Toy talk with Lego CEO Jørgen Knudstorp
Dressed in jeans, open shirt and rolled up arm sleeves, he gave an interview in a former warehouse converted into an arts centre in a suburb of Copenhagen.
Knudstorp had chosen the venue to provide some out-of-office training as well as motivational seminars for his staff. It was also the only slot he could find within a heavy time schedule.
Ex-McKinsey man Knudstorp is a strategic thinker who has been instrumental in turning Lego around after the company had got seriously out of kilter by diversifying away from its core proposition. Last year, the Lego group posted annual sales of €1.3bn.
During the interview, it was a pleasure to let Knudstorp's analytical mind play over the international toy segment. It was also reassuring to learn from him that children still play with colour plastic bricks in an age of electronic games.
"Children have less time to play"
Dr. Knudstorp, do children still play with toys like Lego in a world full of video games?
They have less time to play due to their increasingly programmed life and they stop playing earlier. We are fortunate in that this is truer for girls than for boys, who still play a lot. So our market is less threatened.
Will Lego remain a physical toy?
Yes. The book didn’t die out in the age of radio and film. The same applies to physical play with Lego blocks — an experience which cannot be recreated on the internet.
Lego satisfies a deep-seated human urge to create something meaningful and represents the joy of building. In fact, during the last couple of years we have produced the largest number of building bricks in our history.
Why then are you also moving into the virtual space?
You have to stay contemporary. People don’t read the same books they used to and don’t read newspapers in the same way they used to, therefore books and newspapers are changing a lot. The same applies to us.
How large is your online business?
Our online offer is mostly in the US and the emerging markets and is approaching 10 per cent of global sales. In fact, lego.com is already one of the most frequently visited boys’ sites in Europe and the USA. We also sell, e.g., Star Wars which is the number one family video game in the US.
Why did your first attempts to take Lego online fail?
The extremely difficult challenge for any innovation leader is translating a physical brand online. When children used to the physical experience of building with Lego looked at it on a screen they didn’t find it exciting. In fine: I may, or may not, like Lego, but, if I like it, I want to do it on the table.
In the past, Lego tried to create a brand portfolio. Why have you shifted your business emphasis back to the core product?
Wherever we departed from our core proposition consumers deserted the brand in droves because what’s unique to us is the creative building material. In Germany our total sales come from as few as half a million households who really love us.
When we tried to capture those customers who aren’t really into Lego, we found that they bought a little more than they used to, but that they still didn’t become core customers. Meanwhile, we disappointed and risked losing our core customers.
With 40 per cent of sales Germany is your core market why not boost your market share by reducing prices?
In toys you will die at the low end of the market because there is always somebody undercutting you, and consumers are always very willing to trade down. Brands must make up their minds whether they are high-quality and offer excellent service or whether they want to go down to the discount level.
We have decided that we must make a statement of authenticity, originality and having meaning for the family. We want to say that we are not just a toy, but creative material. So we’re trading up.
What are the consequences for the sales channels you sell to?
We are a premium, but not a luxury brand. Therefore, we are not into selective distribution and need to leverage all mass market channels. Obviously specialist retailers are particularly important to us because they offer the customer specialist advice.
However, we divide our proposition in such a way that every retailer is able to offer some exclusive points of differentiation.
In the past, some retailers found Lego arrogant. Have you changed this?
We now listen much more carefully. We also invite leading retail customers to our headquarters as early as 18 months before new product launches and hold joint discussions on box design, advertising, campaign etc. This is very productive because the head buyers are very knowledgeable.
In 2003, Lego sales fell 30 per cent and earnings by 22 per cent. This was the biggest loss in the history of the company. But, by 2005, you recorded a return on sales and invested capital for the first time since 1994. How was this achieved?
By virtually eliminating our debt and by generating cash. We fundamentally reduced our fixed asset base. A big chunk of this was the sale of Legoland, including the real estate. There was also a big one-off write-down.
How do you see the future of your group?
As a 'premium network', and premium because we are a niche player offering a high-quality product. Network because now use partners in every aspect of the business, whether that be in manufacturing, selling, running stores and parks or in innovation.
Why are you outsourcing your packaging plants to eastern Europe rather than China?
As 60 per cent of our business is based in the EU, eastern Europe provides a better supply base than China in terms of transport times. If we were to produce in China, we would need more inventory and longer lead times.
We are in a seasonal and highly unpredictable business where demand can vary dramatically and where it is not uncommon to have a monthly forecast error of 30-50 per cent. Therefore any increase in shipping time means a high cost of obsolescence.
What else is so attractive about eastern Europe?
It is the world’s new Shanghai. The wages which we can access in eastern Hungary and certainly western Ukraine, as well as also potentially in Rumania and Bulgaria, are comparable to those found in southern China. Further opportunities will arise through EU expansion.
So, by the end of next year, we will likely have moved 90 per cent of our packaging plants out of Denmark, Switzerland and the US to countries such as Czech Republic, Hungary and Mexico.
Why also in Mexico?
Because of its proximity to the US, which means shorter lead times. Also we get a dollar reach, as the peso is pegged to the dollar, which has often been good for our balance sheet.
Why are you rescinding an earlier decision to save labour costs by automating the packaging process?
We found that automation was a mistake. Manual packaging is better because the most flexible machine in the world is the human being. Automated production runs can take up to two hours to change, with human beings it takes only 15 minutes.
Why do you still mould 90 per cent of your bricks in Denmark when 80 per cent of the world’s toy manufacturing is performed in China?
Moulding is a difficult and complex process. It is affected by pressure, air humidity etc., it’s a real art which takes years of know-how with highly trained operators.
There are no suppliers anywhere in the world that can provide us with 15bn pieces of brick per year in the necessary quality, and certainly not in China, where you often have two or three persons manning a moulding machine, and there is a high defect rate.
Are there also copying and secrecy issues?
Yes. In theory our intellectual property rights are protected by the People’s High Court in Beijing, but the problem is compliance, it’s a big country.
To what extent has Lego been hit by Islamic protests against Danish companies?
It was an extremely difficult period and put us on a high level of security. We have consistently refused to make any political statement other than that we employ and respect all races and religions. Unlike many other Danish businesses, thankfully we have experienced no negative impact whatsoever on our sales.
To date, Lego has produced over 400bn plastic bricks and currently adds around 15bn new ones every year. How biodegradable are your products?
The plastic itself is not biodegradable, and to make it so would actually run counter to our promise that it can last at least 50 years. Regrettably, we don’t have a sustainable recyclable model because at the end of the day our product is plastic.
However, we use environmentally-friendly technology and reduce energy consumption, wherever possible. For instance, at our Billund site, which is the world’s largest plastics manufacturing plant, we cool with recycled groundwater, re-granulate surplus plastic and do not use phthalates . We have also reduced the cardboard content in our packaging.
Does the Kristiansen owner-family intend to sell Lego, for instance, to private equity?
Clearly from a purely financial point of view a merger with one of the bigger international players such as Mattel or Hasbro would achieve tremendous one-off cost synergies. However, despite the obvious financial advantages our strategy is organic and not acquisitive.
Also, I’m not so sure that there would be synergies in innovation, marketing and creativity, which is what we are all about.
Do you ever have enough time as a CEO to play Lego with your children?
Yes, but only because I make time for them. The only thing I’ve done in the last four years next to managing Lego is to spend time with my kids. Their childhood won’t ever come back again, so now is the time to be with them.