LEGO Cut Its Complexity and Saved the Company: An 80/20 Squared Case

By Todd Hagopian, business transformation author and speaker, VP of Product Strategy and Marketing. Book Todd to speak · Todd’s books

• What Went Wrong at LEGO?
• What Did Jørgen Vig Knudstorp Change?
• Why Was Complexity the Real Problem?
• What Do 80/20 Squared and the 80/20 Matrix Say About LEGO?
• What Role Did LEGO's Fans Play?
• What Business Lessons Come From the LEGO Turnaround?
• Frequently Asked Questions
• Sources
• About the Stagnation Assassin

In 2004 the LEGO Group lost DKK 1,931 million, more than double its loss of the year before, according to its own 2004 annual report. The report said the company had to change course fundamentally “if it is to survive as an independent, Danish family-owned group.”

It did survive, and the turnaround that followed is now a Harvard Business School case. The short answer to how LEGO was saved: it stopped trying to be everything, concentrated on the core brick, and stripped out the complexity that had been quietly destroying its margins.

This piece covers what went wrong, what the new CEO changed, why complexity was the real enemy, and how the 80/20 Matrix and 80/20 Squared from Stagnation Assassin explain the result.

What Went Wrong at LEGO?

In the 1990s the toy market shifted under LEGO. Big-box discounters pushed prices down, children had less time for play, and interest grew in toys with instant gratification, as Harvard Business School’s Working Knowledge summarises. LEGO’s response was to grow, extending the brand into children’s clothing, media and many new product lines.

The products got more complicated. Sets carried more and more unique components. The number of LEGO-branded items rose, but sales didn’t follow, and in 1998 the company recorded its first financial loss. HBS professor Stefan Thomke described the problem simply: top-line growth was slowing while costs were accelerating.

A conventional turnaround followed: layoffs, streamlining, globalisation. It didn’t work. By 2003 and 2004 LEGO was losing heavily, and its annual report described a global toy market in decline.

What Did Jørgen Vig Knudstorp Change?

Jørgen Vig Knudstorp was 35 when Kjeld Kirk Kristiansen, the founder’s grandson, handed him the CEO role in 2004. He had no family ties to the company. His approach, as HBS describes it, was careful cash management, a focus on core products, and reducing complexity.

The 2004 Action Plan, set out in the annual report, had three themes: set a clear direction and change the way the company did business; restore competitiveness by focusing on customers, “in particular their profitability”; and reduce risk by right-sizing activities and costs to a lower revenue base. The company concentrated again on “the Group’s classic, core products – LEGO bricks.”

The plan cut production and operating costs by DKK 1,523 million, about 20 percent of their 2003 level, and reduced the workforce by roughly 1,000 people. LEGO decided to sell the LEGOLAND parks because they were not core business. On the supply chain side, Knudstorp did away with many of the unique brick components added in the previous years.

Why Was Complexity the Real Problem?

Every unique component multiplies cost across the supply chain. It needs its own mould, its own forecast, its own inventory. HBS’s account notes that more elements made products harder to assemble, forecasts harder to make and inventory harder to manage, so some kits had too much stock and others had none, with restocking taking months. Thomke called it “this multiplier effect of added complexity.”

The cost of complexity is easy to miss because it rarely shows up on a single product’s profit line. Each new element looks reasonable on its own. The damage appears in overhead, working capital and missed deliveries. A business can grow revenue and lose money at the same time, which is exactly what LEGO did.

The 2004 results showed the effect of reversing it. Before special items, the play materials business went from a loss of DKK 1,061 million in 2003 to a profit of DKK 103 million in 2004, even as revenue fell.

What Do 80/20 Squared and the 80/20 Matrix Say About LEGO?

In Stagnation Assassin, the 80/20 Matrix of Profitability sorts every combination of customer and product into four quadrants. The top customers buying the top products are the quadrant you bear-hug. The bottom-left quadrant, the wrong customers buying the wrong products, holds the value destroyers that need immediate action. 80/20 Squared applies Pareto twice: if 20 percent of the business creates 80 percent of the value, then about 4 percent creates about 64 percent.

LEGO’s Action Plan reads like a company rediscovering its top 4 percent. The classic brick system and the fans who loved it were the core. Clothing, parks and the long tail of unique components were consuming resources the core needed. As I put it in the book: “The truth: Revenue that costs more to generate than it returns in profit is organizational cancer.”

The book is just as clear on the opposite mistake: “By the way, don’t kill SKUs for the sake of killing.” LEGO didn’t stop innovating. HBS notes that new product design became informed by research and user feedback, and that putting parameters on creativity made the designers better at it. The 3-S Method makes the same point about capacity: Sketch the real capacity, Streamline complexity before you try to solve anything, then Solve the constraint. I explain it in the 3-S Method.

What Role Did LEGO’s Fans Play?

A large one. According to Thomke, one of Knudstorp’s insights was that LEGO needed to reconnect with its community of loyal fans, whom HBS calls one of the most powerful assets the company had. Adult builders and long-time customers knew exactly what made the product special.

That is customer intelligence in its most useful form. In Stagnation Assassin I call the discipline Magnificent Obsessions: a bounded, systematic obsession with understanding customers and competitors, using the 5% Rule to keep about 5 percent of capacity on intelligence and the rest on execution. LEGO’s best customers had been telling it what mattered all along. It took a crisis to listen. If your own focus has drifted, the Karelin Method‘s Focus factor is a good place to restart.

What Business Lessons Come From the LEGO Turnaround?

• Growth can hide decline. More products and more revenue lines masked rising costs until the losses arrived.
• Complexity is a cost multiplier. Every unique part, SKU or exception carries hidden cost across the whole chain.
• Find your top 4 percent. The classic brick and its loyal builders were LEGO’s core. Know yours before you cut anything.
• Focus on customer profitability. LEGO’s own Action Plan named it. Revenue that loses money isn’t growth.
• Constraints can improve creativity. Designers did better work with clear parameters than with unlimited freedom.

Frequently Asked Questions

How much did LEGO lose in 2004?

The LEGO Group’s net loss for 2004 was DKK 1,931 million, against a loss of DKK 935 million in 2003, according to its 2004 annual report.

Who led the LEGO turnaround?

Jørgen Vig Knudstorp, who became CEO in 2004 at age 35, succeeding Kjeld Kirk Kristiansen.

What did LEGO do to recover?

It refocused on its core LEGO bricks, cut operating costs by about 20 percent, sold the LEGOLAND parks, reduced unique components and reconnected with its fan community.

Why was complexity so damaging for LEGO?

Each unique component added cost to moulds, forecasting and inventory. Harvard Business School’s account describes a multiplier effect across the whole supply chain.

What is 80/20 Squared?

A framework from Todd Hagopian’s book Stagnation Assassin. Applying Pareto twice shows that about 4 percent of a business creates about 64 percent of its value.

Sources

• LEGO Group: Annual Report 2004 (PDF)
• Harvard Business School Working Knowledge: HBS Cases, LEGO
• Harvard Business School: LEGO (A), The Crisis (case)

About the Stagnation Assassin

Todd Hagopian is VP of Product Strategy and Marketing, the founder of Stagnation Assassins, and a business transformation author and speaker. Known as The Stagnation Assassin™, he has led transformations at Berkshire Hathaway, Illinois Tool Works, and Whirlpool that generated $3B+ shareholder value across five turnarounds. He is the author of Stagnation Assassin: The Anti-Consultant Manifesto and The Unfair Advantage: Weaponizing the Hypomanic Toolbox. His blog is published in 15+ languages and read by operators worldwide. Bring him to your stage via his speaking page or connect with him on LinkedIn.

Your move this week: Pull your product list and rank it by profit, not revenue. Mark the top 4 percent of customer and product combinations. Then ask which ‘unique components’ in your business exist only to serve the bottom of the list. If you want this thinking in front of your team, see my speaking page, or start with my books.