Toys "R" Us (TOYS) has basically three main businesses in the
United States: toys, video games and baby products. None has done
particularly well, as the chart below demonstrates:
(click to enlarge)
Not so surprisingly, toys are the company's main business and
its primary raison d'être. Toys "R" Us is also the last remaining
specialty toy retailer, after the demise of Zany Brainy, Noodle
Kidoodle, Imaginarium and others, and it thus offers innovative
start-ups a way to showcase their products in a way no other
retailer lets them do it. In 1996, the company added Babies "R" Us
as a new retail sector, partly as free-standing stores and partly
as a component of a regular Toys "R" Us store. Video games and
consoles were the last addition to round out Toys "R" Us' product
Both Babies "R" Us and video games were introduced to correct
one major flaw in Toys "R" Us' concept - seasonality. The fourth
quarter accounts for more than 40% of yearly toy sales, and it is
absolutely crucial for the company to generate enough profit then
to offset the losses incurred during the lean three quarters. This
also makes it impossible for Toys "R" Us to follow the strategy of
its main competitors - Wal-Mart (
) and Target (
) - to use toys as loss leaders during the fourth quarter as a
strategy to draw in consumers and then sell them other stuff.
Babies "R" Us and video games were introduced to flatten this
seasonality curve. More so, it was hoped that the young mother who
comes in to buy Pampers returns later to also buy toys. And that
the teenager who visited the store as a young child with his or her
mother to buy toys would later return to buy video games as well.
To further accelerate this process, the role of Babies "R" Us
within the TRU universe was further expanded by giving it more
space and more promotional dollars.
In the U.S., its stores are in two major categories - regular
stores and side-by-side stores. The difference is less in the
overall footprint but rather how this footprint is allocated. In
the regular stores, space is allocated roughly 60% toys, 20% baby
products [Babies "R" Us], 15% video games and 5% stuff like
check-out counters, service desks and toilets. Side-by-side stores
allocate less space to toys [about 40%] and more to baby products
[also 40%]. Regular stores are being converted to side-by-side
stores on an ongoing basis, and today about half of the total 873
stores in the U.S. are in this format.
However, these diversification measures did not work out too
well. Not only did overall U.S. sales, all categories, dropped from
$8.317 million in 2009 to $7.638 million in 2013, the percentage
contributed to these totals by Babies "R" Us and video games
dropped from 52.7% in 2009 to 48.79% in 2013. In other words, sales
of toys themselves stayed flat in terms of dollars and grew in
terms of percent participation in the total - from 47.3% in 2009 to
51.2% in 2013.
This picture is replicated by what web searches say about
consumer interest levels:
As you can see, the direction for Toys "R" Us overall is clearly
trending down, and the same applies to Babies "R" Us. Also,
competition did not stand still. This is what happened between 2009
and March 31 of this year in terms of market shares:
(click to enlarge)
In other words, Toys "R" us had a U.S. toy market share of 17.2%
in 2009, gradually increased it to 20.8% at the end of the third
quarter 2012, and from there again declined to end up at 17.5% at
the end of the first quarter this year. In fact, I suspect that the
decline would have been even faster and steeper had it not been for
the fact that both Wal-Mart and Kmart fell on their respective
keisters due to their appallingly bad in-store management during
the past few years. So, the question is why Toys "R" Us did
relatively well for a while and then lost it again.
Many different reasons have been quoted, but two stand out
because they affect the fundamentals of Toys "R "Us' mission -
broadest product selection at competitive prices. The company fell
down on both accounts.
First, product selection. Toys "R" Us' most potent competitor is
), and Amazon is the company to beat in toy selection. I looked at
Amazon's best-selling thirty toys at three time points and checked
whether Toys "R" Us had these products available as well. This is
(click to enlarge)
In short, Toys "R" Us on average had only about half of Amazon's
top-selling toys available to its customers. If the consumer wants
a product and your competitor has it and you don't, you lose.
The second is price. I again checked Amazon's price against that
of Toys "R" Us for those top-selling products carried by both
retailers, also at the same three time points. This was the
(click to enlarge)
In two of the three cases, Amazon had clearly and significantly
lower prices than Toys "R" Us, with Toys "R" Us being 16% and 24%
higher. The most recent reading suggested that Toys "R" Us was in
fact more competitive than Amazon by 6%. This is, however, due to a
very recent price action by Toys "R" Us which, while on the surface
tending in the right direction, was done in a very confusing manner
and is likely to backfire rather than benefit the company.
This is how one of my esteemed colleagues described it:
"They now have color coded clearance. Each box gets a
different color sticker. Yellow is 20% off the marked clearance
price. Brown is 30% off. Green is 40% and blue is 50%. So… simple
"clearance" is not enough. We now have tiers of clearance.
Furthermore, the stickers have the old price, but don't have the
new clearance price. Nor do the stickers tell you how much off
the clearance price you get. You have to know that yellow means
an additional 20% off. So if you see a toy for clearance at $8.99
and it has a green sticker, the price is actually $5.39. But,
again, you have to know green means an additional 40%, and then
you have to do your own math."
First reactions from consumers are mixed. A lot are simply
confused and there are, according to my retailer panel contacts,
continuous discussions at the checkout counters about pricing.
Also, the Service Desks report numbers of unhappy consumers arguing
that they have been misled and wanting to return merchandise. It
would appear that somebody in the company's Wayne, N.J., HQ was
just too clever for their own good when designing and implementing
I do not think that these price reductions signal a change in
Toys "R" Us' overall pricing strategy, but that they are simply
designed to reduce inventory built up over the past six
However, there is little doubt that Toys "R" Us' management is
trying to adapt its business model to accommodate pressure from the
company's owners for greater profitability. I understand that a
number of changes are in the offing to achieve this. Specifically,
following the lay-offs already implemented at its Wayne
headquarters, staff cuts are slowly being carried out on the shop
floor level. Secondly, the closing of a significant number of
unprofitable stores is under consideration. And finally, a greater
emphasis on more profitable private label toy products is likely to
become apparent as we move towards the 2014 fourth quarter selling
season. This is likely to be only the beginning - all the three
leading rating agencies Moody's, Fitch and Standard + Poor's -
downgraded Toys "R" Us' debt this year, which means significantly
higher borrowing costs starting in 2016. In short, Toys "R" Us'
outlook over the next few years will be characterized by cost
cutting, store closing, store staff lay-offs and other measures
designed to boost short-term profit at the expense of long-term
It could well be that Toys "R" Us' overriding consumer promise
of broadest product selection at competitive prices is no longer
practical in the face of competition from Amazon and others who
have a built-in economic advantage. It is also understandable that
the owners - Bain, KKR (
) and Vornado (
) - are pressuring management to cut costs and to boost profits,
regardless of long-term consequences. However, this is a one-way
street littered with signposts that say "Kmart," "Frank's Nursery"
and "Borders." Consumers do not forgive retailers who stray away
from their fundamental mission promise.
However, it is not only consumers that are affected if Toys "R"
Us changes its posture. The large toy manufacturers - Mattel (MAT),
Hasbro (HAS), Jakks (JAKK), and Lego - depend on TRU to a major
degree. They have basically two choices: they can either support
the company with promotional activities and markdown dollars, or
they can elect to leave the sinking ship. Whatever they choose to
do will determine whether Toys "R" Us will live or die.
All charts courtesy of
Klosters Retailer Panel unless noted otherwise.
(This article was first published on April 30 by the Toy
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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