A five forces analysis of Lego

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Lego is a market-leading toy brand famous worldwide for the interlocking plastic bricks it makes.

Its most important product is the Lego brick, but it also makes theme sets based on various themes like Star Wars and Superheroes, educational products, and digital games.

Ole Kirk Kristiansen founded the Lego Group in 1932. It is a family-owned business and is headed by the founder’s grandson Kjeld Kirk Kristiansen.

Lego’s name is a derivative of two Danish words, ‘leg godt’ meaning play well, which is also Lego’s ideal.

The company is headquartered in Billund, Denmark.

The company has achieved impressive growth in recent years.

Even during the pandemic, the company has performed well and experienced impressive e-commerce growth throughout the first half of 2020.

Several forces in the toy industry affect the businesses’ market position and their competitive strength.

One of the simplest tools used throughout the industry and academic circles for analyzing firms’ competitive position and the level of competition in a particular industry is Porter’s five forces model.

This analytical model was named after Michael E Porter, who created it.

Harvard Business School.

In a 1979 article titled How Competitive Forces Shape Strategy, published in the Harvard Business Review, Michael E Porter noted regarding this model that the collective strength of these forces ultimately determines the profit potential of any industry; and it can range from intense to mild.

The profit potential grows as these forces weaken.

In each industry, a different force may grow more prominent compared to the others.

Porter offers three examples in his HBR article.

In the ocean-going tankers industry, the buyers are the most important force, whereas, in the tires industry, it is the powerful OEM buyers and tough competitors.

On the other hand, in the steel industry, foreign competitors and substitutes are the most prominent forces.

In Porter’s words,

“Every industry has an underlying structure, or a set of fundamental economic and technical characteristics, that gives rise to these competitive forces. The strategist, wanting to position his or her company to cope best with its industry environment or to influence that environment in the company’s favor, must learn what makes the environment tick.”

Michael E Porter in his HBR article, How Competitive Forces Shape Strategy.

Let us take a look at how these forces work in the toy industry and how Lego can best manage the possible negative impact of these forces.

Bargaining power of suppliers:

The bargaining power of suppliers is higher in the following cases:

  • It is dominated by a few companies and is more concentrated than the industry it is selling to.
  • The products the supplier sells is unique or at least differentiated, or if it has built up switching costs.
  • It is not obliged to contend with other products for sale to the industry.
  • Itr poses a credible threat of forward integration into the industry’s business to which it sells.
  • The industry is not a significant customer of the suppliers’ products or the supplier does not generate a significant revenue from the particular industry. 

In the case of Lego, it makes its bricks from a polymer called acrylonitrile butadiene styrene.

However, all the plastic that Lego uses for the production of its toys is derived from oil.

So, the oil manufacturers are the leading suppliers for Lego.

They hold significant bargaining strength since the company cannot bargain for oil prices. Every year Lego produces around 60 billion Lego bricks. 

Around three-fourths of its carbon footprint comes from the extraction and refinement of the oil used to produce Lego bricks.

However, the company has still not been able to reduce its dependence on the oil industry because it will take time to develop a biodegradable substitute for oil-based plastics.

Despite these facts, the oil industry does not pose a significant threat of forward integration before Lego.

There are some other factors too that moderate the bargaining power of oil suppliers.

For example, apart from the US and UAE, there are other oil-producing nations too, and the company has several options to switch. Overall, Lego suppliers’ bargaining power is moderately high until the company has found a cheaper and renewable substitute to make plastic.

Bargaining power of buyers:

Buyer groups are powerful and hold substantial bargaining strength in the following cases:

  • Buyer groups can be powerful if they are concentrated and buy in larger volumes. If the fixed costs are high in the industry, the large buyers are particularly a potent force. 
  • Products are standard or undifferentiated or if the buyer poses a threat of backward integration. 
  • If the buyers earn low profits and are highly price sensitive.

In the case of Lego, the larger buyers like Walmart and Toys R US are among the most significant buyers that buy in bulk from the company.

These retail brands purchase from Lego in large volumes and therefore hold significant bargaining strength.

However, none of these poses a credible threat of backward integration.

Apart from that, the individual customers do not hold a significant bargaining strength.

Moreover, the products sold by the Lego group are highly differentiated or unique and therefore it reduces the bargaining power of the buyers.

Lego is a leading player in the Toy industry and also one of its kind.

The products sold by Lego are highly unique and their demand is high.

As a result, the company can charge premium prices.

These strengths of the company help it control the bargaining power of both the buyers and suppliers.

The overall bargaining power of customers is moderately high.

Threat from substitute products:

The threat from substitute products is perhaps the strongest of the five forces in the case of Lego.

The threat of substitutes mainly comes from the products that the rival brands make, and as in the case of Lego, there are still four or five direct competitors apart from smaller and less known brands.

A high level of differentiation and product quality helps the company manage the threat from the substitute products.

Apart from that, marketing also plays an important role in helping the company manage the substitute products’ threat. 

It is the twenty-first century, and the use of digital technology and digital games and apps has grown in customer groups of all ages, including children, teens, and adults.

Kids in larger numbers are using online resources to play and learn.

While Lego offers an entirely different experience, digital games and apps have also achieved a high level of engagement and customer loyalty, making them tough competitors for the brand.

The company has focused on product quality, marketing, and innovation, to reduce the threat from substitute products, including physical products and online services.

Overall, despite its differentiation and great marketing strategy, the company faces a heavy threat from the substitute products.

Threat from new entrants:

New players in an industry generally bring new capacity, the desire to gain market share, and often substantial resources. Companies that diversify into new markets through acquisitions often leverage their resources to cause a shakeup (Porter, 1979).

However, the seriousness of the threat of entry depends on the barriers to entry present in the industry and the level of reaction from the incumbent players.

If the entry barriers are high and the newcomers can expect sharp retaliation from incumbent players, the threat of entry will remain low. Following are the main barriers to entry into an industry.

Economies of scale: It is a significant barrier since the companies will either need to enter at  a large scale or accept a cost disadvantage. 

Product differentiation and brand identity: If established players sell highly differentiated products and also enjoy strong brand loyalty, it acts as  a significant barrier for the new entrants since they will be required to spend heavily to overcome the level of customer loyalty established players enjoy.

Other significant sources that can act as barriers to entry include capital requirements, cost disadvantages, access to distribution channels, and government policies related to the business.

Patents and copyrights also act as barriers to entry into a particular business.

In the toy industry, capital requirements and government policies do not act as significant barriers to entry for new players.

However, other factors, like product differentiation and economies of scale, may constitute a significant barrier.

Lego is one of the two largest brands in the toy industry, and that places it at a significant advantage compared to any new player that may enter the market through an acquisition or afresh.

Marketing also places Lego at a significant advantage.

Any other brand trying to make an entry and compete with Lego will have to spend heavily to overcome the customer loyalty it enjoys.

It will also be required to differentiate its products significantly to win in the toy industry.

Overall, the threat of new players entering the market and taking away market share from Lego is absolutely minimal. 

Intensity of competitive rivalry in the industry:

The intensity of competitive rivalry in the industry is moderately high, and while competition mainly comes from the brick and mortar players, the competition from digital players has also grown.

Lego has several competitors in the market, including Bandai Namco, Fisher-Price, Barbie, Mattel, Hasbro, and others.

However, Lego also enjoys substantial advantages based on its brand image, marketing, market position, and differentiation.

The company has achieved a unique identity in the market.

Apart from that, its focus on innovation has also helped it strengthen its market position and market share globally.

The level of competition grows because of the diversity of players in the industry and the high exit barriers.

Companies have to focus on marketing and brand image to maintain user loyalty apart from innovation and product quality.