Another brick in the wall

BRAND REBUILDING:IF BUILDING BRICKS can be used to construct an empire, they can also be used to reconfigure it when the going gets tough. Refocusing energy on its iconic core product – the simply ingenious building brick – underlies Lego's turnaround from gloom to boom.

The Lego company, makers of the world’s favourite toy, last month scooped first place in Denmark’s annual corporate image awards. The return to pole position for the first time in a dozen years was a welcome local accolade and acknowledgement of one of the most remarkable company turnarounds in recent years.

Lego has had a chequered past. Despite a truly impressive global fan base and the fact that the iconic building brick beat the Barbie doll and the teddy bear to win Toy of the Century in 2000, six years of sluggish sales and poor earnings jeopardised its very survival.

The fall from grace was spectacular. In 1998, the family-held company announced its first annual loss since its founding in 1949, blaming competition from computer games and electronic gadgetry. The chosen solution – which eventually almost proved its undoing – was to play the competition at its own game by expanding into the brave new world of robotics and cyberculture.

The brand name was also leveraged into a smörgåsbord of lifestyle offerings including watches, clothes and video games. Even Duplo, the oversized version of the regular Lego brick designed for the tiniest of toddler fingers, was dropped from the range as the company laboured to establish cool credentials with precocious tweens.

But the cure very nearly killed the patient. Kids and their parents refused to play along. Sales slumped, revenues headed south and the tiny town of Billund, where Lego is headquartered, was blighted by savage redundancy rounds.

By 2004, global private equity funds were hovering in the wings, keen on plucking up their favourite sort of prey – a venerable but mismanaged family firm.

Kjeld Kirk Kristiansen, the grandson of the company’s founder, made a bold decision and handed over the reins to the first outsider to run Lego in 72 years.

The move stunned the business community and media. Not only was Jørgen Vig Knudstorp a newbie to Lego, having joined only three years previously, he was only 36 years old, with a PhD in business economics and a background in management consultancy.

His penchant for “business casual” attire – jeans and sneakers – did little to enhance his reputation with the sceptics.

Knudstorp, an affable and eloquent man, candidly admits his elevation to the chief executive’s chair raised some eyebrows. His rise through the ranks had been meteoric, with some seven promotions in the space of three years – including two in the same week.

The disbelievers soon had their comeuppance. The Young Turk’s solid academic credentials and keen outsiders’ eye allowed him identify and correct the major fault lines.

The first insight was that Lego had strayed too far from its roots in its headlong rush to be "modern". Around the turn of the millennium, long before the global economy went sour, business opportunities were waiting to be plucked like cherries in an orchard.

And Lego, the chief executive decided, had plucked too much fruit. "Most companies that go down don't starve themselves to death, they die from indigestion because there are so many opportunities," Knudstorp said.

Having gone into everything from lunchboxes to robots, Lego had been adding three to five business units a year. For Knudstorp, the proper pace would have been the reverse – one big development every three to five years. "I think that's what nearly killed us," he said.

Companies that allow themselves to get swept up in the scramble for novelty inevitably lose focus on their core business. "For me, the paradigm shift is that it's the core business that's the most exciting," he said.

In line with this back-to-basics thinking, big brick Duplo went back on the shelves (to whoops of joy from toddlers worldwide) and Knudstorp set about clearing the clutter from his own corporate toybox.

The first imperative was to restore profitability. Before Knudstorp, Lego often seemed to have the genteel air of a family playground where talk of money was seen as impolite. The talk at management meetings was all about play and creativity and sunshine childhood moments.

The attitude was more "we're doing great stuff for kids, don't bother us with finances" than deference to the fundamental requirement to turn a profit.

In 2003 – a full five years after posting its first ever annual loss – the struggling toymaker posted a massive 1.6 billion kroner operating loss on sales of 6.8 billion kroner.

Against this background, Knudstorp set about a thorough rejig of company culture, downgrading the imperative to "nurture the child" from Lego's mission statement and giving top priority to the bluntly prosaic "I'm here to make money for the company".

The turnaround plan brought more pain to the sleepy town of Billund. Almost half of the firm's local employees lost their jobs, as production was moved out of western Europe into the Czech Republic and Mexico. Even the jewel in the Lego crown – its four Legoland theme parks – was not spared the knife: the Blackstone Group, a private equity firm, took control of these.

While undeniably a severe loss of prestige for the company, the theme park sale proved crucial in getting the bottom line back into shape and addressing Lego's hefty 5 billion kroner debt.

Knudstorp's seven-year turnaround strategy, "Shared Vision", launched in 2004, bore fruit almost immediately. The massive 2004 loss was replaced, the following year, by a modest net profit of 214 million kroner and an equally modest 3 per cent revenue increase. Each year since then, success has been gathering momentum. In 2009, Lego posted net profits of 2.2 billion kroner on the back of 11.7 billion kroner of sales.

And while 1,322 people lost their jobs in 2005 (reducing the figure to 5,302), the payroll total has now expanded to over 7,000.

Last year, as the global economy continued to be convulsed by economic crisis, and Chinese factories churned out electronic gadgets and games unabated, Lego still managed to increase its grip on children's imaginations and on their parent's purse strings.

While the company says that the market for traditional toys will be "flat to slightly declining" in 2010, it nonetheless expects to increase its own sales and earnings.

Indeed, last year's stellar performance upped its share of the global market to 4.8 per cent – an enviable slice of a market that the Toy Association of America estimates to be worth over $80 billion.

For Lego, and Jørgen Vig Knudstorp in particular, it's been a job very well done. So what's the secret? What magic formula did the young McKinsey consultant apply to give the kiss of life to this most beloved but temporarily troubled brand? What novel strategic plan did he pull out of his management box of tricks?

The almost baffling answer is – none. At least to begin with.

Having taken the helm of a sinking ship, Knudstorp ploughed his energy into stabilising the business. Many companies in a similar situation, he said, would push forward for growth on the assumption that growth is tantamount to profitability.

"By contrast, we said that there would be no growth for the first three years, but there would be a manifold increase in productivity," says Knudstorp.

While some observers have dubbed this the "Knudstorp strategy", the man himself laughs off all such grandiosity. "This is not just generic, it's super-generic. You'll find it on the first page of any business consultant's handbook."

Indeed, as he points out, it's a tactic sometimes used by governments in a downturn – by setting their caps at increased competitiveness instead of higher consumption and economic growth, they bring their countries back on track. "Take a few years to stabilise things – you'll eventually get back to organic growth," he says.

And all the time, he says, you keep a steady eye on costs. Walmart, the gargantuan US chain store group, is one of his biggest customers, and one that provides useful lessons.

Whenever a Walmart executive visits him in Billund and is given a cup of coffee, the American invariably drops a dollar onto the table. The man from Walmart, Knudstorp says, does not want Lego "dishing out coffee for free" because this would ultimately end up being paid by the consumer. "I love this attitude – it's leadership by example."

While Knudstorp is frequently hailed as a "miracle man" in Danish newspaper headlines, he would be the first to admit the doctrine of infallibility does not apply to chief executives.

The biggest lapse, perhaps, was his early decision to outsource brick manufacturing not just to the Czech republic but also to an outside sub-contractor, the Flextronics group. The intention was to cut Lego's domestic wage bill by getting a sub-contractor to take on routine manufacturing and packaging tasks in low-pay eastern European sites.

While it sounded fine in practice, and Flextronics certainly had (and still has) a sterling reputation for precision engineering, the plan flopped.

Producing a little plastic Lego brick is much more difficult than it sounds, especially given the company's exacting quality limits. Out of every one million bricks made, just 18 will be faulty. Given an annual production total of some 19 billion bricks, or 36,000 a minute, the tolerance for duds is effectively zero.

After only two years, Lego and Flextronics called time on their partnership, allowing the Danish company to keep tight quality control of its manufacturing in every site worldwide.

There have been other more minor mistakes in the last six years. But, overall, the impression Knudstorp leaves is positive. In the prevailing environment when leaders – both political and corporate – all too frequently display a dispiriting inability to assume responsibility for their actions, the soft-spoken but determined toymaker is a breath of fresh air.

"Do you take responsibility or do you base it on some external factor like the financial crisis or bad weather? Because if that's your main reason for how your business is progressing, what the hell are you doing in the job?"