You are on page 1of 8

This paper is analyzing whether it was a good decision for LEGO to outsource

its distribution to DHL, by means of three theories: the Transaction Cost Theory,
Resource-Based Theory, and Evolutionary Theory. Furthermore, a recommendation is
given what LEGO should do next: stick to the original plan and outsource all the
distribution to DHL or keep three distribution centers (one operated by DHL and two
by LEGO).
One of the main thoughts of the Transaction Cost Theory (TCT) is that firms
exist because the costs of organizing transactions internal are sometimes lower than
the costs of using the market for transactions (Coase, 1937; Williamson, 1975, 1989).
Two important assumptions are made within the TCT: (1) bounded rationality (e.g.
incomplete contracts) and (2) some people are opportunistic (self-interest seeking
with guile). There is a distinction between vertical integration/insourcing
(internalized transactions, executing the production of own inputs) and vertical
disintegration/outsourcing (rejecting the internalization of an activity, Gilley &
Rasheed, 2000, p. 764). Three dimensions determine the transaction costs when
deciding on outsourcing: (1) uncertainty/complexity, (2) asset specificity and (3)
transaction frequency (Langfield-Smith & Smith, 2003). If the transaction costs are
high for those three dimensions, it is better to internalize the transactions. Translating
this to the situation of LEGO, low transaction costs mean that is was a good decision
to outsource the distribution processes to DHL.
First of all, the transaction costs are higher for a transaction with the external
organization (DHL) because of uncertainty/complexity: high bounded rationality (a
DC on such a scale had never been built before in Czech Republic, Cordon & Seifert,
2009, p. 6) and the plan of changing its customer ordering processes (not all specific
customer requirements were known at that time, Cordon & Seifert, 2009). Second, the

transaction costs are lower for a transaction with DHL because of asset specificity
(LEGO has room to be opportunistic, because of the vulnerable position of DHL
caused by the asset specific investment of DHL in the new DC) and low frequency of
transactions (long-term contract of 5.5 years). However, there is no room for
improvement or discussion during the long-term contract, which makes the contract
slightly more risky due to the impossibility to adapt the contract to a dynamic
environment. Overall, the decision to outsource the distribution processes is supported
by the TCT, because the transaction costs are slightly lower for outsourcing.
The main thought of the Resource-Based View (RBV) is that a company
should obtain resources and capabilities with specific characteristics (VRIN) that
enable firms to achieve superior performance, which creates sustained competitive
advantage (SCA)(Barney, 1991; Grant, 1991). Concerning outsourcing, the RBV
suggests that a company should obtain this resource or capability from outside, if a
company does not have the resources or capabilities itself, because investing in their
creation will not lead to any SCA (Gilley & Rasheed, 2000). Additionally, as stated by
Prahalad and Hamel (1990) regarding the concept of core competences, a firm should
continuously invest in those activities that are part of its core competence while
outsourcing the rest. From this point of view, outsourcing has a positive influence on
firm performance in three ways: (1) by outsourcing peripheral (non-core) activities,
firms can focus on their core competences; (2) outsourcing peripheral activities may
greatly improve the quality of those activities, because the activity is the core
competence of the outsourcer; (3) outsourcing peripheral activities to the lowest-cost
suppliers may lead to incremental improvements in a firms overall cost position
(Gilley & Rasheed, 2000).

When applying this to the LEGO-case, it can be concluded that it was a good
decision for LEGO to outsource their distribution activities to DHL. According to the
RBV, LEGO did not have the resources and capabilities to superiorly perform the
distribution activities itself. LEGO did invest in the development of resources and
capabilities to execute the distribution activities successfully, however, LEGO did not
manage to effectively execute this process. Instead it became a highly complex and
costly activity. Additionally, looking at the core competences of LEGO it can be
deduced that outsourcing enhances performance since (1) LEGO can now focus on
their core competence of selling creative toy-products in competitive and highly
seasonal marketplace (Cordon & Seifert, 2009), rather than focusing on the
distribution processes which is categorized as a non-core activity; (2) the quality of
the distribution process is expected to improve when DHL takes over the distribution
process, since DHL has specialized knowledge regarding this activity; (3) the cost
position of LEGO is also expected to improve when they outsource the distribution
process to DHL, considering distribution processes are the core competence of DHL
and therefore can operate more efficient. In conclusion, based on the above arguments
regarding the RBV and the core competences, it can be concluded that at that moment
in time, it was a good decision to outsource the distribution processes of LEGO to
DHL.
The evolutionary theory (ET) provides the core of a process theory of an
economic organization (Mahnke, 2001). ET yields important insight relevant to the
process of outsourcing (Mahnke, 2001). The ET is emphasizing (continuous) growth,
rather than economic profit. A dynamic competitive advantage is created through
favorable learning asymmetries, where it is outperforming its competitors regarding
the generation of variations in its activities (variation), aligning internal choices with

external selection criteria in order to make sure the firms output is in line with
customer needs (selection), and where it can reliably reproduce successful activities
across time and space (retention) (Stoelhorst & Bridoux, 2015).
Analyzing the LEGO case from an ET perspective, one can conclude that it
has been a good decision to outsource distribution. First, although the ET suggests
that the learning cycles LEGO will experience regarding distribution will decline
drastically when deciding to outsource, since the outsourcer will be executing the
VSR-cycles and is acquiring new knowledge regarding effective and efficient
distribution processes, this vertical dis-integration as well will extend the firms
boundaries in order identify (new) possibilities to improve or enhance its current
processes through collective action patterns (Nelson and Winter, 1982). Second, the
ability of LEGO to eventually reintegrate the distribution processes in-house will
become less and less likely, due to the growing distance from its core competences
(risk of losing its capability). However, distribution is not categorized as one of
LEGOs core competences, and therefore emphasizing on peripheral outsourcing will
grant LEGO with the opportunity to more extensively emphasize on the development
of its core activities (Gilley & Rasheed, 2000). In other words, LEGOs decision to
outsource their non-core distribution processes are providing them with the
opportunity to emphasize productive learning within the processes that are
categorized as core activities. Thirdly, according to Domberger (1998), another
reasoning for outsourcing is that external specialists are likely to be better capable of
flexibly and quickly adapting to the changing environmental circumstances, resulting
in more alignment. And lastly, the risk of (knowledge) spillover is also minimized
since DHL is not dealing with one of LEGOs core competences and also does not
have any linkages with other core processes of LEGO. One threat LEGO will be

confronted with is that outsourcing the distribution processes increases the risk that
the distance between the know-how of LEGO and the know-how of DHL will
continue to disperse, which increases the difficulty for LEGO to assess the value
delivered by DHL.

What should LEGO do next?


In order to advise LEGO on whether to continue outsourcing all the
distribution to DHL or to keep the other two DCs for the company itself, the
advantages and disadvantages of previously mentioned contributions are to be
summarized first. According to the RBV perspective, an organization should
outsource its activities, when they are not considered as core activities. Since
distribution is not considered as core, this peripheral outsourcing will grant LEGO the
opportunity to emphasize its core business. Furthermore, LEGO is showing to be
dysfunctional when it comes to their distribution processes which already implies that
outsourcing is rather a solution towards efficiency, due to the specialized knowledge
DHL will bring along.
On the other hand, considering the ET, there might be disadvantages in terms
of differences in know-how between the different firms and decreasing learning
processes of LEGO, which might cause difficulty for LEGO to assess performances
of DHL. However, since DHL is not dealing with any core competences of LEGO,
this risk of learning decrease is minimized. Next to that, DHL will enhance its
productive learning, and therefore increase its efficiency, which in turn will lead to a
cost reduction for LEGO.
Moreover, considering the TCT, the situation became very complex/uncertain
(e.g. changed delivery process, cultural clash, etc.), which led to a very low

perception of fairness and high fairness-response transaction costs (Husted & Folger,
2004). Transaction costs increased, but can be lowered by drawing up a complete
contract and improving the interactional justice. Furthermore, the TCT is not taking
into account the production costs. As mentioned above, the production costs will get
lower when continuing outsourcing due to the continuous learning of DHL.
Therefore, it is suggested that LEGO should indeed stick to its original plan
and outsource all the distribution to DHL. Yet, it is to be pointed out that the contracts
need to fully specify what the parties expect from each other, in terms of the logistics,
delivery, and further investments as well. Also importantly, better conflict resolution
and communication need to be visible, improving the relationship and building trust
and goodwill.

References
Barney, J.B. 1991. Firm resources and sustained competitive advantage. Journal of
Management, 17: 99120.
Coase, R. H. (1937). The nature of the firm. Economica, 4(16), 386-405.
Cordon, C., & Seifert, R. W. (2009). Lego: Consolidating Distribution (A).
International
Institute for Management Development, 1-14.
Domberger, S.: 1998, The Contracting Organization (OUP). Oxford
Gilley, K.M., and Rasheed, A. (2000). Making more by doing less: An analysis of
outsourcing and its effects on firm performance. Journal of Management, 26
(4). pp.
763-790.

Grant, R.M. 1991. The resource-based theory of competitive advantage: Implications


for
strategy formulation. California Management Review, 33 (3): 114135.
Husted, B.W., and Folger, R. (2000). Fairness and transaction costs: the contribution
of
organizational justice theory to an integrative model of economic organization.
Organization Science, 15(6), 719-729.
Langfield-Smith, K., and Smith, D. (2002). Management control systems and trust in
outsourcing relationships. Management Accounting Research, 14, 281-307.
Mahnke, V. (2001). The process of vertical dis-Integration: an evolutionary
perspective on
outsourcing. Journal of Management and Governance, 5, 353-379.
Nelson, R. & Winter, S. (1982). An evolutionary theory of economic change.
Cambridge,
MA: The Belknap Press
Noteboom, B. (2004). Governance and competence: how can they be combined?
Journal of Economics, 28, 505-525.
Prahalad, C.K., & Hamel, G. 1990. The core competence of the corporation. Harvard
Business Review, 68(3): 7993.
Stoelhorst, J.W. and Bridoux, F. (2015). An evolutionary resource-based theory of
competitive advantage. Working Paper.
Williamson, O. E. (1975). Markets and hierarchies. New York, 26-30.
Williamson, O. E. (1989). Transaction cost economics. Handbook of Industrial
Organization,
1, 135-182.