How Lego Became the Most Valuable Toy Company in the World

A bucketload of license deals

“Guys, please don’t take pictures of that,” said the publicist ushering journalists around Lego’s booth at this past February’s Toy Fair in New York. Indeed, several little configurations of plastic bricks were labeled “NO PHOTOS.” That’s because the Toy Fair is always a magnet for camera-brandishing nerd bloggers, and some of the toys being shown there revealed entire scenes from upcoming movies and popular TV shows—among them, Man of Steel, The Lone Ranger and the new Ninja Turtles cartoon on Nickelodeon. The scolded photographer’s ears turned red, and he and his friends scattered.

“Does that happen a lot?” I asked.

“All the time,” she sighed.

Entertainment companies love that kind of fandom because it indicates brand loyalty, which is a valuable commodity in this steal-your-favorite-TV-shows world. But brand loyalty is hard to come by among the primary Lego consumers: children. Neither Warner Bros. nor Disney would dream of making a movie in which Spider-Man rides in the Batmobile, but kids play out this scenario all the time because they don’t care. Lego is the exception that proves the rule. While there are hundreds of different makers of action figures and dolls whose corporate logos children are resoundingly indifferent to, Lego boasts an estimated 85 percent share of the building block market.

And Lego has a fandom, too. Grown-up aficionados of the product spend incredible sums to acquire out-of-print sets or painstakingly build stop-motion animations of scenes from their favorite TV shows and post them to YouTube. More than one serious sculptor uses Lego as his medium. Combining fandoms by licensing a popular TV show or movie results in something like a feeding frenzy. A Lego press kit from last year’s Toy Fair sold on eBay for $3,200 last week because it featured a pair of little figures from The Avengers.

All that serves to illustrate that Lego is a particularly desirable partner in the toy-licensing world, not only because kids like the product but also because Lego is very selective about who it chooses to sign deals with. Its partners tend to be major entertainment properties or movies with settings that fit into themes around which Lego designs its toys—usually both. With Disney’s forthcoming The Lone Ranger—the reunion of the original Pirates of the Caribbean team, producer Jerry Bruckheimer and director Gore Verbinski—Lego brand relations director Michael McNally says the company was looking for something in a cowboy outfit. “We look at how to rotate themes in, to have novelty and drive enthusiasm,” he says, “and we hadn’t expressed the Western theme for a while.”

The partnership is an impressive one, and exemplifies Lego’s clout not merely within the toy industry but in the entertainment world as a whole. Among the Ranger toys, there’s a little town with a burglable bank and a sheriff’s office, a full-blown train set (the envy of all AFOLs—adult fans of Lego), an elaborate silver mine and a stagecoach. Not all were originally slated to show up in theaters July 3. “The stagecoach is one of those vehicles…you just have to have one,” says McNally—even though the filmmakers hadn’t included one. What to do? Remember that licensing is a major concern for Disney. Its two Cars films each topped $2 billion in revenue from licensed merch alone, far exceeding box-office receipts. Lego submitted a stagecoach toy anyway, just to see what would happen. And Disney added a stagecoach in postproduction.

The Billund, Denmark-based maker of small plastic bricks recently became the world’s most valuable toy company at $15 billion, surpassing Mattel, which makes Barbie dolls, among other toys. Lego’s annual report put 2012 revenue at $4.09 billion, profits at $981 million. Lego is closely held by the family of founder Ole Kirk Christiansen; his grandson Kjeld Kirk Kristiansen is chairman of Kirkbi, which owns 75 percent of Lego Group. Kristiansen happens to be the richest man in Denmark. (In March, Forbes estimated his net worth at $7.3 billion.)

Lego got into the intellectual-property game late. The company has emphasized tradition and consistency over brand expansion and resisted creating licensed toys until 1999, at which point the game of slapping Batman on something to earn a cheap buck had become so common that there was a coffee-table book devoted to it. As Lucasfilm geared up for the release of The Phantom Menace, Lego began manufacturing toys based on the Star Wars franchise, which complemented its own spaceships and rockets. It also licensed a Winnie the Pooh line for its younger-targeted Duplo brand.

Lego built its library of licensed toys a few at a time, but that library is now composed solely of major names, many of them direct competitors known for negotiating hard over exclusivity. The company makes toys based on characters from both DC and Marvel comics, for example (which demand loyalty from Mattel and Hasbro, respectively), Nickelodeon and Disney, all under the same roof.

Essentially, brands have to prove to Lego that they’re worth the time and effort the toy maker must commit, laying out not just a product’s appeal to kids but also its appeal across borders. “It has to have global clout, which is very different from other partners in the industry,” explains Manuel Torres, svp of global toys for Nickelodeon. “[Others] will have a strategy for what they do domestically and another for what they do overseas. For Lego, you have to show that you have interest in Europe, that you have interest in the Americas—and then they’ll pursue a partnership.”

Toy partnerships tend to span years and demand breathtaking sums for licensors. Hasbro’s most recent agreement with Marvel, for example, goes across eight years, until 2017. It pays Marvel a base of $100 million, with a potential for $140 million more in royalties.

Lego owes some of its partners far less, according to a source with knowledge of Lego’s business dealings who declined to comment on the record. For one of Lego’s licensed lines, a recent two-year agreement guaranteed a base of less than $1.5 million, with royalties halved if a product is sold at one of Lego’s own retail stores. Across all its lines, licensing and royalty expenses came to about $263 million in 2012. Hasbro and Mattel each topped $400 million—though to be fair, their toy offerings encompass a much wider range. With the exception of a few line extensions like watches and flashlights, Lego stays close to home (more on that later).

“They are incredibly smart and strong managers of their brand,” says Karen McTier, evp of domestic licensing and worldwide marketing for Warner Bros. Consumer Products, which has several properties with Lego—Harry Potter, the DC Universe superheroes, The Hobbit and The Lord of the Rings movies. “The goal is to be in that Lego aisle or assortment no matter what other properties sit alongside you.”

If imitation is the sincerest form of flattery, then the toy industry has been throwing laurels at Lego’s feet since a crucial patent expired in 1983. Lego has argued in court, usually without success, that the “stud-and-tube” system of bricks constitutes a trademark, not just a patent. It has sued several companies, including the now-defunct toy maker Tyco Industries, Canada-based Mega Brands, and the Chinese company Tianjin Coko over its CoCo line (which Lego won). Such companies have even played off Lego’s popularity in their marketing, with Tyco ending every ad with the line “They work with Lego, too!” and Mega Brands’ Mega Bloks emphasizing that its bricks are “compatible with leading brands including Lego.” But among collectors and children alike, there is consensus: Lego bricks are just better made.

The manufacturing specs on a single plastic block are hyperspecific. The margin of error is an astonishing two microns, or 0.000079 inches (the average human hair is about 100 microns wide). Meanwhile, the plastic used is the same material from which car bumpers are made. The plastic is dyed, not painted, and the mix of ingredients is precise enough to make each brick extremely hard—as anyone who’s stepped on one can tell you.

But lawsuit or no lawsuit, expensive or cheap, plastic building blocks keep cropping up, often among rivals that see Lego’s (figurative) inflexibility and its position in the toy market as a threat. Mattel has licensed its crown jewel, Barbie, to Mega Bloks, which also holds licenses for video-game franchises Halo, World of Warcraft and Skylanders. Hasbro has twice tried to create construction toys, first in the early 2000s with a line called Built to Rule that focused principally on G.I. Joe and Transformers, and recently with Kre-O, toys that landed on shelves in fall 2011 with Joe and Transformer versions. Kre-O expanded this year to include the new Star Trek movie, a major coup. Hasbro says there are more external licenses to come but declined to identify them.

Construction toys “just seemed like an obvious next step for us,” says Kimberly Boyd, senior director of global marketing for Kre-O. Boyd says that Hasbro’s goal with this and other lines is to see its intellectual property realized in as many different versions as possible, and it wants to own all major iterations rather than licensing them out. “Our characters are really the spokespeople for the brand with the target consumer,” she says.

This is something like blasphemy to Lego. “We do not aspire to be an entertainment company,” declares McNally. “We are not one of these companies that says the path forward is to make entertainment.” But, mind you, Lego does make entertainment. Its cartoon Ninjago, produced by Copenhagen-based Wil Film, which Cartoon Network aired last year, was the highest-rated series on the net in 2012 among boys 2-11 and 6-11. Those are key Nielsen demos for the children’s market—particularly among toy sellers, since boys’ toys outsell girls’ toys by a wide margin. The season finale pulled in 3.3 million viewers—more than the season-to-date average for NBC’s Smash.

Even though it would appear Lego is well-positioned to become a fairly large entertainment company, McNally refuses to budge. Of Ninjago’s success, he says, “That is awesome, and it engages kids. But it does not mean we want to be an entertainment company.”

There’s a reason Lego does not see itself as an entertainment company—it tried and failed to do something similar about a decade ago. Under then-CEO Kjeld Kirk Kristiansen, it built theme parks, started a division to design video games (Lego’s popular, current line of licensed games is developed by Tt Games) and launched several varieties of toys to tap into existing trends.

The company nearly went under—one reason McNally’s job requires a delicate touch. “Licensing was one thing that…I don’t want to say was responsible for it, but there were properties that were translated into the Lego world that needed to have very specialized pieces to go along with them,” he says. “And one day, we turned around, and we had 7,500 different pieces in 70 different colors.” For a company that takes so much pride in refusing to skimp on the manufacturing end, that presented a serious problem in the supply chain. Kristiansen stepped down, and current CEO Jørgen Vig Knudstorp sold off the parks to Britain’s Merlin Entertainments Group before giving something on the order of the St. Crispin’s Day speech to his staff.

“He said, ‘I don’t believe that I’m tying your hands behind your back. You’ll still be able to make beautiful models—you’ll just have to find new ways to make them,’” McNally recalls. “At first it was, ‘Ugh, I can’t believe we can’t make those pieces,’ and then it became more, ‘Wait, how do we make it with the pieces we have?’”

That exhortation to build more creatively embodies the almost religious ethos permeating the toy company that doesn’t want to be an entertainment company. Lego has another show on Cartoon Network, Legends of Chima, featuring creatures from its new line of toys, which resemble other “play patterns” currently popular in the toy world—lines like Bakugan or Beyblade that have a gaming, point-scoring component as well as an action figure.

Playing with the similar Ninjago action figures, McNally says, was “a low-intensity building experience” designed for kids who are intimidated by a huge castle or a Star Destroyer. “It was about recruitment, and it worked, and that’s why we’re doing Chima.”

Recruitment?

“It’s really about getting as many kids as possible to build,” he says. “Every time a child engages in that, she’s learning really important life skills—she just doesn’t know it. It’s about patience and persistence, and trial and error, and at the end, she’s really proud of what she built.”

That is the central creed at Lego: Get kids to build things. And because many at the company truly believe that Lego products exist in the service of children, rather than the reverse, employee loyalty and quality control are more or less a given.

That is also what attracts Lego’s branding partners—who, in turn, attract the kids to building.

And that is how you build a successful toy business: block by block.