For most of its history, LEGO seemed immune to crises. Founded in 1932 in a small workshop in Billund, Denmark, the company built its leadership around a simple idea: plastic pieces that fit together, regardless of when they were purchased. That compatibility, patented in 1958, was almost magical for any parent—the grandmother’s bricks could still be used with her grandchild’s.

But by the late 1990s, something had broken. And what LEGO did to emerge from that crisis has a specific name in corporate strategy theory: it was not a story of innovation, but a story of strategic retrenchment and portfolio rationalization.

The Diagnosis: When the Symptom Is Mistaken for the Cause

Every strategic diagnosis begins with an uncomfortable question: Is the problem really what we think it is?

In the late 1990s, LEGO reported losses for the first time in its history, and management’s initial interpretation was straightforward: children were losing interest in traditional toys, attracted by the rise of video games.

That interpretation was partially correct, but diagnostically insufficient. A complete strategic diagnosis does not stop at the most visible symptom; it requires separating the decline in sales—the effect—from its structural causes: where and why value was being destroyed within the portfolio itself.

The Wrong Formulation: Unrelated Diversification

With this incomplete diagnosis, LEGO pursued a strategy of unrelated diversification: in theory, growing by taking the brand into categories increasingly distant from its core business.

The response was an aggressive expansion into clothing, books, magazines, theme parks, and television programs, moving further and further away from the product that had made the company successful.

The result was a level of portfolio complexity that the organization could not operationally sustain. By the early 2000s, LEGO was facing severe losses, declining sales, and mounting debt.

This is a recognizable pattern in corporate strategy: when a company diversifies without a clear logic of synergy or distinctive capabilities, every new business line does not simply compete for resources with the core business—it dilutes it.

The Turning Point: Governance Before Strategy

Before reformulating its strategy, LEGO had to address a governance issue.

In 2004, Kjeld Kirk Kristiansen—grandson of the founder and then CEO—stepped down and handed leadership to an executive from outside the family, Jørgen Vig Knudstorp.

It is an important reminder: in many cases, executing the right strategy first depends on resolving who has the authority—and the emotional distance—to make difficult decisions.

The Reformulation: Strategic Retrenchment and a Return to the Core

The new leadership did not arrive with a promise of more innovation. It arrived with a promise of discipline—what strategy calls retrenchment: deliberately reducing the scope of the business to concentrate resources where a real competitive advantage exists.

The first moves were direct: reduce costs, sell the LEGOLAND parks, bring production capabilities back under greater control, and reduce the workforce. The LEGOLAND parks were sold to Merlin Entertainments in 2005 as part of the turnaround.

But retrenchment did not mean abandoning growth. It meant rationalizing the portfolio.

Instead of measuring success by how many new products were launched, the organization began focusing on which products generated real margins—and systematically discontinuing those that did not.

The strategy combined financial discipline, portfolio simplification, and a deeper reconnection with the brand’s fan community—an asset the company had neglected while pursuing external licenses.

Execution: Integrating Without Losing Identity

A common mistake when retrenching is interpreting “simplification” as “rejecting anything new.”

LEGO avoided that trap.

Rather than competing against video games by ignoring them, the company integrated new forms of entertainment without abandoning its core identity: applications, video games featuring LEGO characters, animated content—and always the physical brick as the non-negotiable core of the business.

Partnerships with brands such as Star Wars and Harry Potter, which could have contributed to excessive diversification, became powerful sales drivers when executed within a disciplined portfolio.

This is the difference between poorly executed and well-executed diversification: success is not determined by the presence of partnerships or new business lines, but by whether there is a portfolio architecture capable of sustaining them.

The Result

In less than a decade, LEGO went from being on the brink of bankruptcy to becoming one of the world’s most profitable and valuable toy companies. Its turnaround was driven by a renewed focus on the core brick and LEGO System in Play, alongside cost discipline and portfolio simplification.

The Lesson for Any Company

The LEGO case is not really a story about toys.

It is a demonstration that growth and diversification are not synonymous with good strategy—and that, in times of crisis, the most valuable question is not always:

“What else can we do?”

Sometimes it is:

“What should we stop doing?”

Diagnose accurately. Formulate with discipline. Execute without losing identity.

That is precisely the process we at bac&asociados call Strategic Transformation—a methodology that moves sequentially from strategy formulation to execution, because each stage requires a different focus and different tools.

Is Your Company Growing—or Just Adding Complexity?

At bac&asociados, we help companies diagnose the difference and build the roadmap to address it.

Let’s talk about your strategy.