What Went Wrong: The Demise of Toys R Us

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Wharton's Denise Dahlhoff and Columbia's Mark A. Cohen discuss the demise of Toys R Us.

In the end, nostalgia couldn’t save Toys R Us.

The once mighty retailer, which has struggled to keep up with changing trends in consumer behavior and childhood play, told a U.S. bankruptcy court on Thursday that it must liquidate its operations, meaning the likely closure of hundreds of stores.

The former leader of the toy industry, Toys R Us filed for Chapter 11 bankruptcy in September after years of slipping sales and mounting debt. While intense price competition from mass retailers Walmart, Amazon and Target has contributed to the company’s woes, experts place the blame squarely on the shoulders of management. They said Toys R Us has failed to innovate its business model, incorporate technology or adapt to changing consumer behavior.

The day of reckoning may have been delayed through a $7.5 billion leveraged buyout in 2005 by private investors Bain Capital Partners, Kohlberg Kravis Roberts and Vornado Realty Trust. But the debt payments proved to be too much for the company, which hoped robust holiday sales would buoy its bottom line and keep it afloat a while longer. The company announced in January it would close 180 of its roughly 800 stores in the U.S. No buyers have stepped up to take over the chain, and the end seems to be in sight. Prior to the liquidation announcement, Toys R Us had announced that it would shutter all 100 of its stores in the United Kingdom.

Wharton marketing professor Barbara Kahn, Denise Dahlhoff, research director at Wharton’s Jay H. Baker Retailing Center, and Mark Cohen, a former retail executive who is director of retail studies at Columbia University’s Graduate School of Business, talked to Knowledge@Wharton about where Toys R Us went wrong. Dahlhoff and Cohen made their comments during a segment on the Knowledge@Wharton show, which airs on Wharton Business Radio on SiriusXM channel 111.

The following are key points from the conversations. (Listen to the full podcast with Dahlhoff and Cohen using the player at the top of this page.)

The End Comes as No Surprise

The dissolution of New Jersey-based Toys R Us, which traces its roots to a baby-furniture store opened in 1948, comes as no surprise to industry watchers. That’s because Toys R Us hasn’t been able to tread water as the tides have shifted in the vast retail ocean.

Cohen described the chain as “guilty of serial mismanagement.”

“Toys R Us has never been able to wrap their arms around the changes necessary, and this is the inevitable outcome.”–Mark A. Cohen

“Retailers today, especially in any kind of fashion or trend segment, have to progress,” he said. “They have to morph, they have to modify. They have to represent the changes in the marketplace and their customers’ behavior. Toys R Us has never been able to wrap their arms around the changes necessary, and this is the inevitable outcome.”

He said the stores were too big, jammed full of inventory, poorly merchandised, and customer service was virtually nonexistent. A poor shopping experience won’t entice busy consumers who would rather grab a toy from Target while they fill their carts with groceries, school supplies and the rest of life’s necessities.

“Toys R Us never made a concerted effort to bring that experiential opportunity into the stores,” Cohen said. “I think once they went private, they could have cleaned up their act a little bit. But there was no consequential effort to re-imagine themselves, to present themselves in a more engaging and attractive way.”

Instead, he said, the company was still trading on the view that it was “the center of the universe for the toy industry,” which was no longer true. “This failure began before they went private,” Cohen noted. “The company was doing poorly. That’s why the private equity trio swooped in … thinking they could fundamentally improve their performance. Frankly, they put someone in the job who had no capacity to do that and didn’t do that.”

Dahlhoff agreed with Cohen’s assessment, adding that Toys R Us didn’t defend itself against a number of external threats.

“The competition has changed so much. Also, the consumer has changed so much,” she said. “Kids spend way more time playing online video games. You don’t have to go to a Toys R Us store for those. In addition, the shopping experience has moved online, and Toys R Us hasn’t been the strongest in that area. Competitors like Amazon, Walmart and Target have been very strong online, so that also added to the difficulties.”

The Amazon Factor

Though Toys R Us’s business was eroded by big box “everything” retailers like Walmart, Target and Costco, Amazon dealt the chain some particularly tough blows, said Kahn, who is author of the upcoming book, The Shopping Revolution: How Successful Retailers Win Customers in an Era of Endless Disruption.

“Amazon changed customers’ expectations about convenience, particularly millennial parents who were a prime segment for Toys R Us,” Kahn said. “These parents became Prime members and got used to the convenience of ordering online.”

At least part of the damage was, in a way, self-inflicted. In 2000, Toys R Us launched a 10-year partnership with Amazon, in which it paid the e-commerce giant $50 million a year plus a percentage of sales to be Amazon’s exclusive seller of toys and baby products.

The joint toy store was a success, but it had serious consequences for Toys R Us. For one thing, the agreement meant that Toys R Us had no autonomous online presence — customers who tried to visit ToysRUs.com were redirected to Amazon. For another, once Amazon saw how well it worked, it began expanding its toy and baby categories, and other merchants, including Toys R Us competitors, began selling those products on Amazon.

“Amazon changed customers’ expectations about convenience, particularly millennial parents who were a prime segment for Toys R Us.”–Barbara Kahn

“Amazon learned how Toys R Us did business … everything Amazon learned about selling toys they learned from Toys R Us, in some sense,” Kahn said.

Toys R Us ultimately sued Amazon and won, allowing the chain to terminate the deal. But it lost years of momentum in developing its own online presence and e-commerce strategy.

Kahn noted that Toys R Us and other category killers had business models built around offering the lowest prices and best assortments — but now Amazon dominates both of those. In order to survive, companies have to find some other differentiator. For example, Best Buy matched Amazon’s prices, but also adopted a showroom model that took advantage of the fact that customers like to see, touch and try electronics, and to get advice from knowledgeable store associates.

“Best Buy appreciated that and leveraged that advantage, and through price matching, they made sure the customers who came also bought from Best Buy,” Kahn said. Toys R Us failed to create compelling reasons for customers to visit, either due to a superior store experience or via partnerships to exclusively sell popular brands or products.

“Toys R Us was trying to win on convenience and price, but it wasn’t convenient and the prices weren’t so great,” she said.

Why No One Wanted to Buy Toys R Us

Cohen, who was an executive at Sears and has held positions with other department and clothing stores, said he’s heard no whispers about buyers for Toys R Us. It seems no one wants to revitalize the chain that was once part of pop culture with its catchy slogan, “I don’t want to grow up, I’m a Toys R Us kid.”

In addition to the crushing debt, what also makes the chain unattractive is the glut of retail space available in the U.S. Decades of overgrowth have resulted in an abundance of empty storefronts as more brick-and-mortar operations move the bulk of their sales online.

“There’s so much excess that’s been developed over the last 30 or 40 years that’s now going vacant through these serial bankruptcies and liquidations that you’d have to be crazy to make any kind of concerted bid, unless you had something you could roll out,” Cohen said. “Frankly, I don’t see anybody making the math work.”

Dahlhoff said smaller spaces are what’s trending now in retail real estate. Target and Walmart are experimenting with smaller formats, she noted, and many retailers are opening showrooms with limited merchandise. Toys R Us stores are cavernous, which make them even less appealing to buyers unless the spaces are broken up.

“The shopping experience has moved online, and Toys R Us hasn’t been the strongest in that area.”–Denise Dahlhoff

Toys Aren’t Top Sellers Anymore

The sales of toys are declining in general, and the professors pointed to the shift to digital as the main reason.

“It has been a weaker category; there hasn’t been much growth,” Dahlhoff said. “Kids are interacting more digitally, so there’s just not as much demand.”

The toy industry has traditionally relied on holiday sales to stay in the black. That span of five or six weeks used to be adequate when manufacturers could create insane demand for products like Tickle Me Elmo or Cabbage Patch Dolls. But kids are less interested in physical toys these days, and marketers are putting their efforts elsewhere.

“It’s an extraordinarily trend-sensitive business with enormous issues of service and supply. The lead times are daunting,” Cohen said. “This is an industry that has been struggling for years from a design, product development, wholesale point of view, and now the retail network that has supported it has gone substantially all into Walmart, Amazon and Target.”

Independent toy stores have been closing for years, Cohen noted, leaving Toys R Us – which was once the category killer driving many of those closures — as “the last man standing, if you will.”

Toy sellers also face pressure from the “voracious discounting” that comes from competition from both online outlets and big-box stores, Cohen said. They can no longer get full margin for their products.

There’s Still Hope

It appears to be lights out for Toys R Us, but that doesn’t mean doom for the entire toy industry. To be sure, the challenges are great. Cohen painted a Darwinian landscape for retail where only the fittest survive. Retail bankruptcies and widespread store closings were rampant in 2017, and the trend seems primed to continue in 2018 – shortly before the Toys R Us closures became public, news broke that mall staple Claire’s is preparing to file for bankruptcy.

“This is an industry that has been struggling for years from a design, product development, wholesale point of view, and now the retail network that has supported it has gone substantially all in to Walmart, Amazon and Target.”–Mark A. Cohen

“The fittest have things that are highly differentiated, that are only available from them, or are the lowest price,” Cohen said. “Independents can differentiate on the basis of assortment and service, but they never can differentiate on the basis of lowest price because they just don’t have the leverage.”

That leaves the shopping experience as the major factor that could help toy stores, Dahlhoff said. She held up Build-A-Bear as a shining example of a store that saw the writing on the wall and pivoted. The stores, where kids can create their own customized stuffed animals, used to be found only in malls. Now, they are on cruise ships and in ball parks. The chain added also a digital component to its products.

“When the world went digital, they started to get more digital” by offering, for example, the ability to take a bear that you built online and bathe it in a virtual tub, Dahlhoff said. “It was just more interactive. You could pick your own customized sound for the bear. That’s an example of a company in that industry that tried to go with the changes and respond.”

Meanwhile, Cohen said, Toys R Us “did nothing but load the shelves with goods, and that isn’t good enough.”

Dahlhoff wondered about the future of play. She predicted that old-fashioned toys will come back into vogue as a sort of backlash to technology. That could be just the opening an innovative toy seller needs to carve out a new niche in the marketplace.

“It could also force them to cut costs and cut their assortments to just focus on the bestsellers and sell them to your big retail partners. However, that reduces variety and price competition between retailers,” she said. “Maybe the off-price channel will benefit from that. Maybe that’s a new channel to explore because that’s been a growing sector.”

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