About the Author
Phil Rosenzweig is a professor at IMD in Lausanne, Switzerland, where he works with leading companies on questions of strategy and organization. He earned his PhD from The Wharton School, University of Pennsylvania, and spent six years on the faculty of Harvard Business School. He is a native of Northern California. Comments to the author can be sent to Phil@The-Halo-Effect.com.
Excerpt. © Reprinted by permission. All rights reserved.
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The Halo Effect
How Little We Know
How little we know, how much to discover...
Who cares to define what chemistry this is?
Who cares, with your lips on mine, how ignorant bliss is?
“How Little We Know (How Little It Matters)” Words by Carolyn Leigh, music by Philip Springer, 1956
In January 2004, after a particularly disastrous holiday season, Lego, the Danish toy company, fired its chief operating officer. No one doubted that Poul Plougmann had to go. Miserable Christmas sales were the last straw at the end of a terrible year—Lego’s revenues were down by 25 percent, and the company lost $230 million for the year, the worst in its history. What went so badly wrong? Chief executive Kjeld Kirk Kristiansen, grandson of the founder, explained it simply: Lego had “strayed too far from its roots and relied too heavily on merchandising spin-offs, such as Harry Potter figures, which proved unpopular this season despite the continuing success of J. K. Rowling’s books.” The solution? Lego announced that it would “return to basics.” Kristiansen vowed: “We will focus on profitability, especially the attractive potential of our core products.”
There’s nothing especially remarkable about a story like this. Every day we read about companies that are doing well and someone gets promoted, and other companies that fail and someone gets the ax. Today it’s Lego, and tomorrow it’ll be someone else. The beat goes on.
Now, I’m really not very interested in Lego. As Rick might have said in Casablanca, the problems of one family-owned Danish toy maker don’t amount to a hill of beans in this crazy world. What does interest me is how we explain Lego’s performance, because the way we think about what happened at Lego is typical of how we think about success or failure in countless other companies. We don’t want to read just that Lego’s sales were sharply down, we want an explanation of what happened. It can’t just have been bad luck—there must have been some reason why a proud company, a fixture on toy store shelves all around the world, a faithful playtime companion to generations of children, suddenly did so badly. So how did the business press explain Lego’s downfall? A few newspapers reported that Lego was hurt by the fall of the U.S. dollar against the Danish kroner, which meant that North American sales—about half of Lego’s total—were worth less on Lego’s books. Some reporters also noted that a strong new rival, Montreal-based Mega Bloks Inc., was chip-ping away at Lego’s dominant market share. But these were side issues. The main explanation for Lego’s losses? Lego had strayed from its core. It lost sight of its roots. That’s what Lego’s chief executive said, and that’s what the media reported, including the Financial Times, The Wall Street Journal, the Associated Press, Bloomberg News, Nordic Business Report, Danish News Digest, Plastics News, and about a dozen others. Depending on the source, Poul Plougmann was variously sacked, fired, axed, ousted, removed, dismissed, replaced, or simply relieved of his duties. But aside from the verb used to describe his departure, not much differed among the articles. Lego’s big blunder was straying from the core.
Consider for a moment the word stray. The American Heritage Dictionary of the English Language defines to stray as “to wander beyond established limits,” “to deviate from a course that is regarded as right,” and “to become lost.” A guided missile can stray off course and hit the wrong target. A dog that runs away from home is called a stray. A company can stray, too, if it goes off on a foolish adventure, if it wanders off course, if it gets lost. Apparently that’s what Lego did—it chased merchandising spin-offs when it should have been focusing on its core product line. It strayed.
Chris Zook at Bain & Company argued in his 2001 book, Profit from the Core, that companies often do best when they focus on relatively few products for a clear segment of customers. When companies get into very different products or go after very different sets of customers, the results often aren’t pretty. But here’s the catch: Exactly how do we define a company’s core? Zook identifies no fewer than six dimensions along which a company can reasonably expand its activities—into new geographies, new channels, new customer segments, new value chain steps, new businesses, and new products. Any one of them might be a sensible step into an adjacent area, radiating out from the core and bringing success. It’s also possible that any one of them might be fraught with danger and lead to disaster. So how do we know which path to take? Where does the core end and where does straying off course begin? Of course, it’s easy to know in retrospect—but how can we know in advance?
Which brings us back to Lego. For years, our friends at Lego did just one thing: They manufactured and sold construction building blocks for children. That was the core. Lego made millions of blocks thanks to modern injection molding manufacturing techniques, it turned out blocks in plenty of different colors, and it made them in different shapes and sizes so they could be easily manipulated by little hands. Children could build just about anything out of Lego blocks—the only limit was their imagination. Lego was always about construction building blocks, nothing else. It built a dominant market share and had huge power over distributors and retailers. In this segment, Lego was king.
Unfortunately, nothing in the business world stands still—customer preferences change and technology marches on and new competitors appear. The market for traditional toys stagnated as kids shifted to electronic games at an earlier and earlier age. By the 1990s, simple plastic building blocks were a mature product and, in a world of video games and electronic toys, well, a bit boring. If Lego wanted to grow, or even if it wanted to stay the same size, it would have to try some new things—the question was what. Of all the things Lego might try, what would make the most sense? If Lego decided to expand into, say, financial services, that would be straying from its core. No one would be surprised if the venture flopped—“What’s a toy company doing trying to become a bank? What do they know about banking?”—and the responsible manager would have been removed without a second thought. What if Lego launched a line of children’s clothing? That one’s not so clear—Lego knows a lot about kids, and it understands consumer products. It has plenty of power over retail distribution, just not in clothing, at least not yet. Maybe it could succeed, maybe not. What about electronic toys? Again, debatable—maybe Lego could build on its experience in toys, and with all the growth in video games, why not? And in fact, Lego had developed Bionicle CD-ROM games and Mindstorm robots made of building blocks controlled by personal computers. But Harry Potter figures? Little toys with little plastic parts that snap together? That should be smack inside Lego’s core. If Harry Potter figures are outside Lego’s core, we ought to ask exactly how broad Lego’s core really is. Because if Lego’s core is nothing but traditional blocks, we’d have to wonder how it could possibly provide sufficient growth opportunities for a company with revenues of $2 billion.
In fact, Plougmann had been brought in from Bang & Olufsen, a Danish maker of high-quality audio equipment, in part to go after new opportunities. His hiring was seen as a coup, symptomatic of Lego’s commitment to new avenues of growth after the company posted its first loss ever in 1998. Under his guidance, Lego began to branch out into electronic toys and merchandising spin-offs, and the initial response was good. At the time, no one said Lego was moving outside its core. But when sales fell sharply in 2003, Kristiansen lost patience and pulled the plug on Poul Plougmann. “We have been pursuing a strategy based on growth by focusing on totally new products. This strategy did not give the expected results.” So in 2004, Lego decided to “return to its core” and “focus on profitability.” Strange, because profitable growth was presumably what Lego had in mind when it went after those new opportunities in the first place.
Imagine, if we could turn the clock back to 1999, that Lego had decided to stick to plastic building blocks, nothing more. Nope, we’re not interested in a tie-in to Harry Potter, which was only the most popular children’s book of all time, whose first two movies racked up box office receipts of $1.2 billion worldwide. Next year’s headline? Probably something like this: EXECUTIVE SACKED AS LEGO SALES FLAT. And the story line? Something like this: “Danish family firm stays too long with a mature product line and misses out on growth opportunities to more innovative rivals.” Analysts will comment that Lego failed to go boldly forward. It lacked vision. It was inward looking. Its managers were timid and complacent—or maybe even arrogant.
Of course, some ventures outside the core are spectacularly successful. During the 1980s, General Electric, America’s largest industrial company long associated with light bulbs, refrigerators, airplane engines, and plastics, sold some of its traditional businesses—home appliances and televisions—and went in a big way into financial services—commercial finance, consumer finance, and insurance. Today, these financial services bring in more than 40 percent of GE’s revenues and a corresponding amount of its profits, close to $8 billion. Did GE go beyond its core? Absolutely. But nobody called for the boss’s head because GE was successful. In fact, GE was ranked at the top of Fortune magazine’s 2005 survey of Global Most Admired Companies, ahead of Wal-Mart, Dell, Microsoft, and Toyota, and was ranked second in the Financial Times’s 2005 World’s Most Respected Companies survey, down one notch after six consecutive years at number one. So much for the perils of straying from the core.
In the weeks following Plougmann’s ouster, the U.K. magazine Brand Strategy looked a bit more closely into Lego’s prospects. Like everyone else, it reported that Lego’s problems were the result of “focusing on new products such as licensed Star Wars and Harry Potter ranges, to the detriment of its core business.” But Brand Strategy went a step further and asked several industry experts what Lego should do. Maybe these industry experts, who presumably know the toy industry and its major players very well, would be able to offer some incisive advice. They were asked: What should Lego do now?
Here was the view of a marketing manager at Hamley’s, London’s legendary toy store:
Lego mustn’t lose sight of what it’s become known for—reliable, colorful construction toys. Its marketing is impressive but Lego needs to continue having the wow factor.
This was the advice from a toy and games industry analyst:
Lego has lost its way to some extent in recent years. It has diversified into a number of sectors and this hasn’t worked. Lego should focus on what it does best and it’s right to focus back on toys.
And here was the view from another toy industry expert:
Lego has to remember its heritage; listen to customers; be innovative; focus on the key issues for long-term success; and go for evolution, not revolution.
A nice set of advice! Every one of these industry experts wants Lego to have it both ways: on the one hand to remember its heritage and focus on what it’s known for, and on the other hand to be innovative and achieve a wow factor. (Remember, pursuit of the wow factor was exactly what Lego had tried to do—and it got creamed for losing sight of its core. Guess that was the wrong wow factor!) Not a single expert suggested that Lego make a clear choice and follow a definitive direction—they all want Lego to have the best of everything. You can bet that if Lego returned to profitability, every one of these experts would say, See, Lego followed my advice, and if Lego continued to lose money, they could say, Lego didn’t do what I told them. And these are industry experts, who presumably understand the toy industry better than you and I do.
Ted Williams, the great Red Sox outfielder, once said there was one thing he always found irritating: With runners on base and the opposing team’s slugger coming to the plate, the manager walks to the mound and says to the pitcher, “Don’t give the batter a good pitch, but don’t walk him,” then turns around and marches back to the dugout. Pointless! said Ted. Of course the pitcher doesn’t want to give the batter anything good to hit, and of course he doesn’t want to walk him. The pitcher already knows that! The only useful advice is, “In this situation, it’s better to throw a strike because you really don’t want to walk this hitter,” or, “It’s better to walk this hitter because in this situation you really don’t want to throw him a strike.” But baseball managers, like industry analysts, find it easier to ask for the best of both.
One final note about the toy business. Lost in all the sound and fury about Lego was the fact that other toy makers were struggling, too. The largest U.S. toy maker, Mattel, in the midst of a multiyear turnaround after several poor years, announced in July 2004 that sales of its best-known product, the Barbie doll, had fallen by 13 percent. Part of Barbie’s woes stemmed from a rival product, MGA Entertainment’s Bratz dolls, said to be an “edgier fashion doll,” which had eaten into Barbie’s market share. What was Mattel planning to do in order to revive Barbie sales? Focus on its core? No, it planned a new line based on the American Idol television show and a fashion-based line called “Fashion Fever.” Months after Lego concluded that merchandising spin-offs were a bad idea, Mattel decided to take that very approach.
Driftingwith WH Smith, Expanding with Nokia
Lego isn’t the only company to be criticized for wandering off course. Consider WH Smith, the troubled newspaper and magazine retail chain. WH Smith got its start more than a hundred years ago as a London newspaper distributor, and over time moved into bookstalls and stores. Nothing odd about that. The New York Times reported: “It was in the 1980s that WH Smith began to diversify well beyond books and periodicals, adding music, office supplies, stationery, and gifts to its store shelves. But in drifting away from its core products, analysts said, the company also made itself vulnerable to competition.” WH Smith now found itself competing with supermarkets and other large surface stores—a dangerous game.
Note the word: drifting. According to the Times, WH Smith didn’t expand or diversify, it drifted. The American Heritage Dictionary defines to drift as “to move from place to place with no particular goal,” “to be carried along by currents of air or water,” “to wander from a set course or point of attention; to stray.” A raft can be cast adrift, left to move with the currents. Wood that flows in and out with the tides is driftwood. A person with no direction or aims is a drifter. (At the start of The Magnificent Seven, the rootlessness—and availability for hire—of the gunfighters is conveyed in this exchange between Steve McQueen and Yul Brynner. “Where are you heading?” asks McQueen. Brynner answers: “I’m drifting south, more or less. And you?” McQueen shrugs. “Just drifting.”)
Well, who says that WH Smith drifted? Who says that selling music and office supplies is an example of wandering off course? Why should we think that WH Smith had no particular goal when it added stationery and gifts? It didn’t get into book publishing. It didn’t try to sell fresh food or alcoholic beverages....
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