5/15/2009

DVC
SUPPLY CHAIN REDESIGNING FOR LEGO
V1

Made by group 4

Jacob Jensen Knold

Michael El-Jabri
Jie Huang
Xuan Yang
Yina Jin
 TABLE OF CONTENTS

Introduction ............................................................................ 1

Background……………………………………………………….…….1

Project Purpose…………………………………...…………………….1

Current State ........................................................................... 2

Structure ........................................................................................................... 2

Demand ............................................................................................................ 3

Retailer and Consumer Demand……………………………………….4

Future State………………………………………….…………7
Strategy and Goals………………………………………….………...….7

Defining segments for products and retaile………………….………….7

Segmentation of Retailers…………………………………………...….9

Forecasting……………………………………….. …………….…….10

Planning…………………………………………….…………………11
Flow of Information…………………………………………………………….11

Flow of Material……………………………………………………….……….12

3rd Party Logistics………………………………………………………….……13

Company culture and defining KPI´s………………………………..………….14

Conclusion……………………………………………………15
 INTRODUCTION
Background

LEGO was founded in 1932 by Ole Kirk Christiansen and the headquarters is located
in Billund Denmark. Over nearly a century LEGO have built up a strong brand power
and supreme quality of their products, they have become the driving force in toy
manufactory.

Into the 21st century, with the company's growth and the maturation of the toy market,
the market has seen increasingly fierce competition, LEGO have found that many
competitors outsource production to use cheap labor and rich resources as part of the
company’s strategy to improve their market competitiveness, but LEGO has not
necessarily found the same method suitable for them, but if they can improve their
supply chain models, to improve market response and adaptability, they are still very
competitive with the market.

Project Purpose

The main purpose of this project is to redesign the supply chain of LEGO, this project
will use 4 semesters we have learned from Value Chain Management, try to use the
knowledge and skills to the LEGO supply chain re-design and improving.

We hope we can use our knowledge and the information which we are can have now
to optimize the supply chain. In the next chapter we will raise a lot of knowledge of
supply chain management, and supplier relationship management and customer
relationship management are our next focus.

Internal analyses considering LEAN production, company culture and so on will not
be widely discussed into deeply details.

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 CURRENT STATE

STRUCTURE
As we can see LEGO have one factory in Billund Denmark, one central warehouse in
Europe, and several distribution centers. They mainly supply to the toy retailers in
Europe.

Supplier Retailer

Process 1 Process 2 Process 3

Moulding Painting Packing

Inventory Inventory CW DC

CW- Central Warehouse

Supplier Retailer
DC- Distribution Center

Figure 1. Goods Flow

LEGO keeps an inventory of raw materials to provide for the manufacturing processes,
first plastic resins is used to make the components, and second the parts are painted or
added some decorations. At last assembly the components and packing into boxes of
finish goods. All the finish goods are sent to a central warehouse, via the distribution
centers and delivered to different retailers according to retailer’s orders.

From the structure of the logistics, we can see the supply chain system is a traditional
make to stock, the main purpose is to meet customer demand for reduced lead time,
but as more and more intense competition in the market, the drawbacks of this system
is the large inventory and product issues to deal with the problem remaining.
The biggest problem they faced is extreme mismatch between the supply and the
demand. Because of the high seasonality, half of the sales are made in November and
December. Another reason is the unpredictable demands from the end customers.
These factors lead LEGO to face higher cost from empty inventory, markdowns and
lost sale. Due to the high fixed cost, inventory cost and labor cost, LEGO have to
heighten the price of wholesale. And basic on priority rule the production department
need produce the higher fill rate production more frequently, which almost is the new
production.
With the higher and unpredictable demand LEGO have to provide a quicker response

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to their retailers. Also because of the high seasonality, it is necessary to balance the
production capacity. In order to reduce the lead time and inventory cost, LEGO realize
they should redesign a physically responsive supply chain. Consider the
geographically distributed toy retailers; LEGO can keep several distribution centers to
achieve the short deliver time, or they can use the Third Part Logistic instead of all
distribution centers. We can see more information about those in the next future state
description.

DEMAND

Forecast

Manufactory Retailer

Warehouse Distribution

Figure 2. Information Flow

LEGO realized there are many problems with producing the “wrong” product
regarding the fill rates and delivery times. They are trying to find some method to fix
it, as the case mentioned that redesign the supply to be a quick response and flexible
supply chain is a feasible method, however, according to customer demand or the
demand of retailers to develop the new supply chain system is now faced with the
choice.
The information flow is basic on monthly forecast of retailers’ demand, and calculated
the contribution margin were without the cost of obsolete inventory, mark-downs, and
lost sales. Many products with high forecast uncertainty and demand are variability,
also many data collected from historical retailer demand, so the forecast is unreliable.
Both LEGO and retailers faced the high cost due to the cost of obsolete inventory,
mark-downs, and lost sales. The retailer asked LEGO to take more responsibility on
finish goods inventory, they also want a lower purchase costs and greater relationship
with LEGO. The consumers ask for the cheapest toys with the highest quality and
innovated value.
Now LEGO only produce to unreliable forecast, and divide the product base on
service level. They already realized that many products are wrongly produced. So
they decide to redesign the different supply chain structure base on different data. So
they propose two projects to reach different result. First project run with the retailers’
demand data. Second project is base on the end customers’ demand data.

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RETAILERS AND CONSUMERS DEMAND
The case describes LEGO set up two different project teams to work together to
investigate and analyse the whole supply chain system, The two project groups were
team X and team Y, respectively to investigate and analysis the consumers demand
and retailers demand to know the basis of the demand data by two different
implementation. Therefore, they found different retailer ordering behaviors according
to different situation. We compare the ordering behavior which mostly according to
actual customer demand (Behavior K) and retailers demand (Behavior M) on the table
1 in below.

Order/Performance Characteristics Ordering Behavior K Ordering Behavior M

Order Characteristics: Percentage of >85% <15%
total orders that accords with consumer
demand
Order frequency Daily Monthly
Order size Pieces Carton/Palle
Seasonality factor Medium High
Average requested delivery lead-time to the Short (1 day to 1 week) Long (4-10 weeks)
retailer
Delivery to Stores Warehouse
Stock turn High Low
Fill rates from the manufacturer Low High
Retail closing stock Low High
Markdowns Medium High
Total percentage of annual manufacturer sales 5% 55%
(approximate)

Table 1. Order/Performance Characteristics

From table 1 where we can see that the use of customer demand, many retailers
demand more than the effect of the different, there are advantage and some
disadvantage, but from the our point of view, we support the introduction of even
more customers to develop new suppliers chain system, of course, not only because of
the table 1 data on the display, we have a number of other reasons, below we explain
the reasons for this:
First of all, only the end customers’ demand is the real demand of the whole supply
chain, and as V.C.M student we should always keep lean thinking in our mind. This is
the first reason for us to avoid this retailer’s demand.
Moreover, according to the case of LEGO, we found that most of the retailers’
actually sending orders to LEGO with their forecast, due to this toy business have
very big variation of the consumers’ demand. Therefore, the forecast uncertainty is a
big problem for themselves and the supplier--LEGO. Especially during the peak
season, the amount of forecast error would be huge which means they will lose a big
amount of the gross margin. They might be keep a big stock of some of product which

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is not able to be sold as much as predict, but some products are sold in excess of
expected. Because of it, some of the customers are not satisfied by LEGO, then go to
buy the competitor’s product. The result is they have lots of products are wrongly
produced, and then it turn to be obsolete inventory, markdowns and lost sales. We thus
expect that they could reach a different result if consumer demand data was used
instead of retailer demand data.
Let’s compare the consumer’s demand and retailer’s demand. We can see the example
below about the different diagram description of the consumer’s demand curve and
retailers demand. (Figure 3)

Consumer's Demand
40
order quantity

20
0 sales figures
0 2 4 6 8 10 12 14 16 18 20
Time

Retailers Demand
100
Order quantity

50
0
Retailers Demand
0 2 4 6 8 10 12 14 16 18 20
Time

Figure 3. Demand Diagram

From Figure 3 we can see that customer demand is showing a linear curve, according
to the customer at different times to reflect the degree of consumption, from which we
can see that the customer needs a lot of variable and unpredictable. At the same time,
some of the more large-scale retailers in the absence of the consumer to provide a
reliable data analysis and co-operation targeted with LEGO, but they expect to meet
customer demand, reduce transport costs and raise profits, they sent orders to the
distribution center of LEGO, is often used in large quantities from time to time of
order, but also because of this formal. They often need to maintain a larger safety
stock to achieve their goals, satisfy consumers. The result is very likely that we have
just mentioned above.

Based on the analysis above, this group is not going to recommend redesigning the
supply chain according the retailer’s demand, but is it a good idea to redesigning the
supply chain 100% according to the consumer’s demand?
In fact, we very much hope to achieve 100% in accordance with the consumer

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demand to re-design the supply chain, but after discussion and analysis, we found that
our concept of LEAN is not entirely suitable for the LEGO supply chain design.
Problems because of the LEGO supply chain systems. Let us now discuss LEGO
supply chain system. First of all, as far as we learned from the case, LEGO logistics
structure now as follows (Figure 4):

Figure 4. Supply Chain Strategy

Retailers primarily through the distribution center to carry out orders and delivery of
goods made. That is to say, LEGO is the traditional mode of production of the make to
stock, the advantages of shorter lead time, to better meet customer needs. The
disadvantage is that due to the unpredictability of consumer demand, the supply chain
model is likely to result in large inventory of poor sales of the product. These retailers
can scale according to their morphology to be classified. We could have divided into
three Tiers retailer.
Tier1 retailers can be compared to those of large-scale chain stores; Tier2 retailers are
those more the size of department stores and hypermarkets, Tier3 retailers are those of
the smaller toy stores. Through consultation and cooperation requirements of the Tier
2 and Tier1 retailers, they are able to provide us with the needs of our consumer data
and conduct analysis, targeted design of new supply chain system.
However, it is very likely that will become as a result of long lead time it will take a
long forecast period and safety stock. We will describe and analysis this system in the
next future state. However, problems have emerged in our Tier3 retailers, due to their
relatively small size and almost didn’t or even not willing to statistical data on
consumption, if we want to abandon the retailer's demand but in accordance to
redesign the supply chain that success is almost impossible, but even if that is the case,
then the price is we are not willing to make concrete commitments.
Therefore, we believe that this re-design of supply chain systems are not simply based
on consumer demand or the retailer's demand to develop, but the situation should be
different for different situations and retailer of the product to develop, and we will be
more in future state detailed analysis and the provision of specific implementation
methods for the supply chain re-engineering.

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 FUTURE STATE

STRATEGY AND GOALS

The future supply chain must in order to prove effective achieve the following goals:

• Differentiated product categories and retailers

• Consumer based forecast where possible and always for products with a high
level of uncertainty
• Minimize stock while at the same time avoiding stock outs
• Achieve flexibility and proof against variability in demand within the entire
SC with special focus on production.
• Product sequenced MPS/MRP in production taking into account stock,
seasonality and level of uncertainty for each product.

To ensure achieving these goals this group furthermore suggests that the company
implement changes to its SC of today:

• Vendor Managed Inventories or approximated systems at main retailer

customers. To ensure access to reliable and real-time consumer data.
• 3rd Party Logistics and subsequent closing of regional European distribution
centers. Relying instead on 1 central DC and the network provided by the 3PL
partner.
• A shift from classic MTS production in all the SC to a value chain introducing
the JIT principles of postponement (ATO) between the Molding process and
the Packaging.

DEFINING SEGMENTS FOR PRODUCTS AND RETAILERS

To create a forecast accurate enough for the new production planning and sequencing,
it is necessary to divide the products and retailers into segments, each with one
optimized forecasting method.

Segmentation of products

As shown in the previous chapters, both team x and y have chosen to divide the
products up into 3 categories, segmented primarily by their forecast uncertainty and
demand variability. Comparing these categories between the 2 teams data, show a
natural division exist here using both methods.

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 Product Product Product
Product Characteristics
Group A Group B Group C
Retailer Low <20% Medium (20-40%) High (>40%)
Forecast uncertainly (errors)
Consumer Low Medium High
Retailer Low Medium High
Demand Variability
Consumer Low Medium High
Medium to
Retailer Low Medium
High
Contribution Margin
Medium to
Consumer Low Medium
High
Medium to
Retailer Medium Medium
High
Seasonality Factor
Low to
Consumer Low to Medium Medium to high
Medium
Retailer 2-4 weeks 1-2 weeks 1-2 weeks
Lead-Time
Consumer 4-10 weeks 2-6 weeks 1 day- 1 week
Retailer 10% 40% 50%
Total Sales (Percentage)
Consumer 15% 45% 40%

Table 2. Product Characteristics

The characteristics of each product are therefore different in each segment:

A. Campaign Products. Products introduced to the market in connection with

either an internal or external marketing campaign. Lego´s cooperation with
Lucas Arts for the 3 new STAR WAR movies and the product launch
coordinated with the release of the movie is an example.
B. Augmenting Products. New models introduced within an exciting theme. An
example could be a new large ship to the space theme or a castle for the
medieval theme. These are mainly launched during high season, but sales
continue throughout the year.
C. Basic Products. Products that have existed on the market for a long time and
make up the foundation of each series. An example being the fire stations that
haven’t changed since this author was a small Lego fanatic.

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SEGMENTATION OF RETAILERS

As today all forecast and planning are based on retailer data, the order management
system is focused on minimizing the orders and maximizing the order sizes. This is
especially the case with the large retail customers, who are given high markdowns and
service level corresponding to the order size.

While such sales strategies do have merits in a traditional MTS culture with long
lead-times and high inventories, they are not suitable for ATO environment with a
high flexibility, short lead-time and consumer data based forecasting.

Rather than as today focusing on the ordering behavior and in particular the
size/importance of each retailer, segmentation based on the existing (or in this case
potential) relationship with each retailer should be created.

In relations to their place in the supply chain in general and demand management in
particular, we suggest the following 4 segments:

1. High integration – Retailers where the establishment of VMI is mutual

beneficial and systems exist to facilitate real-time exchange of Consumer
Data.
2. Medium Integration – Where VMI is not beneficial but the order process is to
some extend automated and based on Consumer Data and Consumer Data is
shared at minimum periodically.
3. Low Integration – Where the order process is to some extend automated and
periodic but no Consumer Data is shared.
4. No Integration – No agreed order process, no shared Consumer Data.

Retailer High Medium Low No

characteristics Integration Integration Integration Integration
Order Frequency Daily Daily Weekly Weekly/monthly
Seasonality High High Medium Low
Lead Time None None Week Week
Gross Margin High High Medium Low
Table 3. Retailer characteristics

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FORECASTING

Creating reliable forecasts remain essential even within an ATO model. Forecasts are
the basis for long term strategies, for production capacity planning and in the creation
of daily production plans for value streams with long lead-time or large batch sizes.

An accurate forecast is therefore equally important regardless if it is based on

consumer data or the demand from the retailers.

Segmenting both the products and the retailers enables us to use different forecast
method for each category, choosing the method with the lowest level of uncertainty
for each group and providing the company with a detailed planning tool for each
individual product.

The three different product types each represent a different approach to forecasting.

A. Products

For the New Campaign Products no past data on demand exists and a forecast will
therefore have to be based on past experience from similar product launches and
focused projects from the initial phase of the sales.

The retailers with VMI relationship are here particularly useful as consumer data is
available in real time and collaboration in market research and demand behavior is
mutually beneficial.

B. Products

With augmented products more past consumer and retail data is available for similar
previous production as well as the demand for these products is less variable. Classic
forecasting method using primarily consumer data can be used more effectively with a
subsequent acceptable level of uncertainty

C. Products

The basic products have a very low demand variability and seasonality. Forecasting
on consumer data is therefore simple and effective. Retailer data from the tier 3-4
retailers become here relative to consumer data more important, in order to predict
possible bulk purchases from retailers at specific times during the year.

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PLANNING

As is seen from figure X, Lego operates today with a classic MTS or pull environment
where forecast based Material Planning Systems make up the planning all the way
through the value chain to the European distribution centers.

A system of this nature is highly dependent on a large inventory located between each
operation in the value chain, this in turn results in a long lead-time on all products and
necessitates forecasts stretching beyond this and the work in progress.

We have shown that by changing the forecasting method to a differentiated system

using consumer data rather than retailer data and introducing a segmented retailer
relationship system, a more accurate forecast can be achieved.

For this to have effect on saving inventory costs and increasing gross margins on each
products, the planning horizon must be drastically reduced, resulting in a change from
the traditional MTS environment to a JIT mentally based on the principles of
postponement (ATO).

- Flow of Information

In the new environment of segmented tier 1 retailer customers the flow of information
is divided along the same divisions. While initially this may seem as complicating the
information flow in the value chain, a high level of atomization such as integrated
ERP – systems, Electronic transaction and VMI (automated reorder points). For the
group 3 and 4 retailers remaining work will be made to standardize the information
flow by offering incentive to use web-based order management, periodic orders and
create a system less dependent on the personal sales representative.

Planning Forecast

Group 1
Moulding Packaging
RM CW CDC VMI Retailers
3PL

Figure 5. Information Flow, Group 1

Group 1 retailers
With a VMI established, Consumer data is available at real-time. Reorder points for
each product initiate the assembly and restocking of goods at the retailer. The
consumer data is then used for forecasting that in turn is used for the purchase of raw
materials and creating the MPS/MRP for the molding production.

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 Planning Forecast

Group 1
Moulding Packaging
RM CW CDC Retailers
3PL

Figure 6. Information Flow, Group 2

Group 2 retailers
Identical to group 1 except the consumer data is send from the retailer itself and
replenishment procedures are established for each costumer. Again the consumer data
is used for the forecasting and subsequent production planning systems.

Forecast

Planning

Group 1
Moulding Packaging
RM CW CDC Retailers
3PL

Figure 7. Information Flow, Group 3-4

Group 3 retailers
Automated and periodic order systems are used by the retailer, with no avialible
consumer data. . The Retailer demand information is indirectly used in forecasting to
calculate volume and for comparison.

Group 4 retailers
Traditional order procedures based on retailer demand is send to the company,
resulting in larger batch sizes and longer lead time. The Retailer demand information
is indirectly used in forecasting to calculate volume and for comparison.

- Flow of Materials

With the new changes to forecasting and the improved relationships with the retailers,
the possibility is open for a change of philosophy.

Introducing postponement in the value chain lowers the lead time and removes the
need for finish goods inventories except for a possible seasonality and safety stock of
group B and C products.

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The molding process is the most time consuming and requires the highest investment.
The optimal solution is therefore to maintain a high batch size MTS production here
and use the WIP warehouse as a supermarket for the packaging.
Packaging is then free to start assembling to order, withdrawing the needed part from
the WIP supermarket.

The result is a direct, not forecast based, 1 unit ATO towards the 1st and 2nd group
retailers and smaller batch-size towards 3rd and 4th. The need for a finished goods
inventory is eliminated and the finish products are transferred directly into the
network of the 3rd party logistics handler. The ATO line together with the use of 3rd
party logistics further eliminates the need to European distribution centers.

The strong seasonality of primarily the 2 first product groups means the capacity of
the packaging needs to be flexible enough to handle this variance. A buffer can be
needed if this capacity is not present and should mainly consist on products with a low
uncertainty from the 2nd and 3rd group of products.

Moulding Packaging Retailers

RM CW CDC
3PL

Figure 8. Production Planning

- 3rd Party Logistics

LEGO decided that as a part of their new strategy of meeting consumer demands by
having a more flexible production, they should have more distribution centers around
Europe.

These have a high cost, and are considered unpractical when a new and bigger system
implementation such as ATO is needed.
A different solution will be having one 3rd party logistics network, operating from one
central distribution center in Billund, where most of today’s production takes place
anyway.

With one distribution center we have limited the implementation process of new
strategic processes in the future. We believe that one distribution center does not
change the lead time radically.

For the distribution center we will use centralized order management, meaning there
will be a complete atomization for order management. This way all data about
re-order point and ect. can be given digitally thru an IT-system.

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 • We have three types of data collection beside the centralized order
management system. First of all we calculate our own consumer data thru
our VMI.
• Retailers whom we cooperate with, in order to collect more consumer data.
This is again automatically served. Every time an order is placed at our
retailer, we receive the data directly in to our system.
• 50 % of all retailers who do not give any accurate consumer data, and
which we can only read from the direct retailer demand.

The last group carriers a big potential for LEGO to develop their relationship with,
and that way move as many as possible up into category to, where LEGO can receive
consumer data directly every time an order has been placed, or one of our toys have
been sold to the end user.

- Company culture and defining KPI´s

A cooperate culture as dominant as the one found in LEGO requires a lot of resources
and time to change. LEGO being one of Denmark’s oldest and most consolidated
production companies, the company have lacked behind the innovations on the market
and in the latest years suffered the consequences.

The media have portrayed the company as a traditionally structured organization,

sometimes lost in its own internal struggles and the supply chain reflects this as we
have seen in this case.

The focus place on differentiate focus in this plan also works to shift focus to new
criteria’s success and new Key Performance Indicators for evaluation.

A shift from departmental KPI´s specific for each function, to process based indicators,
reflecting the success of each function throughout the value chain.
The most actual example is the new strategy of the sales department. A change from a
key and/or area account system with success placed primarily on price, volume and
gross margins to establishing and maintaining an ever improving relationship with
retailers, focusing on lead-time reductions, stock-outs, delivery service and of course
always grosses margins.

The commitment to change is fundamental to the continued success of any project and
education of the work force is the only way to achieve this. Only by creating an
overview for each employee do the benefits of this new philosophy become apparent.

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 CONCLUSION
We have in this report analyzed the supply chain of LEGO with the main focus on
forecasting as planning. In doing so we have answered the four questions put to us by
the case description
• Should the toy manufacturer differentiate its supply chain according to its
products?

In order to achieve the optimal supply chain a segmentation of products must take
place. Such a segmentation aids in achieving more accurate forecasts, smooth the
effect of seasonality and make closer relationship with retailers possible.
Segmentation further allows for a change in the production from a classic MTS to a
ATO, resulting in lower finished goods inventories and shorter overall lead-times.
• Should the toy manufacturer produce according to retailer demand

While retailer demand data have proven sufficient for the MTS system with finished
goods inventories, it is not a suited basis for any future optimization. The retailer
demand data does not necessarily represent the true demand on the market and the
derived forecasts suffer from high uncertainty of demand and seasonality.
• Should the toy manufacturer produce according to consumer demand

Consumer demand show the markets true demand of products and is the best
foundation of a forecast for all 3 product groups. Unfortunately is consumer demand
data not available in sufficient quality to accurately be used alone in forecast. To
retrieve this information would require a trusted relationship requiring resources to be
use to create this over time. Consumer demand data will therefore probably never be
readily availible and a compromise must be found
• Should the toy manufacturer combine the 2 types of demand data

We have in the chapter Future State attempted to outline our suggestion for a optimal
supply chain, combining both types of demand data with a segmentation of products
and retailers. By applying different models for each segment it is possible to achieve a
more accurate overall forecast for all products. This allows the introduction of ATO in
the value chain, thereby removing or reducing the need for finish goods inventory.
The creation of VMI at group 1 retailers further cuts the reaction time of the supply
chain, lowering seasonality and the variability of the demand.
We believe that only through segmentation is it possible to align the planning system
with a complex reality and assure LEGO stays competitive in the global marketplace.

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