With the prospect of an Initial Public Offering hanging over toy retailer Toys ‘R’ Us at a time when its sales remain stable but flat, the stakes for the company have arguably never been higher—and funding its global expansion in an effort to build value while fending off jabs from big-box retailers that deliver rock-bottom prices to consumers has never been tougher. It’s fair to say that as the New Year dawns, all eyes in the industry are on the 64-year-old Wayne, New Jersey-based retailer that generates more than US$13 billion in annual sales.
“Toys ‘R’ Us is the only company that sells only toys now,” says Isaac Larian, founder and CEO of MGA Entertainment and a 30-year toy industry veteran. “If it isn’t doing well, the whole business suffers—TRU is very important.”
When major mass-market outlets in the US (read Walmart and Target), decided to dive into toy sales in a serious way in the mid-2000s, TRU started on its current path of evolution, shying away from relying solely on lower prices to drive traffic. While the big two can sell toys as loss leaders to drive sales in other areas of their stores, that isn’t an option for specialty outlets like TRU. “You don’t want to compete on price because it can kill you,” says Richard Gottlieb, a toy industry insider and publisher of The Global Toy Report. As a result, the toy-centric retailer has shifted its focus away from competing on price to the aggressive pursuit of private labels and exclusives—signalled, in particular, by its appointment last year of toy manufacturing heavyweight and ex-Mattel exec Neil Friedman to the post of president of US operations.
Friedman’s move from manufacturer to retailer set the industry abuzz. It’s not like he had much direct retail experience, but arguably few know more about marketing and building toy brands than he does. The injection of this marketing and manufacturing know-how—not to mention Friedman’s deep connections within the entertainment licensing community—into TRU’s top ranks was a clear indication of its strategy moving forward.
“When they introduced Neil, they also called him ‘head of product development and global sourcing,’” says Gottlieb. “That sort of tells you all you need to know.” He adds that in recruiting Friedman, TRU is seriously ramping up the private-label business it has been building over the past five years, with the aim of pushing these goods to the forefront of its more than 1,600 worldwide retail outlets. Further fuelling this perception is TRU’s purchase of a 70% stake in Toy ‘R’ Us Asia’s operations (100 stores across nine Asian markets) from manufacturing giant Li & Fung last fall. While the retail outlets are a major aspect of the deal, one can safely assume that the inroads made into the manufacturing hub of China will greatly assist TRU in its ability to source goods.
“It’s a strategy that Toys ‘R’ Us has embraced with more fervor than anyone,” says Lutz Muller, founder and president of Klosters Trading Corporation, a retail consulting firm based in Williston Hills, Vermont. He explains that while the strategy was probably developed as far back as five years ago, what US consumers saw this holiday season was the end-result of a carefully thought-out plan. TRU’s 44-page holiday 2011 catalogue, for example, detailed the retailer’s more than 30 exclusive and private-label brand offerings. The list continues to grow, as do the SKU numbers.
The history of TRU’s reliance on private labels has given them a distinct advantage over their closest competitors in the area, say analysts.
“Because of Neil Friedman and their own factories, they have a built-in advantage over Walmart and Target in this area,” contends Muller, adding that Friedman’s personal contacts in China are an invaluable resource for TRU.
If a retail strategy relies on stocking shelves with private-label goods, some lessons from the past should be heeded, and according to the experts polled, TRU has learned them well.
“It isn’t attempting to produce a cheaper version of products that are out there,” says Gottlieb. “TRU’s notion is not to go out and produce a crappy, cheap product. It has realized that it is more profitable to produce its own evergreens that give it a competitive advantage over Walmart and Target.”
Gottlieb compares TRU’s private-label strategy to food brand President’s Choice, and says that the retailer’s efforts are spent in creating “higher-perceived value” that places a heavy consideration on design.
Lynn Vantassel, director of retail insights at Cambridge, Massachusetts-based research firm Kantar Retail, agrees. “I’m finding that this follows what Target did with Archer Farms,” she says. “TRU is trying to make these brands elite and upscale.”
Gerrick Johnson, a BMO Capital Market analyst who tracks the toy industry, says that the retailer’s efforts to create true brands on their own recalls efforts made by other retailers that have successfully built private-label brands not saddled with a lower-quality stigma. “I think the Holy Grail in private label is like what Sears has done with Kenmore,” he says. “It has created brands that can stand alone and have their own reputations.”
Margins ‘R’ Us
Another interesting aspect of the strategy that indicates how much investment TRU has made in its own labels and products is the emergence of co-branding deals and direct-to-retail licensing deals.
There’s the True Heroes line, for example. TRU’s successful private brand mines the military action figure vein in the face of slowing G.I. Joe sales, and TRU introduced a co-branded line of playsets with Montreal-based toy manufacturer Mega Bloks this past fall. By co-branding with an established supplier and treating the SKUs as “exclusives,” TRU elevated consumer perception of the private-label brand, further expanding upon its traditional definition and imbuing it with a pedigree.
“TRU is branding its higher-quality private-label goods and then calling them exclusive,” says Kantar’s Vantassel. “It has done that with the FAO Schwarz brand, for example, which makes sense for Toys ‘R’ Us because it also helps their margin, too.”
On the direct-to-retail front, US broadcaster TLC’s Animal Planet stands out. “We have had an Animal Planet DTR since 1999,” says Debra Joester, founder and president of New York-based licensing agency, The Joester Loria Group. “It continues to see double-digit growth year after year. TRU does the design and sources all the products—it has great experience and sourcing capabilities that really drive the program.” More recently, the retailer has followed a similar path with its Home Depot line of toy tools and accessories licensed from the US-based home-improvement goods retailer.
Another obvious advantage of private label, and one that cannot be overlooked, is the bottom-line advantage of cutting out the middleman. These branded SKUs have the potential to be even more profitable than unbranded private-label or third-party licensed goods because of their perceived pedigree and quality. Simply put, TRU does not have to offer discounts that consumers would expect to receive on unbranded goods because of the equity it’s built in these exclusive brands. With the price differentiation playing less of a part, there’s also no need for TRU to pass on private-label savings to the consumer.
And according to Muller, the use of high-value private labels has widened profit margins for TRU across the board. His research indicates that the combined price of the top 14 toys in all stores at the end of Q4 revealed that TRU actually enjoyed higher margins than its competitors. The sum of the top toys sat at US$578 for TRU, while competitors Walmart and Target took in US$502 for the same items.
“What this tells you is that with private labels and exclusives, Toys ‘R’ Us is able to sell regular toy brands at a higher price than anyone else,” he says. “Essentially, if you get the customer into the store via private labels and exclusives, you can get them to spend more money on other toys while they are there.”
Given the potential payoffs associated with private-label business, TRU’s suppliers would have reason to be concerned about getting squeezed out of licensing deals or losing large tracts of shelf space. But there are several factors at work preventing those things from happening entirely.
“There really is a delicate balance,” says BMO’s Johnson. “As a retailer you really don’t want to [alienate] the Spin Masters, Crayolas and Hasbros of the world.”
A toy industry analyst at Needham & Company, Sean McGowan also notes that toy retailers often have leverage to ask for compensation if particular SKUs or products just don’t sell as expected—an advantage that disappears the minute a retailer sources its own product.
“One of the sweet things about being a toy vendor is that when something doesn’t sell well, you can beat up your supplier for markdown money,” McGowan says. “I think you would be more hesitant to do that if the supplier is the guy in the office down the hall.”
Joester mentions the same point, adding that the one major problem with developing and sourcing private-label goods is that “there is no one to send the markdown bill to.”
Additionally, if the products don’t sell, the retailers are left holding the bag completely since there are no other retail outlets—namely the deep discounters—that will carry proprietary labels belonging to another chain.
“It’s bad enough as a retailer to have too much product, but it’s even worse when it’s something that you have sourced yourself,” says Johnson. And while the gap might be closing, it is fair to say that toy retailers aren’t as adept at marketing their products as toy manufacturers, which could leave valuable shelf space in a state of suspended animation.
For the same reasons that private label is becoming more important to TRU, so are exclusives. Muller’s numbers (see sidebars on p. 66 and 68), in fact, indicate that the amount of valuable space the retailer is willing to dedicate to exclusives compared to its competitors.
“Retailers are walking into showrooms and saying ‘Give us everything,’” says Gottlieb, “I have heard about that more than a few times.” Similarly, and perhaps no surprise to suppliers out there, “‘Can we have an exclusive?’ has become the first question interested retailers ask now,” Johnson contends.
For the most recent holiday season, in fact, TRU sewed up exclusives for UK-based Wow! Stuff’s mini toy My Keepon, as well as the manufacturer’s Air Swimmers, The Trash Pack from Australia’s Moose Toys, Mind Candy’s Moshi Monsters and the Cars 2 wooden vehicle, licensed from Disney Consumer Products and manufactured by TRU.
Richard North, MD at Wow! Stuff, opted to give TRU a time-limited exclusive on the hyped toy and has been pleased with the result. “We had a number of meetings with major retailers,” he says. “It’s no secret that innovation and exclusives are key to TRU’s competitive advantage …[They] moved lightning-fast, and together we were able to build a great program.”
As North could tell you, TRU can offer toy manufacturers heavily trafficked areas in the store and robust promotions for exclusive retail rights.
“With My Keepon, after TRU got the exclusive, it made the toy one of its top 15 toys of the year,” says Gottlieb. “With an exclusive like that, the retailer is going to make sure that it is promoted through its catalogue, and in-store, and in a way [its success] just becomes a self-fulfilling prophecy.”
Of course, no retail strategy comes with a guaranteed pay-off, and the elements of risk involved in setting up exclusives fall on both the manufacturer and the retailer.
Perhaps the biggest con associated with exclusives is that since every manufacturer views his bottom line as a function of shelf space and availability, limiting options in terms of retail outlets seems counter-intuitive—the potential upside has to outweigh the limiting of options. On a more technical level, managing and executing exclusive deals requires more man hours and resources than stocking everyday product.
“Some manufacturers view it as a headache,” says McGowan, explaining that a lot of extra man-hours are spent on parsing out SKUs to their various exclusive retail homes.
Muller says that marketing exclusive products can create another hurdle. Although TRU can promote through its in-store and online channels, as it did with My Keepon, he believes the retailer’s promotional efforts are not on par with those of a big toy company. “Toys ‘R’ Us is not quite as skilled at promoting items as Mattel and Hasbro,” he says.
Additionally, there is always the risk of misjudging the market in terms of exclusives. For instance, with a hot property like Moshi Monsters, the exclusive line was initially greeted with enthusiasm by consumers. However, hot properties come and go, and rival retailers can use the exclusive period as a test-market of sorts for their potential product orders down the line. Competitors can use perceived results of the exclusive to better gauge the interest of consumers and then place their orders accordingly. And if that first exclusive is a dud, they can avoid the IP and dead inventory altogether with no associated risks.
Limiting shelf space
Experts are in agreement that there has to be a rational level of exclusives and private labels on retail shelves. While Vantassel reported that years ago she heard a toy retail executive claim he wanted to reach a 50% threshold with exclusive and private-label products, many now believe that number probably hovers around 30% at the high end. The reason, as any toy manufacturer and licensor is happy to tell you, is that traditional brands still hold the majority of consumer trust.
“If you are in the mass toy market, you need to have the toys that people want,” says Gottlieb. “You are going to have to have the popular products.”
“In the end, your seven-year-old is still going to want Star Wars and so on,” notes Joester. “Private label is never going to replace that. It’s just too hard to compete with something that has that TV and media push behind it.”
Larian says he has seen similar pushes on private label before and expects to see them again. “The pendulum swings,” he says, adding that he is very pleased with the direction that CEO Gerald Storch and Neil Friedman have taken with TRU. However, in a business that he says is “all about product design,” he is not worried that private brands will start to eat away at MGA’s bottom line. “They can do all the private brands they want,” he says. “But they’ll never have a brand like Lalaloopsy, Little Tykes or Bratz.”