Turf Wars! Specialty toy retailers map plans to win back ground lost to mass-market marauders

Mass-market retail giants Wal-Mart and Target took their fight for consumer dollars into the toy aisle this past Christmas, offering low-priced loss-leader items to lure traffic into their stores. And holiday shoppers took the bait hook, line and sinker. Thanks to that, 2003 will arguably go down as the year that the discounters took over the US$21-billion U.S. toy biz, nudging specialty king FAO Inc. into Chapter 11 for the second time, putting KB Toys into Chapter 11 for the first time, and leaving the rest of the nation's specialty toy retailers scrambling.
February 1, 2004

Mass-market retail giants Wal-Mart and Target took their fight for consumer dollars into the toy aisle this past Christmas, offering low-priced loss-leader items to lure traffic into their stores. And holiday shoppers took the bait hook, line and sinker. Thanks to that, 2003 will arguably go down as the year that the discounters took over the US$21-billion U.S. toy biz, nudging specialty king FAO Inc. into Chapter 11 for the second time, putting KB Toys into Chapter 11 for the first time, and leaving the rest of the nation’s specialty toy retailers scrambling.

But the troubles began long before the holidays. The past few years have not been easy for specialty toy retailers, as consumers seem to be consistently on the hunt for rock-bottom bargains. According to industry tracker NPD, while unit sales of toys were up 4% heading into Q4 2003, gross sales by dollars were down by the same amount. Wal-Mart’s bargain-driven rise to become America’s top toy retailer, with a 21% market share, is playing a key role in this shift.

Ultimately, the consumer’s quest for lower-priced toys has had a dramatic impact on the sheer size of the specialty toy retail sector. There are currently between 1,500 and 1,800 specialty toy retailers in the U.S., down several thousand from the estimated 4,000 that were in the market five years ago. And while cries rang out in the consumer press that Wal-Mart and its ilk were stealing Christmas from America’s mom-and-pop toy retailers, the demise of FAO and TRU’s 36 Imaginarium stores both underscored their plight and added to their problems.

Citing weak sales and intensified competition from big-box outlets offering more products that were once exclusively found at specialty, FAO declared bankruptcy in January 2003 and then again in December. At the height of the Christmas shopping season – a time when most toy retailers expect to pick up at least 30% of their annual sales – FAO began clearing out merch at its 15 FAO Schwarz, 89 Zany Brainy and 38 Right Start stores. It’s these hefty discounts, according to toyco BRIO’s VP of sales Cathy Blankenship, that are responsible for the bulk of what she estimates is a 32% drop in 2003 specialty retail sales.

Joe Diaz, president of 112-store toy chain Learning Express, says having to compete with FAO liquidations on both ends of the year has a lot of smaller retailers taking it on the chin. ‘Generally, mom-and-pop stores don’t have the war chest to fight off that kind of competition,’ he says, adding that sales at Learning Express stores, which moved US$80 million in 2002, ended up flat for 2003. Similarly, Mike Klein, VP of sales development for manufacturer Manhattan Toy, says any specialty store near a liquidating FAO location was hit hard. ‘When people see 50% off, they get blinded’ and don’t feel the need to go anywhere else, he explains.

However, the short-term crunch caused by the liquidations might be the least of specialty retail’s worries. Sean McGowan, managing director of retail analysis firm Harris Nesbitt Gerard, says FAO’s failure is a symptom of a larger problem. He says the Zany Brainy closure, in particular, cuts to the quick of specialty’s difficulties. ‘Zany Brainy did a lot of business in creative and learning products. So I think the moral of that story is there’s only so much of that type of business to go around, and it’s hard to grow that business when Wal-Mart and Target are popping up everywhere,’ he says.

Wal-Mart yanked the competition’s pigtails early in November, offering deeply discounted toys at prices often below wholesale. Target yanked back by matching or, in some cases, undercutting Wal-Mart prices on top-selling toys, and Toys ‘R’ Us had to follow suit to stay in the game. But lacking the bulk-buying power of these giants, specialty retailers had no hope of getting onto the playing field.

Interestingly, McGowan sees Target as a bigger threat than Wal-Mart. Not only is the mass retailer stocking its toy shelves with SKUs and licenses traditionally found at specialty (Thomas & Friends is a good example), it has also

created new toy lines with National Geographic and Discovery Planet brands that are designed to appeal to the specialty shopper. (The Nat Geo range, for example, includes a star planetarium and a 3-D space projector.) McGowan says Target is essentially a cross between Wal-Mart and Zany Brainy: its aisles are filled with educational toy product, the shopping environment is more up-market, and the prices remain excellent.

Despite the encroachment of mass players onto their turf, specialty retailers are hardly ready to throw in the towel. Interestingly, none of the five retailers KidScreen talked to for this piece said their sales decreased this year – all were holding steady or reporting moderate increases. Brian Miller, owner of four Geppetto’s toy stores in San Diego, California, says his outlets experienced double-digit sales increases in December 2003 over the same month last year, and he’s convinced the hole left behind by FAO is a ‘huge opportunity for specialty.’

Learning Express’s Diaz agrees. ‘Independent stores will capture more market share. Consumers are going to back away from the shopping experiences that the big boxes offer as they narrow selection and go to more private labels.’

So these smaller retailers are getting in shape for the fight, with some spending more on advertising and local marketing strategies, and others rethinking their product mix or opting to get out of the price wars altogether. But all of them are working to maintain top-notch, knowledgeable, personalized customer service – the bedrock of specialty retail.

Joanne Farrugia, owner of Princeton, New Jersey’s JaZams and president of the American Specialty Toy Retailing Association, says after the first FAO bankruptcy in January 2003 she started focusing on grassroots community marketing to drive traffic to her store. Along with adding more in-store visits by kids authors to promote book products and sending out a staff-penned quarterly newsletter to customers, she’s begun to mount bigger community-wide events.

Last June 20, Farrugia organized and financed a ‘block party’ with the merchants in JaZam’s strip mall to celebrate the launch of Harry Potter and the Goblet of Fire. They set up a replica of ‘Diagon Alley’ in the parking garage – with the local pet store bringing along spiders, lizards, rats and frogs to add to the witchy atmosphere – and ran a bunch of kid-centric activities including wand-making, face-painting and a trivia contest. Farrugia estimates the effort brought in about 1,500 consumers.

Geppetto’s Miller, forecasting FAO’s troubles as early as last fall, splurged on local TV advertising and more print ads to pick up some extra market share. Given his December sales upswing, he says the move really paid off. Miller has also bumped up Geppetto’s sponsorship of kiddie community events including concerts and school auctions.

At Learning Express, Diaz says his buyers are shaking up the product mix. ‘Gifts have become a very important part of our business,’ he says, drawing in a lot of tween girls. Of LE’s top 50 items in 2003, 30% were from the gift category, including just about any Hello Kitty merch, High Intencity charm bracelets and charms and The Bead Shop’s Build-A-Better-Bracelet line. Diaz estimates LE gift sales were up 20% in 2003 over 2002.

The chain is also looking at jumping into the home décor pool for spring 2004, adding small kids housewares items such as picture frames, lamps and book ends to its stock list. (See ‘Retail Radar’ on page 47 for more.) ‘We’re looking at partnerships with other kinds of children’s product companies, like furniture and swing set companies, that can provide a little more to the overall shopping experience of our customers,’ says Diaz.

Jonny Girson, who owns two stores under The Learning Tree moniker in Kansas, says he’s ‘moving away from the concept of discount’ in an attempt to get out of the Wal-Mart/Target trap. Like most small specialty retailers, he knows he can’t compete on price, and in an attempt to get customers to abandon the ‘When is this going to be on sale?’ mentality, he’s discontinued his annual warehouse sale.

Moreover, he’s looking at eliminating any product that could draw him into the price wars. ‘In the past, I may have become very upset about the manufacturer who supplied a US$30 toy that Wal-Mart ended up selling for US$14.99. But now I have a decision to make. Either I buy it and try to sell it for what I can, or I choose not to sell it at all and get something else. We have 35,000 items in this store, so it’s very easy to get rid of a couple of thousand.’

And this even more specialized direction is where retailers and analysts alike feel specialty toy retailers ultimately need to head. Like Girson, Geppetto’s Miller is looking to make his product mix as unique as possible, quizzing vendors about where product is being sold and choosing to avoid any toys readily available at mass.

Diaz expects vendors to start seeking out Learning Express stores to mount exclusive high-end programs in the way they used to use FAO Schwarz as a product showcase, especially for licensed lines. While LE currently stocks a limited number of evergreen properties, he says it would be willing to look at new properties if he finds licensors that are prepared to ‘help stores out’ by dedicating substantial mark-down dollars if the merch doesn’t fly off shelves.

Diaz may be onto something. Although properties once exclusive to specialty retail are moving into mass, licensors haven’t written off specialty. Jamie Cygielman, HIT Entertainment’s brand business group senior VP, says the line for Thomas & Friends is still going strong at specialty retailers – even with the property’s introduction to Target in 2002. She says consumers are buying both the high-end wooden train line and the mass die-cast line: Moms like the die-cast train sets for their kids to play with outside or take on trips, reserving the more expensive line for home play.

Cygielman says HIT and its Thomas licensees still work at providing promotional opportunities to specialty retailers, including organizing traffic-driving events like in-store book readings and play days, and offering exclusive product packages. For example, an offer pairing the Thomas wooden railway with specially-priced Thomas home videos/DVDs is currently only available at specialty toy stores.

And reports that vendors are ignoring their relationships with specialty retailers in order to get specialty-oriented product into alternate retail channels (offering book, drug and grocery stores special pricing, limited-edition product and more marketing support) seem overblown, according to Jeff Franklin, owner of Be Beep – A Toy Shop, which has two locations in Maryland. ‘I’ve seen more marketing support and better programs from manufacturers this year,’ he says. Diaz agrees that vendors have been, if anything, more aggressive in supporting LE stores, and adds that they really have no choice if they’re looking to make up the volume lost from the FAO closures.

However, retailers are the first to admit that the solution to the difficulties vendors are facing just isn’t that simple. The precarious situations of toycos looking to make up sales by selling what was once specialty-exclusive product at mass (which undercuts the products’ value), and those faced with shrinking distribution and sales, are worrisome. ‘Their customer base is eroding to the point where it will be more difficult for them to produce as much good product as they have in the past 10 years,’ says Be Beep’s Franklin, adding that as R&D budgets shrink, it becomes less likely that vendors will produce innovative toys that could be ‘the next big thing.’

The Learning Tree’s Girson is more fatalistic. He says vendors have been affected terribly and thinks 2003′s FAO bankruptcies will force toycos out of business or into downsizing mode. Geppetto’s Miller agrees, adding: ‘This year, as it is, we have the worst back-order situation. Many things we ordered at Toy Fair came in late or weren’t made at all. Vendors are hurting from retailers not paying their bills, and there’s certainly going to be less money for product development.’

BRIO’s Blakenship admits that it was not a great year for her company, and it’s no secret that overall sales were down. But BRIO is sticking with its specialty focus, continuing to offer smaller toy dealers co-op advertising dollars and helping them root out new consumers. It will continue to educate consumers on the value of specialty toys through ads and marketing at retail, which Blakenship maintains will help specialty retailers achieve ‘the point of difference’ they need to keep customers making special trips to their stores.

As to whether or not BRIO will stay out of mass, Blakenship is evasive. ‘We’re always looking at new opportunities, whether that’s defined as true mass or as TRU. But what’s most important is profitability, not sales volume.’

Manhattan Toy, which has a specialty hit with its Groovy Girls doll line, doesn’t intend to go the mass route and is maintaining specialty as its top retail priority, while building existing relationships with other specialty-oriented channels such as book and gift stores. ‘If Wal-Mart and Target stay in the price wars, they’re going to ask for more concessions, and prices will have to come down at the manufacturer level,’ says Klein. In turn, that will cut into profit margins and ‘maybe even cheapen product.’ It’s a cycle he says the larger toycos are aware of, and no one really wants to get into it.

But while successful specialty retailers and toycos like Manhattan Toy and BRIO are trying to keep specialty special, it may not be up to them in the end. Toy industry analyst McGowan says the gap in product offering – with specialty marketing products to parents that they can feel good about, and mass selling the toys kids are clamoring for – will only get wider.

‘If [specialty's] going to flourish, the discounters need to decide they don’t want to lose money on toys anymore, and I don’t know if that’s going to change.’

About The Author
Lana Castleman is the Editor & Content Director of Kidscreen and oversees all content for Kidscreen magazine, and related kidscreen events.


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