The Economics of LEGO

There is perhaps no simpler toy than the humble LEGO brick. The iconic four plain flat sides and two studs are simple to make, simple to use, and simple to learn. One would also think theyd be simple tideland yet the LEGO Group has had a remarkable number of ups and downs in its 88-year history— scares during which it seemed to face certain death, and high points during which it seemed invincible. The company’s path has been so turbulent because, as it turns out, selling LEGO really isn't that simple. A mere 6 bricks can be combined in an astonishing915 million different ways. The LEGO Group is tasked with finding which of these combinations will excite children the most and, ultimately, create the most profit.And while the buildable brick may seem an obvious invention today, they were once neither obvious nor easy to make. At a time when premium toys were all made of wood, plastic LEGO bricks were a radical departure from the norm.They seemed cheap, less friendly. The decision to use plastic was also far from straightforward.Initially, bricks lacked the “sticking "mechanism in which they stay together until deliberately detached — meaning any creation could be destroyed with one flick of a finger. After years of experimenting with different materials, in 1958, LEGO settled on a design that remains unchanged to this day — meaning those 62-year-old bricks can still be stacked with that manufactured yesterday. The second revolutionary idea of its founder was called the “LEGO System of Play” — that every set would be composed of the same basic bricks — allowing them to be combined to produce something even grander. The financial genius of this idea was simple: Now, not only would LEGO have a brand, like all companies, that consumers would grow to love, but they would also invest in the ecosystem. The interoperability meant that once a child bought his or her first LEGO set, they now lived in a LEGO household. There was more value to be had from buying more and more sets. It was on these two foundational pillars that LEGO grew to become the global sensation it is today. As of 2013, a total of 4.4 billion Minifigures have been produced, 80 LEGO bricks per person on earth, and 300 million tires per year — technically making it the largest producer of tires, above Michelin and Goodyear. But it wasnt all smooth sailing. There were many missteps and challenges along the way which directly led to the LEGO we know today — one of movies and licensed, branded themes like Star Wars and Minecraft. The first of these problems began to surface at the end of the 1980s, when the last of its core patents expired, ending its long-held monopoly on interlocking, buildable toy blocks. In hindsight, although LEGO had seen decades of profit, this was the first time it was tested as a company, not merely as a product. During the life of the patent, LEGO could coast on the brilliant idea and design of its founder, knowing that no other company could sell in the same market. This insulated the company from competition, creating a culture in which feedback or suggestions from parents, or even children themselves, was unwelcome. Its designers took a similar philosophy to those of Apple — that they could create demand and that they didnt need to chase it.In 1988, however, all that changed. Now, any toy giant could sell similar brightly-colored, themed playsets, which kids may or may not be able to distinguish. At first, the LEGO Group shamelessly sued its competitors — MEGA Blokes, Oxford Bricks, and others — claiming that although its patents had expired, their similar designs were now infringing on its trademarks. When this failed — miserably — it Tooka different approach. It decided to throw every theme, set, and character out there and just see what stuck. Between 1994-98, LEGO tripled the number of toys it produced — introducing at least5 new themes every single year. The one new addition which succeeded — did so fabulously. LEGO Bionicle's had very little in common with its counterparts — they were based on a story of warring robots were visually dark, and used entirely different parts — but kids loved them. Just a few years later, 85% of American boys aged 6-12 said they knew of the brand, and45% owned at least one of them. Over 40 books were written based on the characters. Bionicle's almost single-handedly kept the company afloat but was just one success atop a mountain of failures. For example, there was Jack Stone — a more detailed character based on a new series of cartoons.And Galidor: Defenders of the Outer Dimension— a live-action sci-fi series which cost LEGO millions and... almost no one watched. By 2003 it had become abundantly clear something needed to change. The company was on the edge of bankruptcy with $800 million in debt, a 30% decline insoles, and an estimated loss of $337,000 US dollars every day. Even worse, the company didnt really nowhither became the task of its then newly-hired CEO in 2004, to figure out why the company was losing so much money. Its original hypothesis was that kids were increasingly turning towards modern alternatives— video games, and electronic toys. This turned out to be wrong. The real problem, it discovered, came from within.The economics of LEGO are simple: What makes it such a compelling toy is that every set is composed of the same basic pieces, which can be creatively rearranged and built upon. This just happens to also be what makes it such a fantastic business. A single, modular, universal part which can be manufactured and later assembled into whatever final product is in demand at that time, is a supply chain manager’s dream. Producing a given LEGO piece requires a $50-80,000plastic injection mold. A popular brick may be produced 60 million times — driving that mold cost down to essentially zero.However, in LEGO’s decade of aimless experimentation of new sets and themes, the number of unique pieces doubled — from 6,000 to over 12,000.The company’s designers, insulated from the financial costs of their decisions had been allowed to go crazy with new, exciting themes.One set, for example, included 8 different pirates, with 10 different styles of legs. Each of those new pieces required its own mold, and thus, rapidly increased production costs.LEGO’s new CEO started by consolidating— getting rid of unprofitable sets, and doubling down on those that worked. What he found was that successful sets generally had one thing in common: they centered around a narrative, especially a branded series, like a movie. Although partnering with existing brands like Star Wars was initially controversial within the company — they were worried it would dilute its “family-friendly, squeaky-clean image — they proved to be immensely popular. In 2004, only Star Wars and Bionicle's sets were making a profit, while the other 94%lost money. The issue was that Star Wars sets only sold well after the release of a new movie-making LEGO sales highly dependent on the cinematic schedule of its partner. These factors combined to usher in the modern era of LEGO. To differentiate itself and diversify, it strikes licensing deals with a large number of brands, and increasingly, seeks to create its own. The success of the LEGO Movie allowed the company to control its own branding, and keep the story alive in the minds of younger generations. Still, these decisions are controversial. LEGO has long attracted a large adult following, some of whom say the company has lost its creative beginnings in favor of Hollywood storytelling.Some vocal adult fans say the LEGO of today places too much emphasis on play and not enough on building. What no one can say is that the company hasn't stayed focused on quality.88 years ago, LEGO began as a creator of premium toys, and today thats no less true. With or without a patent, customers choose LEGO simply because theyre better. If anything, the premium feel of the humble LEGO brick has only grown — as you discover those from your childhood still smoothly, satisfyingly, click-in-place after decades of waiting. If youre someone who likes playing with LEGO, theres a pretty good chance you 'recreative and like learning new things.