Lego & DHL: The Logistics Nightmare

Lego & DHL: The Logistics Nightmare Sam Barclay, Alex Davidson May 6th, 2014 MKTG 210 1108598, 1108208  Executive Summary This report provides an analysis and evaluation on Lego’s logistics and supply chain set up both pre and post DHL. Prior to DHL’s involvement, Lego had several problems in its supply chain, including too many suppliers, transport providers, and fixed assets. After Lego’s near bankruptcy, DHL became Lego’s main logistics provider when it started its operations at the new central distribution center in Jirny. In Jirny, various issues arose from a lack of communication, mistrust and miscalculations. These issues tarnished the relationship between the two parties. Lego was in trouble and it needed to find a solution. After an analysis of Lego’s various options we believe Lego should continue with the original decision to centralize its distribution with DHL. However, they must make the necessary adjustments to successfully integrate this change. These include rewriting all or parts of the contract, implementing safety procedures and creating an environment that encourages communication and trust in a relationally based alliance. This will ensure Lego can continue to deliver the toys the world has grown to love. Table of Contents 1. Problems Before Outsourcing 4 2. Addressing The Problems 4 3. Consolidating Into Chaos 5 4. A Destructive Relationship 6 5. Selecting The Right 3PL 6 6. Evaluating the Options 7 6.1. Continuing With The Planned Proposal 7 6.2. Keeping Three DCs 8 6.3. Taking Over From DHL 8 6.4. Finding a New Partner 8 7. Determining the Proposal for the Future 8 Problems Before Outsourcing Lego had many problems in its supply chain before it outsourced to DHL. Some of the most significant problems were the large number of suppliers, selling in the wrong business-to-business (B2B) segment and the large number of fixed assets and transport services. According to Oliver, Samakh & Heckman (2007), Lego had over 11,000 suppliers. This was because product developers were empowered to create their own relationships in order to get the new materials for their new, innovative products. Too many suppliers created more volatile prices for raw materials and added to complexities. These independent relationships also created a large amount of waste because product developers would often not use all the material ordered. Overall, this made Lego powerless to leverage its scale with suppliers (Oliver, Samakh & Heckman, 2007). Oliver et al. (2007) explains that Lego was in the wrong B2B segment because it was selling custom orders to small retailers, which meant 67% of deliveries weren’t full cartons. This created unnecessarily high per unit transport costs and labour intensive ‘pick-packing’ (Oliver et al, 2007). The segment also required immediate or next day delivery, which didn’t help the poor on-time delivery rate of 62% that subsequently broke down Lego’s B2B relationship (WeMan, Cordon & Seifert, 2009; Wilson, 2014b). According to WeMan et al (2009), Lego had too many fixed assets and transport services. It had eleven different warehouses and distribution centers (DCs) throughout Europe, which had an average capacity utilization of 70%. There were also over 55 transport services. Together, this would have contributed to the unnecessarily high costs and complexities in the supply chain. (WeMan et al, 2009). Addressing The Problems To truly understand the problems in the supply chain there needed to be some form of visibility for management. The ‘war room’ provided this visibility through charts, data and other information (WeMan et al, 2009). Now management could see these problems and address them as needed. Oliver et al. (2007) explains that Lego reduced its suppliers significantly to stabilize the volatile prices and reduce complexities. This required product designers to follow strict rules and requirements that ensured more existing materials (instead of new materials) were used to create new products (Oliver et al, 2007). This is an example of a centralized policy because product designers were no longer empowered to make local level decisions, but instead required to follow a single ‘voice’ in order to reduce costs, enhance visibility and create greater volume leverage in the supply chain (Wilson, 2014a). According to Oliver et al. (2007), Lego realigned its logistics services towards a new B2B segment that focused on larger retailers. This would have reduced Legos per unit transport costs because cube utilization in truckloads was no longer incomplete (Cooke, 2009). It also reduced the need for labour intensive ‘pick-packing’, further reducing costs (Oliver et al, 2007). WeMan et al. (2009) explains that in this new segment Nielsen discovered differences in delivery sensitivity. Larger retailers preferred less frequent, larger orders that were made two months in advance if it meant they were more likely to be on time. Under these new delivery sensitive requirements, Lego would have been able to improve its 62% on-time delivery rate because there was now less pressure to meet the immediate or next day delivery requirement (WeMan et al, 2009). This would strengthen the B2B relationship (Wilson, 2014b). Lego needed to become ‘asset-light’ so it sold and outsourced several fixed assets, including the mold-making factory and its four LEGOLAND theme parks (WeMan et al, 2009; Nielsen & Budik, 2009). Lego then planned to consolidate its 10 different European logistics operations into one. This would make inventory easier to track, reduce stock shortages and decrease the average distance to the company’s largest markets (Oliver et al, 2007; Nielson, 2009). The running of the multi-client central DC was to be operated under the third-party logistics provider (3PL), DHL (WeMan et al, 2009). This would improve Lego’s capacity utilization because DHL could balance its available capacity with other customers (Cooke, 2009). DHL was also required to run Lego’s transport function to reduce transport services for greater economies of scale. It ended up reducing transport providers to 7, which created transport cost savings of 10% (WeMan et al, 2009; Oliver et al, 2007). Consolidating Into Chaos Consolidating to the central DC was expected to solve a lot of problems in Lego’s supply chain, but little did they know it would also create new ones. Some of these new problems included a lack of trained staff, an unreliable I.T. system and inadequate warehouse capacity. WeMan et al. (2009) explains that DHL didn’t have nearly enough trained employees to operate a DC of this size. After signing the contract, DHL estimated that it would need 180 full-time employees for 2006, a figure that it could easily meet. However, the reality was closer to 500. This meant DHL had to quickly hire a temporary workforce, which took longer than expected. Issues continued when most of the workforce couldn’t understand English operated equipment and systems, so they had to be trained on how to operate these (WeMan et al, 2009). The numerous delays and additional training would have led to extra, unplanned costs for DHL, which contributed to the establishment of its poor relationship with Lego. According to WeMan et al. (2009) another problem during this consolidation phase was that DHL did not have an I.T. system capable of handling the volume of transactions and the many different rules for customer delivery. As a result, the system stopped working several times, which led them to hire even more workers to do the machine’s job, thus adding to DHL’s costs (WeMan et al, 2009). For this to happen, Lego must not have established clear enough service and performance expectations during the implementation process of the outsourcing framework. Had it done so earlier, DHL may have been able to modify their system to handle these higher volumes and rules (Wilson, 2014c). WeMan et al. (2009) explains that the packaging of finished Lego sets was changed to a new design, which reduced the quantity on each pallet by nearly 20%. As well as this, to mitigate the relocation of some production (that was outsourced to a contract manufacturer around the same time), production was increased temporarily. This meant that the DC, which could only hold 76,000 pallets, had to somehow hold 155,000 pallets, a problem that caused Lego to find additional, unplanned storage space that would have created additional costs (WeMan et al, 2009). All the costs associated with these problems were initially taken by DHL, but Møller Nielsen knew that eventually Lego would have to bear some of them (WeMan et al, 2009). Therefore, DHL’s problems ended up always becoming Lego’s problems as well. So why were things falling apart? According to WeMan et al. (2009), DHL and Lego were both inexperienced with the size of the operation. Both were going forward with no true understanding or experience of the issues that could arise (WeMan et al, 2009). The fact that DHL was such a large 3PL meant that it would have been difficult to negotiate terms (Wilson, 2014c). Perhaps this is why there were so many disagreements over the contract. There was little trust between Lego and DHL. For example, DHL didn’t trust Lego’s quote for the DC’s number of full-time employees and as a result it suffered (WeMan et al, 2009). There was also limited information sharing and a lack of communication. For example, Lego didn’t communicate the package size change to DHL and, as a result, DHL ran out of room in the DC (WeMan et al, 2009). Wilson (2014c) presents the fact that things began to fall apart because there was an arms-length relationship. This involved self-interest, opportunism, limited information sharing, and independence. The parties needed a relationally based alliance under which information sharing, interdependence, integrated decision-making and mutual interest would all occur to ensure a long-term, win-win relationship (Wilson, 2014c). A Destructive Relationship It was obvious that Lego’s relationship with DHL had not gone to plan because the contract was executed under this arms-length relationship (Wilson, 2014c). WeMan et al. (2009) explains that DHL blamed Lego for failing communicate and making the contract too difficult to understand. Lego blamed DHL for failing to accept responsibility and not delivering on what it had promised. This created mistrust in the relationship illustrated when Lego brought some of its own workers into the DC to do DHL’s job. The relationship was breaking and it was heading in a direction that would suggest it was to end. The main problem was that neither party trusted each other on the basis of a complex contract that DHL could not properly comprehend (WeMan et al, 2009). Selecting The Right 3PL There are several considerations that need to be addressed when selecting and working with a 3PL. Wilson (2006) discusses the importance of collaborative behaviours in the relationship. Common objectives, goals and conflict resolution procedures are needed, so both parties can effectively achieve their aims. It’s important to have constant communication and information sharing through Electronic Data Exchange and Information and Communication Technologies. There also needs to be a relational commitment through “the establishment of trust and commitment, relational and social norms” (Wilson, 2006). For these aspects to be accomplished, they need to be reflected in the terms of the contract. According to Bury (2004), the business should independently work out the 3PL’s capabilities before selecting it. If the business selects a 3PL that cannot handle the operation it will create new problems, as shown in Lego’s case. Firstly, determine whether the 3PL can handle the client’s activity surges. Does it have the required labour available to manage these surges? If the 3PL is required for global operations it must have experience in this area as issues could surface when crossing borders. More often than not businesses want a 3PL with a complete logistics solution. If several logistics functions are operated under one 3PL, costs are reduced, the supply chain is simplified and there is clearer visibility. The client also needs to consider the 3PL’s technology. Does it have the technology to pack, bar code and deliver in the way the client wants them to? The 3PL needs to be competent in managing change. If a new software or product line is introduced will the 3PL be able to quickly implement these changes in order to meet the end consumers needs? The size of the 3PL should match the size of the client. A large client needs a 3PL that has relatively more employees, space and other resources to sufficiently operate alongside it (Bury, 2004) According to Wilson (2014c), it’s important that the 3PL is financially sound, the costs of the services are detailed enough and the payment structure is sufficient. Businesses also want 3PL’s that provide not just the basic services, but also some additional services (e.g. cross docking) to add more value to its supply chain and therefore, increase its competitiveness in the market (Wilson, 2014c). Although it’s easy for a 3PL to tell its clients what it can offer, management can confirm this by obtaining customer references (Wilson, 2014c). Selecting the right 3PL needs to be done on the first attempt because it’s very costly to change a relationship once it has started (Bury, 2004). In the end, clients want to be able to stand back and see their logistics activities being handled more efficiently and effectively with a 3PL than if they were doing it themselves (Sweeney, 2007). Evaluating the Options Continuing With The Planned Proposal If Møller Nielson follows through with the decision to have a centralized DC operated by DHL there will be many advantages and disadvantages. The advantages of a central DC are less handling of inventory, fewer stock shortages, improved product tracking and reduced average transport times, which reduces costs and improves customer service (Cooke, 2009; Nielson, 2009). According to Wilson (2014c), the advantages of DHL operating the DC are savings in time and money (associated with the particular logistics functions), flexibility, scalability and access to specialist expertise. DHL would also be able to continuously optimize its logistics activities through technology and software updates to ensure efficient and effective inventory management, advanced reporting and visibility (Wilson, 2014c). There are also some disadvantages with this option. Having this central location means that if there is a disaster (e.g. fire) at the DC it could have a catastrophic effect on the company, destroying a large proportion of its finished goods (Nielsen & Budik, 2009). Also, with DHL as the 3PL, Lego would lose its flexibility and control over the logistics functions, which means it may be less capable of responding to challenges that may arise (Selviaridis, Spring, Profillidis, & Botzoris, 2008; Murphy & Wood, 2010). There is also the chance that, if not resolved, the arguments and mistrust could continue, which would lead to ongoing problems. Keeping Three DCs The second option is to stop the transfers and keep the remaining three DC’s. This will provide Lego with more available capacity to meet the higher inventory levels in the short-term. It will also remove the additional delays expected from putting everything into the central DC, thus allowing Lego to get back to focusing on the normal day-to-day operations more quickly. The disadvantages of this option are the additional complexities that come from having to operate three DC’s instead of just one. There is more difficulty in directly focusing on each individual service if they occur in multiple DC’s and there is also the requirement to train multiple workforces for each DC (Cooke, 2009). Taking Over From DHL Another option could be to terminate the contract with DHL and have Lego take over the central DC’s management. Although this would give Lego more flexibility in its decision-making and stop the arguments and disputes that waste valuable time, it would be an option outweighed by disadvantages. In stopping the contract immediately with DHL, Lego would lose its specialist expertise and experience in regard to the operations of the DC. Lego would then have to solve its problems again on its own, something they weren’t capable of doing in the years immediately prior to contracting DHL. New issues would arise with regard to hiring new staff and transportation services, and overall costs will rise again. Finding a New Partner The final alternative would be to find a new partner to take over DHL’s role completely. The only real advantage is that it would stop the arguments and misunderstandings between Lego and DHL, which have slowed their operations. But who’s to say that the new partner won’t create a relationship just as bad and therefore, develop the same problems? That is assuming that a 3PL would be willing and able to work with them, after all they didn’t exactly prove that they were a good company to work with. Finding another partner would take a significant amount of time because Lego would need the 3PL to meet its selection criteria of which has proven to be very critical. There would need to be additional time taken to then train the new workforce if an adequate 3PL is found. This is extra time and costs Lego would not be able to bear, given the scale of their problems already. Determining the Proposal for the Future After weighing up the advantages and disadvantages of each option, it’s clear for us that the first option, to continue with the original plan, is the best one for Lego. This is because it has the most advantages and the disadvantages can be minimized to a greater extent than any other option. To minimize these disadvantages Lego will need to put contingency measures in place to reduce losses in not only stock, but also employees (Cooke, 2009). There has to be clear evacuation procedures and emergency systems in place, e.g. evacuation to the car park and automated sprinklers to minimize the affects of a fire. Lego and DHL also need to rewrite all or parts of the contract so there are clear service level agreements that both parties can agree on (Wilson, 2014c). There needs to be more trust and communication between the two parties in a relationally based alliance. Lego should also employ a performance evaluation framework with DHL in order to regularly monitor their operations (Wilson, 2014c). Overall, if Møller Nielson follows through with his original decision to centralize Lego’s distribution with DHL and makes the necessary changes to successfully integrate this change, Lego will be able to go back to focusing on their core competencies of product quality and innovation under their motto “Only the best is good enough” (Selviaridis et al, 2008; Oliver et al, 2007). References Bury, S. (2004). Selecting a 3PL that's right for you. Materials Management and Distribution, 49(1), 2-A4,A8. Cooke, J. (2009). LEGO’s game-changing move. Retrieved from http://www.supplychainquarterly.com/archives/2009/03/ Murphy, P., Wood, D. (2010). Contemporary Logistics (10th ed.). Upper Saddle River, NJ: Prentice Hall. Nielsen, E. M., & Budik, F. (2009). BRICKS STACK UP FOR LEGO. Supply Chain Europe, 18(1), 28-29. Oliver, K., Samakh, E., & Heckman, P. (2007). Rebuilding Lego, Brick by Brick. Strategy & Business, 1(48). Selviaridis, K., Spring, M., Profillidis, V., & Botzoris, G. (2008). Benefits, risks, selection criteria and success factors for third-party logistics services. Maritime Economics & Logistics, 10(4), 380-392. Sweeney, E. (2007). Perspectives on Supply Chain Management & Logistics. Dublin, Ireland: Blackhall Publishing. WeMan, E, Cordon, C, & Seifert, R W. (2009). LEGO: Consolidating Distribution. IMD No. 6-0316. Lausanne, Switzerland: IMD Publishing. Wilson, M. J. (2006). SUPPLY CHAINS BEHAVING BADLY: A DYNAMIC MODEL OF INTER_ORGANISATIONAL SUPPLY CHAIN EXCHANGE BEHAVIOUR UNDER RATIONAL, RELATIONAL AND CHAOTIC PARADIGMS. (Published doctoral thesis). Lincoln University, Lincoln, New Zealand. Wilson, M. (2014a). Lecture 18: Operational Design in Logistics [PowerPoint slides]. [Available from Lincoln University Learn@Lincoln MKTG 210 Web site]. Wilson, M. (2014b). Lecture 19: Building External Relationships [PowerPoint slides]. [Available from Lincoln University Learn@Lincoln MKTG 210 Web site]. Wilson, M. (2014c). Lecture 20: Logistics Service Providers [PowerPoint slides]. [Available from Lincoln University Learn@Lincoln MKTG 210 Web site]. Running Head: Lego Distribution Centre Lego Distribution Centre 2 9 10 10