point. The entire portfolio was built around Galidor being the first priority.”
When the TV series flatlined, Galidor lost its platform. Retailers couldn’t clear the toy from their shelves, and it quickly hit the discount bin. Just a year after its launch, Galidor was a goner. LEGO later called Galidor its “worst-selling” theme of all time. Mused Plougmann, reflecting on his decision to green-light the line: “I still don’t understand why we didn’t burn that project.”
In fact, there were very good reasons to launch Galidor. LEGO couldn’t catch up with the rapidly changing toy industry if it simply continued to churn out classic play themes such as Space and Castle. Repeating past successes would never help LEGO get ahead of competitors that were ramping up new businesses faster than ever. To get to the future first, LEGO had to outinvent the competition. And given that Bionicle—the first LEGO toy to be based on a work of fiction created by LEGO itself—was a world-beater in just its first year, why couldn’t another fictional, buildable action figure prove just as successful?
Aside from the Galidor TV series debacle, the LEGO Group’s big mistake was that it didn’t properly pace its innovations. Instead of allowing designers to spend more time developing, focus-testing, and getting Galidor right, LEGO pushed the line out into the market as soon as it saw that Bionicle was an unequivocal success. Kids wouldn’t gravitate to Galidor when they were already clamoring for Bionicle. “Had we done Galidor a few years later, that would not have been stupid,” Nipper asserted. “What was stupid was doing Bionicle and Galidor in parallel.”
The LEGO Group’s attempt to innovate new consumer experiences and services through its LEGOLAND theme parks and LEGO branded stores likewise had the perverse effect of bleeding its balance sheet. Plougmann bet that unveiling a new park every two to three years and rolling out three hundred stores would help rocket the LEGO brand to the top of the toy world. But former LEGO executives such as Peter Eio argued that, once again, poor pacing doomed both initiatives.
“The success of Star Wars gave [Plougmann] a kind of euphoria, that this was the time to really expand into a lot of areas,” noted Eio. “But instead of researching them and tackling them one at a time, there was a flurry to do as much as possible. It was all intended to build the brand, but there were a lot of negative factors that had to be overcome.”
Among the toughest challenges was surmounting the fear among the LEGO Group’s retail partners that LEGO stores would cannibalize their businesses. Eio recalled that soon after he launched the first store, the LEGO Imagination Center at the Mall of America, he was summoned to a meeting with Charles Lazarus, the founder of Toys “R” Us. “You’re making stores to compete with me,” Lazarus snapped. In fact, Eio demonstrated that one year after the LEGO Imagination Center opened its doors, sales at the nearest Toys “R” Us store, in Bloomington, Minnesota, jumped by 25 percent. Clearly, the Imagination Center had a halo effect on Toys “R” Us. At that point, Lazarus “seemed quite comfortable that we weren’t going to take away his business,” said Eio.
But for retailers, the notion of LEGO launching hundreds of stores raised the threat level from guarded to severe. Even within the LEGO Group, the plan was greeted with great skepticism. “The stores had, so far, not been very successful and also had been considered a very expensive adventure,” said Knudstorp, whose first assignment as the company’s strategist was to review the entire store enterprise. “Most important, they were threatening to the retail trade.”
As for the theme parks, LEGO lacked both the management know-how and the deep pockets to ensure their success. Although the Billund LEGOLAND was profitable, the newly launched parks in California and Germany quickly plunged into the red. Each cost DKK 1.5 billion to build and each sustained operating losses of DKK 300 million in their first year. “The parks were draining cash and still they wanted to build more,” recalled an incredulous Jesper Ovesen, the CFO who joined LEGO in late 2003. “It was completely crazy.”
Crazy or not, LEGO did explore the full spectrum of innovation. But the company was too myopic to spot the ominous warnings that it was dangerous to bet a priority product on an untested TV show and delusional to think that managers could master the retail and theme park businesses all at the same time. LEGO forgot that when it comes to igniting a range of ambitious innovations, you reduce the risks by taking a stepwise, learn-as-you-go approach.
Build an innovation culture. By almost any standard, the LEGO Group’s new regime created a fertile culture for sowing the seeds of innovation, out of which germinated a dazzling array of ambitious ventures. But from an innovation management perspective, Plougmann and his executive team were too content with half measures. They never supported all of those sundry innovations in a way that would yield a rich harvest. Just consider:
✵ In recognizing they couldn’t always bring top design talent to Billund, they essentially brought Billund to the talent by launching small project teams throughout the world. But they never truly connected those far-flung design teams with the company’s core product development units. The result was that the outposts ended up as orphanages, filled with ventures for which the Billund-based teams bore too little responsibility.
✵ Although the LEGO Group’s leaders encouraged, even insisted, on risk taking, they had little tolerance for the too-frequent outcome: failure. As we saw with Ciccolella’s refusal to discuss the KidPad misadventure, rather than learn from setbacks, LEGO often preferred to sweep them aside.
✵ To borrow a phrase from Apple’s overused argot, Plougmann and his lieutenants challenged people to “think different” and deviate from the norm. Kids wanted to play, not build. The brick was out; cool and edgy was in. “New and different” was better than “more of the same.” But when people pushed back and questioned, say, whether it was smart to kick over a beloved subbrand such as DUPLO, the company’s leaders ordered the skeptics to fall into line. In so doing, they reneged on a core tenet of every truly innovative culture: the right to honestly dissent.
Poul Plougmann and his team were hardly the first executives in the history of business to slap back internal skeptics. No doubt it sometimes required a heavy hand to push a change agenda through the LEGO Group’s insular culture. Much to his credit, Plougmann dared to think big and act boldly. And some of the company’s innovations might well have worked had they been given sufficient direction and focus:
✵ The impulse behind LEGO Explore—to nurture preschoolers’ creativity—might or might not have been spot-on, but management’s inability to graphically define the brand’s value proposition and coordinate the efforts of its Milan and Billund designers ultimately doomed the line.
✵ There was a clear and compelling need for LEGO to convert its physical bricks into digital bits, but the company’s leaders likewise failed to ring-fence Darwin’s copious initiatives and better integrate them into the rest of the organization.
✵ LEGO quite rightly sought out untapped markets, but it lacked both the feedback mechanisms to know whether to kill a flawed project before it hit the market (Jack Stone) and sufficient oversight to course-correct troubled but still promising product lines (Galidor).
✵ Above all, LEGO never nailed down the right sequencing and pacing of its myriad innovations. A new LEGOLAND theme park every two to three years, three hundred new LEGO stores by 2005—the all-out race to launch these and other expensive forays severely taxed the company’s management machinery and its balance sheet.
In the end, the LEGO Group’s poor execution of the seven truths of innovation brought it to the brink of bankruptcy. The company’s leaders welcomed an influx of talented new designers but never melded their contributions with the business’s real needs. They promoted creativity but never sufficiently channeled it. And they brazenly pushed into new markets but never instilled sufficient focus to ensure that its innovations harvested outsize rewards. The result: runaway innovation, which soon proved a curse.
By late 2003, the LEGO Group’s leaders finally began to concede that the glowing success of LEGO Star Wars, as one executive put it, was ultimately a “thick, fat layer of cosmetics” hiding the raw blemishes of a sickly core business. By November of that year, it was apparent that all the rouge and mascara had melted away. Without a Star Wars movie, LEGO couldn’t reprise the line’s explosive growth, and sales rapidly lost altitude.
Of course, LEGO knew there wouldn’t be a new Star Wars movie until 2005 and anticipated a drop-off in the interim. But executives believed that the company’s big-bet product lines—Galidor, Jack Stone, and Explore—would pick up the slack. Their collective and expensive failure threw even more accelerant onto the fire that was consuming LEGO. To make matters worse, the company’s inability to master the many ambitious ventures it had undertaken—the television shows, the video games, its own retail stores, and, not least, the theme park business—made the flames burn even hotter.
As the year drew to a close, Plougmann admitted in a November bulletin to the LEGO Group’s employees that 2003 would be “much worse” than originally forecast. He pleaded with staffers to “put in that extra effort” and insisted, “A final year-end push can improve our result.” It’s doubtful many believed him. As LEGO headed into the all-important Christmas season, a grim mood permeated its Billund headquarters. “It’s hard to describe how bad things were,” recalled designer Niels Milan Pedersen. “There was this feeling that LEGO wouldn’t exist in another year.”
Behind the scenes, Kristiansen and a few trusted lieutenants launched a make-or-break bid to save the company. Two weeks before Christmas, Knudstorp was summoned to a meeting with Kristiansen, CFO Jesper Ovesen, and the chairman of the LEGO Group, Mads Øvlisen. The LEGO Group’s owner asked Knudstorp and Ovesen to formulate a rescue plan and recommend a management team that would pull the company out of the fire. Plougmann and Ciccolella were out. (Their firing was announced in early January 2004.) Kristiansen was back as chief executive. But in an arrangement that was not made public, the grandson of the LEGO Group’s founder tapped Jørgen Vig Knudstorp to take over the company’s day-to-day operations. It was an unconventional, perhaps even desperate gamble. The future of the LEGO Group, which had just embarked on its eighth decade, was in the hands of an untested exconsultant who’d been with the company for barely two years.
LEGO was beset with so many challenges that for more than a year, a turnaround strategy eluded Knudstorp. Even so, he knew from the outset that unless they quickly learned to master at least two of the seven truths—“build an innovation culture” and “be customer driven”—LEGO wouldn’t stand a chance of getting back in the black.
The company’s anything-goes work culture, where developers were encouraged to think far beyond the brick and managers were expected to pursue market opportunities that were only remotely connected with the brand, had very nearly sunk LEGO. As a result, Knudstorp and other leaders would have to shape a performance-based culture where people’s passion and creativity were balanced with discipline and focus. Only then could a higher percentage of people’s ideas be channeled into developing profit-generating products.
Under Plougmann, LEGO had hotly pursued the vast numbers of kids who were indifferent to the brick but turned on by electronic games and action-oriented toys. The results were disastrous. To survive, LEGO would have to move its focus back onto the kids who loved to create with construction blocks. But that wasn’t enough. LEGO needed to discover new ways to delve into the lives of LEGO kids and learn to see the world through their eyes. If LEGO didn’t reorient itself around its core customers, it would be far harder to reanimate its core products.
LEGO had badly botched its first attempt at mastering the truths of innovation. This time, with its future hanging in the balance, LEGO would have to get them right. It wouldn’t get another chance.
* This is the one “truth” that Kristiansen—not Plougmann—pursued. Darwin’s failure helped precipitate the 1998 financial loss. By the time Plougmann arrived at LEGO later that year, the stink of Darwin was still so strong there was no appetite for major investments in virtual play experiences.