Building an Empire One Block at a Time

And as Lego expanded, its toy line languished. Classic models—like its fire station—were discontinued. There was a single bright spot in the Lego toy lineup, however. In 1999, Lego began producing licensed "Star Wars" merchandise, which took off; items like the 3,104-piece $299.99 Imperial Star Destroyer capitalize on nostalgia for the older movies and the popularity of the new prequels. In retrospect, however, managers say that success actually exacerbated problems, because the "Star Wars" profits helped paper over the poor performance of the new non-toy businesses, allowing the muddled expansion strategy to continue longer than it should have. By the time Danish-born McKinsey consultant Jorgen Vig Knudstorp joined Lego in 2002, "it was a company that had lost its way," he says. In 2003, the company suffered a net loss of more than $300 million. "There could not be another year like this—the company would have lost its independence," says Knudstorp, who quickly ascended to become the first CEO from outside the Kristiansen family. "The situation was extremely grave."

To rebuild, Knudstorp first focused on the finances. Lego sold off a majority interest in its theme parks to the Blackstone Group, the private-equity giant. It unloaded real estate to reduce debt. It outsourced entire departments: today IBM runs its tech department and DHL runs its warehouses. Ten years ago Lego employed more than 8,000 people; today its global payroll is about 4,000. Managers also decided to outsource the bulk of its manufacturing operations. At its U.S. headquarters in Enfield, Conn., last month, workers dismantled the last of the its machinery, which is bound for Juárez, Mexico. Today you can still find Lego clothing, but it's produced through licensing deals, which allow Lego to keep its attention where it should be: on toys.

Walking around the annual Toy Fair in a New York City convention center this winter, U.S. president Laursen pointed to the fruits of their labor. Old favorites—like the fire station—are back. There's a motorized Ferris wheel, offering a slightly more high-tech experience.

Laursen, a 22-year Lego veteran who's worked in nine countries, has two children. His 6-year-old son loves Legos, but his 11-year-old daughter illustrates the company's challenge. She still plays with the bricks sometimes—when she's not talking on her cell phone or plugged into her iPod. "We're desperately trying to hold onto her in the toy category," Laursen says, admitting he fears she'll soon completely forsake toys for cosmetics.

At the Toy Fair, Laursen walks by more licensed Lego products, including Harry Potter and Bob the Builder. He stops at a Lego mosaic kit, an arts-and-crafts-style toy meant to appeal to girls. (Once kids hit school age, boys account for 70 percent of Lego's customer base.) There are $250 MindStorms robots, sold to teens and adults and programmable on a PC. MindStorms accounts for a tiny slice of revenue, but it's a PR hit, giving Lego a bit of a high-tech halo.

Many of the newer products are designed for "hybrid play": instead of just building them and then asking Gramps to ooh and ahh, kids construct these new-generation Legos and then use them like action figures or model cars. Yes, you can still buy giant tubs of bricks that allow kids to build anything they like. "That's what the parents want to buy, but that's not what the kids want," says Laursen.