By Yuxin Gao
The pre-teens building robots with Legos at the Jacob Javits Convention Center last weekend probably weren’t thinking about oil prices. But whether they knew it or not, the teams of primary and middle school students competing in a city-wide Lego robotics competition were working with oil.
The Lego kits they used to build and program their robots contain motors, sensors and 610 Lego bricks, which are completely made of ABS, a medium-strength heat-resistant plastic processed with crude oil. Each kit sells for $350.
For toy manufacturers, the falling price of oil should have been a major advantage. However, the toy industry reveals that even the companies that depend most on plastics, such as Lego, have reaped only minimal benefits from oil’s plunge.
The oil price has dropped by two-thirds since mid-2014, and over 90 percent of toy products—plastics, nylon and others—are made of crude oil derivatives. But Lego had only a small amount of cost savings last year; its gross margin grew 0.8 percent, even lower than its 1 percent growth in 2014. Mattel, manufacturer of Barbie and Transformers, even saw its gross margin slightly decrease, because it had greater losses from exchanging foreign currency for dollars than it saved from the costs.
The toy industry’s struggles show how the advantages of low oil prices have been more limited than expected, because the price of plastics doesn’t always drop when oil does.
Data source: FRED ; Chart: Yuxin Gao
“There is definitely a lag time,” said Kent Furst, a senior polymers and materials analyst at Freedonia Group, in an email. Since mid-2014, crude oil has dropped 70 percent from the original price, but plastics dropped only about 10 percent in the same period, said Furst.
The price of plastics hasn’t come down as much as crude oil because the market wants more plastics than producers can supply.
“As long as there is a tight supply-demand balance, as is the case for many plastic resins right now,” said Furst, “producers will be able to keep prices relatively high and reap increased profit margins from the low oil price.”
That suggests that the low oil price has benefited plastic producers more than toy manufacturers.
Eventually the price of plastics will likely fall along with oil. Even then, however, analysts believe toy manufacturers might not see their costs fall because other trends are going against the oil price.
Data source: BMO analyst Gerrick Johnson; Chart: Yuxin Gao
“Labor cost prices are going up faster,” said Stephanie Wissink, a Wall Street toy industry analyst at Piper Jaffray, referring to the growing labor cost in China, “and labor is a bigger percentage than resin. And you still have high cost of goods inflation.”
For a typical toy company, the cost of labor is close to 20 percent, larger than the plastic resin cost of 15 percent. Although 44 percent of cost for a typical toy company comes from materials, non-resin materials like metal and wood play a larger role than plastic resin.
Another trend is that big toy companies are embracing record-high content licensing and royalty expenses. Lego is engaged in getting toy licenses from Disney movies and Marvel comic books.
However, the benefit is significant. Last year, Lego had a revenue surge of 25 percent, which largely came from sales of licensed sets, such as Star Wars, Batman, the Simpsons and Minecraft.
These trends make the impact of the oil price smaller.
For consumers, chances are slim that oil price benefits will transfer to retail prices. Businesses usually do not lower retail prices because they spend less on manufacturing; they lower their prices for excelling in competition.
Large toy companies usually do not have direct competitors, because they have exclusive rights to their brands.
For example, if customers want to buy Barbie dolls, they have to go to Mattel. If they want Transformer figures, there is only one choice: to buy them from Hasbro. Although Lego does not own brands as Mattel and Hasbro do, most other toy makers don’t make the stud-and-tube brick forms that Lego does.
It may be a different story for generic toy manufacturers, however. Manufacturers of a basic ball or a hula hoop might lower their prices as the material costs decrease.
On one hand, they have no protection from branding. The market for hula hoops is much more competitive than for Barbie dolls. Customers can turn to other companies if they are not satisfied with the current one. On the other, resin cost might take on a larger share for generic toy makers because they generally have no royalty expenses.
“Every year [the big toy companies] raise their price 2 percent or so,” said Gerrick Johnson, toy industry analyst at BMO Capital Market. “Maybe next year they won’t raise their prices.”
Contact: yuxin.gao@journalism.cuny.edu
