Explain why would it be interesting for an international supply chain student to

Question

Explain why would it be interesting for an international supply chain student to study this Case Analysis?

The LEGO Group: Envisioning Risks in Asia (A)

The Scenario Exercise

"What if we can't rely on the LEGO brand to sell the products for us in Asia?" Asger Juncher Metais asked.He was a senior distribution manager, invited to the scenario meeting because of the global perspective he could give on supply-chain issues. Metais was surrounded by senior managers from different functions but with a shared responsibility for the success or failure of the company's new strategy, referred to as "Stepping Up in Asia." Uwe Christiansen, a 34-year LEGO veteran wbo oversaw sales in 80 Asian and emerging-markets countries, was quick to respond : If construction toys become commoditized, that will have a disastrous impact on us. Imagine parents saying, "We don't want to give our kids branded bricks. We just want to buy unbranded colorful bricks in plastic bags." li this scenario happens, retailers will struggle to sell our boxes and their inventoty turn will drop. Then they will tell us: "Either you give us more margin or you get less shelf space." Either way, it will cost us dearly. Infact, it would be lethal .

Kenneth Fr0lund Christensen, freshly appointed senior controller to LEGO Asia and Emerging Markets, had been poring over the numbers for the last two weeks and understood what declining inventory turnovers would mean to the LEGO Group and the retailers that carried its products:"We would have to become a low-cost producer, so as to be able to give higher margins to retailers. And to compete, we would be under pressure to lower prices to consumers. It would be a price war."

Metais could not help countering: "Never! We would have to exit those markets. We can't survive a price war.'' "IVhy not?" asked senior strategic risk manager Rico Ferrarese, a former officer in the Danish army. "Think of it as a naval battle. We would have to try to sink eve1yone else or wait until they sink each other. We'll just have to float and survive."

As the discussion heated up, senior director of strategic risk management Hans Laess0e, who had convened the meeting, decided to intervene:

Wow! We are in danger of running ahead of ourselves. For now, all I asked you to do was to identify two parameters that could make or break our Asia strategy. The future is uncertain, but what are thekey drivers of that uncertainty? Indeed, you have discussed a major change in consumer preferences and have already honed in on one issue: "Brand is king" versus "Bricks are just a commodity." But there are several other dimensions to consider. Other changes in consume1· preferences, market size development, demographics, regulation, emerging technologies. .. . Look at these.

He picked up several slips of paper, each with a pair of opposite types of uncertainty facing the company, and continued:

Looking ahead five or seven years, what sort of environment wjll we face in the Asian markets? "Free trade" or "a thousand restrictions"? "A world of tension" or "a world of peace"? "A green agenda" or "a green debate"? Think about our growth projections. What if they turn out to be pessimistic and we find the markets are growing so fast we cannot keep up? Or should we worry about an unforeseen decline in Asian toy markets, making all our projections look far too optimistic? I want you to find a second driver of uncertainty that we should be pru·anoid about. With the two most relevant parameters, we can capture four scenarios (see Exhibit 1). Today, we want to face up to our future fears -and see if we can summarize them into meaningful scenru·ios. Then, we can have a healthy debate about a vexing question that lknow is on your minds: Should we build a factory in a low-cost location in Asia within the next five to seven years?

Laess0e hoped that thls group of managers from sales, product development, supply chain management, quality management, governmental affairs, and financial control could agree on two key issues that would guide their scenario-planning exercise. Which issues mattered most to the LEGO Group and what risks did they pose for the company's business model and its ambition to grow in Asia? ln particular, should the LEGO Group depart from its past practice of manufacturing only in a few sites in Europe and North America, and build a factory in a low-cost location in Asia wjthin the next five toseven years?

Background

The origins of the LEGO Group go back to 1932, when Ole Kirk Kristiansen, a Danish carpenter and joiner, stru·ted to make wooden toys. Two yeru·s later, the company adopted the name LEGO, a combination of the Danish words "leg" and "godt" ("play well''). In 2012, the Group was manufacturing a wide range of brick toys and board. games, with the majority of its products still in the construction toys category. With a mission to "inspire and develop the builders of tomorrow," the LEGO Group was well known for its iconic play themes-such as cities, fire engines, trains, castles, Vikings, pirates, dinosaurs, and undersea exploration -and had licensed themes from numerous

cartoon and film franchises such as Toy Story, Indiana Jones, Star Wars,and Harry Potter (see Exhibit 2).

Between 1993 and 2004, the LEGO Group diversified into "family lifestyle" products and theme parks, publishing, and customized toys. The latter demanded the creation of new, specialized elements with their own molds, production methods, and inventory. The number of different elements doubled to 12,9001 and the number of suppliers grew to 11,000, almost twice the number of suppliers Boeing needed to build a plane.2 Some of the new products cannibalized core products and the increasing complexity resulted in manufacturing and supply chain inefficiencies, leaving retailers frustrated by stockouts and slow-moving inventory. The Group's chrome overdiversification and "loss of confidence in its core product" led to sharply decreasing sales and colossal losses in 2003- 2004 (DKK 888 million and DKK 1.8 billion, respectively). The family-owned company had to be recapitalized (receiving a family loan of DKK 800 million) and J0rgen Vig Knudstorp, the energetic 35-year-old head of strategic planning and former management consultant, was appointed as CEO.

After that near-death experience, the LEGO Group made an astonishing return to profitability. Between 2004 and 2010, revenue grew by 139%. Net profit margin was double that of the Group's two main competitors,Mattel and Hasbro, and rose above 20% in 2010, outperforming a stagnant toy

market.3 With sales approaching $3.5 billion in 2011, the LEGO Group was the third-biggest toy manufacturer in the world (see Exhibit 3). lt enjoyed a 5.6% market share in the worldwide traditional toys and games sector and a 60.9% market share in the worldwide construction toys category, in whlch it was the leading company in most countries.4 With its head office in Billund, Denmark, the Group had subsidiaries in the Americas, Europe, Australia, Africa, and Asia and was selling its products in over 130 counh·ies. At the end of 2011, it had 9,374 full-time employees.5

Constructing a New "Business Architecture"

With hindsight, the secret of the company's astonishing turnaround lay in Knudstorp's c1ystal­ clear diagnosis of a threefold problem: overconfidence in the LEGO brand's selling power, overdiversification and the complexity of the company's product offering, and loss of confidence in its brick-based core products.

Knudstorp declared a new sh·ategy -refocu.sing on core products and core processes -which became known in company parlance as "return to the brick." The theme parks were sold. The model of a LEGO fire h·uck from one of the oldest play themes became the symbol of the new strategy. Inside and outside the company, LEGO pieces were celebrated for their versatility, durability, and quality.The new strategy titled "Shared Vision" underlined three core principles:6

"Be thebest at creating value for our customers and sales channels"

"Refocus on the value we offer our customers"

"Increase operational excellence."

Sticking to the "focus on the core" imperative, Knudstorp set out to "fix" the inefficiencies that in the previous decade had crept into the broad spectrum of the LEGO Group's production and supply chain, and demanded excellence in three major areas: prod uct development, customer relationship management, and supply chain management. In the product development function, the main challenge was to simplify LEGO sets and to reduce the excessive variety of the shapes and colors of the components.7 Advocating a "partnering" approach to consumers, Knudstorp placed a new emphasis on "listening to the children and parents" in order to develop the right products. In customer relationship management , the company decided to focus on the large retail chains that were increasingly gaining dominance in the toy market. Finally, the Global Supply Chain Management function set out to deliver the most efficient production and distribution value chain, which included thedevelopment of molding machines, molding, assembling, packing, and distribution .

By 2012, these capabilities were organized into centralized functions and were seen as the building blocks of a powerful new ''business architecture" (see Exhibit 4).

Product Development

One of the new management team's first decisions was to simplify production and design by limiting the number of different brick elements in use at any time to 7,000.8 In 2011, the limit was raised to 7,800 to support the growth of the company and to facilita te the launch of a new play theme, LEGO Friends, which targeted 6-12-year -old girls, an entirely new market segment for the company. All the same, a control function caUed "Elements and Standards" closely monitored the limit (which

was reviewed by top management evety year), approved new elements, and communicated the value of a simplified product range to developers. In addition, across the product lines, two or three in every four bricks in each new set had to be part of other sets. In 2012, roughly 80% of the elements were used in multiple sets and two in three were "evergreens" used in multiple product lines over more than a year.9 The target rate varied slightly across product lines: Star Wars products had about 85% common elements across the play theme, while other lines, such as buildable characters, were

below the 70% target.10 These rules lived in curious tension with the company's relentless drive to innovate. Every year, up to 70% of the company's sales were from new product launches. When asked how it was that such enforced commonality did not curtail the LEGO Group's innovativeness,

senior director John KeUey liked to pick out a few boxes of LEGO products from the display shelves that decorated his office: If you take a product theme like LEGO City here, most of what's in this product -the Fire Station -is probably also in this box -the Marina -and this box -the Coast Guard. If we take our competition, nobody else has cracked how to do that. They may have cool products, but they have a lot of unique components in them. It is because we have so much volume that we can put these bricks, these 7,800 different elements, into 413different sets.We make 36 billion LEGO pieces evety year. You can also think of us as the largest tire manufacturer in the world. We produced over 300 million miniature wheels in 2011. Our competitors would have to get that volume before they can get our level of commonality.It's a huge competitive advantage.

Commonality was also at the heart of standardizing the key operating processes of product development, such as concept meetings,"seUing in" meetings with retail customers,and the monthly monitoring of product performance. Project managers had to adhere to a standard timetable for the two-year development window. These standardized interlocking operating processes were the norm in all of the LEGO Group's markets. It was believed that company's competitors, in contrast, had different processes for different products and for different regions.

The LEGO Group prided itself on its ability to use consumer insight in product development. As Kelley put it: "Anyone can get consumer insight, but many people have a hard time dissecting thls information and utilizing it in their product development ."

The marketing staff conducted extensive research to explore new concepts, embedding research teams with families for weeks to understand how children lived and played.ll The company not only validated products with families, but also co-a·eated concepts with them. For instance, to develop LEGO Friends, sales strategists and product designers conducted extensive research and prototype testing with 3,500 girls in the U.S., the UK, Germany, and Korea. The new product line was launched worldwide in January 2012 and sold twice as much as expected in the first six months.12

Customer Relationship Management

LEGO products were sold to consumers by a variety of retailers: local toy specialists, regional chains, global retailers, and e-tailers. ln mature markets, the company operated its own branded stores as well, but even in those markets, most sales were handled by "general retailers" (see Exhibit 5). While in most established markets the Group followed its so-called "direct sales model", having invested in a subsidiary that put a well-oiled marketing engine behind the products, in many emerging markets the firm only supplied distributors who supplied local retailers with many labels.

Retail customers' satisfaction, measured annually by an independent party, was a weighted component of the scorecards that determined variable compensation for top management. 13 In markets in which the Group followed the "direct sales model", its leadership teams had a goal of minirrUzing customers' closing retail stock. Compared to markets in which the company relied on distributors, the "direct sales model" meant that the company's key account managers, marketers, and supply chain managers could speed up turnover by working closely with retailers (see Exhibit 6a).

The aim was to turn over LEGO inventories more quickly than competitors' products while also keeping an adequate level of closing stock to prevent stockouts. Key account managers sought to better promote LEGO products inside the stores iby negotiating more shelf space or "store-in-a-store" product displays, by persuading retailers to feature LEGO products prominently in their catalogues and promotional activities, and by making sure the right products were on the shelves. 1n managing key accounts, LEGO managers constantly looked for improvement opportunities in the stores. Some retailers, for instance, were reluctant to get rid of slow-moving stock; others only considered product margins and ignored turnovers and overall product profitability. Such inefficiencies gave an opportunity for the LEGO sales team to recommend solutions. Ola Tykesson, director for emerging markets, explained:

The more figures our retail customers share with us, the better the decisions we can make together. So it's a question of building this confidentiality of information between us. And we really say to our retail partners: "OK, how can we optimize your business?" And that's where we are strong. We're not talking about selling in. We're really talking about a true partnership, developing a common strategy together. We may suggest to them:"We want to create thebest LEGO shoppin g destination in your stores through the whole country. In return, we ask for some special Christmas displays, ads in the catalogues, et cetera." That could be a joint decision taken at headquarters level. Then our sales team will follow up with the buyers at local stores and implement our own in-store design, add the displays, the logos, et cetera. So you really build up all these kind of activities together.

In addition, we're really training the retailers, saying:"You should not look at the margin. The margin is not important. No. You should look at how much net income are our products generating for you on your shelf? And then you should compare it with our competitors'. And we know we're strong there -we can help the retailers have good stock control by ensuring speedy and reliable deliveries, so that the w01'king capital that is on their shelves is very limited.And then is rotating quickly.Very fast.

Developing a "win-win partnership" with retailers allowed the Group to command a higher margin than its competitors did (see Exhibit 6b).

Supply Chain Management

The Group's close working relationships with retailers enabled it to respond to very specific demands.For instance,Toys "R" Us focused on broad assor tments while Target wanted exclusivity.14 Walmart demanded in-store availability; if a specific LEGO product was not available in 92% of the stores,Walrnar t punished the supplier by temporarily delisting the item

The distribution function took care of logistics and ensured that the right amounts of the right products got from production to theretailers at the right time. Kelley put it in terms of the company's customer value proposition: "We may not offer the best margin to our retailer partners. We give an OK margin, but then we say: 'We're going to give you best-in-class inventory turns, high shelf productivity through constant newness, and keep the products available."'

In the U.S. and Europe, the Group was targeting finished goods inventory turns of 7.5 times a year. The company achieved this by having its operations close to the markets; it had molding and packaging facilities in Europe and North America and did not outsource production to Asia. "We don't have Asia -sourced productsper se," Kelley explained. "If we're putting a footprint or operations in Asia, it's because we have a market in Asia. We're not putting it there for cost reduction. We want to be more responsive toour markets."

To keep distribution employees focused, three metrics were typically tracked: lead times, stock turns,and delivery reliability .Quick lead time (the time it took thecompany torespond to a retailer's stock request) was necessary for hlgh inventory turns. Delivery reliability was also crucial; if retailers were not able to predict deliveries, they would need fro operate with higher inventory levels or switch toother products.

When the Group entered a new market, distribution was in charge of designing a new supply chain, taking into consideration whether the company was using the "direct sales model" or only distributors in that country. A key question was whether the company needed to set up a new, regional distribution center and, if so, where. Next, it had todetermine the necessaiy inventory levels for both its distribution center and its distributors.These decisions were interrelated; as long as the distribution center could providejust-in-time delivery, the Group did not have to require distributors or retailers to hold high inventory. However, running distribution centers was more expensive than relying on third-party warehousing, so decisions were made on a region-by-region basis. Having built a 51,000 square mete1· distribution center in the Czech Republic, the Grnup centralized its five European distribu tion facilities, and, in addition, opened two other centers in the U.S. to serve North America. For the time being, these centers handled customers throughout the world, although shipping times to Asian marketscould take several weeks,and sometimes even two months.

Given its global aspiration, the Group had to consider if, in addition to new distribution centers, it needed to set up production facilities in the proximity of the new markets. In spite of the fact that approximately 95% of global toy production was located in China, the LEGO group had kept its production facilities in the proximity of its main markets, Europe (60% of Group sales) and Nor th America (30% of sales). However, in order to save costs, the company scaled down production in Denmark and Switzerland and opened factories in the Czech Republic and Hungary; and moved the

U.S. plant to Mexico. Given its high-volume production of bricks, the Group rationalized sourcing through economies of scale and further reduced production complexity by outsourcing some packing toglobal subcontractors such as Sonoco and Greimer.15

Advantages of the Business Architecture

The LEGO Group's finely tuned business architecture provided several advantages. The first was "late dedication." Kelley explained : "Because we have a high level of common bricks, we can just prod uce a toh of bricks and then -based oh what the consumer wants-we can put those bricks in different boxes. If Star Wars is really cool, then we put them in Star Wars boxes."

Second, by tapping consumer research and retailers' sales data, the Group could gauge demand trends-essential for remaining relevant and new in the highly dynamic toy market, which many LEGO executives referred to as the "fashion indushy for kids."

Third, key account management and information sharing with retailers enabled the LEGO sales team to offer a differentiated service. By promising "best-in-class inventory turns" while ensuring product availability on the shelves, the company kept a fine balance between innovation, inventory management, and shelf productivity. Kelley explained:

Every year, about 70% of our turnover is from new products. We know that the kids love that newness. They want new products-thait's what makes them (or their parents) buy five products in a lifetime versus only one. This is what drives shelf productivity. The fact that we can provide high shelf productivity with a high inventory turn is really quite unique. Products fly off the shelf, but the retailers can keep a low inventory. Our competition can keep the shelves full at their retailers and they also bring a lot of newness, but they do it with a ton of inventory! But we don't have to do that. We carry the invent01y in our components, the bricks. And then we just pack those bricks to one box or the other.

In the past, tensions had often arisen beitween product developers, customer relationship managers, and supply chain managers as a result of the competing and of ten conflicting pressures each faced. By specifying the business architecture as a set of interlocking capabilities, Kelley's intention was that managers would find it easier to discuss trade-offs in interdepartmental meetings. In particular, there was a monthly cross-functional meeting at which 14 managers from product development, sales, and supply chain management debated shared challenges, such as how to modify product launch patterns to better fit the ibusiness architecture. Kelley found that these meetings helped the functions align their activities and expectations and become more empathetic to each other's needs:

They start to understand each other and the wall starts to break down. Consider what it takes for a product developer to tell a supply chain manager:"[ now know the challenge I'm putting on you and I feel bad ." But then it becomes a more constructive dialogue. Because then the product guy says:"Actually, maybe we won't make more differentia6on, because it asks too much of supply chain, it asks too much of key account management." Or, alternatively, when they do push for more product differentiation,we all have to know exactly what that costs us as a company in terms of managing the supply chain and customer implications.

Overall, the goal of specifying the business architecture was to enable the firm to avoid failures by surfacing trade-offs and tensions early. Kelley compared it to a "compass" that would help managers see more clearly how an opportunity would or would not fit into the firm's core capabilities. As the Group planned to increase its presence in Asia, it intended to use the business architecture model as a guide to decide whether the new strategy was compatible with its way of doing business and, ii not, what risks arose.

Redesigning the LEGO Organization

Knudstorp inherited an organizational structure that had evolved organically over the course of the Group's history. It comprised eight main business areas, three of them organized around markets ("Americas," "Asia/Pacif ic," and "European Markets & LEGO Trading") and five of them organized around functions ("Brand Retail," "Supply Chain," "Corporate Affairs," "Innovation and Marketing," and "Corporate Planning"). Another business area had also been created to manage the company's investment in theme parks ("LEGOLAND Parks").16

Over time, Knudstorp simplif ied the structure to three business areas: "Operations" (which included the production value chain from molding to packing and supply chain management), "Markets" (which included product development, consumer marketing, and retail customer relationship management) and "Business Enabling" (which included corporate functions such as treasury, corporate finance, and HR), see Exhibit 7. Each business area was headed by an execu tive vice president. Together with the CEO, these four executive vice presidents made up the Corporate Management team of thefirm. In2011, the Corporate Management team was expanded to encompass an additional 18 senior vice presidents from the next layer of management. Four cross-functional boards were also set up undeT Corporate Management to ensure coordination and fast decision­ making ("Brand & Innovation," "Operatjons," "IT," and"Corporate CompLiance").17

The new structure emphasized centralization. Laesseeexplained:

Compared to others, the LEGO Group is very much built on the principle of "one brand, one company'' - our decisions are made centrally. Local markets decide on local campaign prioritization, and implementation, but 90% of all campaign materials and 100% of all new products are developed by the centralized product development process. Local markets also handle issues like key account management, but again, that has to be based on our centralized customer business plarrning. Take another example from manufacturing - the factories are interwoven like a spider's net. The easy explanation is that we flow components from anywhere to everywhere. So, manufacturing planning is a global centralized function as all factories depend on the others for parts. This gives us operating speed, fleXIbility, and high capacity utilization - at the significant expense of the autonomy of, say,a factory manager in Mexico.

Annual planning and resource allocation were also centralized. Every October, the corporate center determined preliminary growth targets, in response to which each senior vice president submitted requests for resources, outlining their planned initiatives. The Corporate Management team then set the priorities and defined which oi these initiatives got funded by how much - which lead to the next financial plan. While the plan was approved by the board of directors in December, the Corporate Management team revised and finalized the performance targets for the year in March, having adjusted preliminary targets in light of the latest Christmas sales results. Laess0e explained:

The reason is the volatility. If in-season consumer sales are higher than expected, the shelves will be empty in January. Also, if our Christmas experience tells us that we faced a relatively light competitive pressure, meeting a target set in previous October would be a walk in the park. We do not want that!On the other hand, if in-season sales are disappointing, January shelves will be full. Add to it higher-than-expected competitive pressure and there is no way on Earth we could meet a target set iin October without that knowledge. So to ensure that we aim for realistic, yet ambitious targets - we finalize them in March.

Stepping Up in Asia

North America and Western Europe together accounted for 72% of all LEGO sales in 2011.18 Although the Group had been present in Asia for three decades,there was much room for improving its market share (see Exhibit 8). Marketing research forecasted that Asian toy markets were set to grow rapidly in the next five years,some reports speculating that the Asia-Pacific toy market would outgrow the Western European and North American markets by 2014-2015 (see Exhibit 9).

On January 1, 2012, the LEGO Group arrnounced a major new initiative to enhance market penetration in Asia by switching from the distributor model to the "direct sales model" in a number of regions. The Group already operated a sales company in Japan, Korea, Singapore, and Hong Kong; in the rest of Asia, it sold its toys to local distributors.

The distributor model suited the company well in some Asian markets; whether or not the switch would be profitable -or even possible -in a particular market depended on at least three factors: the size of the market, the quality and performance of LEGO's current distributor in that market, and the regulatory environment in that market. That is, could the LEGO Group generate sales over US$5 million, whlch would j ustify the investment? Could its own staif pedotm any better than the current distributor? Was it allowed to sell its prod ucts in th is market?

A five-year three-stage strategy was outlined. First, the company would establish regional distribution centers, operated by third-party companies, and build up regional safety stocks so it could shorten lead times to local customers.Second, ithe group would open a packing facility in Asia. The firm could thus be more responsive to local demand, while carrying less inventory in its distribution centers. But the bricks would still need to be shipped from plants in Europe, with each shipment taking between four and six weeks. Finally, depending on the success of Stepping Up in Asia, the LEGO Group may consider building a factory in the region.

Envisioning the Challenges

As the scenario-planning exercise continued, the participating managers brought forward a variety of issues to consider.

The Risks of Outsourcing Production

Controller Kenneth Christensen argued there was an increasing pressure to build scale efficiencies and shorten lead times in Asia. Many local retailers, operating with low inventory levels due to limited real estate, expected the LEGO Group to deliver "just in time." ln turn, this required the company and its distributors to build safety inventories.While the Group saw the solution in setting up efficient local supply chains, it had experience with the risks and quality-control issues of moving molding operations to Asia.

Senior vice president John Hansen, responsible for engineering and quality, recalled that, in 2004, the LEGO Group had experimented with outsourcing some molding operations to Flextronics,a large Singaporean manufacturing services provider,19 only to move the majority of the production back in­

house three years later. It had proved to be too difficult to align the Group's seasonal and unpredictable demand with Flextronics's stable business model, dependent on economies of scale. As half of the LEGO Group's sales took place in the ]Q weeks before Christmas and the demand for a

certain theme could fluctuate between plus or minus 30%,20 the company's demands seemed untenable to Flextronics. In addition, the Group was not satisfied with the effectiveness of the outsourced facilities: Inventory accuracy and mold lifetimes both decreased, while some pmchasing

costs rose.21 The company finally brought the outsourcing experiment to an end by terminating the contract.

The Uncertainti of Market Grawthand Demand Projections

John Kelley pointed at the diagram of the LEGO Group's business architectme which he had drawn on the white board. As a principle, he argued, the company would never risk being unable to cope with product demand. In order to supply the most optimistic sales forecasts in Asia, it would need to build costly new capacity for warehousing, packing, and-possibly -molding. However, what if the Asian market stagnated and LEGO products didn't sell as much as expected? Kelley argued to his colleagues that this would be catastrophic

Explanation / Answer

Answer:

It would be interesting for an international supply chain student to study this Case Analysis of “The LEGO Group: Envisioning Risks in Asia” for the following reasons

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.