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LEGO's game-changing move
If you have children at home, then you probably also have Lego plastic bricks. The colorful, interlocking toys are loved the world over by youngsters who use them to design and construct buildings, vehicles, robots, and other imaginative toys. It's not unusual for children to amass thousands of pieces in all shapes and sizes.
Despite the product's popularity, The Lego Group found itself struggling financially a few years ago, and in 2004 the toymaker's board of directors decided that the company needed to cut 20 percent of its logistics costs. A key step in achieving that objective was consolidating most of Lego's European warehouses and distribution centers (DCs) into one facility located in the Czech Republic. It was a bold move: No other major company had consolidated its regional distribution in Eastern Europe; in fact, none other has done so to date, says Egil Møller Nielsen, vice president of global logistics for Billund, Denmark-based The Lego Group.
It also was a potentially risky decision, Møller Nielsen acknowledges. "To be the first mover had some benefits, but it also had some risks. We decided we wanted to be the first mover," he says.
It turned out to be a risk worth taking. The move to a single distribution center yielded savings that have helped the toymaker's bottom line. In 2008 the company recorded a nearly 19-percent jump in annual revenue to DKK 9,526 million (about US $1.8 billion) with a profit margin of 21 percent.
Given the worldwide economic downturn, sales are unlikely to be as strong in 2009. But Lego is well-positioned to ride out the economic storm, thanks in part to a distribution strategy that will continue to provide a high level of service at a significantly lower cost than in the past.
In 1932 Ole Kirk Christiansen founded what is now the sixth-largest manufacturer of toys in the world. The name Lego is derived from the first two letters of the Danish words "leg godt," which means "play well." Today Lego products are sold in more than 130 countries, with principal markets in the United States and Europe.
Lego's financial problems in 2004 prompted the company to adopt a seven-year strategy called "Shared Vision" to revitalize its sales and profits. At the time, its products were manufactured in Denmark, Switzerland, and the Czech Republic. Lego had 11 warehouses and distribution centers in Denmark, Switzerland, France, and Germany that handled order execution and customer deliveries.
The Danish toymaker recognized that it could cut its logistics costs by consolidating all of its European distribution activities under one roof, save for the Billund, Denmark, warehouse that handles fulfillment of Internet orders. After considering a number of options, Lego settled on Prague in the Czech Republicâ€”a highly unusual decision. "Not many companies have one DC for all of Europe. Normally, they have two, three, or four," observes Møller Nielsen. "If a company has only one DC, it's always located in Germany or the Benelux [BelgiumNetherlands- Luxembourg] area."
Lego chose Prague largely because of its low labor costs. The medieval city, known for its elegant architecture and vibrant arts scene, also offered a larger pool of skilled labor than other Eastern European locations. "We wanted to be close to Prague because of the [workers'] competencies," Møller Nielsen says. "If you were too far away, it would be difficult to get employees who know how to work a complex operation."
The company elected to forgo construction of its own warehouse and instead leased a one-million-square-foot building from the commercial realtor ProLogis. It also decided to hire a third-party logistics company, DHL Exel Supply Chain, to run the day-to-day distribution operation. The main reason why Lego decided to work with a contract logistics company was the seasonal nature of its salesâ€”60 percent occur in the months leading up to the December holidays. "If we had to carry all that [warehousing] capacity ourselves, we would have eight months of a year with huge idle capacity. If you have an outsourcing partner, they can at least try to balance [available capacity] against other customers," Møller Nielsen explains.
It was important that the switch from many warehouses to the single distribution center go smoothly. As Møller Nielsen notes, "Customers and sales don't accept performance interruptions." To minimize the chances of service disruptions during the changeover, Lego conducted its warehouse consolidation in two phases, including a period when it ran parallel operations. In 2006, it closed down five DCs and transferred those operations to the Prague facility. A year later, it closed five more facilities and shifted their responsibilities to the new DC, which by that time was serving all of Lego's markets except the United States.
The move to Prague required Lego to undertake an extensive analysis of its transportation network. Because the adoption of a single distribution hub would profoundly affect its delivery patterns, the company opted to make some changes in its carrier base prior to any relocation. Up to that point, The Lego Group had used 55 transportation providers for inbound and outbound shipments to its 11 warehouses in Europe. It trimmed those ranks to 10 international carriers that could serve not only Europe but also Asian markets. Today the toymaker has at least two carriers handling deliveries to every market it serves.
The carriers' representatives have offices in the Prague DC alongside those of Lego's and DHL's employees. "In our corporation, one day a year we negotiate. The rest of the year we work together," Møller Nielsen says.
Although DHL Exel Supply Chain manages the daily tendering of loads, Lego selects its transportation providers and handles contract negotiations with them. Initially there was some discussion within Lego about which party should handle various aspects of carrier management, says Møller Nielsen. The final decision was that this division of responsibility would be the best way to coordinate activities in the distribution center with inbound and outbound transportation.
Once the new transportation structure was in place, careful planning helped Lego achieve its goal of more efficient line hauls. Working around holidays was a special challenge, as most European countries prohibit truck movements on national highways on those days. "You cannot go from the Czech Republic to the United Kingdom without passing through Germany," Møller Nielsen points out. "So, when we have a delivery scheduled for the U.K., we need to take into consideration when are the [German] bank holidays, because on a bank holiday, you are not allowed to drive the trucks."
Lego also needed to change its shipment scheduling to improve load consolidation. To do that, Lego and DHL together developed a Web-based transportation management system. The software is used to tender loads to carriers, optimize loads, and route shipments, taking into account such factors as the aforementioned holidays to ensure that Lego meets its customers' delivery requirements. Lego and DHL decided to build their own solution to accomplish all this after careful review of the existing packaged solutions. "We couldn't find any solution that provided the things we wanted," explains Møller Nielsen. "We wanted one platform where three or four different parties could access it in real time."
The challenge of knowledge transfer
Transportation wasn't the only issue that Lego confronted when consolidating its distribution operations in the Czech Republic. The relocation meant that the toymaker would need to hire a large number of qualified workers for the new DC. That proved to be more difficult than anyone had anticipated. "We couldn't find people who knew how to drive a forklift in a complex operation," Møller Nielsen says.
Lego and DHL worked together to recruit and train some 400 year-round employees. (In the peak selling season, the labor force climbs to 900 workers.) The goal of the training was to educate the Czech employees, who had little distribution experience, about the ways Lego managed worldwide logistics and order fulfillment.
To collect that knowledge and transfer it to the Czech workers, Lego began to document the steps its existing distribution operations would normally take to meet sales commitments to customers. In many cases, that required the sales staff to describe in detail the obligations included in service-level agreements. "We said to the sales people, if you don't describe it, you won't get it," Møller Nielsen recalls. "If it is a campaign for a customer and we need to do special labeling, we need to describe it."
The process-mapping exercise had an unexpected side benefit. Lego discovered that it was providing customers with additional services that were not only expensive but oftentimes unnecessary. For instance, the toymaker found that it was not achieving complete cube utilization of truck shipments because some customers wanted special-sized pallets that hindered efficient stacking. Some customers had even requested that only one stock-keeping unit be placed on each pallet, even though that meant shipping partial pallet loads. "A lot of things came to the surface," Møller Nielsen says. "A lot of truckloads were only fifty-percent utilized because of [odd] agreements." Thanks to those discoveries, Lego was able to change some of the terms of its sales agreements to eliminate inefficient handling and distribution practices.
Unexpected cost savings
The rationalization of Lego's distribution network and the establishment of the distribution center in Prague turned out to be more successful than the company had originally predicted. For example, Lego now receives inbound loads from manufacturing plants and prepares them for shipment to customers more quickly than it could in the past. Moreover, the move not only achieved the target of 20-percent savings in distribution costs, but Lego could reach the 40-percent mark this year, according to Møller Nielsen.
The reduction in labor costs was only one of several reasons for those savings. Another is that the shift to a single distribution center eliminated unnecessary "touches." "In the old days, most of the product was handled in two or three DCs before it went to a customer," says Møller Nielsen. "Now it's only handled once."
In the past, moreover, several different DCs might have been required to provide a value-added service, such as applying price labels for a particular retailer. Now Lego only needs to train a single group of workers, who can efficiently perform value-added tasks again and again. "We can build the expertise to drive down costs," Møller Nielsen says. "When you bundle things together, you can be more efficient."
The change to a single distribution center also has helped Lego to reduce unnecessary inventory. "If the product was out of stock in one DC, you would fill it with product from another," says Møller Nielsen. "That increased safety stock."
Finally, carrier consolidation greatly reduced Lego's shipping expenses. The company used its leverage as a large-scale shipper to obtain lower freight rates, but it wasn't the only one that benefited from those deals. By committing to a steady volume of shipments to certain markets, Lego gave the transportation providers a base on which they could expand their services between the Czech Republic and other countries. "We asked for services to places like Italy or Norway, and that was new because the carriers had never served there on a regular basis," says Møller Nielsen.
Because it worked with competent partners and took the time to create an efficient operation without compromising service, Lego gained long-term cost benefits that any company would be happy to achieve. Yet, if the move to Eastern Europe has proved to be so successful for Lego, why haven't other companies followed suit and beaten a path to the Czech Republic and neighboring countries? Perhaps the amount of time, effort, and preparation involved are too daunting for most companies. As Møller Nielsen points out, Lego had to build its own foundation for the project's success: "Even when we did this, there were a lot of uncertainties because the competencies aren't there. We had to train people in the Czech Republic to do worldwide logistics."
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