The Game Has Changed: It’s Toys R Us, or Them

One day during this holiday shopping season, a customer will walk into a Wal-Mart to buy a Barbie doll or a Hot Wheels car. And when the cash register rings, Toys R Us will tumble from its long-held position as the single largest retail customer of Mattel Inc., the world’s largest toy manufacturer.

The steady exodus of American children and their parents from Toys R Us stores over the last decade is just one chapter in a high-stakes toy story that has left the Paramus, N.J.-based chain reeling and the $20.3-billion retail toy industry scrambling to adjust to fundamental changes in how Americans shop and play.

When all manufacturers are included, Toys R Us still sells more toys than any other retailer. But its lead has steadily dwindled since 1990, when the company accounted for 25% of all toys sold. Its share slipped to 18.4% in 1997, while competitors such as Wal-Mart Stores Inc. and Target, a unit of Dayton Hudson Corp., continued to gain ground.

Toys R Us shook up the toy industry in September by taking a $495-million charge to cover a massive corporate restructuring that includes a much-needed face lift for its huge stores. That’s bound to please shoppers who’ve struggled to find toys or a salesperson along a Toys R Us aisle cluttered with un-shelved merchandise. And, retail experts say, it’s a long overdue move given the relatively bright and well-organized aisles at competing chains.

There’s an obvious sense of urgency at Toys R Us, observers say. Six outlets have already been remodeled, and the company hopes to update 75% of its 700 stores within two years.

“Who would ever have thought the seemingly impregnable Toys R Us would appear eminently pregnable,” quipped Gimme Credit, a New York-based newsletter that tracks the corporate bond market. “Yet, here’s [Toys R Us] embarking upon a major project involving store redesign, inventory markdowns and supply-chain rejiggering just at the start of the season.”

Mass merchants aren’t the only force that’s eroding Toys R Us’ once-dominant position. Upscale shoppers are flocking to newcomers such as Zany Brainy, a 58-store chain whose small, tastefully appointed stores cater to parents who demand that toys educate as well as entertain. And when it comes to video games, consumers can buy them just about anywhere.

The competition also extends beyond the world of brick and mortar. Toys R Us recently established an online service to defend against Internet interlopers such as Santa Monica-based EToys. And after Mattel acquired the American Girl doll company, which does $600 million in business through the mail, Toys R Us jump-started its own mail-order business by sending out 2 million catalogs.

“For years, Toys R Us was the only kid on the block with its warehouse-style stores,” said Kurt Barnard, publisher of Upper Montclair, N.J.-based Barnard’s Weekly Retail Marketing Report. “The chain succeeded because it gave customers the impression that they were buying a dollar’s worth of toys for 50 cents--which really wasn’t the case.”

Toys R Us executives declined to comment.

One of the chain’s toughest challenges will be luring back consumers. It plans to stock a wider array of electronic goods and add children’s apparel and a section, called Deal World, aimed at bargain hunters.

But its forte will remain toys, which means it will be hard-pressed to boost profit given the increasingly stiff competition.

“During the holiday season, the Wal-Marts and Kmarts cherry-pick which [toys] to stock,” said Isaac Lagnado, whose New York-based Tactical Retail Solutions Inc. tracks toy industry sales. “And outside of the holiday season, they can do a substantial business without having to carry all those [products] year-round.”

And while playthings are the main course at Toys R Us, mass merchandisers have shrewdly used toys as an appetizer to entice customers to their stores.

“Wal-Mart, among all the mass merchandisers, has recognized the traffic-generating value of toys,” said Mattel Chief Operating Officer Bruce L. Stein. “They’ve made toys a key part of their promotional program, and since their growth has outpaced that of just about every other retailer, our growth has been commensurate. . . . They will be our largest single retailer.”

Once Furby and Pokemon have lured shoppers into the toy aisle, mass merchandisers use their marketing savvy to tempt shoppers into buying products that carry fatter profit margins than toys.

Toys make good business sense for mass merchants. Courting kids is a solid way to build sales because kids spend $24 billion of their own money annually and have a say in how nearly $200 billion more is spent. More important, childhood shopping trips shape brand preferences that could last a lifetime, said James McNeal, a marketing professor at Texas A&M.;

And pint-sized shoppers increasingly prefer Wal-Mart. “Children tell us that [mass merchants] are where they like to buy their clothes and things because they feel more welcome,” McNeal said.

Wal-Mart’s success isn’t all retail rocket science.

“A year or so ago, I jokingly commented to Toys R Us that not even a giraffe could get to some of their shelves,” McNeal said. “And Toys R Us does recognizes that it hasn’t done as good a job at merchandising more complex, technical toys.”

The company’s current plight is in stark contrast to the 1980s, when it truly changed the way toys were sold. Its huge stores offered a stunning array of choice and attractive pricing. It ran rings around mom-and-pop toy stores and eventually forced chains such as Lionel Kiddie City and Child World into bankruptcy.

Despite its lost market share, Toys R Us remains a major force in the retail toy industry. The Federal Trade Commission and 44 states maintain in two lawsuits that the company illegally extracted agreements from major toy makers to restrict sales of popular toys to warehouse-style operators like Price-Costco, a subsidiary of Costco Cos. Toys R Us denies any wrongdoing. But on Thursday, Hasbro Inc., the nation’s No. 2 toy maker, agreed to pay $6 million to settle the states’ lawsuit, which continues against Mattel and other manufacturers.

Toys R Us’ success during the 1980s was mirrored at Mattel and Hasbro. The two manufacturers arranged lucrative Hollywood licensing deals and Toys R Us gave them an easy conduit to consumers.

But Toys R Us can’t use popular licensed toys to build a competitive advantage, because stores like Wal-Mart are quick to stock the hottest sellers.

The chain has also failed to capitalize on the growing market for toys that educate as well as entertain, a profitable niche that chains such as Philadelphia-based Zany Brainy are mining.

But Zany Brainy Chairman and Chief Executive Keith C. Spurgeon, a former Toys R Us executive, doesn’t view the big chain as a major competitor. He sees specialty stores as the opposition for Zany Brainy’s blend of educational toys, music, books and computer software.

Spurgeon isn’t simply being diplomatic. Unlike Toys R Us’ big boxes, Zany Brainy’s stores are compact. The laid-back locations have carpet on the floors where kids can play. Parents appreciate the free gift-wrapping and the relative abundance of sales help. And, other than for a few toys such as Lego building bricks, shoppers find very little on Zany Brainy shelves that’s also carried by Toys R Us.

The other glaring difference involves licensed merchandise. While Toys R Us keeps one eye on Hollywood, Zany Brainy pulls licensed toy lines from storybooks with heroes like Arthur the Aardvark.

When it comes to online competition, Toys R Us is fighting the same unknown factors that bookstore operators face with Amazon.com. Online companies are losing money, but in the process they’re building important brand loyalty among Internet adventurers.

Even before the holiday retail season began, EToys was shipping thousands of packages each day from its converted bottling warehouse in Santa Monica. Executives are betting that their understanding of online buying habits will give them an edge over Toys R Us.

As they grapple with savvy competitors, Toys R Us executives also are coming to grips with demographic swings and a changing definition of what makes a toy. Many kids are dropping their plush toys at an earlier age and turning to electronic games.

Observers say that a decade ago, Toys R Us and other retailers probably couldn’t have imagined the changes that are now reshaping the industry.

“I think you could have seen 10 years ago the logic that’s made Wal-Mart successful because what retail is all about is traffic generation,” said Mattel’s Stein. “But would you have known that consumers’ lifestyles would have changed to the point that they’re trying to get as much shopping done at one place as possible? And that they’d be as value-conscious as they are now? No, I don’t think you could have deduced that.”

Some observers speculate that Toys R Us will continue to cede market share to savvy retailers like Wal-Mart. “The heyday of Toys R Us is long behind them,” said industry tracker Lagnado. “You’ve got a lot of square footage competing for the same purses. It’s going to continue to be a fluid marketplace, particularly in places like California where there’s so much competition.”

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Profits in Toyland

Toys are big business, but the retail mix is changing. Meanwhile, overall shipments, measured by dollar volume, continue to increase.

Top Toy Retailers’ Estimated Dollar Share of U.S. Toy Industry

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Rank Retailer 1997 1996 1995 1994 1993 1 Toys R Us Toy 18.4% 18.9% 20.3% 21.0% 20.2% 2 Wal-Mart Discount 16.4 15.3 14.9 14.1 12.7 3 K Mart Discount 8.2 8.3 8.5 7.4 7.3 4 Target Discount 7.1 6.4 6.0 5.7 5.3 5 Consolidated Stores,Closeout 6.1 6.2 4.4 4.3 4.5 6 J.C. Penney Discount 1.5 1.7 2.2 1.6 NA* 7 Hills Discount 1.2 1.3 1.5 1.4 1.0 7 Service Merchandise, Catalog 1.1 1.6 1.8 1.9 1.6 9 Ames Discount 1.1 1.2 1.2 1.0 NA* 10 Meijer Discount 1.1 1.0 1.2 1.0 NA*

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*Not applicable. Took over spot from another company no longer in the top 10.

Source: Toy Manufacturers of America

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Annual Sales 1988-97 (billions of dollars)

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

1997 Wholesale: $15.3 billion

1997 Retail: $22.6 billion

Source: Toy Manufacturers of America