Aalborg
University
2012
GROUP 4:
Aalborg
University
Rosaline M. K.
Samuel Fulop
Vytautas Pavalkis
BSc.
Economics and
Ignas Markauskas
Business
Administration Piercarlo Gastaldi
SEMESTER
PROJECT EXAM
Aalborg University
Semester project
LEGO
Program:
BSc. In Economics and Business Administration
Semester:
4th Semester.
Date of delivery:
05/01/2012
Supervisor:
Heather Louise Madsen, PhD Fellow
Number of Pages:
91
Authors:
Rosaline M. K. Woufack ….................................................................................................
Samuel Fulop …..................................................................................................................
Vytautas Pavalkis ….............................................................................................................
Ignas Markauskas …............................................................................................................
Piercarlo Gastaldi …............................................................................................................
Table of Contents
Introduction................................................................................................................................................5
Methodology..............................................................................................................................................7
Theory......................................................................................................................................................11
Resource based view and VRIO framework ...............................................................11
Resource based view....................................................................................................11
VRIO Framework........................................................................................................23
Porter's five forces..........................................................................................................................28
Introduction..................................................................................................................28
The Threat of new Entrance.........................................................................................29
Bargaining power of Suppliers ...................................................................................33
The Bargaining Power of Buyers.................................................................................34
The Threat of Substitute Products and Services..........................................................37
The intensity of rivalry in the industry........................................................................37
Lego case..................................................................................................................................................40
Introduction to Lego group.............................................................................................................40
Resources and Capabilities.............................................................................................................42
Efficiency.....................................................................................................................42
High quality and value product development..............................................................47
Responsiveness to market trends.................................................................................53
Brand management......................................................................................................54
VRIO framework............................................................................................................................59
Question of Value.........................................................................................................59
Question of Rareness...................................................................................................77
Question of Imitability.................................................................................................79
Question of Organization.............................................................................................81
Competition analysis......................................................................................................................82
Introduction to the toy and games industry.................................................................82
The Threat of new Entrance LEGO Group..................................................................83
Bargaining power of suppliers.....................................................................................84
3
The bargaining power of buyers..................................................................................85
The threat of substitute product and services...............................................................87
The intensity of rivalry in the industry........................................................................89
Future outlook.................................................................................................................................93
Expected market performance in the following years.................................................93
Conclusions..............................................................................................................................................98
References..............................................................................................................................................100
4
Introduction
Society experiences huge changes. Globalization minimizes cultural differences and brings
global trends. Information becomes more and more open and easier to obtain.
Social networks
penetrate everyone’s life. Consumers' needs and behavior changes along with these trends, causing a lot
of problems to the traditional business. All businesses face new challenges and understand that “old
ways of doing business” are not good any more. Then the problem appears – what needs to be done in
order to adapt to customer's needs?
This problem is more and more relevant because the speed of changes increases. It concerns
business from all over the world and companies must return to business theories in order to rediscover
their businesses. After finishing university we will enter the companies as employee’s having both –
academic knowledge and the feeling about undergoing shifts both in society and businesses. The lack
of experience prevents us from inveteracy of managerial assumptions and could lead into discovering
the changes companies seek. We must find suitable tools and instruments in order to overcome these
challenges.
The project is written in order to find suitable approach to solve the problem of inadequacy of
product companies sells compared to customers’ needs. Companies must redesign products and
services as well as their own structure. First they must evaluate their assets and capabilities. For this
process we find it suitable to use the Resource Based View and VRIO framework as a tool.
We have chosen the LEGO group for our analysis as it represents a company that has undergone
pressures not only from the industry itself but also from the ever-changing external environment. In this
industry changes like for example digitalization, development of new customer electronics, and video
and computer games have a great impact on the toy industry. Apart from that there are also changes in
customers (kids) preferences, perceptions and habits that inevitably shape the direction of this industry.
A recent survey by the consulting firm Funosophy found that kids 6 to 8 years old prefer toys over
consumer electronics 49% to 30%. The trouble is, kids a little older (9 to 11 years old) favor the
electronics 42% to 24%.1 The notion that kids are growing more sophisticated and tech savvy, a trend
called age compression, has in some ways bedeviled the toy companies.
1 Fonda D., (2004), Zapped! How the toy industry is being outplayed by video games this holiday season, Time Magazine,
<http://www.time.com/time/magazine/article/0,9171,1009648-1,00.html>
5
The LEGO group survived a crisis in 2004 when the company experienced a huge deficit after
which they turned their business focus even more to their customers’ needs. In addition to toys they
created a global network of LEGO inveteracy fans in order to create communication between them and
the company. The company also started to develop computer games in order to fill the gap in the
supply. Currently LEGO is growing rapidly. Consequently, the group in 2010 created a profit of
3,718mil. DKK, which is an increase of 70,4% compared to the year 2009. 2 In the light of the above
mentioned, we want to investigate why LEGO is doing so well despite the development of new
consumer electronics, video, computer games, the effect of age compression on traditional toys and
games. We would also like to investigate which strategic managerial steps that have been made in the
recent years, how they adapted their production, which products and services have been launched in
order to create higher value to the customers and which assets the company currently possesses and try
to predict their importance in future. In another words, in this project we want to answer the following
questions:
1) Why LEGO is doing so well today after the crisis in 2004;
2) Are the assets the LEGO group possesses able to maintain its competitive advantage in the toy
industry for the next 5 years?
2 LEGO group annual report 2010
6
Methodology
After choosing the direction of the project and determining the problem statement which
is investigated in this project, there is another question to be answered in relation to the way this
analysis is going to be undertaken.
There are many different typologies of paradigms (paradigm can be defined as pattern of
thoughts), but in this project we are going to use one offered by Abnor and Bjelke (2009). They suggest
the following six overlapping paradigms. Based on these paradigms they identified three
methodological approaches that researchers can use for creating knowledge: the analytical, systems and
actors approaches. See the table below:
Source: “Project Work Processes” power point slides, Kuada J., John Kuada, PhD. Associate Professor Department of
Business Studies, Aalborg University
The analytical approach
This approach is characterized by the belief that reality is objective and independent of
the observer.3 Researchers using this approach believe that they can take a problem or phenomenon
3 Kuada J., 2010, Research Methodology, a project guide for university students, Centre for International Business
Department of Business Studies, Aalborg University.
7
divide it into parts, investigate each of them separately and then bring them together, which will create
a total picture. This approach is strict and rigid in order to be repeatable (reliability criteria) and uses
more of a linear structure. Here are very often used experiments, surveys (these have to be categorised)
and statistical tools. In this approach it is very important that the reality is measurable and concrete.
The systems approach
“In Abnor and Bjeke’s view, the systems approach focuses on the relationships between
the individual parts of a system.”4 This approach has also an objectivist view on reality, but only partly.
Here it is believed that the structures within a system are stable and rigid. On the other hand the
relationships and processes that take place between them are under a constant change. There is an
investigation of the patterns that are behind these changes between the structures, not only of the
structures themselves. The analytical approach assumes the environment to be stable, while the systems
approach views the environment more unpredictable and changing. It has a ffexible methodic and the
learning is based on a process of feedback and reflections until sufficient degree of empirical material
is first collected and then systematically analysed.
The actors approach
This approach is very much different from the two above mentioned ones. The
researchers inclining to this approach in their investigation see the reality as not independent from an
individual, but resulting in the interaction and experience of the individual with its surrounding. It
characterized more as a subjectivist approach where human beings are engaged in continuous
observation and interpretation of environment and make their own voluntary decisions. Here it is
believed that the people’s behavior cannot be determined or manipulated by changing their
environment. Dialogue and in depth interviews are important tools in this approach.
In this project we are using the systems approach in finding the answer to the problem
statement and in a way we are conducting the research and analyzing the obtained data. In our research
we want to focus on company and the industry where the LEGO group operates in other words on these
two systems or structures. Here we look at different parts of these structures (like for example the
4
Kuada J., 2010, Research Methodology, a project guide for university students, Centre for International
Business
Department of Business Studies, Aalborg University.
8
various assets of the company or different aspects of the industry the company operates in), we will
analyze them and afterwards we will go further and analyze the processes that are taking place between
these parts and point out the mechanism and patterns that cause changes in these structures. For this
reason we have chosen the systems approach. We did not choose the analytical approach, because we
do not want to merely investigate aspects that are measurable like for example analyzing the annual
reports of the companies in the industry and drawing conclusions only based on the calculations. We
decided to look also on the processes that take place in the company and in the industry and analyze
them.
In this respect we have chosen theories and frameworks that fit with the system approach
´s view of reality and way of investigation. In the project we used the resource based view (RBV)
theory and the VRIO framework in order to analyze the LEGO group and Porter´s five forces in the
analyses of the industry. In the analysis of the LEGO group we find the RBV together with VRIO
framework more useful than other commonly used frameworks for investigating companies like SWOT
analysis. These frameworks go more in depth and provide view into the company that other
frameworks cannot do in such an efficient way. They focus on the analysis of the internal resources and
strengths of the company more accurately. The VRIO framework gives us an insight into the assets of
the company (tangible, intangible and human resources) and analyses if they are rare in the industry,
imitable and exploited by the company. Investigating these questions will provide us the answer to
question if the company has a sustainable competitive advantage. Apart from that, we will be able to
see which specific changes within the company elevated it from the crisis in 2004.
The porter´s five forces will give us an insight to the toy industry and aspects discussed
here will provide us important information like how big is the threat of substitute products like video
and PC games, what is the probability of new firms entering this market, what is the bargaining power
of the specialized toy retailer´s chains and others. All these aspects have a direct impact on the LEGO
company and can either in a positive or negative way influence its revenues and future direction.
For the purpose of this project, we have chosen to use only secondary data. The reason for this is:
firstly the time constrain and secondly, we believe that for the theories and frameworks used in this
project the secondary data will provide information that is adequate and accurate enough for the
purpose of this investigation. The data is used from reliable sources like annual reports of the LEGO
group and other companies, reports from organizations like Datamonitor or Euromonitor, reliable
sources like International council of toy industries and books and articles from recognized authors.
9
Theory
Resource based view and VRIO framework
Resource based view
Introduction
Resource based view (or RBV) is a tool used in strategic planning. It started in first half
of 20th century. Authors like Coase, Selznick, Chandler and others emphasized importance of resources
company exploits. That was only elements though. First more comprehensive research showed up in
1984. It was written by Birger Wernerfelt and published in Strategic Management Journal. Author
suggested the analysis of companies form the resource side rather than the product side. Next step was
made by Barney. He published couple of articles in 1986. RBV was supplemented by other concepts as
inimitability (Dierickx and Cool, 1989), uncertain imitability (Lippman and Rumelt, 1982) and isolated
mechanisms (Rumelt, 1984). In 1991 Barney introduced resource-based framework which gave
background to further theoretical and practical development of RBV. The framework was generally
accepted and numerous writings showed up.
According to Wernerfelt RBV most of the economic tools is product or market orientated.
They give a lot of attention to market, client needs and the way the firm should operate in particular
situations. Barney states, that RBV “focuses on idiosyncratic, costly-to-copy resources controlled by a
firm –resources whose exploitation may give a firm a competitive advantage” 5. It analyzes competitors
only in order to determine whether resource is rare or not and to evaluate it more accurate. It success
can be explained by quite simple logic RBV follows. According to Barney companies are threaded as
“bundle of resources” managed in different ways. These resources allow companies to produce goods
or services and satisfy needs of the client. RBV states that companies exploiting unique and rare
resources can create additional value to the client in a unique way and ensure sustainable competitive
5 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
10
advantage. RBV and its tools allow managers to identify and evaluate resources companies posses and
decide whether they can create such advantage or not. It also helps to create a better understanding of
company and make strategic decisions on what resources must be acquired in the future to strengthen
advantage company posses. Because of these reasons RBV is a great tool for our aim. On the other
hand, some resources can be difficult to distinguish and evaluate properly without deeper knowledge
on the tool. In order to avoid these difficulties we have to understand the theory.
Sustainable Competitive Advantage
In order to understand the view of the RBV we have to define sustainable competitive
advantage. According to the BusinessDictionary.com competitive advantage is “a superiority gained by
organization when it can provide same value as its competitors but at lower price, or can charge higher
prices by providing greater value trough differentiation.”6 RBV states that lower prices or additional
value can be achieved by exploiting resources of the company. BusinessDictionary.com defines
sustainable competitive advantage as “a long term competitive advantage that is not easily duplicable
or surpassable by the competitors”7. In order to achieve that resources must be unique (or at least rare)
and not easily imitable as it will be explained in the following part. However, sustainable does not
mean permanent. Changes in the market, technology, buyers’ preferences and number of other elements
can eliminate even sustainable competitive advantage. But again, making strategy based on market in
unstable environment is even harder then based on internal resources.
Basic assumptions
Susane E. Jackson, Angelo DeNisi and Michael A. Hitt, authors of Managing Knowledge
for Sustained Competitive Advantage: Designing Strategies for Effective Human Resource
Management (2003), states that RBV is based on two main assumptions: resource diversity (also called
resource heterogeneity) and resource immobility.
Resource diversity (or heterogeneity) assumption states that resource cannot provide
sustainable competitive advantage if it is not rare. If resource is commonly possessed any competitive
advantage it creates will not be long term or sustainable. That is because of the fact that companies are
usually aware of situation in the market and they will react to balance shift in the market. Competitive
6 Definition from dictionary <http://www.businessdictionary.com/definition/competitive-advantage.html>
7 Definition from dictionary <http://www.businessdictionary.com/definition/competitive-advantage.html>
11
advantage will create bigger than normal economic profits and result in imbalance in the market. The
resource providing this advantage will attract competitor’s attention and they will start exploiting it.
Brand with known and strong image is an example of diversified resource. For example Ferrari is
known as luxury Italian supercar. It is unique resource other companies do not have. On the other hand,
there are other supercar producers which have the same technical background and this resource is not
unique. That leads to competitive parity in technical side of the competition.
These resources should not be overlooked though. They can create only temporary
competitive advantage but not having them will put company in disadvantage. Company cannot stop
using telephone because it is heterogeneous resource. That will create competitive disadvantage.
Commonly possessed resources must be carefully evaluated, because they allow keeping competitive
parity and can create additional barriers for competitors.
Assumption of resource immobility means that resource which is easy to obtain cannot
create sustainable competitive advantage. It's closely related to and complements the first assumption.
If the resource is easily obtainable competitors will try to acquire or imitate it. For example company
discovers new product delivery channel which creates additional value to the clients. It is unique in the
region but if there are no barriers to exploit it other companies is going to use it as well resulting in
competitive parity. We already used Ferrari as example. It is impossible to copy this brand directly.
Similar brand is also difficult to obtain, because the cost of developing, acquiring or using that resource
is too high.
To sum up resource diversity (heterogeneity) and immobility assumptions states, that in
order to create sustainable competitive advantage resources must be unique (or at least rare) and hard to
acquire, copy or imitate8. In order to secure its resources and advantage company must create some
barriers for competitors. Otherwise competitors will try to obtain the resource and take competitive
advantage.
Resources
In order to create competitive advantage we must distinguish company’s resources and
evaluate them. It can be difficult because all the tangible and intangible assets of the company can be
defined as resources. From the perspective of RBV term resources can be split into resources and
8 Jackson S. E., DeNisi A., Hitt M. A., (2003) Managing Knowledge for Sustained Competitive Advantage: Designing
Strategies for Effective Human Resource Management, 1 ed., Pfeiffer, US.
12
capabilities. According to R. M. Grant (2005) resources are what company has while capabilities can be
defined as what company can do. He grouped resources as it can be seen in graph 1.
Figure 1: Classification of Resources. Source: Grant R. M., (2005) Contemporary Strategy Analysis, 5th chapter: Analyzing
Resources and Capabilities, 7th Edition edition, John Wiley & Sons, US.
As you can see resources are divided into three main groups: tangible, intangible and
human resources. First two groups focus on company while the third one emphasizes employees. We
will look trough each of the groups in order to create better understanding about what assets should be
analyzed and evaluated.
Tangible resources
Resources in this group are usually easy to identify and evaluate. The primary source of
information about these assets can be found in company’s financial statements, especially balance
sheet. Although you need more information in order to understand accurate image of the real value and
usefulness for the company.
Physical assets cover land, buildings, equipment, machinery, materials and so on. Usually
these assets are common among competitors and require exceptional circumstances in order to give
13
competitive advantage9. For example position of the land can create unique business opportunities. All
hotels have some land and buildings, though their value is different. Sea view creates additional value
to costumer and allows increasing price of the hotel room. This is also true for hotels based in the cities
– the more convenient and easier to access it is the more competitive advantage it can create. Another
good example of very valuable resource is access to raw materials and natural resources. For example
water in the island of Crete is very valuable because there are no big springs in the area. Most of
drinking water is brought by ships and it is quite expensive. Company owning the natural spring’s sells
local water at little bit smaller price but its margin is 2-3 times bigger because they don’t have expenses
of transporting. In order to identify these resources company need to analyze the assets it posses and
carefully analyze them.
Financial capital covers all financial resources company can use. Most common is the
capital form equity and bond holders as well as authorized capital. These are simpler to identify and
evaluate because their “book value” is quite accurate. On the other hand there are other types of
resources in this category. Stable and wealthy cash flow inside company also is an important resource,
because it allows continuing activities without interruptions. Furthermore, in order to make big
investments company need to raise funds by issuing shares or bonds. The ability to do that is also an
important resource. A blue chip companies or those with high bond rating (Moody’s, P&R) will be able
to raise funds much easier and faster than risky or speculative ones. Small and medium enterprises can
also face difficulties in attracting needed capital because they are usually evaluated as risky investment.
Managers should also analyze retained earnings because they are important source of capital if that is
not against policy of company. Reduced dividends according to the theory of Clientele Effect can have
negative effect on company’s social and financial image10.
Intangible resources
Resources in this group are much harder to identify and evaluate then ones on the
previous group. The main reason they are invisible and cannot be found in documents or financial data.
Yet they usually are very important in company’s activities and can be source of strong competitive
advantage. These resources create difference between book value and market price which is usually
called P/B ratio. It is calculated as ratio between company’s value stated in the balance sheet and the
9 Pupo G. A. R, (2002), Attain Sustainable Competitive Advantages by means of Organizational Learning,
<http://www.managementweb.com.ar/Estrategia4.htm>
10 Elton E. J., Gruber M. J., (1970) Marginal Stock Holder Tax Rates and Clientele Effect,
<http://pages.stern.nyu.edu/~eelton/papers/70-feb.pdf>
14
price investors are willing to pay in the stock market 11. For example Apple Inc. P/B ratio is 4.88 12.
Intangible assets of Apple are worth almost 5 times more than tangible ones and that illustrates their
importance.
First subgroup – technological resources covers all the intellectual property of the
company which helps them at their activities. It includes patents, technological and industrial secrets,
licenses, trademarks, franchises and other intangible assets defined in law. New patented invention can
create strong competitive advantage and ensure bigger margin for the duration of patent but it bears risk
as well. In order to register invention company needs to reveal a lot of secrets and patent can bypassed
by creating modifications in the product or technology. Some companies tend to secure their secrets
inside company as Coca-Cola does. Their soft drink is in the market for more than hundred years and
yet its recipe is still unknown. This type of asset is very important in pharmaceutical, digital, high-tech
industries13. Yet other companies found it important and able to generate high incomes as well.
Another important group of intangible resources is reputation. Attention should be
brought to the image of the product and company itself as well as to relationships, connections, brand
names and other trademarks. Companies valuate, preserve and try to strengthen good public opinion
because strong image of the company or product often becomes leading force of marketing campaigns
and helps to increase both awareness and sales. In reverse, dark secrets of the company can be used by
competitors against it in order to damage its reputation. While it could look more important to huge
corporations but it is much more vital to small companies. At local level contracts are usually based
more on trust and relationship. It is because technological or price difference is minimal and cost of
more in depth analyze of available contracts would be relatively too high. On higher level this role is
played by brands. Trademarks represent reputation and awareness of the company and helps both in
business to business and business to client relations. It helps to separate the product from the mass and
helps buyer to familiarize with it trough advertising. According to BrandZ Apple was most valuable
brand in 2011 worth almost 118 billion Euros14. Brand as well as reputation can be attached to the
company and to the product. Proctor & Gamble owns few very popular brands for each group of the
product while BiC uses the same brand for all its products. While the strategy in first case helps to
11 Shiller R. (2005). Irrational Exuberance, 2d ed., Princeton University Press, US.
12 Http://finance.yahoo.com/q?s=AAPL
13 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
14 BrandZ 2011 Report, http://www.millwardbrown.com/BrandZ/default.aspx
15
differentiate products it also brings competition between brands in the same product market. So
managers should evaluate brands and reputation carefully. The last but not the least in this group is both
formal and informal relations. Access to information or key persons can grant opportunities that are
unavailable to competitors and create competitive advantage as well. Best example is common practice
in Japan, where small companies tend to co-operate with international corporations because that
ensures sales15. If company is unable to find such “sponsor” they need to compete in mush worse
conditions.
Third and probably most problem causing subgroup is culture inside the company. Barney
(1996) tends to assign it to human resources though it is not stated clearly. But in our opinion Grants
(2005) classification is better because human resource covers individual skills and knowledge as well
as the ability to work together. That depends on the employees only. In our point of view culture is the
environment of the company and it is less dependent from the employees and more from managers.
Culture is formed primary by the firm’s aims and goals, vision and the attitude towards clients and
staff. These are formed by the head managers rather than employees and managers are responsible for
their use in everyday work. So we can state, that culture is “let down” from the top to the bottom 16. It is
not easy to understand and even harder to identify and evaluate. It is even harder to compare it because
it requires time inside the company to know it. Yet culture is very hard to imitate and can create strong
sustainable advantage. One of the companies emphasizing its culture is Southwest Airlines. Their
culture helped to create extraordinary service to clients and innovate a lot of inside processes17.
Human resources
Last group of resources owned by a company is human capital. Evaluation of this group is
complex and difficult process because of several reasons. It is very difficult to get accurate view
because each employee must be evaluated separately and together as a whole. Evaluating them
separately underestimates the result of synergy while evaluating them together will ignore the unused
abilities of each individual. Another issue companies faces is time required to evaluate these resources.
Some skills and abilities cannot be evaluated trough interviews or questionnaires. The true ability of the
staff can be revealed only through observations over time and analysis. There are methodologies
15 McMillan C. J., (1996) The Japanese Industrial System, 3rd ed., Walter de Gruyter & Co, Germany.
16 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
17 Yeh R. T., Yeh S. H., (2004) The Art of Business: In the Footsteps of Giants, Zero Time Publishing, London
16
allowing evaluation of human capital but company must choose them according to their strategy and
point of view. Our aim is to introduce the main groups and get common understanding about each of
them.
First one is “know how” or skills and competencies personnel posses. Staff with required
skills is vital, but extra knowledge and abilities gives additional value for the client. Software
developers can create IT based accounting system for the company by communicating with
accountants. But the same process would be much more efficient if there would be intermediaries with
knowledge in both – software development and accounting. These skills are usually evaluated upon
hiring people and allow selecting proper employees with reasonable set of abilities. That is a common
practice. Yet this group should be evaluated more often in order to keep employees up to date and
aware of changes in their professional environment. Especially when making decisions about future
strategy or when rapid changes occur18.
Second group is about capacity for communication and collaboration. Communication is
unavoidable in organization because it is based on relation. Although there is strategy to divide
company into separate units it still requires a lot communication inside them and some coordination
between. The ability to communicate depends on culture, climate, rules set by top managers and people
working inside the companies. And in spite of the fact that we face communication all the time in
organization it is still very hard to evaluate. In order to analyze company’s ability to pass required
information, generate new ideas and collaborate we have to identify their effect on the performance.
Examples of success and fails in communication and the impact on performance can help to identify
the weak points of the communication chain and to get image of the overall performance of
communication in the company. Besides, competitive advantage created by communication will be
harder to identify and imitate and therefore long lasting19.
And the last subgroup of human resources is motivation. Unmotivated employees will not
use their abilities to the maximum and thus the result will be lower than they could be. In order to
exploit human resources to the higher degree managers should use motivational system. There is
variety of theories about motivations. Some of them emphasize importance of material rewards (F. W.
Taylor’s Scientific Management (1911)), others – recognition and respect (D. McClelland’s
18 Grant R. M., (2005) Contemporary Strategy Analysis, 5th chapter: Analyzing Resources and Capabilities, 7th Edition
edition, John Wiley & Sons, US.
19 Grant R. M., (2005) Contemporary Strategy Analysis, 5th chapter: Analyzing Resources and Capabilities, 7th Edition
edition, John Wiley & Sons, US.
17
Achievement Motivation (1953)). Managers analyzing their company according to RBV should acquire
information about motivation of the employees, the motivational system and its effectiveness.
Capabilities
Although resources are very important they are useless on their own. In order to make
them productive company must be able to organize them in a particular to way to get desired result.
Specialist without tools and raw materials cannot make a product and those tools and raw material
cannot be used by end consumer before they are made by specialist. So in order to achieve desired
result company must have required capabilities to be successful. Capabilities can be identified in few
different approaches. According to Grant (2005) commonly used are functional and value chain
approaches.
Functional Approach
Functional approach is based on an assumption, that there are principal functional areas of
the company. So in order to distinguish capabilities we should analyze important operations in those
areas. Table below identifies each of the principal function of the company and gives examples of
capabilities in each one of them 20 as well as some examples of companies doing extremely well in that
area. Also, there are more capabilities in each area, and these are only examples.
Functional area
CORPORATE
FUNCTIONS
MANAGEMENT
INFORMATION
RESEARCH &
DEVELOPMENT
Capability
Financial control
Strategic Management of multiple
Business
Strategic innovation
Multidivisional coordination
Acquisition management
International management
Comprehensive, integrated MIS
network linked to managerial decision
making
Research
Innovative new product development
Exemplars
Exxon Mobil, PepsiCo
General electric, Procter & Gamble
BP, Google
Unilever, Shell
Cisco, Bank of America
Shell, Citygroup
Wall-Mart, Capital One, Dell
Computer
IBM, Merck
3M, Apple
20 Grant R. M., (2005) Contemporary Strategy Analysis, 5th chapter: Analyzing Resources and Capabilities, 7th Edition
edition, John Wiley & Sons, US.
18
OPERATIONS
PRODUCT DESIGN
MARKETING
SALES AND
DISTRIBUTION
Fast cycle new product development
Efficiency in volume manufacturing
Continuous improvements in
operations
Flexibility and speed of response
Design capability
Brand management
Promoting reputation for quality
Responsiveness to market trends
Effective sales promotion and
execution
Efficiency and speed of order
processing
Speed of distribution
Quality and effectiveness of customer
service
Canon, Inditex (Zara)
Briggs & Stratton, YKK
Toyota, Harley-Davison
Four Seasons Hotels
Nokia, Apple Computer
P&G, Altria
Johnson & Johnson
MTV, L’Oreal
PepsiCo, Pfizer
L. L. Bean, Dell Computer
Amazon.com
Singapore Airlines, Caterpillar
Figure 2: Capabilities - Functional Approach
Value Chain Approach
Second approach is based on value chain. It is business model displaying how each
activity adds value to the product. The concept was created by M. Porter and his model is still
commonly used. However it is quite general and made to fit all companies. Some activities mentioned
in the model can be expanded in order to reflect the business specification better. Alternatively
managers can create value chain model for their business from scratch in order to emphasize most
important proceses for their business and its strategy.
Figure 3: Porter's Value Chain. Source: Porter M. E., (1996). What is strategy? Harvard Business Review, US.
19
Practical use of RBV
As we already mentioned RBV is a managerial tool for strategic planning. Although each author
applies the theory in a little bit different way the three main steps remains the same: identification of
key resources and capabilities company posses, appraising them and making strategy decisions. Grant
also suggest fourth step – “developing new assets and capabilities”, but that already concerns strategic
decisions and requires additional knowledge background we are not going to introduce. In this part we
are going to introduce each of the steps shortly and then represent framework based on RBV.
Companies possess long list of different assets and capabilities which are more or less
important. It can be difficult to identify most important ones. Grant (2005) suggests starting from
outside analysis. Situation in market and current advantages will show in what areas company is more
successful than others. These successes are based on some sort of assets and can direct towards them.
After identification of key resources and making a list focus should shift towards inside point of view.
Resources should be grouped according to the first table (Figure 1) and capabilities according to the
second table (Figure 2) or value chain (Figure 3).
After identification resources should be appraised and evaluated as potential tool creating
sustainable competitive advantage. Barney (1996)
suggests VRIO framework which is widely
accepted and commonly used. Grant (2005) gives alternative. According to him each asset should be
evaluated twice. At first evaluation have to be based on their importance on company’s activities and
after that how strong are they in relation to competitors. Both evaluations are put into the matrix as it is
seen in fourth table (Figure 4)21. Yet this type of evaluation displays only current strengths and
weaknesses and ignores the rareness and imitability which are key factors for the sustainable
competitive advantage. Because of these reasons we have chosen VRIO framework in our further work.
21 Grant R. M., (2005) Contemporary Strategy Analysis, 5th chapter: Analyzing Resources and Capabilities, 7th Edition
edition, John Wiley & Sons, US.
20
Figure 4: Grant's Matrix of Resources Evaluation. Source: Grant R. M., (2005) Contemporary Strategy Analysis, 5 th
chapter: Analyzing Resources and Capabilities, 7th Edition edition, John Wiley & Sons, US.
The last step is developing strategy according to key strengths. The main task is to find a
way how to exploit key strengths in order to get best result. For example, if the key strengths are about
engineering and developing the decision could be to seek differentiation and suggest new functions of
the product. Companies with capabilities in high volume production could try to seek increase its
market share and thus suggest smaller price. Although RBV gives better insight on company’s strengths
and weaknesses it should be used along with other theories and tools in order to make more accurate
decisions. Barney (1996) suggests SWOT as one of the additional tools when making decisions 22 (then
Grant’s suggested analysis becomes more relevant) and Porter Five Forces model as another. Managers
should also use either of these theories and evaluate the need of new resources and capabilities. They
will require additional investment thus they also should be evaluated according to RBV in order to
understand are they able to create sustainable competitive advantage or to strengthen the current ones.
22 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
21
VRIO Framework
Introduction
There are two main frameworks used along with RBV. They are called VRIO and VRIN.
Both of them consist of 4 main questions. First two questions are the same for both frameworks:
question of value and question of rareness. The next two parts of VRIN are questions of imitability and
non-substitutable. VRIO though covers both of them in the question of imitability and emphasizes the
importance of organizational aspect. Because of this VRIO are considered more comprehensive and
used more often. Because of this reason we have chosen for analysis in our project.
VRIO was created by J. B. Barney and published in his book Gaining and Sustaining
Competitive Advantage in 1996. He suggests it as a practical tool for managers and explains it in the
form of Figure .
Is the resource or capability…?
No
Yes
Yes
No
Yes
Costly to
imitate
No
Yes
Yes
Yes
Valuable
Rare
Competitive implications
Exploited by
organization?
No
Yes
Competitive disadvantage
Competitive parity
Temporary competitive advantage
Sustainable competitive advantage
Figure : VRIO Framework. Source: Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice
Hall, US.
Each of the identified assets should be evaluated accordingly to the table. Answering the
questions in an appropriate order will give the answer about competitive implication and their effect on
economic performance. First question to answer is about the value, if the answer is negative then the
resource result in competitive disadvantage. But if the asset or capability is value then the rareness
must be evaluated. Even though asset is not rare it can result in competitive parity and normal
economic performance if it is exploited by organization. Otherwise arrow redirects us to the first line
and that asset creates competitive disadvantage. In order to get better understanding about each aspect
we will analyze each question in depth.
22
The Question of Value
Do a firm’s resources enable the firm to respond to environmental threats and opportunities?23
Book value not always gives accurate information about the real value of the asset. In the
view of RBV resource is only valuable if it helps company to respond to environmental threats and
opportunities. That is because every asset generates some sort of costs and puts company into
competitive disadvantage if not used in appropriate way. Thus only those assets which help to reduce
cost and/or increase revenue can impact economic performance positively.
Although, managers should keep in mind that the time even sustainable competitive advantage
can disappear, so do resources can lose their value too. That can happen because of the changes in
consumer taste, technological advance, shift in politics or economy and so on. For example, Nokia
sales are decreasing24 as well as its stock price, because their capability to produce high quality mobile
phones is not as valuable as before. Consumers prefer smart phones and platforms with mobile function
over traditional mobile phones25. If company no longer posses valuable resources it has two basic
decisions. First one is to develop new assets or capabilities in order to compete in the market. This step
requires time and investment as well as strong strategy to follow in order to be successful. The other
choice is to apply traditional strengths in new ways. For example IBM used the ability to engineer and
create systems which was developed in computer and software industry and used it in business
consultancy26.
The Question of Rareness
How many competing firms already possess particular valuable resources and capabilities?27
Valuable resources give company internal strength and helps to compete in the market.
Although if the resource is common in the industry it is not likely it can create sustainable competitive
advantage, so valuable but common resources results in competitive parity. Fact that resources are not
23 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
24 Data taken from Nokia’s annual reports
25 2008-2010 reports on mobile communication devices sales from Gartner.com
26 Official IBM information in www.IBM.com
27 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
23
rare does not mean that they are not important. Competitive parity ensures normal economic profits and
helps company to survive. For example web site of the company is common resource most companies
posses. Although it is not creating competitive advantage not having it can put company in a serious
disadvantage and reduce its economic performance.
Barney also explains term rare more in depth. According to him resource not necessary
has to be unique in order to be source of competitive advantage. As long as the number of companies in
the particular industry possessing the resource is bigger than number of companies needs it resource
can provide competitive advantage. Barney states that even if there is only one company that does not
possess the resource it is rare. That is because that company is in relative competitive disadvantage thus
others posses competitive advantage over it. Of course, this advantage are not as strong as the one
created by totally unique resource. But that leads to the question of imitability.
The Question of Imitability
Do firms without a resource or capability face a cost disadvantage in obtaining it compared to firms
that already possess it?
We can conclude that in the view or RBV only rare resources can create competitive
advantage. It is not necessary sustainable though. Competitive advantage will not only provide
company with above normal economic profits. It also attracts the attention of competitors. If the
resource is easily obtainable or imitable other firms in the industry will acquire it as well resulting in
competitive parity. There is couple of ways to imitate resource as well as barriers who protects them.
We will analyze them separately.
Direct duplication or substitution
Easiest way to imitate resource is to directly imitate him. We gave example of web site.
Company can easily destroy competitive disadvantage by obtaining it, but it is not always possible. If
the resource is inelastic in supply it can be expensive and difficult, or even impossible, to obtain. In that
case companies can try to substitute resource – get the same or similar result by using other resources.
Barney gives classic example of fertile land. This resource is inelastic in supply. But fertilizers can
increase fertility of other lands and thus result in the same harvest. If the price of fertilizers is not too
high and company using them does not face cost disadvantage this way can be called substitution and
24
competitive advantage of the fertile land owner will disappear. However, there are barriers which
protect resources from imitation.
Barriers of resources imitation
Why firms trying to imitate some sort of resource should face cost disadvantage relative
to the first one? In general development and research requires more time and investments than
imitation. But that is not always truth. First reason is historical conditions. Some firms took place in
unique historical events which helped them to develop particular resources or capabilities. Recreation
of these events is impossible or too costly to imitate the resources. Another reason can be path
dependency when the decisions made in the past resulted in unique opportunities in the future. For
example land bought cheap few decades ago can contain important resources which increase its value.
Competitors must pay full price in order to get the same assets and imitate competitive advantage.
Another sort of barrier is casual ambiguity. It means that it is hard or impossible to
determine connection between resources and competitive advantage. Even though big decisions are
usually emphasized as main reason of success there can be a lot of small reasons which gives the
desired result. And these small decisions are invisible from outside and hard to determine from inside.
Other companies tend to hide its processes and structure. Though main assets and capabilities can be
determined connections between them are hidden and thus require a lot of experimentation in order to
imitate.
Third reason is social complexity. While a lot of depends on official roles and
communication in the company, unofficial connections also plays a huge role. The interaction between
head managers, ability to motivate their employees, staff ability to work together and support each
other at the time of crisis is only few examples of resources and capabilities most of the companies
posses. Some of them do that better than others. We already emphasized how hard is to evaluate human
capital within the company. To do that from outside is even harder.
And the last main reason is patents. They provide protection for unique assets and help
company to sustain its competitive advantage. However this barrier is weaker than the others. Patents
protect assets from direct duplication but sometimes it can increase the chance of imitation. So if the
resource is valuable, rare, costly to substitute and hard to imitate it can provide company with
sustainable competitive advantage but only if it is exploited by organization.
25
Question of Organization
Is a firm organized to exploit a full competitive potential of its resources and capabilities?28
Event though resource is valuable, rare and costly to imitate it can provide competitive
disadvantage if company does not exploit it. Structure of organization, reporting structure,
compensation systems, management and control systems are usually called complementary resources
because they can do a lot on their own. But they are very important in the question of organization 29.
These resources help reach full potential of other resources of the company and thus provide
sustainable competitive advantage. According to Grant Xerox was losing their market during 1980’
while the company was superior to its competitors in Japan in most ways. The only reason they was in
competitive disadvantage was that company was not exploiting their resources. After starting to
benchmarking and exploit these resources company revived and now successfully competes in the
market30.
Conclusions
RBV is helpful managerial tool which helps to determine strengths and weaknesses of the
company. Unlike most others tools which analyses from market perspective RBV focuses on internal
resources and capabilities. These insights help to determine key activities at which company are
superior to others. The more unstable the market the harder is to make decisions. RBV provides
companies with more reliable knowledge about company and helps to choose right paths. However
VRIO frameworks covers main aspect of the RBV additional theories and analysis can provide
additional knowledge and should be used in order to make more accurate decisions.
28 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
29 Barney J. B. (1996), Gaining and Sustaining Competitive Advantage, 1st ed., Prentice Hall, US.
30 Grant R. M., (2005) Contemporary Strategy Analysis, 5th chapter: Analyzing Resources and Capabilities, 7th Edition
edition, John Wiley & Sons, US.
26
Porter's five forces
Introduction
This theory was originated by Michael E. Porter in 1980 in the book “Competitive
Strategy, a method used to analyse industries and competitors. It became one of the famous tools used
in analysing industry structure and its corporate strategy since then. 31 The theory is mainly used to
analyse existing and operating industry. There might be uniqueness in each organization or industry but
there are some common forces that will be able to affect their performances and profitability. Porter's
five forces tries to generalise all the forces within the industry. The five forces are taken from the
prospective of a firm but it could also help to determine if an industry or firm outside the industry could
enter the industry.32 In order for an organization to enter an existing industry it needs to be prepared to
compete successfully with it's competitors. One of the best tool for analysing the competitive
environment of a firm is the Porter's five forces because it helps an organization to be able to determine
the profit potential of the industry or in other words the return on investment. The porter five forces
look at the industry,s position as compared to it's competitors, and this five forces are> bargaining
power of buyers, threat of new entrant, bargaining power of suppliers, threat of substitute products or
services, and the intensity of rivalry in the industry.
Figure 1.Porter five forces. Source: Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business
review, Boston, MA
31 Henry A., (2007) Understanding strategic management, OUP Oxford, London.
32 Henry A., (2007) Understanding strategic management, OUP Oxford, London.
27
The Threat of new Entrance
New competitor may decide to enter an industry to take it's own share of profit being
made by it's competitors. Industries where there are very high profits and very low production cost,
tends to attract new entrants. 33Then the problem becomes: The more an industry is easy to enter, the
easier new organizations can enter, the greater or more intense is the competition. Threat of new entrant
depends greatly on the entering barriers and how the existing players in the industry will react when a
new competitor enters the market.34 When there are very high entry barriers, few companies enter the
market .i. e . the threat of new entrant is low with very high entering barriers, the reverse is true with
low threat of entrant in an industry. There is new capacity and desire for market share with the entrant
of a new competitor in an industry and as such, pressure on prices and cost. 35The main barriers to entry
are: economics of scale, capital requirement, product differentiation, access to distribution channel, cost
advantages independent of size and switching cost.36
In our industry LEGO, threat of new entry is low due to the barriers.
1. Economics of scale.
Most industries have higher margins when producing on larger volume. This is because
cost per unit reduces when producing at larger volume as the fixed cost are spread over the volume of
units produced, with the use of efficient technology not letting out the good terms they have with their
suppliers.37
This become or serves as an entry barrier because, any new entrant will have to think
twice before engaging, They* new competitor* will have to make 2 options. They will either accept to
enter the market by large scale production, wait and accept the reaction from the existing players ,or
enter the market with low scale production in order to avoid reaction from existing players, by such
operating at lost due to cost advantage.
When we look at LEGO they have a cost advantage, since they produce in larger scale making it
difficult for new firm to enter the market.
33 Henry A., (2007) Understanding strategic management, OUP Oxford, London
34 Henry A., (2007) Understanding strategic management, OUP Oxford, London
35 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
36 Henry A., (2007) Understanding strategic management, OUP Oxford, London
37 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
28
2. Capital requirement
The need of huge capital or financial resources to compete in an industry, leads to an
entry barrier e. g. huge fixed costs need to start up a business. Fixed cost are cost that do not change
with an increase or decrease in the amount of goods or services produced, and these are expenses that
the company needs to pay back, independent of any business activity.
3. Product Differentiation.
Make product to look more attractive and unique qualities with other competitors which
gives room for competitive advantage for the seller as product is seen as unique or superior for
customers.38 It can be achieve in many way. e. g. packaging goods in a creative way, incorporating new
functional features, new advertising campaign or other sales promotions. 39 where the product is already
in the market, creating high brand awareness and customer loyalty. As a new comer in the industry you
will have to spend a lot of money on advertising and promotion to establish product on the market.
Patent and proprietary knowledge serves to restrict entry into an industry. Ideas and knowledge provide
competitive advantage thus treated as private property creating a barrier of entry.40
4. Switching cost or sunk cost.
If buyers from firms have to change supplier's product to another, they will be faced with
one problem which will be the one - off –cost. With high switching cost any new entrant will need to
offer a product that is greatly improved *Differentiation or offer product at very low cost if buyer has to
switch. In business and economics sunk cost are past cost which have been made and cannot be
recovered. 41 This cost are not dependent on the volume of activity of the industry. The extent at which
the firm's assets could be used to produce a different product also saves as an entry barrier for new
entrant. If the asset are highly specialized technology or plant and equipment, potential entrant will feel
reluctant to commit because it will be difficult to convert into other uses should in case there is failure.
38 Henry A., (2007) Understanding strategic management, OUP Oxford, London
39 Kotler P., Kevin L., K., (2006), Marketing Management, 12 ed., Prentice Hall, New Jersey
40 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
41 Mankiw G. N., (2003), Principles of Economics, Third Ed., South-Western, US.
29
5. Access to distribution channels.
It could be easier to enter a market, but as a new entrant you will need to have access in
the distribution channels for to be able to compete in the market. It takes time to access the distribution
channels and some industries have sole agreement with distributors making it impossible for new
entrant to access this channels. Supermarkets retailers usually have very small space for new products
and from small producers and this also might create a barrier of entry. 42 New competitors coming into
the market, with distribution channel being a barrier, will have to bypass the existing distribution
channels and create their own distribution channel which will required a huge amount of money for the
sales men and for advertising their produce.43
6. Cost advantage Independent of size.
Some players within an industries might have some advantages which are independent of
the size or economics of scale. e.g. they could have entered the market earlier and as such have some
benefits of first – mover advantages. Due to their early experiences it might be difficult for new entrant
to imitate. Some of the advantages like favourable low cost to raw materials, use of patent to protect
proprietary knowledge and some government policies which might favour incumbent firms.We can also
look at cost advantage as an entry barrier from a different angle
Figure 2. Demand curve. Source: Anderson S., (2011), Cost Reduction ≠ Cost Advantage,
<http://www.qualitydigest.com/inside/quality-insider-article/cost-reduction-cost-advantage.html>
42 Henry A., (2007) Understanding strategic management, OUP Oxford, London
43 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
30
The above curve illustrates the law of demand. Quantity of product demanded by
customer in an industry, is inversely proportional to product price. At P1, firm A is able to sell Q1,
which is the quantity that will be demanded by customers at that price. Then when it is able to achieve
a cost advantage and lower prices to P2, to customers then, the quantity demanded will move from Q1
to Q2. Those players in the market who will want to follow the cost advantage or cost leadership
strategy, will have to do so at lost because their margins will be lower. On the other hand firm A will be
increasing it's market position at the expense of the competitor. While firm A will be increasing it's
market position at the expense of competitors. What we want to say here is that, as a market cost
advantage leader with no other sources of differentiation between competitors, The only thing to
compete will be price.44
Entry barrier are in some ways similar to exit barriers. Below is a summary some of an industry's entry
and exit Barriers.
Easy to enter if there is
Common Technology
1) Little brand or franchise
2) Access to distribution channels
3) Low scale threshold
Easy to exit if there are
- Salable assets
- Low exit cost
- Independent businesses.
Difficult to enter if there is.
1) Patented or proprietary know – how.
2) Difficulty in brand switching.
3) Restricted distribution channels.
4) High scale threshold.
Difficult to exit if there are.
1) Specialized assets
2) High exit cost
3) Interrelated businesses.
Figure 3. Entry and exit barriers summary. Source: http://www.quickmba.com/strategy/porter.shtml 45
7. Restrictive government policy
There are always government policy and legislation in every country and business. Some
could encourage or aid new competitors to enter a market, and some could discourage new entrant or
prevent new entrant to enter the market. The government by funding of some research can indirectly
make way of entrance for new competitor much more easier as funding will help reduce some of the
organization cost and directly the government can make it easier for some competitors to enter a
market by providing subsidies.46By granting of monopolist and through regulation government restrict
44 Anderson S., (2011), Cost Reduction ≠ Cost Advantage,
<http://www.qualitydigest.com/inside/quality-insider-article/cost-reduction-cost-advantage.html>
45 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
46 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
31
competition.47
Bargaining power of Suppliers
All producing industries need raw materials, labour and other supplies. To able to buy raw
materials at reasonable prices a buyer – seller relationship need to be created between buyer and the
seller.48 Depending on certain conditions the supplier can either have strong or weak Bargaining power.
See below table.
Suppliers are powerful if.
Example
-
Credible forward integration threat by
suppliers.
-
-
Suppliers concentrated.
-
-
Significant cost to switch suppliers
-
-
Customers powerful
-
Suppliers are weak if.
Baxter international, manufacturing of
hospital supplies, acquires American
Hospital supply, a distributor.
Drug industry's relationship to hospital.
Microsoft's
relationship
with
PC
manufacturers.
Boycott of grocery stores selling non –
union picked grapes.
Examples
-
Many competitive suppliers – product
is standardized.
-
Tire industry related
manufacturers.
-
Purchase commodity product
-
Grocery store brand label products.
-
-
-
Credible backward integration threat
by purchasers.
Concentrated purchasers
-
Customers weak.
-
Timber producers relationship to paper
companies.
Garment industry relationship to major
department stores.
The relationship between travel agency and
Airlines
-
with
automobile
Figure 4. summary of suppliers bargaining power. Source: Porter M. E., (2008), On Competition, Updated and Exploited
ed., Harvard Business review, Boston, MA
1.Threat of forward integration.
This happens when suppliers are able to integrate forwardly into buyer's industry and as
such they can be able to complete with their buyers. It reduces buyers profits in buyer's industry since
47 Henry A., (2007) Understanding strategic management, OUP Oxford, London
48Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
32
there is more competition, caused by the forward integration of sellers into buyers industry.49
2.The supplier's products are differentiated or there high switching cost for the buyer.
If switching cost to other suppliers are difficult of very costly for the buyers, the buyer
will find it difficult to switch sellers and as such will have to hold with the suppliers they have rather
than switching because it will turn to increase their cost of production thereby selling prices will have
to increase to cover their cost.
3.The suppliers, product are an important input to buyers, business.
If the supplier's product are an important input to buyer's business, i.e. buyer's
manufacturing process or its product quality, then the bargaining power of supplier's is high.
4. Suppliers are faced with few substitutes.
In an industry where supplier's are faced with very little or no substitute, the bargaining
power of suppliers are high because the suppliers have power over the buyers and can set their prices as
they want since there is very little competition.
5. When industry is not an important customer of the suppliers.
When suppliers sell to many industries and most of the industries do not represent a
significant proportion of their sales the bargaining power of the suppliers are high.
The Bargaining Power of Buyers
The degree of intensity of power of buyers can have an impact on the particular industry
in many different ways. If the power of Customers is high, they can for example demand lower prices,
higher quality of products, additional services or other advantages. Consequently the high bargaining
power can create pressure on company´s profit margins due to lower prices or using additional
resources for meeting customers’ needs and it has also the ability to influence the company´s sales. The
49 Henry A., (2007) Understanding strategic management, OUP Oxford, London
33
power of buyers is increased in following circumstances:50
4) There is a concentration of buyers and high volumes of purchases
In a case where the concentration of buyers is high compared to the number of suppliers
and their volume of purchase is high, we see the tendency of increasing power of the buyer. For
example a large supermarket chains can create an immense pressure on their suppliers due to huge
volumes in purchases. In addition to that, because of the overall high proportion of sales in some of the
supermarket chains, it is also very important for the producers to get shelf space in these supermarkets
which further increases the power of the buyer.
5) The products sold in the industry are standard and/or undifferentiated
Where there is no or little difference between the products sold on a particular market, the
buyers can easily switch to another supplier since there are no extra benefits from purchasing from one
supplier. Buyers therefore seek the place where they can get the product in the best price abandoning
loyalty to a particular supplier. In this scenario, the firms experience higher pressure in order to
decrease their prices, which is the only way to compete when selling standard products.
6) Switching costs are low
If the costs connected to switching from one supplier to another one are low and/or
associated with low risk, the power of the buyer is increased.
7) Threat of backward integration
The threat of backward integration has also the ability to increase the power of suppliers.
The backward integration means that the buyers can obtain the ability to provide the products or
services themselves. This can for example be a company producing soft-drinks that instead of
purchasing plastic bottles from a third party decides to manufacture these bottles itself. If the threat or
probability of this integration of a buyer is high, the supplier has to be aware of it a deal more
cautiously with its customers especially concerning the prices. There is however another possibility that
can decrease the power of buyers and that is the forward integration of suppliers.
8) The industry´s product does not play an important role in relation to the quality of the
50 Henry A., (2007) Understanding strategic management, OUP Oxford, London
34
buyer´s products or services
In the case that the quality of the product is highly dependent on the material supplied
from another industry, the bargain power of the buyer decreases. For example the products a
manufacturer of an expensive wood furniture are highly dependent on the supply of quality wood like
mahogany, oak, walnut or birch. The quality and value of the furniture would rapidly deteriorate if
there would be chosen another alternative materials. In this scenario the manufacturer would be less
price sensitive and his bargaining power would be low. There are however products where some of the
parts can be replaced for instance from metal to plastic without losing on its quality. Here the
bargaining power of the buyer, in relation with the supplier of metal parts, would be on the contrary
high.
9) The buyer earns low profit
Generally if the buyer operates in an industry gaining high profit, the incentives of putting
pressure on the suppliers are low and the buyer of less price sensitive. The opposite is also true and
therefore if a buyer runs a business with low profit margins, there will be tendencies and attempts from
his side to find ways of increasing the profits. One of the ways is to decrease the cost of inputs.
Depending on the size of the buyer, he can even use the threat of closing down the business if the
supplier is not willing to negotiate on better price or sale conditions.
10) The buyer is well informed about the industry
The availability of information for the buyer about the demand, costs, prices and
competitors in a particular industry also increases the power of buyer. On the contrary if the buyer does
not have adequate knowledge about the industry and its players, the supplier can display opportunistic
behavior and demand sale condition that will benefit him. In this era the internet made it easy for
buyers to gain necessary information before making purchases and compare the prices and other sale
conditions of different suppliers. This access to information strengthens the power of buyers.
The relevance of the power of buyers in this project
To asses and analyze the power of buyers in the toy industry is important since it directly
impacts the way the toymakers run their business and influences their profit margins. Investigating this
question will help us to answer if the LEGO group will be able to sustain its competitive advantage in
35
the next 5 years.
The Threat of Substitute Products and Services
The threat of substitutes exists if the demand for substitute products increases in response
to increase of the price of an industry product. In other words a product´s price elasticity is affected by
substitute products – as more substitutes become available, the demand becomes more elastic since
customers have more alternatives. A close substitute product constrains the ability of firms in an
industry to raise prices.51 The substitute products come from outside of the industry but have the ability
to perform the same function or meet the customers’ needs in a similar way.
A substitute services for example for railways are bus transportation, cars or airplanes.
Therefore when the management for instance of DSB is setting the prices for train tickets, it has to
consider the prices of bus tickets, fly tickets or even prices of petrol and other expenses associated with
owing a car. The power of substitutes does not solely depends on the price of the product, but also on
other factors. The transportation with train has an advantage of relatively comfortable and safe
transportation especially on shorter distances. When it comes to longer distances, the transportation
through air provides a faster substitute to trains with comparable prices.
The company has to therefore identify what are the substitute products in its industry and take them
into consideration when making strategic managerial steps.
The relevance of analyzing the power of substitute products in this project
The substitute products have more than anything else shaped the toy industry in the recent
years. In the same time these products are the greatest threat of traditional physical toys. For these
reasons it is crucial to investigate how strong actually the power of substitutes in this industry is.
The intensity of rivalry in the industry
The rivalry can increase when competitors in an industry see an opportunity to improve
51 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
36
their market position.52 Any move made by a firm is however retaliated by other firms in the industry.
Depending on the type of the market these firms operate, the competition goes beyond the prices and
includes other areas like improved quality of service to customers, promotional and advertising
campaigns and others. Especially in an oligopoly market structure, if one of the competitors decreases
its prices, the others simply follow this step and consequently none of the firms gains the advantage of
lower prices. Therefore the firms look for other way of creating value for the customers and sustainable
competitive advantage for the firm itself. If the intensity with which the firms in the market compete
between each other is high, the industry profits are reduced.
The economists measure the rivalry by a measure called concentration ratio 53 (CR), which
can be done for the largest 4 firms in the industry. (CR can be also done for the largest 8, 10 or 25 firms
depending on how many firms this calculation is made for). This ratio indicates the proportion of the
market share that the given firms hold in the industry. The high ratio indicates that few companies hold
a large market share. The low ratio shows that none of the firms in the industry has a large market
share, which results in a more intense competition. The intensity of rivalry is influenced by following
characteristics:54
5) High number of firms
This increases the rivalry because a larger number of competitors have to divide the profit
of the market and fight for customers. If several competitors have similar market share the rivalry
increases as each attempts to become the market leader.
6) Slow industry growth
If the growth in the industry is high, the companies can easily enjoy increase of revenues
without using many resources for gaining market share from its competitors. However if the industry
growth is slow, firms tend to compete more fiercely with each other in order to gain higher revenues
and profits.
7) High fixed costs
52 Henry A., (2007) Understanding strategic management, OUP Oxford, London
53 Porter M. E., (2008), On Competition, Updated and Exploited ed., Harvard Business review, Boston, MA
54 Henry A., (2007) Understanding strategic management, OUP Oxford, London
37
If the firm operates in an industry with high fixed costs, the companies have to sell many
products or generate high revenues in order to cover these costs and simply survive. Therefore the
companies strive for reaching higher volume of sales in order to implement economies of scale. These
attempts often lead to price war.
8) Lack of differentiation or switching costs
If there are low switching costs or low difference between the products offered in the
industry, the companies have a difficulty in preventing customers from buying from their competitors.
Therefore the companies have to fight for customers more intensely with low prices and higher quality
of services provided.
9) High exit barriers
Some of the industries are very specialized, but at times as the demand or customers
needs changes, the companies suddenly face a situation where they have a very specialized technology
and machinery and lower customer base to target. Since the equipment cannot be used in other sectors,
the costs of leaving the industry are too high and companies choose to stay. Consequently the rivalry
between the firms is intensified.
The relevance of analyzing the intensity of rivalry in this project
How will the future development of LEGO group be will in large extent depend on its
competitors and how intensely they decide to fight back every step the company makes. The force with
which the companies compete in this industry will have an impact on the profit margins, variety of
products the companies offer and ultimately the market share of each player.
38
Lego case
Introduction to Lego group
The LEGO company, leader in the field of children's toys, has been producing the famous
colored bricks in 1949, but in 1953 bricks took the form that is still in production nowadays. The idea
comes from a Danish carpenter, residing in Billund, Ole Kirk Christiansen. At first, the company
produced toys like trucks, cars and money boxes. But in 1929 company faced tough times due to the
Great Depression. Mostly no one could afford to buy toys for children and those few people who could
afford paid with barter, in most cases, food. The name LEGO comes from the Danish leg godt ("play
well"). With the advent of plastic, Christiansen, composed his first toy truck piece. In 1947 were
produced for the first time assembled plastic bricks. The bricks, made of cellulose acetate, were
developed following the tradition of wooden blocks to overlap already marketed by the company years
earlier. A few years later, in 1958, Ole Kirk Christiansen died, and his son inherited the leadership of
the company Godtfred. In 1959 the division was founded within the company Futura, a small enterprise
which had the task of creating new ideas for the development of the creative product.
The 1961 and 1962 were years of the introduction of the first wheels. That allowed to
build cars and other vehicles with bricks. In 1963, cellulose acetate, was replaced by a more stable
compound, ABS plastic (acrylonitrile butadiene styrene), which is still used nowadays. The new
material is non-toxic, does not lose color and deformation and is more resistant to heat, acids and other
chemical elements. In 1964 the company decided to attach to each box of product an instruction
manual so that children could be guided in their creative play. Success was the creation of the train
system, produced since in 1966: in the original package there was a 4.5-volt motor, and two years after
it was introduced a 12 volt motor. In 1968, took the light in Billund, Denmark town, the playground
made entirely in Lego and nicknamed Legoland. The park now has an area of 12,000 square meters. In
1971, Lego began to focus on the toys market for girls by introducing pieces of furniture and doll's
houses and in 1972 we see the birth of the first ships, boats and floating hulls. But the real turning point
39
was in 1974, when Lego gave birth to the first human figure. In 1979, another brilliant idea came to
light. These were the years in America of the first sets in space. LEGO decided to produce characters in
astronaut suits, rockets, spaceships and lunar rover. In 1981 many new accessories were introduced
such as lights, switches and signals controlled remotely, even clutch systems. In 1986, the LEGO
Educational Division Products produced the Technic Computer Control, a system of robots, trucks and
other motorized machines, piloted by a computer. In 1989 company introduced the Lego Pirates series,
which included treasures, pirate ships and islands precisely. The standard colors of the bricks are the
basic red, yellow, blue, black, white and light gray. The other colors were added later with the advent of
year 2000 together with the development of new forms and posters. The LEGO bricks refused to
produce green, with the anxiety that could be used to produce military vehicles and the company had
negative approach to war. This 'vision' changed with the production of Indians, Knights and Pirates.
LEGO Star Wars and LEGO Harry Potter were the inventions of recent years inspired by the stories of
cinema. LEGO over the years has proven to be always in the flow with the technology and the
requirements of novelty and the changes that brought the world. Company is also creating a line
dedicated to LEGO video games. The target of LEGO products is certainly children. Each Lego
production allows children to 'play' with their creativity55.
55 Introduction is based on material from <http://www.essortment.com/lego-history-58761.html>; Hansen W., H.,
(1982), 50 Years of Play. The Lego Group; Lego group homepage www.lego.com
40
Resources and Capabilities
Lego group is a world known toy maker. It has some unique resources and capabilities
that allows the company to achieve great results. As mentioned in the theory part one can choose
resources and capabilities to analyze due to outside or inside information. Companies capabilities have
been chosen from outside and inside analysis. On the company's outside and what is visible to the
society part is brand, promotion and production quality can be analyzed. Mainly articles about Lego
brand management, statistical data about consumer satisfaction levels and added value to production
was analyzed as outside visible resources and capabilities. Inside capabilities include making things
efficiently, following trends and supply chain. Those capabilities require analysis from internal
companies resources – annual financial and performance reports. To answer the problem statements
Lego groups capabilities to do business efficiently, follow market trends, development of high quality
production and brand management had been chosen. These are the main outside and inside capabilities
that Lego group posses and focus very strongly on them.
Efficiency
After a financial crisis that hit Lego in 2003 company's new management placed new
goals for efficiency. It had to develop new way to do business, restore competitiveness, and reduce
level of risk by having lower costs and less assets in the company. Before the crisis the company
mostly was industrial and focused on how to develop new ideas for toys. It's main strategy was to be a
creative company. After the crisis the management was changed and it's new CEO Jørgen Vig
Knudstorp with its American management style decided to focus not only on creativity on developing
toys, but how to make some money and develop capability to create efficiently. Making Lego Groups
value chain more efficient led to higher gross margin. The company's main ability to work efficiently is
seen in the production facility, energy consumption, logistics and waste management.
Production facility
Before the financial crisis in 2004, Lego group had a very big production facility and high
expenditures on innovating new type parts for existing production (new colors, figure designs and etc.).
41
Lego had a lot of different parts and type of bricks despite the fact that just 30 products generated 80%
of revenues56. Companies designers were innovating new toys without any calculation for the price of
materials nor the cost of production. Lego group wasted a lot of its resources dealing with suppliers,
which it had more than 11,000 in all. In comparison, Boeing uses twice as much suppliers to build
airplanes.57 Product developers and engineers had too many power and had the opportunity to choose
suppliers they liked and not to go with companies interest. To solve these problems and do things
efficiently, Lego reduced color pallet from 100 to around 50, removed some figures (different types
and appearance of same Lego characters), rules for designers made them not to create new figures, but
use existing ones to create new products and make cost-effective choices.
Company also outsourced its production facility from United states to Mexico and to
Czech Republic. The company decided to boost efficiency by locating its factories near its most
important markets. A plant in Eastern Europe would get products to European store shelves in three to
four days — an important consideration given that Europe accounts for 60% of total Lego groups
revenue.
Lego groups motto is “only the best is good enough”. In their annual reports Lego group
states a zero product recalls strategy. By having a zero recall strategy, which they have failed only in
2009 by having 1 product recall from 2007, Lego group is trying to work as efficiently as possible,
because product recalls put a loss for the company. To reach this goal company has to invest in it's
manufacturing, has to have great suppliers and employees whom will have eager to do their job
efficiently and according to Lego groups values. Lego group has outsourced it's production facility to
Czech Republic and Mexico. That gives greater efficiency due to lower labor costs. And according to
Lego groups CEO Jørgen Vig Knudstorp due to development of EU countries, future production may
go further and further to the East. Supply chain is managed very precisely. Lego group inspects
companies in supply chain with annual audits by checking their performance, employee rights and
environmental performance. Companies that do pass the audits are chosen to supply materials and parts
for the Lego group. Company is driven by it's employees and after Lego financial crisis in 2004
management started to optimize number of work force. Lego Group is constantly improving its
production facility and using its labor force more efficiently, because one employee was creating more
56 Oliver K., Samakh E., Heckmann P., (2007), Rebuilding Lego, Brick by Brick, <http://www.strategybusiness.com/article/07306?gko=99ab7>
57 Oliver K., Samakh E., Heckmann P., (2007), Rebuilding Lego, Brick by Brick, <http://www.strategybusiness.com/article/07306?gko=99ab7>
42
value to the customers in 2010 then in 200458. And from Lego groups revenue and number of
employees chart it is seen that the gap between sales and total amount of full time labor is increasing.
That means labor is getting more and more efficient and transmits more value to customers.
LEGO
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
2002
Revenue
Employees
2003
2004
2005
2006
2007
2008
2009
2010
Chart was made with collected data from Lego groups annual reports from 2002 to 2010.
Energy consumption
Fossil fuel energy is getting more expensive and in the long run its price will definitely
increase due to its limited resources and increasing demand from developing world. Lego group is
adapting to this changing trend by consuming energy more efficiently and investing into renewable
energy resources. Energy consumption has a direct influence on financial performance of the company.
Lego group is investing in intelligent lighting, cooling systems, optimizing compressed air systems and
replacing its hydraulic pressures.
58 Based on data about Lego revenue and number of employees from Lego annual reports from 2002 to 2010.
43
Energy efficiency index
180
160
140
120
100
80
60
40
20
0
2007
Energy efficiency
index
2008
2009
2010
Chart was made with collected data from Lego groups annual reports from 2007 to 2010.
This chart illustrates that Lego group energy efficiency index is increasing. Based on
Lego groups from 2007 to 2010 annual report energy efficiency index is calculated as the rate between
value add and energy consumption. Value added is defined as revenue minus net value of purchased
goods and services59. Eventhough Lego groups energy consumption has increased from 2007 to 2010
around 45%, but company has managed to increase its value add at the period around 104% 60. This
explains why energy efficiency index has been climbing from 2007 to 2010.
Supply chain
Before 2004 Lego was mostly focusing on selling their production through small retailers
which led company to high transportation costs. Some retailers required only small amount of
production. That resulted in huge costs due to small amounts ordered by retailers, distance between
them and maintenance of 5 logistics centers in Denmark, Germany and France. In addition, to serve all
small retailers, Lego had to have complex distribution system which resulted in missed sales and high
inventory levels.
Lego financial crisis and change in management resulted in need to rethink supply chain.
Company decided to focus on large retailers (for example Wall Mart in USA and Carrefour in France),
because they ordered large quantities and had their own logistics centers. Furthermore, Lego benefits
from large retailers by figuring out demand for particular products and new ideas for possible new
59 Data based on Lego groups 2010 performance report.
60 Calculations are based on Lego groups energy consumption GWh, revenues and costs on raw materials and consumables
data from 2008 and 2010 annual and performance reports.
44
products.
Lego group decided not only to outsource its production to cheaper labor countries, but
did the same with its logistics center. Firstly, Lego closed 5 logistics centers in Denmark, Germany and
France and opened one in Czech Republic. It is operated by DHL. Having a one major logistics center
resulted in better inventory tracking and lower transportation costs due to Czech Republics
geographical position in the center European Union. Furthermore, Lego group has cut its logistics
providers from 26 to only 3. That decision led to benefit from economies of scale and saving 10% in
transportation costs61.
Indoor transportation was also made more efficient by new management. In Lego
headquarters in Billund for trips between administration center and production facilities employees are
obliged to use companies bicycles instead of cars. These short trips not only reduce energy
consumption, but also have less negative impact on environment. Lego group has developed its
benchmark model to equally evaluate logistics provider for transportation from production facilities to
stores. About 95% of all goods transported from Denmark to European distribution centers were
transported by rail62. Equipment format enables logistics provider to quickly and with no additional
costs to change from rail to truck transportation. Inter modal transportation allows to achieve higher
efficiency with lower costs.
Waste management
Lego group states in their 2010 performance report that companies future goal is to
recycle 100% of their waste. In 2010 around 87% of waste was recycled indoors 63. Waste from
moulding machines are passed through grinders and returned directly to the machines, saving both raw
materials, waste handling, and waste disposal costs. By recycling waste Lego group has a positive
impact on their production costs. Also, company has a facility that collects used and broken Lego
production and recycles it.
61 Oliver K., Samakh E., Heckmann P., (2007), Rebuilding Lego, Brick by Brick, <http://www.strategybusiness.com/article/07306?gko=99ab7>
62 Data based on Lego groups 2010 performance report.
63 Data based on Lego groups 2010 performance report.
45
Source: Lego groups 2010 performance report.
High quality and value product development
Lego group is famous for its simple to use construction toy that allows consumers to
make any shapes and figures they like and it wont fall to peaces when it is thrown into air. The basic
idea is that you can construct anything that comes to your mind and the bricks will hold one another
tight and it will be tough as rock due to special plastic materials. Todays environment is more
challenging for toy manufacturers as demand for physical toys is decreasing and computer games are
fulfilling kids hearts. Lego group nowadays is focusing not only on making high quality physical
bricks, but tries to create community, adds value to production with special characters from movies and
invests money for creating digital Lego world64.
High quality production
Lego bricks possess high quality and long durability materials. Usually Lego production
lasts long and is transferred from one generation to another. Lego brick has a standard design. Due to
this fact Lego bricks are compatible from different production years. This fact transmits added value to
consumers and lets to collect products rather than buying new production and getting rid of old one.
64 Based on 2007 Lego groups performance report.
46
The core elements of LEGO products of today contain plastic polymers that are primarily based on
fossil oil resources. Looking to the future, no doubt that materials for Lego bricks will get more
expensive due to higher demand for fossil oil resources and increased costs for waste, that's why Lego
group is focusing on its production environment issues and tries to find ways how to minimize polymer
needs for their production. Materials quality is taken seriously by Lego group, because it concerns
health and safety of consumers, influence to the environment and legislation from EU that restricts
unsafe toys to go into stores65.
Lego group is putting a lot of effort and resources to make safe products for its
consumers. In the LEGO Group, product safety is an integrated part of the development of new LEGO
products. This involves ongoing testing and monitoring of the individual elements and of the raw
materials used. New toys go through a number of tests to ensure safety of toys. Chemical tests ensure
that materials and paint used for decorations are safe and wont affect customers in any way. Mechanical
tests include investigation of toys size in order to avoid customers from choking or swallowing
products66. Mechanical tests also include various strains, such as bite, twist, fall, pressure and pull
testing. And the figure is tested for flaws or sharp edges that may damage the user. When these and a
number of other tests have been successfully completed, the product is in principle ready to be included
in the LEGO products. However, tests do not end when product is approved and put in to stores, they
continue as long as production is manufactured67.
Not only Lego group is very strict for its suppliers, but the company is also strict for
itself. Lego insists that external audits would be as aggressive as possible to find all even smallest non
conformities. By analyzing them Lego group removes those non conformities from their production
facilities and that way increases their production quality. Their goal is to have zero non conformities
found out by external auditors. In 2010 the company had 5 discovered non conformities68.
Higher value products
Lego group transmits more value to consumers by involving popular themes in their
production. Lego follows market trends and makes its production with characters from movies (“Pirates
of the Caribbean”, “Harry Potter”, “Cars” and etc.) and popular activities among children (cars, earth
65 Directive 2009/48/EC of the European Parliament and of the Council.
66 Lego groups 2006 performance report.
67 Lego groups 2006 performance report.
68 Lego groups 2010 performance report.
47
digging machinery, architecture, cities and etc.) 69. Playing with Lego production involves creative
thinking and problem solution. That is the main advantage what Lego production differs from
competitors and is liked by two very different group – children and parents. Also a huge advantage is
that Lego bricks fit one another even if they are from different series or models (excluding the bricks
for babies and toddlers) which makes its new production collectible and supplemental to older one
instead of replacement. Lego gives recommendations about how old child should be to play with
specific model. That is very useful for parents, because they will know that is safe to follow those
recommendations and not risk that their child can choke with small construction details. Also Lego
group invest a lot of effort in figuring out children's psychology and discovering for what age group a
toy suits best. All in all, Lego production transmits additional value to kids and their parents, which is
very smart decision, because parents always make final decisions about presents and etc., because they
are the ones with money.
Lego stores are not only a place where to buy buy bricks, but a fun place for customers.
Not only they get to see all new Lego products, but they also get inspiration for new constructions,
because in Lego stores there are always some interesting models made. Also customers can build some
models at Lego stores and then buy these models so they will have the model they made at home.
Customer satisfaction
140
120
100
Overall customer satisfaction
Consumer complaint
call rate
80
60
40
20
0
2006
2007
2008
2009
2010
Chart was made with collected data from Customers survey from Lego groups performance reports from 2006 to 2010.
Lego group has established a new business unit which is responsible for focusing on
relationship with customers. Annual survey which includes customer satisfaction about marketing,
69 Based on actual Lego production in stores.
48
value, service, product and partnership helps to improve experience that customers meet 70. By
analyzing this survey Lego group tries to increase value to consumers. For example, when Lego found
out that customers buying from their Internet store had complaints about missing parts and manuals,
Lego immediately developed a brick finding system on their website so that consumers can order
missing parts and also uploaded product manuals71. Decreasing customer complaint rate and increasing
Lego groups sales shows that company is looking very seriously to its surveys results and customers
satisfaction level.
Supply chain audits
Up to 80 per cent of the production of LEGO bricks take places at suppliers 72. This is a
major challenge, where the focus is particularly on continuing to ensure the same high quality. In order
to maintain the high quality production levels Lego group trains its suppliers employees to minimize
risks involved with having a lot of suppliers and possibility of having not the same quality production.
Cooperation with suppliers is being constantly developed.
In 1997 the LEGO Group drew up a set of guidelines expressing the minimum
requirements which the suppliers are expected to meet with regard to labor standards, human rights, the
environment and anti-corruption73.
Lego education
Lego group involves a lot of education into play process. The LEGO Care for Education
program includes a specially designed LEGO Learning System for schools 74. The program consists of
monetary donation from the LEGO Foundation and LEGO Education materials. Focus is on already
existing schools in OECD countries where the aim is to secure the development of learning skills at a
higher level than that existing today. In order to be able to document that the LEGO Education concept
makes a difference, impact studies are initiated. At present, this is done in Mexico, South Africa and
Brazil75.
70 Lego groups 2006 performance report.
71 Data based on Lego groups 2010 performance report.
72 Lego groups 2010 performance report
73 Lego groups 2006 performance report
74 Lego groups 2009 performance report
75 Lego groups 2009 performance report
49
In 1999 Lego group established Lego learning institute. The institute actively collaborates
with some of the most respected academics and experts in the field of child development from around
the world. Purpose of this institute is to bring knowledge and science into new product development. In
2009, the LEGO Learning Institute published their latest study of “Defining Systematic Creativity in
the Digital realm”. The study explores what creativity is in the digital realm, what it is like to grow up
in a digital world, and how the digital realm is influences the way children play, learn, and create ideas.
Over the years, a profound understanding of how children of today learn effectively has been
accumulated at the LEGO Learning Institute76.
Creating a Lego community
Lego group tries to create community of kids, parents, grandparents and young adults. It
is a open source company77 and tries to involve its customers into innovation process. Community
helps to develop new products. When Lego upgraded its mindstorm NXT production it involved about
100 fans around the world to help develop and test the updated product. And result was extraordinary,
because in 2006 Lego mindstrom NXT received several innovation awards. This shows that by
involving its products fans and enthusiasts, Lego group removes uncertainty concerned faults and
possible popularity issues.
Children are encouraged to create their own blog web pages at www.lego.com to share
new models and ideas about constructions with their Lego friends from all around the world. This
allows to solve problems and to discuss any creativity issues. Parents are also involved in Lego
community. In a web page for Lego adults discussions related to children development, suitable toys
for particular age groups, upcoming events and other family activity issues are held. By creating a
community and that way offering a higher value production to consumers, Lego group minimizes
threats in case of crisis or external environment instability.
Lego digital world
As computer games are becoming more and more popular among younger children, there
is a big threat for the traditional toys and Lego company. Thinking of and following market trends had
helped Lego group to survive crisis in 2004. Lego group invests its resources and capabilities to create
76 Lego groups 2009 performance report.
77 Interview with Lego groups CEO Jørgen Vig Knudstorp, 2009.
50
digital products for customers. Firstly, company develops its web page that everyone can access and
find relevant information for them78. News about coming and existing products, information about
upcoming events, manuals for new Lego constructions, interaction with other Lego fans, discussions
about related topics, blogs, information for parents about production and its safety, children's
development and other interesting things for Lego enthusiast can be found on Lego homepage. This
helps to create a virtual social environment and increase production popularity and adds value for
existing customers. Also Lego web page is full of simple flash games for a short brake time. They
involve logical and creative thinking and speed.
Lego uses tactics as an open source company. That means that Lego enthusiast can build
virtual Lego constructions with special software and after some time those products can actually go on
sale in stores. This way Lego finds out genuine demand for their products.
Lego also is participating in video game business. Computer game development
companies create games with Lego brand figures participating in them. The games involve characters
from films (Indiana Jones, Caribbean pirates, Batman, Starwars and etc.) and are mostly adventurous
with purpose of achieving missions and solving problems. Having video games in their production
range helps to keep up with changing toys market trends that goes further from physical to virtual
world.
Lego group puts a lot of effort in their production safety and virtual world is no exclusion.
First of all, it is about ensuring a digital social interaction which is safe and secure; secondly safety
legislation in this field is still limited, which calls for companies to create their own ethical standards.
All the LEGO Group’s digital offerings are compliant with the two acknowledged standards Children’s
Advertising Review Unit and Children’s Online Privacy Protection Act, whose respective goals are to
ensure responsible advertising towards children and outline the responsibilities any online host has to
protect children’s safety and privacy online. Lego online privacy includes constant moderation, report
system, code of conduct which declares how people should interact with one another, special game
characters who constantly remind about safety in digital world79.
78 Lego groups web page www.lego.com
79 Children’s Online Privacy Protection Act; Lego groups privacy policy statements; Lego groups 2006 performance
report.
51
Responsiveness to market trends
Corresponding to theory section about RBV, resources are only productive if company
has the capabilities to organize them in a particular way to get desired results. If Lego group would not
respond to changing market needs and wont adjust its main product – brick, then probably it would not
have survived crisis in 2004. Lego group goes to the market with their main product brick construction
and to keep it live, up to date and attractive it has to constantly offer some new features for its
production. The Lego brick is in the market for more than 50 years and it has not changed a lot from
the time when it was invented. What Lego group does to their production when it reaches maturity spot
in product life cycle, they develop new appearance. Lego group buys licenses from movies like “Cars”,
“Star Wars”, “Harry Potter”, “Pirates of the Caribbean” and other and puts the whole stories and
characters into their production. This strategy helps company to go with the trend and make their
products attractive to customers, because they receive more value from their production. This shows
that Lego group goes with really popular movies among children and that way tries to make their
product up to date with changing market.
Going into video games is also one of signs that Lego reacts to changing market trends
and tries to adjust their production to it. More and more at younger age children are leaving physical
toys behind and going to virtual reality. Seeing this as a threat Lego group puts their brand and main
idea that learning should be playful into video games. Lego group also has to think about safety in
virtual reality. By investing their resources and capabilities into video games, Lego group responds to
the changes in the market and minimizes its risks concerned with product life cycle decline.
Todays world not only goes for playing into virtual reality, but also communication is
going virtual as well. This helps to communicate with people around the world with no big problem.
Lego group is not standing still and also tries to create a virtual community. With Facebook and Twitter
overlying the market, Lego group is creating blogs for children where everyone can share their ideas
about new models, thoughts about Lego characters and etc. Parents are also involved into visualization
process by reading articles about children's development, upcoming events and discussing about Lego
production. By establishing Lego web page into communication site, company is creating a community
around the world which help to figure out new ideas, help keep up with changing trends, solve
52
complaints and increase popularity of Lego bricks.
Brand management
Corresponding to theory section about RBV, resources are only productive if company
has the capabilities to exploit them. Without brand world popularity and great history, Lego group
probably would not have been able to survive crisis in 2004. Lego is world known toy brand. When
Lego faced financial problems in 2004, company's old management instead of making production more
efficiently, began to spend money on advertising. But that was a bad decision, because Lego at that
time was one of the best recognized toys in the world 80. Lego company has a different strategy to form
a strong and world known brand. The main success of Lego brand was not accomplished by marketing
department, but the result of a close dialogue with key stakeholders. Lego communicates closely with
its customers, suppliers, employees and other key stakeholders81. Also, to create a world known toy
brand, helped a strategy to promote high quality production, saving the environment, recycling and
having an open source company.
According to Majken Schultz and Mary J Hatch, corporate branding depends on strategic
vision, organizational structure, stakeholders image and identity82. Strategic vision refers to companies
future performance83. LEGO groups future performance involves formal statement of strategic goals,
which also include a statement of corporate beliefs and mission. The current strategic goal of the
company for the long-run is “To become the worlds strongest brand among families with children” 84. It
is supported by mission “inspire the builders of tomorrow” 85 and core beliefs “inventing the future
80 Oliver K., Samakh E., Heckmann P., (2007), Rebuilding Lego, Brick by Brick, <http://www.strategybusiness.com/article/07306?gko=99ab7>
81 Ind N., Schultz M., (2010) Brand Building, Beyond Marketing, <http://www.strategy-business.com/article/00041?
gko=9efe7>
82 Schultz M., Hatch M. J., Larsen M. H., (2000), The Expressive Organization: Linking Identity, Reputation and the
Corporate Brand, Oxford University Press, USA
83 Schultz M., Hatch M. J., Larsen M. H., (2000), The Expressive Organization: Linking Identity, Reputation and the
Corporate Brand, Oxford University Press, USA
84 Lego groups performance report.
85 Http:/www.lego.com/en-us/group/vision.aspx
53
play”86. The expression of vision includes the highly visible yellow-red-black logo 87. With Lego groups
mission and values, company has a strategic vision and can plan future performance.
Organizational culture refers to the internal values, beliefs and basic assumptions that
involves the history of the company and how employees feel about the company they are working for.
Most consumers refer to the bricks and mini-figures as “LEGOS” thereby linking them to a key symbol
of the company – its name. Lego states that its business is only possible because of the skills,
dedication, and commitment of employees. Lego group asks employees about their experience in
company and how it could be improved, resulting in communication and enrich working conditions for
people. As Lego group is an open company it has stated goals to have a gender diversified environment
by setting a target for 2010 to have 25% of women working in management positions and above. Lego
group is focusing on strengthening openness and trust in the company, improve the opportunities for
employees on all levels to feel their job allows them to make best use of their talents. Health and safety
is serious aspect for Lego group. Due to viewing health and safety issues seriously, having special days
for employees to check their health, improving safety measures by asking its work force for opinion
Lego group has lowered injury rate in company from 2007 to 2010 by more than 50%88.
Stakeholders image refers to overall impression of the company's external stakeholders
including the views of customers, shareholders, the media and the general public. Lego is a company
active in the social issues. Lego group is a big charity participant. Lego believes that their donations
will help children develop their creativity, enabling them to learn through play. The Company is very
active in social and human rights. From the point of view of work supports freedom of association and
recognizes the right to collective bargaining, the elimination of all forms of forced and compulsory
labor, child labor, elimination of all forms of discrimination in employment and profession. From the
environmental point of view Lego group supports a precautionary approach to environmental
challenges, undertake initiatives to promote greater environmental responsibility and encourages the
development and diffusion of environmentally friendly technologies 89. The active fight against
corruption: LEGO is committed to fight corruption in all its forms, including extortion and bribery.
That is the main point why Lego group has not outsourced its production facility further into Eastern
86 Http:/www.lego.com/en-us/group/vision.aspx
87 Schultz M., Hatch M. J., Ciccolella F., (2004) Expressing a Corporate Brand through Symbols and Artifacts: The Case
of LEGO Company, <http://ie.technion.ac.il/Home/Users/anatr/Book/MAjken-Hatch-Revised-Chapter.pdf>
88 Data based on Lego groups 2010 performance report.
89 Lego groups 2010 performance report.
54
Europe (Belarus, Ukraine)90. In some markets, mostly Germany and Scandinavia, Lego group is highly
associated by consumers with values enhancing children’s learning and development, making the
LEGO brand more than bricks. The Company engages consumers directly in events, such as the First
LEGO League, where children compete in the construction that they created themselves91.
Identity refers to company's vision, culture and image and supports the corporate brand.
Lego group is a value driven company (Creativity means Self Expression; Imagination means Endless
Ideas; Learning means Playful Learning; Fun means Active Fun; Quality means Trusted) 92. These
values are visual expressions and are displayed on everything from posters to mouse pads used by
LEGO Company employees93.
Source: http://lenkendall.posterous.com
The outdoor advertising posters that can be found near railway stations, subway or bus in the Europe
90 Based on interview with Lego groups CEO Jørgen Vig Knudstorp, 2009
91 Schultz M., Hatch M. J., Ciccolella F., (2004) Expressing a Corporate Brand through Symbols and Artifacts: The Case
of LEGO Company, <http://ie.technion.ac.il/Home/Users/anatr/Book/MAjken-Hatch-Revised-Chapter.pdf>
92 Lego groups 2010 performance report.
93 Schultz M., Hatch M. J., Ciccolella F., (2004) Expressing a Corporate Brand through Symbols and Artifacts: The Case
of LEGO Company, <http://ie.technion.ac.il/Home/Users/anatr/Book/MAjken-Hatch-Revised-Chapter.pdf>
55
countries capitals. They have the characteristic to take an existing space in the area in which they are
affixed by adding special tie. As seen in picture, Lego uses its own production for advertising as Lego
brick is known for more than 50 years.
Source: http://copyranter.blogspot.com
Some posters are interactions between Lego and the real world. Advertisements show the
main Lego toy strategy “creating builders of tomorrow”. They try to transmit through advertising that
Lego production is not only fun, but also develops creativity and figuring out solutions to problems.
Targeting children and parents is one of Lego groups advertising goals.
56
Source: http://www.dsgnwrld.com
The last image that we see here is reported to be defined as marketing more conventional,
although the methods of expressions are completely original. It starts from the claim that "pure food for
the mind", praising the ability even in education and cognitive use of this type of games. The
representation of this idea is not entirely new, because once again you confuse the real with the
imagination and metaphor, being able to observe various types of food items all made of Lego.
Conclusion
The capabilities mentioned above allow Lego group to be a famous world toy maker. By
looking at business efficiently, Lego group saves money and resources. That helps to achieve higher
margins than competitors. High quality and value production attracts customers and tempt them to stay
with Lego products due to great value for money aspect. Responsiveness to market trends allows Lego
group to follow changing environment and always keep up with changing customers needs. And world
known brand gives advantage of achieving spectacular results.
57
VRIO framework
As mentioned in the theory part about RBV, VRIO framework is valuable to understand if
the company has a competitive advantage among competitors and whether it is sustainable or
temporary. Lego had a big crisis in 2004 and they were forced to change their management. Due to this
fact we must analyze what had helped Lego group to survive and if the companies resources and
capabilities can help company in the future to achieve stunning results and have a sustainable
competitive advantage.
Question of Value
As explained in theory part about VRIO framework's question of value part, in the view
of RBV resources and capabilities are only valuable if they help company to respond to environmental
threats and opportunities.
Efficiency
Looking into business efficiently is very valuable for Lego group. Firstly, company saves
money and has a higher gross margin and EBIT compared with major competitors in the toy industry.
Gross margin
80
70
60
50
Lego Group
Megabrands
Mattel
Hasbro
Hornby
40
30
20
10
0
2002
2003
2004
2005
2006
2007
2008
2009
2010
Chart was made with collected data from Lego groups, Megabrands, Mattel, Hasbro and Hornby financial reports from
2002 to 2010.
58
EBIT %
40
30
20
10
0
2002
-10
2003
2004
2005
2006
2007
2008
2009
2010
Lego Group
Megabrands
Mattel
Hasbro
Hornby
-20
-30
Chart was made with collected data from Lego groups, Megabrands, Mattel, Hasbro and Hornby financial reports from
2002 to 2010.
These charts show that Lego group by doing thinks more efficiently and outsourcing part
of its production to other companies have higher margins than main competitors in the toy market
(Megabrands, Mattel, Hasbro and Hornby). Also world financial crisis has effected very little Lego
group when some competitors even suffered from loss.
Secondly, due to increasing prices for fossil fuel which is basically the main material for
plastics and electricity some competitors face a negative trend for their financial indicators. But Lego
group right now is ahead and trend is upward, although not everything is accomplished and company
still uses at some level not renewable energy and does not recycle fully its waste. The only assumption
is that Lego groups trend will be further upward.
Thirdly, in 2003 when Lego group faced a financial crisis change in management and new
strategy to do business efficiently helped to get up. New strategy focused on turning Lego group from
industrial company to innovation driven company. Company has more agility and can react to changing
trends more quickly and with strict audits for their suppliers they minimize risk that something might
go wrong.
High quality and value product development
Having a high value and quality production is very valuable to Lego group. Firstly, its
59
sales are increasing and world financial crisis has not affected them in any way. That means that great
product will not be affected by any external factors. Lego groups CEO Jørgen Vig Knudstorp has an
opinion that if companies management for company's performance failure blames external factors like
exchange rates, interests rates, economic cycle or other, then they do not belong to this company. In
other words, everything depends on business itself and by having a great product Lego group has been
in business for more then 50 years.
Secondly, customers satisfaction is increasing which means that Lego group fulfills value
gaps94 and leaves no possible entry for competitors. Lego is constantly looking for what is popular and
what is trending to adjust their products in particular way. This may be having popular characters,
develop video games or creating a community. All of these features adds value for customers and
minimizes possibility that they will go for competitors production. All in all, Lego group's capability to
develop high value and quality products help them minimize threats like world financial crisis and
exploit opportunities with show up in increasing revenues.
Responsiveness to market trends
Capability of responding to trends is valuable for Lego group. By following market trends
company minimizes risk to go into declining zone in product life cycle. It also helps to increase
demand for its production, because by choosing characters from popular children's movies, Lego adds
to its potential customers list movie enthusiasts. Basically, by following trends Lego group minimizes
threats that could occur when product becomes mature and less attractive to costumers and making the
production more attractive to wider audience.
Brand management
By having a world known brand, Lego group has the opportunity and ability to enter any
market and be successful. As the companies production has stayed the same for more than 50 years,
different generations know the production. This is useful, because parents, as they buy toys for kids,
remember their personal experience with Lego production and want that their children would
experience the same. Also, Lego has always had the same main idea for toys, that they have to develop
children's creativity and systematic thinking, that is another advantage why parents want their children
to play with Lego bricks. Lego mainly gained their notoriety by communicating with its customers.
94 Vandermerwe S., (2000) How increasing value to customers improves business results, Sloan management review,
<ss.textcube.com/.../how_increase-choihs0228.pdf>
60
That was and is the main idea of Lego group, to create community which share and create. That is a
very huge reason why Lego group has survived its crisis in 2004 and by making business more efficient
started to more profitable again.
Question of Rareness
As explained in the theory part about VRIO framework's question of rareness part, if the
resource is common in the industry it is not likely it can create sustainable competitive advantage, so
valuable but common resources results in competitive parity.
Efficiency
All companies in the world and in all industries try to do business efficiently. But the fact
is that Lego group compared to other toy manufacturers does things more efficiently. By using
efficiency tools for companies structure, logistics, production, energy consumption, waste management,
Lego group has a bundle that gives better results compared to industry competitors.
Total asset turnover
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
2002
Lego Group
Megabrands
Mattel
Hasbro
Hornby
2003
2004
2005
2006
2007
2008
2009
2010
Chart was made with collected data from Data from Lego groups, Megabrands, Mattel, Hasbro and Hornby financial reports
from 2002 to 2010.
Total asset turnover shows what amount of sales is created with one unit of assets. Higher
indicator shows that assets are managed more effectively and create more revenue. This chart
emphasizes that the bundle of tools that Lego group uses to reach efficiency is leading and therefore is
61
rare.
High quality and value product development
Sales growth
80
60
Lego Group
Megabrands
Mattel
Hasbro
Hornby
40
20
0
2003
-20
2004
2005
2006
2007
2008
2009
2010
-40
Chart was made with collected data from Data from Lego groups, Megabrands, Mattel, Hasbro and Hornby financial reports
from 2002 to 2010.
This chart illustrates sales change compared to previous year of Lego group and its
competitors. It shows that Lego group has a stable increase in sales, while competitors are volatile and
were highly affected by world financial crisis. Also Lego product is for niche market and it has
particular customer portrait which company tries to satisfy.
Secondly, Lego is a product that both kids and parents love it. That gives it huge
competitive advantage. And because Lego group transmits more value to consumers with its learning
abilities, established community, and special care for safety its product possesses competitive
advantage.
Responsiveness to market trends
Ofcourse, a lot of toy companies are creating products for kids that involve characters
from popular movies. From that perspective Lego groups ability to follow trends is not that rare. But
not a lot of companies try to create community that involves kids, parents, grandparents and young
adults. Actually, that hugely depends on product itself and Lego is successful for creating a community
due to production popularity and satisfaction of different age groups, but without following todays
62
virtual socializing trend, Lego group wont be able to create this big and strong community.
Brand management
Most toy manufacturers make their products popular with huge expenses on advertising
and for marketing department. Lego group has a different approach and mostly uses promotion tools to
manage their brand. Lego is an open source company and communicates with customers and even lets
them to create Lego models that may go into production. Also, Lego group is a big charity organization
and gives away lots of its production to kids in need. Company is a big fighter for people and
environment rights. Company even has goals to recycle all its waste and use only renewable energy
resources for production. In some markets, mostly Germany and Scandinavia, Lego group is highly
associated by consumers with values enhancing children’s learning and development, making the
LEGO brand more than bricks.
Not to mention all the big events and games that Lego holds for children and their families. This is
Lego group's strategy to make their brand attractive and known in the market and it is rare due to the
fact, that competitors have different strategies.
Question of Imitability
As explained in theory part about VRIO framework's question of imitability part, if the
resource is easily obtainable or imitable other firms in the industry will acquire it as well resulting in
competitive parity.
Efficiency
Competitors use different strategies to have an efficient business. Some make everything
indoors and others outsource their production into Asia. Lego uses strategy to outsource their
production not far away from selling points and to save money on monitoring and production
transportation. Change from one strategy would take some time due to need of investments. Secondly,
waste recycling and going fully to renewable energy sources require big investments and change of
strategy. Due to huge amount of money needed and time to fully change strategy to different direction,
63
Lego group tools to reach efficiency are quite hard to imitate.
High quality and value product development
Lego groups biggest competitive advantage is that they only have one product. And by
filling up value gaps95 with creating community, involving kids and parents, developing video games,
and getting famous characters into Lego world its demand sky rockets. To imitate this product is almost
impossible. Firstly, there are patents and licenses that protect Lego group rights to the product.
Secondly, product is in the market for more than 50 years so even if imitated everybody will know the
real thing. Thirdly, Lego group is quite open sourced company and gets a lot of new ideas from its
customers. Not a lot of companies allow this opportunity for production fans. And finally, by having a
whole bundle value transmitted to consumers fill up its value gaps and leaves no space for competitors
to enter. All in all, Lego group's high quality and value product is hard to imitate due to high costs and
brand awareness.
Responsiveness to market trends
Imitation of licensing is quite expensive due popular movie brands and going into video
games business also requires money, because Lego group does not create its video games by itself.
Everything is outsourced to companies that does this job best. Due to the fact, that if toy manufacturers
want compete in global market they have to follow changing market trends and consumers needs. Lego
group possess advantage that it only has to change its production appearance.
Brand management
Firstly, Lego is a very old company and its main product brick is in the market for more
than 50 years. Secondly, Lego has only one product and users often call all companies production as
“Legos”. That means that brand and production is very known and customers relate production to
companies brand name. And finally, for competitors it would be too expensive due to time and change
of strategy to focus more on promotion instead of advertising to try to reach Lego groups brand
notoriety.
95 Vandermerwe S., (2000) How increasing value to customers improves business results, Sloan management review,
<ss.textcube.com/.../how_increase-choihs0228.pdf>
64
Question of Organization
As explained in theory part about VRIO framework's question of organization part, if the
resource is not exploited by organization it is not likely it can create sustainable competitive advantage,
so valuable but not exploited by organization resources results in temporary competitive advantage.
In Lego group employees are one of the groups key stakeholders. Company tries to
develop only the best products for their consumers. Employees benefit not only from high salaries and
good working conditions, they also get advantage of cosy and friendly working atmosphere. Due to
these facts and the companies motto that only the best is good enough employees try to do their best by
figuring out what new can they offer with standard Lego brick and how can they make learning more
fun. Lego states that its business is only possible because of the skills,
dedication, and commitment of employees. Company surveys its employees about their experience in
company and how it could be improved. Huge gender and cultural diversification makes company
friendly to the employees and lets it to take all the best and creative specialists in the market. Lego
group is focusing on strengthening openness and trust in the company, improve the opportunities for
employees on all levels to feel their job allows them to make best use of their talents. And also by
looking at employees health and safety seriously, Lego groups capabilities are exploited by the
organization.
Conclusion
Without looking at serious external issues related to toy industry, which will be discussed
later, Lego group has a sustainable competitive advantage, because the capabilities mentioned above
area valuable, rare, expensive to imitate and and exploited by organization. Making business efficient,
responding to market trends, having a high value and quality production and managing brand forms a
bundle of capabilities that helps to exploited opportunities and minimize threats. That is proven by the
fact that Lego went out of the crisis and increased and made stable its financial results.
65
Competition analysis
Introduction to the toy and games industry
The toys and games market includes revenues from different categories of toys which are:
-
Activity toys
-
Dolls (including girl´s toys)
-
Games and puzzles (including card games)
-
Infant/pre-school (including other educational toys)
-
Plush (including other soft toys)
-
Ride-ons (bicycles, tricycles and etc.)
-
Other toys (plastic, rubber, textile toys)
The largest players among toy manufacturers are: Mattel, Hasbro, LEGO group, Bandai, Tiger,
Playmobil, Galoob, BRIO, Playmates Toys and Toymax.
The market for traditional toys is under pressure due to increasing popularity of computer
and video games. There are however higher revenues generated from infant and preschool category that
supplement for the loses of toys for the children in higher age. This can also due to the fact that the
grandparents especially in the western-world are wealthier than the ones in the previous generations
and are able to give to their grandchildren more toys.96 Apart from this there are higher revenues
generated from the emerging markets that have a huge population (for example India and China). Due
to rapid economic growth in these countries increasing number of families can effort to buy toys for
their children.
The most lucrative segment was the infant and preschool toys with a share of 16,1% of
the market´s total value. On the second place are activity toys with 15% of the market´s total
performance.97 The market has experienced a moderate growth in the period from 2005 to 2009 where
it in 2009 decreased to the growth of 3%. (see table below) The market development in terms of sales
can be seen in the table below:
96 Datamonitor report: Global toys and games, 06/2010
97 Datamonitor report 06/2010, Global Toys and games report
66
Source: Datamonitor report: Global toys and games, 06/2010
The Threat of new Entrants
This chapter is corresponding to the section dealing with the theory part, subsection about
the Porter´s five forces, namely The threat of new Entrants, page 31.
The threat of new entrant into LEGO, depends on how easy it is to enter into the industry
and also how the competitors will react when any new company enters the market or the industry. To
enter this market it requires an enormous amount of capital or large development cost. There is
significant economies of scale in the production of plastic toys in the toy industry. In this industry the
marginal cost of plastic material is relatively small, while the fixed cost associated with casting is great.
Thus it will be of great need a large production of goods that will help to bring the average cost down.
To get this large scale as LEGO, it will require considerable large investment. While it will be
necessary to invest in new capital in costly machinery and large investments, well known brands makes
it difficult for new companies to capture market share in the LEGO industry. To make new product
known it will also require large marketing cost, as well as it is extremely difficult to break consumer
habits and brand loyalty. Brand loyalty is guaranteed by the durability, safety and quality. It will also be
very difficult and expensive for new products to be distributed to the right stores and many retailers
often have as customers preference toward known brands. Lastly legislation may also be an entry
67
barrier where there are patent rights, environmental requirements, control, can make it harder to
penetrate the market. There is Licensing agreement in this industry with some organizations such as
BEN 10 and Disney world and due to this agreement the threat to entry is high due to the barrier.98
The Bargaining power of suppliers
This chapter is corresponding to the section dealing with the theory part, subsection about
the Porter´s five forces, namely The bargaining power of suppliers, page 39.
When there are few suppliers and the when suppliers have power then the bargaining
power of supplier is high, on the other hand when there are few customers, the suppliers power is
reduced or low. To be able to maintain earning, the supplier will be pound to sell to the customer at
hand. In order to optimize the value chain and streamline collaboration, LEGO Group ensures a close
cooperation with their suppliers. The major strategic and key suppliers of LEGO Group are located in
Eastern Europe and Mexico. LEGO Group has chosen this new production sited in Eastern Europe and
Mexico in order to be closed to their main market in Europe and USA. Bargaining power of suppliers is
low in LEGO due to the fact that the suppliers over rely on LEGO Group for survival as the size of
suppliers are small compared with the company * LEGO* production capacity. The dependence of
suppliers on LEGO Group for survival makes LEGO Group to become price marker .i. e. they
influence prices and Quality of the raw materials to be used, due to their high purchasing power over
their suppliers.
As we said before Lego ensures that they have a good cooperation with suppliers who can
deliver good ingredients with good quality. They make sure that the supply chain is managed very
precisely. Companies in the supply chain are inspected with annual audits by checking their
performance, employee rights and environmental performance. There must be indeed be common
usefulness and interest, to cover the end – user needs as possible. LEGO Group has terminated
relationship with Flextronics as their strength profile was too strong. The main goal of the outsourcing
were among others, to ensure the LEGO Group delivery ability to lower cost, but instead the
outsourcing led to great uncertainty in the delivery and product quality because Flextronics customer
was not substantial. When they had the bad experience with the supplier Flextronics, LEGO Group
decided to stand for the production and Flextronics will have to take over the production operations in
98 Giwa M., (2009), Situation Analysis Report Presentation, <http://www.authorstream.com/Presentation/aSGuest58206457492-marketing-management-presentation-mba-grp-3-c/>
68
Kladno, Czech Republic which will help achieve higher flexibility and efficiency. LEGO Group is also
working with Game developers NetDevil and together they have developed an internet game called
LEGO Universe, which gave good results in their accounts and a success among consumers, and at the
same time cooperates with external partners, where the focus is towards stronger brand.
Force profile between suppliers and the LEGO Group could be considered to be at the mean level,
where the two partners are more dependent on each other.
The bargaining power of buyers
This chapter is corresponding to the section dealing with the theory part, subsection about
the Porter´s five forces, namely The bargaining power of buyers, page 36. In the following pages we
are going to analyze how strong power of buyers since it can create a substantial pressure on the
companies towards either lowering the prices, increasing the quality of services or changing the terms
of business. Therefore it is very relavant to assess it as it can either enhance the revenues of the
company of decrease them. When analyzing this aspect in the toy and games industry, we have to take
into consideration two types of buyers from the manufacturers’ perspective. There are the end
consumers and the game and toy retailers.
1) Concentration of buyers and high volumes of purchases
The individual consumer has a very low bargaining power due to a low concentration and
small volume of purchases..99 Since toys and games cannot be classified as necessity, the overall
volume of purchases depends on the affluence of the buyer. Nevertheless the sales of toys globally have
been increasing despite of the financial crisis with compound annual growth rate of 3,4% in the 20052009.100 And the worldwide sales of toys in 2010 grew by 4,7%. 101 The power of individual buyer is
assessed low.
When we however look at the customers of toy producers –the retailers, we can observe a
different scenario. Currently small toy retailers have a difficulty to compete with large chain of
specialized toys retailers as they make purchases in large volumes and have the advantage of
99 Datamonitor report: Global toys and games, june 2010
100 Datamonitor report: Global toys and games, june 2010
101 Riley D., (2011) World Toy Sales In 2010 Were $83.3 Billion, An Increase Of Nearly 5 Percent Over 2009,
<https://www.npd.com/press/releases/press_110620.html>
69
economies of scales. Apart from that traditional supermarkets mainly focusing on sales of groceries
also offer wider range of toys which are able to sell these products with lower risk as the costs are
divided between different varieties of products. Consequently the concentration of buyers in this
perspective has increased as large share of the total sales is represented by few players, which in high
degree increases the power of buyer. In this respect the CEO of LEGO group Kjeld Kirk Kristiansen
states already in 2004 in the group’s annual report the following in relation the retailers:
“Demands are made upon toy manufacturers for shorter delivery times, lower stocks at the retailer,
more exclusivity products, higher profit margins and increased marketing activity. The consequence
has been sustained pressure on prices and a further diminishing of gross margins”102.
The above mentioned proves that changes in structure of this market on the retail level puts the toy
manufacturers under pressure and has increased the bargaining power of the buyers which is considered
to be relatively high from this perspective.
2) The degree to which the products sold in the industry are standardized and/or
undifferentiated
As already discussed before, the low differentiation of the products increases the power of
buyers. Even though there is a low loyalty of customers in this industry, the companies put more
emphasis on promoting their brands and differentiate themselves. The LEGO group has for example
succeeded to create a strong brand name. Based on the study of Reputation institute the LEGO´s
corporate reputation is the fifth in the world. 103 This is due to the company´s continuous focus on
promoting its brand, relatively high brand awareness and basically global presence. There is also a
general perception of LEGO toys as toys of high quality, long life time and toys that help to enhance
the creativity and healthy development of children. Thus higher differentiation increases loyalty of the
buyers.
3) Switching costs
102 LEGO group annual report 2004
103 Daujotas G., (2011), LEGO’s Secret: Powerful Blend of Old Favourites with Innovation,
<http://blog.euromonitor.com/2011/06/legos-secret-powerful-blend-of-old-favourites-with-innovation-.html>
70
When we take general public as a whole and also the retailers we can assess its bargaining
power as moderate due to low switching costs to another manufacturer.
4) The threat of backward integration
The threat of backward integration from customers is also low. This means that there is a
low probability of buyers producing their own toys because of their wide availability in the market and
the quality of the toys which is difficult and costly to copy.
5) The degree to which the industry product plays an important role in relation to the
quality of the buyer´s products or services
This point is not relevant when taking the end customers since they do not further offer
these products to third party. When we look to the retailers, we conclude that this aspect plays only a
minor role and does not increase the power of buyer. If the quality of some toys the retailer sells is
inadequate, it can easily return them to the manufacture. If the error is prevailing, the retailer removes
this type of product from its shelves.
6) The level of profitability of the buyer
The individual customer is not affected or does not take this aspect into consideration.
The small retailers faced by hard competition from specialized toy retail chains and supermarkets earn
lower profits. There might be therefore attempts from these firms to negotiate better sales conditions
from the manufacturers, but because of low volume of purchases, their bargaining power is low.
The large supermarket and specialized toy retail chains enjoy higher profits through economies of scale
and discounts they get from the manufacturers. These conditions are demanded by the retailers in order
to increase their profits. Therefore this aspect increases the power of the buyer.
7) The degree to which the buyers are informed about the industry
Both individual buyers and retailers have access to information about prices, products on
the market and conditions of sales and are able to choose the one that best suits their needs. Thus the
power of buyer is increased in this perspective.
Overall we can conclude that the power of buyers is moderate especially due to the concentration of
71
buyers and the high volume of products they purchase. The toymakers including LEGO group fight
back especially through online sales that are becoming more and more popular in many countries. The
demanding business conditions and other requirements from the retailers can become a hindrance for
the LEGO group as the company is dependence on the retailers as its important distribution channels.
This can have a potential negative effect on the competitive advantage LEGO possesses especially if
the retailers in some countries will for example give better business conditions to local toymakers.
The threat of substitute product and services
This chapter is corresponding to the section dealing with the theory part, subsection about
the Porter´s five forces, namely The threat of substitute products and services, page 39. The most
important and significant substitute products for traditional games and toys are computers, mobile
phones, MP3 players and consoles. These are playing an ever growing part in children's lives by
providing games, education and entertainment. Despite not providing a cheaper alternative on the
whole, computer games are becoming more popular.104 In the following lines we are going to discuss
the threat they provide to the toy industry.
There is a tendency of children losing their interest in traditional toys in a younger age
than it was for example a decade ago. Children are getting older younger (also called age compression)
and become interested in other means of entertainment. Girls prefer music, fashion, make-up, television
talent shows while boys are moving towards already mentioned video and computer games at younger
age. Apart from that social media on the internet, movies and different sports activities capture many
children´s interest as well. The children that are playing with toys are simply not “in” just few years
after they start going to school. The fear of being different than everyone else and not being part of the
crowd leads even those children who would like to play with toys to join the others doing the more
“cool” things. On the other hand sales of plush toys are being increasingly popular for older kids and
are frequently bought by/for teenagers.105
The threat of PC games and game consoles is also stronger due to the fact that kids
become computer savvy at younger age, which increases the tendency of being more interested in
104 Datamonitor report: Global Toys and games, 6/2010
105 Tansel U., (2010), Effects of age compression on traditional toys and games,
<http://blog.euromonitor.com/2010/10/effects-of-age-compression-on-traditional-toys-and-games.html>
72
computer games and internet before traditional toys. The table below shows the comparison of sales of
the traditional toys vs video games in a time span of 2004 – 2009.
Source: Datamonitor report: Global toys and games, 06/2010
Here we can see that the growth in sales of video games worldwide in this period was
more than 100% while the growth in sale of traditional toys in the same period was about 25%. 106 The
chart also indicates that the main markets that contributed to this number were the sale in emerging
markets in Latin America, Asia and Pacific, and Middle East with average growth of traditional toy
sales of approximately 40% in the period 2004-2009. And these are the markets that are expected to
keep the global sales of toys growing also in the future making them a target for toy manufacturers and
retailers.
Based on the above mentioned, we can conclude that the power of substitutes in this
industry is strong and the companies will have to be very vigilant and creative especially with the
competition from the video and PC game industry. One of the ways to do so is actually offering not
only the physical toys, but also entering the video game industry, which many of the traditional toy
manufacturers have already done included LEGO group. The level of demand for toys LEGO group is
manufacturing can either increase or decrease the value of the competitive advantage it possesses.
106 The chart is downloaded from: http://blog.euromonitor.com/2010/10/effects-of-age-compression-on-traditional-toysand-games.html
73
The intensity of rivalry in the industry
This chapter is corresponding to the section dealing with the theory part, subsection about
the Porter´s five forces, namely The intensity of rivalry in the industry, page 40. There are several
factors that influence the intensity of rivalry in the toy industry. We are going to look at them one by
one:
1) Number and size of the firms operating in the industry
The first is the number of players in this industry, which is very high and constantly
changing. Because of the general low customers loyalty, no switching costs and low entry barriers it is
easy for new companies to enter this market (at least at a country level) and this intensifies the
competition. Popularity of many toys and games is short-lived and/or seasonal this can attract
newcomers to enter especially the niche markets.. About 60% of all toys sales are in the moths of
November and December107 and the companies are trying every year to offer toys that should become
the most popular toy of the year. Because of the seasonality of the products, the market is subject to
rapid change, further boosting rivalry.
2) The level of the market growth
The toy industry experienced a decrease of growth from 2007 to 2009108, followed by an
increased in 2010. The reason for the past negative development can be found in the financial crises
when the sales declines as toys are classified more as luxury products and not necessities. Another
reason is the already mentioned age compression of kids. Slow growth in this market increased the
competition since the only way the companies could increase their revenues was by taking market
share from their competitors. The outlook for the future is however brighter with expected relatively
high growth in this sector in the future. 109 The higher growth will cause the competition to be less fierce
or intense.
107 (2011) The Toy Sector In Europe <http://tietoy.org/index.php/home/page/30>
108 See table in the section: Introduction to the toys and games industry
109 see the next chapter about the expected market development
74
3) Fixed costs
The fixed costs in the industry are relatively high, this is due to the fact that especially
large companies invest heavily to R&D of new products and research and analysis of customers needs
and wishes. This is due to the fact that the revenues are highly dependent on the Christmas sales and
the toymakers have to come up every season with toys appealing to their end customers. High fixed
costs intensifies the competition in the industry as companies have to sell high volumes of their
products in order to cover these costs.
4) The degree of standardization and/or differentiation of products
The degree of differentiation of toys is high, there is lot of categories of toys with large,
breadth and depth in the variety of products. Many manufacturers are to some degree specialized on
one category of toys for example Hasbro is known for the board games, Mattel for dolls and LEGO
group for its construction sets.
In attempt to increase their revenues, the companies in this market have offer products
outside their primary categories through different innovations. LEGO group for example in 2009
introduced LEGO games featuring buildable board games and this step proved to be a success as the
group become the 3rd largest player in the category of board games and puzzles.110
Another competitor on the other hand has recently decided to target LEGO´s main construction
category. Hasbro has announced the Kreo-X line bringing the existing products like Transformers into
building blocks.111
Companies also attempt to promote their brand in order to differentiate themselves.
Nevertheless the customers´ loyalty is quite low in the industry to a particular brand, which increases
the competition.
5) Exit barriers
If the exit barriers in a industry are high, the companies will stay in the business even
though they are not generating profit. Consequently they keep a market share, which under different
circumstances would be divided among other companies. This aspect intensifies the competition. In
110 Daujotas G., (2011), LEGO’s Secret: Powerful Blend of Old Favourites with Innovation,
<http://blog.euromonitor.com/2011/06/legos-secret-powerful-blend-of-old-favourites-with-innovation-.html>
111 Daujotas G., (2011), LEGO’s Secret: Powerful Blend of Old Favourites with Innovation,
<http://blog.euromonitor.com/2011/06/legos-secret-powerful-blend-of-old-favourites-with-innovation-.html>
75
this industry are generally in the same level as in other industries producing durable goods. The
companies in addition do not have to keep high inventories as most of their goods are seasonal. In
addition to that, there is a large number of competitors in the industry that might be willing to purchase
licences, know-how, or even purchase production facilities. Therefore this aspect does not play an
important role in the degree of rivalry in this industry.
The competition on this market
Apart from a traditional way of competing like product innovation, advertising,
promotion, pricing strategy and launching of new products, there is also another aspect of competition
in this industry and that is licensing. According to the NPD Group´s research: “In the U.S. alone,
licensed toy sales account for an average of 25 percent of total toy industry annual revenue.” 112 There
are especially the large players who use licenses from movie producers or media companies in order to
use for example popular cartoons or TV programs figures as an inspiration for their toys.
Mattel has for example recently announced that is
acquiring the British media company HIT Entertainment
for a sum of US$ 680 million. Through this acquisition
Matell will become the owner of many media brands like
Thomas and Friends, Bob the Builder, Fireman Sam,
Barney, Angelina Ballerina and Mike the Knight.113 By
this purchase the company is strengthening its license
business as some of these brands generate revenues also outside traditional toys. Brand like Thomas
and Friends have been very successful outside toys, which is a great opportunity for this company to
explore. The company will be in this way also able to decide if it keeps the licenses in-house or to
which of its competitors in toy industry will sell them.
Overall the intensity of rivalry in this sector is assessed as moderate. The large global players will focus
their attention in the emerging markets in the years to come, where the sales are expected to expand
112 The NPD group, (2011), The NPD Group Provides Insight Into Licensed Product Sales Trends For Kids During The
12-Months Ending August 201 <https://www.npd.com/wps/portal/npd/us/news/pressreleases/pr_111122>
113 2011, Mattel Delves Deeper into Licensing with HIT Entertainment Acquisition
<http://blog.euromonitor.com/2011/11/mattel-delves-deeper-into-licensing-with-hit-entertainment-acquisition1.html#more>
76
with double digit growth rate. The high demand in this region will cause the competition to become
less intense as companies will be able to increase their revenues from the market growth. This
development will increase the value of the competitive advantages the LEGO group has. On the other
hand if more large companies would enter the construction toy market following the example of
Hasbro, the LEGO group might lose the strong dominance in this category and with it the competitive
advantage over its competitors.
77
Future outlook
Expected market performance in the following years
The performance of this market will in large extend depend on the ability of the toy
producers to come up with innovative and creative products. Currently approximately 60% of all toys
sold during a year in Europe are newly developed products. 114 The success of this industry in a large
extend depends on its ability to meet customers’ needs and wishes. The toy producers proved their
ability to do exactly that in the 2010 and after several years of declining growth in this industry
(especially in Europe), we have seen growth of 3,5% in 2010 in the European market.115
The trend of digitalization will continue also in the future and will in a larger scale
affect this market. The video and PC games market, applications market for iphones, ipads and other
smartphones, online games market and toy market will be in many ways blurred. This development can
be already seen now. For example Hasbro, the manufacturer of monopoly with cooperation with
Electronic Arts have created this game as a video game and as an application to smartphones. One of
the most famous smartphone application is Angry Birds. Followed by a big popularity, this brand has
already made the swift towards other categories and apart from video games, there are now available
board games and plush toys based on this brand.116 Because of these trends, we can expect as a research
made by euromonitor.com states:
“An adaptation of the toys and games industry would be developments of long-term partnerships or
114 (2011) The Toy Sector In Europe <http://tietoy.org/index.php/home/page/30>
115 (2011) The Toy Sector In Europe <http://tietoy.org/index.php/home/page/77>
116 Tansel U., (2011), Boundaries Blur Between Toys, Video Games and Phone Applications,
<http://blog.euromonitor.com/2011/08/boundaries-blur-between-toys-video-games-and-phone-applications.html>
78
mergers between toy, software and phone app manufacturers”.117
From this point of view, the digitalization and age compression among children does
not necessarily have to be a threat, but can be viewed as a new opportunity for toy manufacturers.
In the future we will see even stronger focus of global toy retailers and manufacturers on the emerging
markets as they are countries with a big potential for this industry. In the table below 118 we can see that
economic boom in the two most largerly populated countries resulted in double digit growth in sales of
toys and games in 2009 and this development is expected to continue in the following years as well.
117 Tansel U., (2011), Boundaries Blur Between Toys, Video Games and Phone Applications,
<http://blog.euromonitor.com/2011/08/boundaries-blur-between-toys-video-games-and-phone-applications.html>
118 The table is downloaded from: http://blog.euromonitor.com/2010/12/consumer-appliance-forecasts-2009-outlookversus-2010-restatement.html
79
The emerging markets will largely contribute to increased global growth in this industry. According to
the estimates made by Datamonitor, the redicted compound annual growth rate in the period from 2009
to 2014 is 5,1%.119 The table below shows the forecasted development in a year to year basis:
Source: Datamonitor report: Global toys and games, 06/2010
Based on the above stated, we can assume that despite of the challenges the toymakers
face, there are also future opportunities for them partly by entering video game and phone apps
119 Datamonitor report: Global toys and games, 06/2010
80
segments and secondly by expanding their presence and awareness in the emerging countries. If the
companies explore these possibilities wisely, they will be able to increase their revenues in the near
future.
Summary and conclusion to Porter´s five forces
In the conclusion of the industry analyses made by the Porter´s five forces, we will
answer the question if the LEGO group has the prospects of maintaining competitive advantage from
the perspective of this industry analysis.
The threat of new entrants in operating in a global scale is low due to high capital
requirements especially for R&D, marketing and the advertisement. The economies of scale
implemented by the large, already established companies, is another aspect, which is increasing the
entry barriers. Since large proportion of sales are made through chains of specialized toy retailer´s and
traditional supermarkets, to get an access to these chains raises another barrier since these require
discounts for creating shelf space for the new products. Licenses and patent rights that the established
companies possess create another boundary for new comers. On the other hand there can be expected
new competition from a number of small companies especially on a country level that will constantly
attempt to enter the market with new innovative products and take their part of the market share. This
aspect is not expected to have a negative effect on the competitive advantage of LEGO group.
Bargaining power of suppliers is low as the size of suppliers is small compared with the
large toy manufacturers. Most of the materials used in production of toys is standard and widely
accessible (for example paper, plastic, metal etc.), which decreases the power of suppliers. On the other
hand these materials can be sold in other industries as well, which in some degree increases the power
of suppliers. Many toymakers use also game and apps developing companies, which have a higher
bargaining power though. The large companies have already established relations and cooperation with
their suppliers. The power of suppliers is overall low and LEGO group should not face a threat
concerning its competitive advantage from its suppliers.
The most important and significant substitute products for traditional games and toys are
computers, mobile phones, MP3 players and consoles. Apart from these there are due to the age
compression of children other substitutes that provide entertainment especially for children in the
school age. These are: television programs, social media, sports activities, fashion, music and others.
The children stop playing with traditional physical toys at a younger age leading to a shrinking
81
customer base for the toymakers. Therefore many of the traditional physical toy makers entered digital
world with online, PC, video games as well as offering phone apps with their products. The threat of
substitute products will however remain strong and a continuous challenge for the companies included
LEGO and probably more than anything else is able to negatively affect the revenues. If the LEGO
products will become obsolete in the opinion of generation especially older children, the company´s
important competitive advantage, which is the brand name, will be damaged.
The power of buyers is considered to be moderate. The reason for this is the concentration
of buyers, which are in this respect in an increasing level chains of toy retailers and traditional
supermarkets that put the toy makers under pressure demanding shorter delivery times, lower prices,
increasing marketing activity and other improvement of sale conditions. The toymakers are in many
ways dependent on these distribution channels and this increases their bargaining power. On the other
hand toymakers offer their products directly to customers through the internet and together with
growing popularity of online shopping, the power of buyer is in this way weakened. Nevertheless the
companies (including LEGO group) will continue to be under pressure from the retailers which can
decrease the profit margins. This can have a potential negative effect on the competitive advantage
LEGO possesses especially if the retailers in some countries will for example give better business
conditions to local toymakers.
Popularity of many toys and games is short-lived and/or seasonal this can attract
newcomers to enter especially the niche markets. Because of the seasonality of the products, the market
is subject to rapid change, further boosting rivalry. There are few large players in this industry with
similar market share and therefore we can expect more intense competition for becoming a market
leader. Many companies enter other categories of games that they have been specialized in, which also
increases the competition. The fixed costs in this industry are also high, which pressures companies to
sell larger volume of their products, which further boosts the rivalry. On the other hand there are new
possibilities and projected high market growth in the emerging markets which softens the intensity of
rivalry as companies instead of trying to take market share from one another, will in a less costly way
increase their revenues through market growth in these countries. The higher demand in the emerging
markets is also a very good opportunity for LEGO group through which the company might actually
maintain and also strengthen its position as a toy manufacturer and enhance its competitive advantages.
82
Future outlook
Expected market performance in the following years
The performance of this market will in large extend depend on the ability of the toy
producers to come up with innovative and creative products. Currently approximately 60% of all toys
sold during a year in Europe are newly developed products.120 The success of this industry in a large
extend depends on its ability to meet customers’ needs and wishes. The toy producers proved their
ability to do exactly that in the 2010 and after several years of declining growth in this industry
(especially in Europe), we have seen growth of 3,5% in 2010 in the European market.121
The trend of digitalization will continue also in the future and will in a larger scale
affect this market. The video and PC games market, applications market for iphones, ipads and other
smartphones, online games market and toy market will be in many ways blurred. This development can
be already seen now. For example Hasbro, the manufacturer of monopoly with cooperation with
Electronic Arts have created this game as a video game and as an application to smartphones. One of
the most famous smartphone application is Angry Birds. Followed by a big popularity, this brand has
already made the swift towards other categories and apart from video games, there are now available
board games and plush toys based on this brand. 122 Because of these trends, we can expect as a research
made by euromonitor.com states:
“An adaptation of the toys and games industry would be developments of long-term partnerships or
mergers between toy, software and phone app manufacturers”.123
From this point of view, the digitalization and age compression among children does
120 (2011) The Toy Sector In Europe <http://tietoy.org/index.php/home/page/30>
121 (2011) The Toy Sector In Europe <http://tietoy.org/index.php/home/page/77>
122 Tansel U., (2011), Boundaries Blur Between Toys, Video Games and Phone Applications,
<http://blog.euromonitor.com/2011/08/boundaries-blur-between-toys-video-games-and-phone-applications.html>
123 Tansel U., (2011), Boundaries Blur Between Toys, Video Games and Phone Applications,
<http://blog.euromonitor.com/2011/08/boundaries-blur-between-toys-video-games-and-phone-applications.html>
83
not necessarily have to be a threat, but can be viewed as a new opportunity for toy manufacturers.
In the future we will see even stronger focus of global toy retailers and manufacturers on the emerging
markets as they are countries with a big potential for this industry. In the table below 124 we can see that
economic boom in the two most largerly populated countries resulted in double digit growth in sales of
toys and games in 2009 and this development is expected to continue in the following years as well.
The emerging markets will largely contribute to increased global growth in this industry. According to
the estimates made by Datamonitor, the redicted compound annual growth rate in the period from 2009
to 2014 is 5,1%.125 The table below shows the forecasted development in a year to year basis:
124 The table is downloaded from: http://blog.euromonitor.com/2010/12/consumer-appliance-forecasts-2009-outlookversus-2010-restatement.html
125 Datamonitor report: Global toys and games, 06/2010
84
Source: Datamonitor report: Global toys and games, 06/2010
Based on the above stated, we can assume that despite of the challenges the toymakers
face, there are also future opportunities for them partly by entering video game and phone apps
segments and secondly by expanding their presence and awareness in the emerging countries. If the
companies explore these possibilities wisely, they will be able to increase their revenues in the near
future.
Conclusion
In the conclusion of the industry analyses made by the Porter´s five forces, we will
answer the question if the LEGO group has the prospects of maintaining competitive advantage from
the perspective of this industry analysis.
The threat of new entrants in operating in a global scale is low due to high capital
requirements especially for R&D, marketing and the advertisement. The economies of scale
implemented by the large, already established companies, is another aspect, which is increasing the
entry barriers. Since large proportion of sales are made through chains of specialized toy retailer´s and
traditional supermarkets, to get an access to these chains raises another barrier since these require
discounts for creating shelf space for the new products. Licenses and patent rights that the established
85
companies possess create another boundary for new comers. On the other hand there can be expected
new competition from a number of small companies especially on a country level that will constantly
attempt to enter the market with new innovative products and take their part of the market share.
Bargaining power of suppliers is low as the size of suppliers is small compared with the
large toy manufacturers. Most of the materials used in production of toys is standard and widely
accessible (for example paper, plastic, metal etc.), which decreases the power of suppliers. On the other
hand these materials can be sold in other industries as well, which in some degree increases the power
of suppliers. Many toymakers use also game and apps developing companies, which have a higher
bargaining power though. The large companies have already established relations and cooperation with
their suppliers. The power of suppliers is overall low and LEGO group should not face a threat from its
suppliers.
The most important and significant substitute products for traditional games and toys are
computers, mobile phones, MP3 players and consoles. Apart from these there are due to the age
compression of children other substitutes that provide entertainment especially for children in the
school age. These are: television programs, social media, sports activities, fashion, music and others.
The children stop playing with traditional physical toys at a younger age leading to a shrinking
customer base for the toymakers. Therefore many of the traditional physical toy makers entered digital
world with online, PC, video games as well as offering phone apps with their products. The threat of
substitute products will however remain strong and a continuous challenge for the companies included
LEGO and probably more than anything else is able to negatively affect the revenues.
The power of buyers is considered to be moderate. The reason for this is the concentration
of buyers, which are in this respect in a increasing level chains of toy retailers and traditional
supermarkets that put the toy makers under pressure demanding shorter delivery times, lower prices,
increasing marketing activity and other improvement of sale conditions. The toymakers are in many
ways dependent on these distribution channels, which increases their bargaining power. On the other
hand toymakers offer their products directly to customers through the internet and together with
growing popularity of online shopping, the power of buyer is in this way weakened. Nevertheless the
companies (including LEGO group) will continue to be under pressure from the retailers which can
decrease the profit margins.
Popularity of many toys and games is short-lived and/or seasonal this can attract
newcomers to enter especially the niche markets. Because of the seasonality of the products, the market
86
is subject to rapid change, further boosting rivalry. There are few large players in this industry with
similar market share and therefore we can expect more intense competition for becoming a market
leader. Many companies enter other categories of games that they have been specialized in, which also
increases the competition. The fixed costs in this industry are also high, which pressures companies to
sell larger volume of their products, which further boosts the rivalry. On the other hand there are new
possibilities and projected high market growth in the emerging markets which softens the intensity of
rivalry as companies instead of trying to take market share from one another, will in a less costly way
increase their revenues through market growth in these countries. The higher demand in the emerging
markets is also a very good opportunity for LEGO group through which the company might actually
maintain and also strengthen its position as a toy manufacturer.
87
Conclusions
In order to understand how company can create and sustain competitive advantage in fast
changing environment we have analyzed RBV as one of the possible tools. We have examined
resources and capabilities it emphasizes as well as main practical tool – VRIO framework. In order to
demonstrate how it can be used to evaluate company we applied it to the LEGO case. Furthermore,
because of purely internal view of RBV we also introduced Porter five force model for external
analysis of toy industry.
After analyzing LEGO with VRIO framework we can conclude that by inventing LEGO brick
this company obtained huge asset which managed to properly lead the company to the top of toy
market. However even sustainable competitive advantage loses his value and in 2004 LEGO faced
dangerous crisis. Jørgen Vig Knudstorp, new CEO of the company understood that traditional LEGO
resources and capabilities do not have enough value to compete in the industry. In order to save
company he used the traditional resources of the company (very well known brand, high quality of the
products and, most important, the unique LEGO brick) in new way: the LEGO started to create video
games and worldwide LEGO community which helped to fill gaps in the value chain. Furthermore new
resources such as efficiency in management, product development, supply and production lines, value
based development and responsiveness to the market trends was acquired or developed. These two
groups of resources and capabilities along with strong organizational aspect allowed LEGO to defeat
crisis inside and once again become strong and competitive company in the toy market.
Analysis based on Porter’s 5 forces model shown, that bargaining power of suppliers is not a
big threat for the company, because of the common raw materials, small size of suppliers and simple
products. Also LEGO’s software designer NetDevil is dependent on this cooperation and does not have
a high bargaining power. Economies of scale, known brand and huge investments required works as
strong entry barriers and protects the market from new entrants at least at LEGO level. Bargaining
power of buyers is increasing because of high standards and increasing size of the retailers.
Furthermore, toy companies sell more of their product online, so the dependency from toy retailers
decreases. Therefore the suppliers and possible new entrants are not expected to have a significant
effect on the competitive advantage of LEGO group, while buyers will assumably continue to put
88
pressure on LEGO group and its competitors.
The biggest threat in the industry is increasing popularity of virtual products such as computer
games or apps. Increasing supply and wide availability creates a huge threat for traditional toys.
Furthermore, kids tend to grow up faster and the age group of LEGO segment becomes narrower.
However company took steps to reduce dependency on the toy market by starting to create computer
games. Each game that is often made according to successful movie not only allows children to
experienced adventures once again but also increase popularity of the physical LEGO constructors. In
order to recover the attention of older age group LEGO introduced Mindstorm – programmable device
which is highly compatible with LEGO brick and thus can be made into robots, machines and other
toys. As we can see from their results these products are very competitive. Therefore from this aspect
of substitute products the challenge will remain in maintaining the competitive advantage with a new
and innovative ways.
However competition in the market also increases. Competitors have spotted and started to
imitate some of the LEGO resources. Mattel bought HIT Entertainment along with the licenses to
popular media brands. Hasbro have announced that its popular product line “Transformers” will be
available in building blocks. In several years prior to 2010 the overall growth rate in sales in the
industry had been decreasing. In order to keep growth in sales companies are trying to take over each
other’s market share and introduces similar product. However the year 2010 was favorable for
toymakers and this trend is expected to continue. This is especially due to high growth of sales in the
emerging markets. LEGO group has also started to penetrate Asian market. Booming economies as
India or China have large populations and though the European toys were relatively expensive they are
finding buyers and becoming more and more popular. Therefore despite of tuff competition, the
forecasted higher sales in the industry, should provide high enough revenues for the company to keep
its competitive advantage.
LEGO has sustainable competitive advantage and already took steps in order to keep it. Their
newly developed resources and capabilities play a huge role and generate additional value to the client
and company. But the threat of substitutes and increasing competition in traditional and new markets
will require LEGO to continue looking for new ways to compete and earn buyers favor in order to keep
its competitive advantage for the next 5 years.
89
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