CASE 01: Rebuilding Lego, Brick by Brick

Precede with modifications by Nhu Ngoc Nguyen (VILAS)

On the surface, the Lego Group didn’t look as if it was in trouble. The fourth-largest toymaker in the world
at the time (today it is fifth-largest), the Lego Group sold €1 billion (US$1.35 billion) worth of toys in 2004,
ranging from its snap-together bricks for young children to Mindstorms, a line of do-it-yourself robot kits
for older kids. Even in the digital age, its toys maintained a surprisingly firm grip on the market and seemed
to adapt well to changing tastes. The company’s steady stream of new products routinely generated
three-quarters of its yearly sales. Popular enthusiasm was so great that in 2000, the British Association of
Toy Retailers joined Fortune magazine in naming the company’s classic bricks “the toy of the century.”
But the Lego Group’s financial performance told another story. Despite its extraordinary hold on the
imagination of children around the world, the Billund, Denmark, company was in trouble. The Lego Group
had lost money four out of the seven years from 1998 through 2004. Sales dropped 30 percent in 2003
and 10 percent more in 2004, when profit margins stood at –30 percent. Lego Group executives
estimated that the company was destroying €250,000 ($337,000) in value every day.
How could such a seemingly successful toymaker lose that much money? Some observers speculated that
the Lego Group had over diversified its product line with moves into such areas as apparel and theme
parks. Others blamed the exploding popularity of video games or pressure from low-cost producers in
China.
Although there was some truth in these hypotheses, many other factors impeded the success of the iconic
global brand, including its innovation capabilities and its supply chain. The company leadership knew it
had to address those problems, and that the supply chain posed the most immediate opportunity for
improvement. The Lego Group’s supply chain was at least 10 years out of date. Poor customer service and
spotty availability of products were eroding the company’s franchise in key markets. Speedy attention to
the supply chain, the leaders reasoned, would not only buy them time to deal with the other challenges,
but could help set in motion a virtuous circle of improvements that would support subsequent changes in
the rest of the company.
To rebuild profitability, the company had to refashion every aspect of its supply chain. That meant
eliminating inefficiencies, aligning its innovation capacity with the market, and re-gearing to compete in
the new big-box world. This was no small matter for the Lego Group, which by the time CEO Jorgen Vig
Knudstorp took the helm in 2004, had grown to roughly 7,300 employees, working mostly in two factories
and three packaging centers — each in a different country — turning out more than 10,000 permutations
of its products packaged in hundreds of configurations.
The company’s leadership team recognized that even though transformation would be painful, it was
imperative. “From my perspective, the supply chain is a company’s circulation system,” says Knudstorp.
“You have to fix it to keep the blood flowing.”

Diagnosing the Problem

The symptoms of a dangerously misaligned supply chain can be deceptive. At the Lego Group, for instance,
it took many years of underperformance before the company realized that the supply chain was a major
source of its difficulties. What made those problems especially hard to identify was that they grew out of
the company’s core strengths: its capacity for innovation and its commitment to quality. Those were the
very advantages that the company’s leaders had relied on at first to reverse the profitless streak, hoping
the company could innovate its way out of trouble. From the mid-1990s through 2004, the Lego Group
moved into video games, TV programs, and retail stores. But the diversification added layers of
complexity, and the red ink continued to flow.
With the mandate for change clear, Knudstorp spent his first weeks as CEO working closely with
Kristiansen and the other members of the board and the leadership team to pinpoint the source of the
company’s problems. Was the Lego Group too diversified? Yes, but focus alone was unlikely to be the
silver bullet. Were costs an issue? Absolutely, but they were just one aspect of an array of challenges,
including service, so a stand-alone cost play was unlikely to succeed. Had the company lost touch with the
video game–obsessed consumer market? That hypothesis withered in the face of a simple fact: Three-
quarters of the Lego Group’s sales every year were from new, mostly non-electronic products. “I believe
that the focus on electronic competition was really a blame game,” Knudstorp says.
Instead, as Knudstorp and his team examined every facet of the company’s operations, they came to focus
on the supply chain. They approached it holistically, analyzing every aspect of the company’s product
development, sourcing, manufacturing, and distribution.

Product Development.
Given the success of the Lego Group’s steady stream of innovative new offerings over the years, the
“Kitchen,” the company’s product development lab, was a point of corporate pride. But the leadership
team found that new products were delivering less and less profit. Each successive generation of offerings
added more complexity. Plastic bricks and other elements that were once available only in primary colors,
plus black and white, now came in more than 100 hues. A far cry from the simple box of bricks that baby
boomers grew up with, Lego sets had grown much more elaborate: A pirate kit included eight pirates with
10 types of legs in different attire and positions.
Such intricacy and attention to detail reflected the firm’s culture of craftsmanship, but also its disregard
for the costs of innovation. The company designers were dreaming up new toys without factoring in the
price of materials or the costs of production. That kind of carefree creativity is unsustainable in the current
global toy market, where cost pressures are a constant concern.
Furthermore, introducing new products every year is not necessarily a bad thing, but the Lego Group did
not align its supply chain with that business strategy. Just 30 products generated 80 percent of sales, while
two-thirds of the company’s 1,500-plus stock keeping units (SKUs) were items that it no longer
manufactured. And the number of SKUs multiplied every year, increasing that backlog.

Sourcing.
The Lego Group dealt with an astonishing array of suppliers, more than 11,000 in all. That’s nearly twice
as many suppliers as Boeing uses to build its airplanes. The numbers had crept up gradually over the years,
as product developers sought new materials. Each engineer had his or her own favourite vendors, and the
company’s lack of procurement compliance procedures allowed the engineers to form ad hoc
relationships with suppliers — a practice that grew more problematic as the group expanded into new
businesses.
These sourcing practices led to incredible waste. A new design might call for a unique material, such as a
specially coloured resin, that sold in three-ton lots. It might take just a few kilos of the substance to
produce the new toy, but the company would be stuck with €10,000 ($13,500) worth of resin it would
never need. Ordering so many specialized products at irregular intervals from a large number of vendors
left the Lego Group’s procurement staff powerless to leverage the company’s scale in dealing with
suppliers.

Manufacturing.
As was the case with sourcing, the Lego Group gained limited advantage from its scale in the way it
organized its production facilities. The company ran one of the largest injection-moulding operations in
the world, with more than 800 machines, in its Danish factory, yet the production teams operated as
hundreds of independent toy shops. The teams placed their orders haphazardly and changed them
frequently, preventing operations from piecing together a reliable picture of demand needs, supply
capabilities, and inventory levels. This murkiness led to overall capacity utilization of just 70 percent.
In such a fragmented system, long-term planning can be exceptionally difficult. Day-to-day operations
were often chaotic. Operators routinely responded to last-minute demands, readily implementing costly
changeovers. That the Lego Group’s production sites were located in such high-cost countries as Denmark,
Switzerland, and the United States put the company at a further disadvantage.
Questions:
1. Basing on what you have learnt from Production and Operation Management Module, discuss the
problems happening in Lego & indicate the root causes (2-3 root causes)
2. Giving your recommendation to solve these issues.
(Note: Problems or issues are symptoms of actual root causes, identify the right root causes and encounter
them shall solve all problems)

Guiding:
The case study focuses on the imbalance of innovation capabilities and its supply chain. The problems are
diagnosed on 3 aspects: Product Development, Sourcing & Manufacturing.
To analysis this case, should start with:
1. What is company’s objectives? What is company order winner? What is company core’s
competence?
2. How did 2 departments R&D and Supply Chain (Operation) achieve those objectives?
3. Analysis Lego product on variety, volume, customisation level
4. What is the manufacturing environment of Lego? Manufacturing process?
5. Is there any misalignment between the manufacturing environment and process?
(Analysis based on the characteristics of the manufacturing environment, and comparing to what Lego
did)
6. How Lego plan their Manufacturing Planning & Control system? Is there any policy or rules?
7. Finding the root causes
8. Suggest solution

Case 02: The Great Nuclear Fizzle at Old Babcock & Wilcox

Babcock & Wilcox was a pioneer of the steam generating business, whose boilers were used in one of the
first central power plants ever built (in Philadelphia, in 1881). It had an impressive $648 million in sales in
1968, making it 157th on FORTUNES’s list of 500 largest industrials, and it has been engaged in nuclear
work in a major way for fifteen years, producing, among other things, atomic power systems for Navy
submarines. However, B&W faced crucial failure to deliver a single vital component of nuclear power
plants.
Moreover, the corporation is one of only five that are engaged in building nuclear power plants in the
United States. However, all of B&W’s troubles involve a single product: nuclear pressure vessels. These
are the huge steel pots which must meet rigid specifications set by the Atomic Energy Commission, and
B&W built a $25 million plant at Mount Vernon, Indiana, just to fabricate them. B&W sold its entire
projected output of pressure vessels for years ahead. But nothing seems to go right at Mount Vernon.
Plagued by labor shortages and malfunctioning machines, the plant produced just 3 pressure vessels in its
first 3 years of operation. The plant that built along the Ohio River at Mount Vernon, Indian, to produce
huge steel pressure vessels for atomic reactors, failed to function as expected. In May, B&W was forced
to make a humiliating disclosure. Every one of the 28 nuclear pressure vessels then in the Mount Vernon
Works was behind schedule, by as much as 17 months. B&W’s customers forced it to turn most of their
partially completed vessels over to other manufacturers. Only 7 nuclear pressure vessels remain at Mount
Vernon.
Neilson – former chairman of B&W, improved B&W’s over-all profitability dramatically. He centralized
and systematized management. Every executive’s areas of responsibility and authority were carefully
spelled out in manuals that defined company policies and aims in all sectors of the business. Some people
said that the seeds of B&W’s present problems were planted by Neilson. It can be seen, in retrospect,
that he may have been too successful in keeping B&W lean. The most biting criticism of Nielson’s regime
comes from men charged with nuclear assignments. In their eyes, Nielson’s lack of formal education
proved a serious handicap. They felt that top management didn’t understand technical problems, and
didn’t trust those who could understand them.
From the start, B&W had foreseen a long wait before its nuclear work became profitable. Developing the
necessary skills and technologies to compete in the nuclear industry has proved to be a slow and expensive
process. But what B&W had not expected was to lose money on its Mount Vernon Works. When the plant
was planned in the early 1960’s, Neilson appeared to believe that he had found a niche in the nuclear
industry that offered a quick return. The plant was designed to produce one completed pressure vessel a
month, once it was in full operation and they have receive full orders even before the plant functioned.
The first delays at Mount Vernon were caused by suppliers falling far behind schedule in providing vital
equipment. A linear accelerator, used to detect welding flaws, was not delivered until 11 months late.
Even worse, a highly automated, tape-controlled machine center – the heart of the plant as originally
conceived – arrived a full year behind schedule.
The location of plant had been chosen mainly because of its position on the Ohio River, safely above any
known flood level. What Mount Vernon did not have was a pool of skilled labor. “Production workers
required a new level of knowledge, intelligence, and judgement to operate the machinery, perform
operations and maintain the very high quality standards”. At the outset, however, B&W took an optimistic
view of its prospects – choosing, according to that 1968 memorandum to regard Mount Vernon as “an
unspoiled labor market”. Presumably, the company expected to find a more tractable group of workers
there than it had at its headquarters.

The company planned to overcome the obvious shortcomings of Mount Vernon’s labour in 2 ways:
- First, through automation – using that sophisticated machining center
- Secondly, through a massive training program that would entice farmers away from their
cornfields and quickly turn them into skilled welders and machinists.

However, almost as fast as men reached the levels of skill required, they left B&W for jobs elsewhere. The
company had trained 3 men for each one it retained. The plant was closed by labor disputes on several
occasions. The most serious occurred when the 3-year contract expired while equipment was still being
installed. The Boilermakers went on strike over wages and work rules. However, new contract, wages
remained too low to stem the flow of workers away from B&W or to attract qualified workers from other
areas. In most plants, less than 10% of the welds must be reworked, but at Mount Vernon 70% or more
of the welds were rejected on being inspected.
In addition to its problems, B&W ran into unexpected trouble with equipment. The linear accelerator for
X-raying welds was functioned until 1 year after installation. The tape-controlled machining center was
even more of a headache, and began functioning as planned only a few months ago.

Questions:
1. What happened?
2. What went wrong?
3. How are the nuclear pressure vessel and boiler customers the same? How are they different?
4. What did the customers want? Why did they contract with B&W rather than other firms?
5. How is the process of making nuclear pressure vessels and boilers are the same? How is the
process different?
6. Could the two operations have been performed in the same factory using:
- Same people
- Same equipment
- Same engineering skills…