CNBC Business | The Real Toy Story

The Real Toy Story

Within five years once-rundown Lego has rebuilt itself as a licensing and innovation powerhouse, reports Scott Berman. And, as Lucy Fitzgeorge-Parker and William Boston discover, other traditional European toy manufacturers are thriving too.

With Transformers: Revenge of the Fallen hauling in €575m at cinemas worldwide this year, movies based on toys could not be hotter. In the last few months, Hasbro, the US toy giant behind Transformers, and its rival Mattel, have struck Hollywood deals for adaptations of several properties, including Battleships and Masters of the Universe. In August, Paramount announced a sequel to GI Joe: The Rise of Cobra, which provided Hasbro with another windfall this summer. And in September, Universal added Mattel’s Barbie to its star stable. But one playtime favourite heading for multiplexes sounds a far less obvious choice: Warner Bros is hatching a movie, which will mix live action and animation, around Lego. The Lego movie is just another step in the transformation of the 77-year-old Danish toy company that churns out around 20 billion tiny building bricks a year – at a mindboggling rate of 600 a second. For the last few years Lego has quietly expanded into video and online games (in 2010, it will roll out Lego Universe, a multiplayer online virtual reality game system), architecture models and software to design and order customised toys. It is also investing in real bricks too, with 15 new retail stores due to open before Christmas to add to its existing 47.

All this activity may seem surprising, given that five years ago the company, based in Billund, Denmark and owned by the founder’s grandson, Kjeld Kirk Kristiansen, appeared doomed in a world in which youngsters had become entranced by computers and videos. After disastrous attempts at launching products for babies and for girls – and a change of the name of the popular Duplo bricks to Explore in 2002, which made it hard to find on shelves – Lego posted losses of €119m for 2003, which doubled, to €242m, a year later.

Fast forward to this August and a buoyant Lego announced a robust increase in turnover and pre-tax profits of €124m for the first six months of 2009, up 61% over the same period of 2008. Company watchers have variously described Lego’s turnaround as everything from innovative to astounding, but painful is equally true. In 2004, Kristiansen stepped down to facilitate the internal promotion of the more pioneering Jørgen Vig Knudstorp to the position of CEO. Knudstorp immediately implemented a programme intended to “reconnect the business model with the brand”, in part – appropriately enough – by dismantling assets and investment risks, and then rebuilding.

The company began by offloading its four theme parks in 2005 and franchising them; Kristiansen, through Lego’s holding company, KIRKBI, later bought shares in the theme park operation, now second to only Disney with 14 million visitors a year. Lego also moved most production to the Czech Republic, Hungary and Mexico, continuing a process that had started in 2000. Distribution and some production is outsourced, but Lego manufactures most of its products itself. The company halved the number of interchangeable parts it moulded, from 13,000 a decade ago to 6,500 now. More painful cuts occurred: the 8,300 employed in 2003 fell to 4,500 in early 2008.

However, within the last 18 months, the number of employees worldwide has risen to 7,000, including 2,000 who were hired or added to the Lego payroll from former outsourcing partners. The move reportedly has developed and brought new products to market in half the time it had previously taken.

It was not just going back to basics that reversed Lego’s fortunes; it was the Danes’ new-found enthusiasm for maximising the earning power of their properties. A decade ago, a begrudging Lego hammered out a deal with Lucasfilm to market a line of Star Wars products. Since then, the number of Lego collectibles based on television, movie and other cultural icons has exploded. These include another George Lucas property, Indiana Jones, SpongeBob, Ferrari, and the Warner Bros. franchises Batman and Harry Potter. Many of the tie-ins now also have spin-offs in the form of successful computer games.

Mads Nipper, Lego’s executive vice president for marketing and products, estimates that these licensed products constitute 25%- 30% of all Lego retail sales worldwide, with the US sales of these items eclipsing European and Asian ones. The themed toys are based on inbound licences; that is, external themes brought in to infuse Lego products. Outbound licences bear the Lego theme stamped onto backpacks, clothes, books and other items; they are sold not by Lego but by outbound licensees, and make up 10% of global retail sales of Lego-branded items.

With inbound, Lego buys the rights to use an external licence; an effort led by Jill Wilfert, Lego’s vice president of global licensing. California- based Wilfert looks for licensing possibilities, along parameters set by Lego: themes must be relatively non-violent and offer scope for attractive toys. Before negotiations, Lego studies reference material from licence owners. Many potentials are nixed because they don’t offer the kinds of subjects Lego is after, such as “cars or iconic buildings” that could be fashioned into toys, says Nipper. In terms of outbound, Lego gets approached by companies in many categories but is not interested in items such as vitamins and batteries.

Hasbro, points out Wilfert, is positioning itself as an entertainment company; Lego has had direct-to-DVD animation movies before and more are on the way. However, the current project with Warner Bros, a family comedy being written by Dan and Kevin Hageman, looks to be a big step. Wilfert declines to give any figures for the deal, but does say that Lego will continue to pick and choose carefully, because “at the end of the day, we’re incredibly protective of the brand.”

“Play is not just the toy, it’s the experience,” says Nipper. In other words, the company’s themed bricks and other nontraditional toys have the Lego DNA because the brand is built on this “play experience”, whatever the product or brand extension. Moreover, Nipper points out that, despite the visions of film directors, kids still customise themed sets, since all Lego bricks are interchangeable with ones produced since the 1950s. This leads to the idea of an entire “system in play”, with sales of one set enhancing sales of another.

The core product may be taken further with the next wave of initiatives: Toy Story, Cars and more movie-inspire d lines with Disney; the global release of board games launched recently in the UK and Germany, designed for whole families; and more online games. Spin-off toys from the movie are also inevitable.

In a few years, says Lego spokesperson Charlotte Simonsen, the company will delve deeper into the virtual world, and will have more customer involvement, more custom toys, and more items for girls, older children and adults. But she stresses it will still be about the brick, adding that new concepts are “just another way of building”.

Delivering the keynote speech at last year’s American Creativity Association conference in Singapore, Knudstorp said that innovation at Lego is also user-driven. The company is a big advocate of mass collaboration and lead users will participate in R&D for free “just for the thrill of being part of the product”.

An example of this is Lego Mindstorms, a line of programmable bricks with electric motors, sensors, bricks, and Technic pieces (such as gears, axles, and beams), which originated from the programmable sensor blocks used in the line of educational toys. This began as a joint venture with Massachusetts Insitute of Technology, but two weeks after the launch, hackers deciphered part of the proprietary code, posted it on the web, wrote advanced code for robots, and created a new operating system. Despite fears of competitors copying the product, Lego didn’t sue, instead releasing a developer’s kit incorporating the best ideas from hackers.

The hackers became an open source community of volunteer beta testers and product developers who accelerated innovation. Mindstorms became a highly profitable product that surpassed the original plans of the internal product development team.

Of course these are small revenue-earners compared to the mainstream products. Challenges still remain in terms of sales, including increasing production to meet demand, according to market analyst Euromonitor International in London. Even though Lego doubled capacity this year, “many independent retailers cannot get Lego products in stock and are forced into reducing shelf space,” while some new outlets “go without having any Lego product lines on their shelves,” according to Euromonitor’s Utku Tansel.

Whatever the concept and wherever this brand heads, kids seem more than able to recognise whatever works about Lego, and if it’s not there will just walk away without a second look. It’s that simple. Nipper adds: “Apart from drunk people, kids are the most honest people in the world.”

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