The "Hazzards" of Lego Investing

Bo and Luke Duke, the eponymous leads of the early 80's hit TV show The Dukes of Hazzard, were two rural Georgia “good ol’ boy” moonshiners that were always on the run from the show’s villain, Hazzard County Commissioner “Boss” Hogg. The show's story arc revolved around the efforts of Hogg and his sidekick, Roscoe P. Coltrane, to intimidate the Duke cousins into leaving them alone to hatch their nefarious, and often times illegal, schemes. Inevitably, Bo and Luke would wriggle out of Hogg’s grasp and thwart his plans, leaving “Boss” frustrated from another stunt gone awry.

Bo’s and Luke’s travails provide a humorous parallel to the recent plight of Lego resellers. While resellers aren’t doing anything illegal (like moonshining), and The Lego Company (TLC) isn’t nearly as bumbling or nefarious as the oft-thwarted Hogg, there seems to be an emerging “cat and mouse” game akin to our favorite 80’s show plots between TLC and Lego resellers. In the recent past, Lego has made a number of decisions that could have a profound effect on the secondary market, and they still have other options that could further alter the resale market. To date, the biggest red flag for investors should be Lego’s recent crackdown on resellers. In the past, TLC allowed wholesale buyers to resell sets in any manner they chose, and many enterprising folk used eBay, Bricklink, Amazon, and other online marketplaces to sell these sets. Some flipped these sets quickly for retail price, while others bought and held until EOL for larger profits. However, TLC recently decided to stop this practice by limiting sales to retailers with a brick and mortar retail store, and forcing every retailer to sell 75% of their sets. After instituting this policy, TLC has now begun to flag buyers that make high volume purchases from Lego S@H and The Lego Store, and halted sales to these perceived resellers. In a year, TLC has swung the pendulum hard against resellers, and there’s no reason to believe it will stop.

So, what else will TLC do to discourage reselling and make Bo's and Luke's life miserable? In simple terms, TLC can either try to limit demand, or increase supply. I have a hard time believing TLC would specifically ever try to limit demand of their own product, even in the secondary market, so their primary weapon is to alter supply. Other industries have found ways to accomplish this in a variety of ways that TLC could emulate, so here are some that may apply:

Re-releasing retired sets

While there is little precedent for this, it’s an option open to TLC and one they may be testing soon. Remember 7641 City Corner? It’s a set from the City theme that was released in 2009 and retired in 2011. It has enjoyed a profitable retirement, earning a nearly 85% ROI in a little under two years. According to Brickset.com, this set is scheduled to be released again soon under a new number, 60031. Everything else about the set appears to be the same: piece count, design and box all appear to be unchanged.

What will a re-release do to the secondary market value of an existing set? FCBarcelona and Grolim, BP members and bloggers extraordinaire, have already outlined the effect “remakes”, or models that underwent a makeover, have had on retired sets in this blog (look for any entries with “Remake”), and this post respectively. To paraphrase, remakes were found to decrease the value of retired sets, and in some cases significantly. By extrapolating that concept, and by using our own common sense, we can assume releasing the exact same set a second time would crater the secondary value of the existing set. If TLC decides to begin re-releasing more retired sets to discourage speculative hoarding, investors could be left holding sets for a lot longer than originally planned. Even the threat of a strategic re-release or two may discourage investors from hoarding. In this scenario, investing in licensed sets would likely become more popular since TLC wouldn't be able to re-release any set with a retired license.

Authorized Lego Reseller

TLC could also get into the secondary market game to control retired set pricing. If this sounds absurd, keep in mind that many US sports teams have opened sanctioned ticket reselling portals for their own event tickets to curb scalping problems. A secondary market platform run by TLC could provide Lego a second “bite at the apple” and effectively set retired prices, especially on the low end. This is probably an unrealistic option since resale isn’t part of their core business, and I doubt TLC would divert any effort or resources from their core competency. Yet, it still remains an option to TLC, and it would likely have disastrous consequences for hoarders.

Eliminate Exclusives

Another way to tamp down the secondary market is to eliminate “exclusives” and “limited edition” sets. These are sets with limited production runs and a history of strong secondary market returns. While this would be a radical departure from their marketing strategy and is highly unlikely to happen, it would likely weed out a large percentage of the highest earning EOL performers. TLC would likely lose a substantial portion of their adult fan base if they ever did this, so I doubt they would ever consider this an option.

Flood the Primary Market

Another bullet in TLC’s arsenal is to flood the primary market with their sets, yet the severe negative consequences for TLC’s products and retail partners make this tactic less probable than any of the previous options. While this tactic would primarily affect hoarders, the resultant decrease in price from a flood of new sets could be a boon to flippers who sell in higher volumes for smaller margins. Imagine the falling prices on Amazon if TLC doubled production! I don’t believe TLC would enact any policy that would benefit one group of resellers at the expense of another group, and I know they would never knowingly reduce the perceived value of the Lego product line by increasing supply of their sets. This will not happen either.

Right of First Refusal

In the timeshare industry, timeshare and vacation club companies that sell properties often times add Rights of First Refusal into their contracts with new timeshare owners. This clauses forces ANY owner of the timeshare that wants to sell the property to give the timeshare/vacation club operator “first dibs” on buying the property from the seller, and allows the timeshare/vacation club operator to set the price for their resale properties. While this option is logistically impossible for TLC and their near-commodity products, it’s illustrative of another option a company has to set or control the price of their resale merchandise.

While TLC may be emerging as a primary threat to resellers, there are still other hazards that face Lego investors today. These threats are all derived from either an increase in market supply, or a drop in market demand.

While it’s been well chronicled in past blog articles, a speculative bubble always remains a possibility. However, it's important to define exactly what a speculative bubble is so that Brickpickers understand its risk. A speculative bubble, by definition, occurs when the value of a product greatly exceeds its “intrinsic value”. This increase in value can be fueled by speculation, by the presence of monetary liquidity in the market, or both. While “intrinsic value” is an abstract term, it’s easy to estimate it. Since a Lego set is nothing more than the sum of its parts, its “intrinsic value” is the part-out price. A quick look at Bricklink.com shows investors the value of a parted-out Lego set based upon sold prices of these pieces. Without reviewing every Lego set’s part-out price, a quick glance shows that many sets never perform as well as their part-out value. Until a large percentage of just-retired Lego sets are selling for significantly higher prices than their part-out value, there will not be a speculative bubble for Lego as a whole. That doesn’t mean a bubble will NEVER happen, so check the part-out values of your preferred investment themes sporadically to see if you notice a divergence between Brickpicker's value and the part out value.

Another potential threat to the Lego secondary market is the refinement of 3d printing. BP member Yellow eloquently outlined concerns from 3D printing here, yet I believe that 3D printing’s physical constraints make copying Lego bricks nearly impossible, especially in the next 5-10 years. Lego uses ultra-precise injection molding with tolerances that are many factors tighter than current 3D printing can provide. Without meeting these tolerances, 3D printed bricks will not bite or grab like an injection-molded brick, rendering these copies useless to Lego fans.

Finally, if the demand for a product in any market erodes, both the primary and secondary market prices will suffer, and previously realized ROIs will erode in step. In our case, this actually can be roughly verified by reviewing sales figures from TLC’s annual report. While it doesn’t specify a split between theme sales, you can monitor yearly sales figures and read the notes to get TLC’s opinion on why sales have reacted accordingly. Fortunately, TLC appears to be successfully designing new product lines, opening new licenses, and exploring new distribution channels for its brand, so any demand erosion would have to come from an external market shock which is nearly impossible to predict.

The Lego secondary market is not foolproof, and it’s not riskless. Threats to this market will always emerge, so it’s incumbent on the savvy investor to continuously monitor the market for clues to where it’s going. Savvy investors, much like Bo and Luke, will continue to escape "Boss" Hogg, and make money!

As always, invest accordingly.