Building an Empire One Block at a Time

Like most parents, Phil and Karyn Corless face a constant struggle to keep their home from becoming overrun with toys. They have a specially designated toy closet in their Coeur d'Alene, Idaho, home, and when playtime is over, they cajole their children—Ethan, 8, and Megan, 5—to store their Play-Doh and Hot Wheels, crayons and Barbies. But there's an exception to this put-it-away rule, a toy that enjoys most-favored status: the family's Lego collection. "They're one of those toys that always stay out, because ... when [friends] come over, you know they're going to play Legos," says Phil, who has fond childhood memories of building elaborate Lego mazes for his hamster. "I've never seen a kid who didn't want to build something."

Like potato chips and pandas, Legos seem universally appealing: does anyone not like them? For managers at the privately held, Danish-based company—which celebrates its 75th birthday this year—that's mostly a blessing. At a time when parents struggle to pry kids away from computer games, moms and dads feel good steering tykes to a wholesome, sit-on-the-floor toy that seems to invite creativity. But in the last decade, Lego experienced the downside of having a brand that's so adored. Emboldened by the public's fondness for its colored bricks, managers tried to expand well beyond toys and build Lego into a full-blown lifestyle brand. The company expanded its Lego theme parks, sold Lego software and created Lego clothing lines. Suddenly parents could send their child to school wearing Lego rain boots and a Lego backpack. Today Lego managers look back on that expansion with a shudder, asking: What were we thinking?

Not every one of these products flopped, but they created no end of corporate distractions—and caused Lego to neglect its core business. Instead of dreaming up new toys, executives were too busy designing apparel and eyeing theme-park locations. Sales slid sharply: from 2002 to 2004, revenue fell 16 percent, to $987 million, and losses stacked up like so many red-brick towers. But lately, Lego's turnaround has gained a steady foundation. A new team of managers has rebuilt the brand by refocusing on toys. For evidence, drop by a child's birthday party; you'll likely find kids unwrapping Lego-brand Bionicle figures, "Star Wars"-licensed spaceships, Technic motorized bulldozers or Aqua Raiders undersea attack vehicles. Lego has returned to profitability, earning $256 million in 2006, according to the company. Lego's North American president, 43-year-old Soren Torp Laursen, says: "We learned the hard way we can't take our brand everywhere."

Lego was founded in the 1930s by Danish carpenter Kirk Christiansen. The brand name came from the Danish phrase "leg godt" ("play well"). At first, Christiansen sold wooden toys. But in 1949 the company introduced its iconic interlocking plastic bricks. The toys became wildly popular in Europe in the 1950s, but didn't catch on in the United States until the company launched a big advertising campaign in the mid-1970s. According to company estimates, kids around the world today spend 5 billion hours a year playing with the blocks—which Lego factories produce at the rate of 33,000 bricks per minute. All told, that means 16 billion a year. The company is still owned by the founder's grandson Kjeld Kirk Kristiansen and his family, who are among Denmark's richest individuals.

As Legos grew to become a fixture in global toy chests, it faced minimal competition: in 1992, it held 90 percent of the U.S. market for brick-based construction toys. Still, other threats loomed. By the late 1990s, toy experts were fretting about "age compression," industry-speak describing how kids were abandoning toys—in favor of the Internet, videogames, trombone lessons and soccer practice—at younger ages than ever. To cope, toy companies diversified. "They began moving beyond their core, saying 'How do we get into other children's share-of-day?' " says Reyne Rice, trends analyst at the Toy Industry Association. If your child watches Barbie DVDs or plays at the Webkinz online game site, you've experienced these efforts firsthand.

At Lego's headquarters in Billund, Denmark, managers toyed with various expansion ideas. Mary Jo Hatch, a University of Virginia management professor who's coauthored a case study of the company, says Lego appeared heavily influenced by the success of brands like Harley Davidson, whose cultlike followers buy scads of hats, T shirts and other branded merchandise. Lego's bricks are so iconic, managers figured, why couldn't they work just as well on all sorts of products? Hatch points to Richard Branson's Virgin Group, which began as a record label and expanded into airlines, cell phones, health spas and comic books, as a successful example of a company that extends its brand. But in their quest for growth, lots of companies try boneheaded extensions: Brandweek's list of the worst brand extensions of 2006 included Cheetos lip balm and Play-Doh perfume. Lego stumbled because its fans associate its brand rather narrowly with a fun building experience. "The company put out products that didn't have anything to do with what people expected of Lego," says Hatch. Even the colors on the new clothing didn't match up with the primary hues utilized for the blocks.

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.

The best example of these build-then-play creations is Bionicle, a line of character-based Legos that have their own mythological backstories. Last year, according to the research firm Funosophy, Lego's latest Bionicle and "Star Wars" toys were two of boys' top-10 most-requested holiday gifts. This broad lineup, retailers say, is testament to how adept the company has become. "Kids don't say, 'Hey, Mom and Dad, I want a construction toy'," says Mark Randall, who runs Amazon.com's toy business, where Lego is among the biggest sellers. "They say, 'Hey, Mom and Dad, I want Lego'."

According to research by NPD Group, Lego controls about 60 percent of the $600 million U.S. construction-toy market. Its closest competitor is Mega Bloks, whose hottest sellers are oversize blocks designed for preschoolers. The other big player is K'Nex, which uses a different building model: sticks instead of bricks, and a "spatial" creation process, instead of "stacking." Each of the three brands has its particular strength. "Mega is more activity-play and preschool focused, and K'Nex is more of an educational, building experience," says Richard Barry, a Toys "R" Us vice president. You'd think rivals like Mega and K'Nex would have been gleeful as Lego's strategy went adrift in recent years, but in fact, the entire category suffered as Lego lagged, and the competition is happy to have Lego back on track.

Now Lego's biggest challenge is keeping up with demand as it shifts nearly all its manufacturing to outside companies. Randall, Amazon.com's toy chief, says he's calling Lego every week to monitor the situation. One smaller retailer complained to NEWSWEEK that Lego is so focused on giving limited supplies to big players like Toys "R" Us, there are few left for non-big-box retailers. Lego attributes the limited supplies to unexpectedly high demand.

Barring short-term supply problems, toy experts say Lego's big long-term advantage is the nostalgia factor, which has lately helped revive 1980s brands like Care Bears and Cabbage Patch Kids. In America, today's parents grew up playing Legos, but most grandparents didn't. In Europe, however, three generations have enjoyed building bridges and towers (and experiencing the even more exquisite joy of smashing siblings' creations). Lego believes that's why construction toys account for 13 percent of toy sales in Northern Europe, compared with just 3 percent in the United States. As more Americans who grew up with the toy come of age, the company hopes Legos will become just as popular here. Until then, they'll keep building, brick by brick.