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The real price of LEGO has declined

Here’s a careful and surprising analysis of the LEGO Group’s product and pricing strategy.  While it may seem that LEGO has become more expensive, it hasn’t when measured on a $$-per-brick basis or $$ per set basis.  Instead, what LEGO has done is increase the number of complex, high-priced sets.  They’ve also increased the number of low priced sets, so average price per set has stayed the same.

How then to LEGO’s nine year run of sales and profit growth? The company grew annual sales at 19% per year on average from 2007-16, and grew profits at 34% per year over the same period.  A few possibilities:

  • More sets through more channels.  Star Wars, Architecture, and Games are sold in Barnes and Noble.  Architecture in Museum Stores.  The online business has expanded.  Geographical expansion into emerging markets.  LEGO Discovery Centers.  All this removes the constraint of shelf space from LEGO’s sales.
  • Decoupling of pieces and sets.  Around 2007 LEGO was able to separate the production of pieces from the assembly of sets.  That was a huge boost to profits, as it allowed the company to shorten its response time to requests from the market.  Before 2007, if a new set sold well and stores ran out, the company would have to begin producing the pieces needed to make the set, then assemble, then deliver.  Now, they can take many of the pieces they need from inventory (stealing them from sets that are less popular than expected), send them to the assembly plant, and get the kits back on the shelves much faster.  Given that 80% of LEGO sales happen around Christmas, this makes a huge difference.
  • Reduced element count.  LEGO cut the number of elements it had in production in half in 2004, and that forced the designers to do more with less.  The Design Lab – a set of 3 grizzled veterans, each with decades of experience, has to approve every new element, and demands that unused elements get taken out of inventory as new elements are added.  As sales have grown, so have element counts, but only slowly.
  • Increased sales per element.  This is the driver for LEGO’s profitability.  LEGO is largely a fixed cost business – the plastic used to make a brick costs almost nothing compared with the cost of the production machinery and molds.  There’s a remarkably consistent rule of thumb:  if sales per element fall below one million Danish Krone, LEGO loses money.  As they rise above that, profits increase exponentially.  Because it decoupled element productions from kit assembly, LEGO has been able to sell more sets using fewer pieces.

Remarkably, that last item makes customers happier.  During the 1999-2002 years, LEGO allowed designers to run amok and introduce new shapes and colors without many constraints.  By doing so, they broke the “system” – the rules by which LEGO pieces should fit together.  Next time you’re visiting a family whose kids were born in about 1993-1997, ask to see the box of old LEGOs.  Try to build something with the pieces and you’ll see what I mean – you can’t recombine them in any interesting ways.  And look at the shapes – you’ll see they’re much more complex and thus more expensive to mold.

But here’s the challenge:  all these improvements are one-time improvements.  Once you’ve optimized the system, you don’t get the benefits any more.  Once you’ve expanded distribution channels, improved production efficiency, and optimized the design process, there’s only so much more you can do.  SoLEGO’s slower sales, which started in 2015, may mean that the company has transitioned from a high-growth to a low-growth company, at least until the next source of growth is discovered.

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