In the run-up to Christmas 2013, Wayne, New Jersey-based Toys ‘R’ Us, made a massive effort to extend its shopping hours—even opening up on Thanksgiving Day—to squeeze the most out of a period that has traditionally buoyed the toy retailer for the entire year. Making approximately 40% of its annual sales in the six weeks before December 25, the time period is always crucial to TRU. However, with a long-rumored IPO still on hold and its bond ratings in flux, many in the industry stopped just short of referring to this past shopping season as “make or break” for the 65-year-old toy retailing institution.

The stark assessment is not surprising given that TRU’s financial position continues to be tenuous. Nine years after venture capital firms KKR & Co., Bain Capital and Vornado Realty Trust took over the retailer in a US$6.6-billion leveraged buyout, the retailer, by many accounts, is staring into an uncertain future. According to published reports, approximately US$1 billion of TRU’s debt will come due on September 1, 2016.

“Market signals indicate that investors are very bearish on the prospects of Toys ‘R’ Us,” says Jerry H. Tempelman, director of the capital markets research group at Moody’s Analytics. “There is concern in the market.”

BMO capital markets analyst Gerrick Johnson says the retailer has relinquished any modest gains made in the early days of former CEO Gerald Storch’s seven-year reign that began in February 2006. (He parted ways with the company in February 2013.) Storch’s favored strategy of securing more exclusives, integrating Babies ‘R’ Us and FAO Schwarz into regular TRU stores, and placing more emphasis on the development of private-label products, seemed to increase the retailer’s market share for a time. “The exclusives just weren’t differentiated enough,” says Johnson. “And TRU’s private-label products haven’t been of a high enough quality to drive traffic.”

The most current numbers from holiday 2013 seem to indicate that the market jitters surrounding the retailer were not unwarranted. For Q4 2013, the company reported that net sales fell to US$5.9 billion, down US$47 million from the same period a year ago. Same-store sales also fell 1.1% domestically and 2.7% internationally in the same quarter.

“Things are not getting better,” says industry veteran Jim Silver, CEO and editor-in-chief of TimetoPlayMag.com. “Last year, TRU pulled through with a strong final two weeks. But this year pricing across the board was more competitive, and Amazon expanded its delivery service.”

According to Lutz Muller, founder and president of Klosters Trading Corporation, a retail consulting firm based in Williston Hills, Vermont, TRU’s market share in the US has been steadily declining over the last 12 months. It did experience a three-year period of growth between 2009 and 2012. At its most recent peak in late 2012, according to Muller’s own research, TRU had a 20.2% market share. But by his last count in December, that number now hovers around 18%. “They have a couple of problems,” he notes. “And most of them are self-inflicted.”

The retailer’s current predicament is really part of a macro-trend affecting “category killer” retailers in the US across many sectors. “It used to be that being a category killer was a good business because you could laser-focus and carry products in a specific area in such depth that you would become a destination,” says Carol Spieckerman, president of newmarketbuilders, a boutique retail consultancy firm based in Bentonville, Arkansas. “But now, if you are a category killer—in an era of extreme price transparency and digital competition—frankly the jig is up.”

Spieckerman argues that TRU’s increased reliance on product exclusives and private-label products was not enough to compete with heavyweight e-tailers like Amazon. “If you have one main category, you are going to be vulnerable to digital operations that can do your business with greater efficiency and lower overhead while being more agile.”

It’s a business model with a heavy burden, says Vanessa Hartnoll, an independent retail expert and former global head of shopper insights for research firm Hall & Partners. “It has been an issue that category-killer retailers are reluctant to change,” she says. “TRU’s objective from the time Gerry Storch took over was to be the ‘biggest toy retailer in the world.’ Is that really the right strategy? TRU put itself in direct competition with Walmart, Target and Amazon.” And any victory achieved by arming for that particular big-box battle would be pyrrhic at best, she adds. “Saying you are going to compete on price and stock availability with those big-box stores is a big problem.”

Muller agrees any strategy that pits TRU against the Walmarts of the world, where competition is based strictly on price and product availability, is destined to be fruitless. “The danger is that, if it stays with its existing model, and TRU doesn’t make money in the fourth quarter, it is toast,” he says. “But its big-box competitors can afford to sell all their toys at a loss in that quarter.”

TRU has faltered in its pricing strategy, says Muller. He recently compiled a list of the top-20 toy items from Amazon.com in the US and compared their price and availability at TRU. The results speak for themselves. “Ten of the 20 toys, Toys ‘R’ Us didn’t even have in stock,” he says. “The other 10 were on average 17% more expensive.”

Another fundamental misstep, Muller believes, is the use of the stores’ physical space and what he describes as some peculiar merchandising decisions. “TRU recently devoted 15% of its floor space to videogames,” he says. “That is very odd because you have a consumer electronics market characterized by innovation and rapid growth, and then you have 15% of store real estate devoted to videogames at TRU, whose physcial software sales have been falling off a cliff.”

Hartnoll says the stores themselves are challenged environments. “It feels like a warehouse in there,” she says. “On a basic level, there are outdated fixtures and features that are not keeping pace with the packaging being created by toy manufacturers.” She adds that the retailer missed an ideal opportunity this past holiday shopping season to showcase new big-ticket items and traffic-driving consoles like Xbox One and PlayStation 4. “The stores were, for the most part, poorly merchandised,” she says. “At their most basic level, the stores are all disruption and clutter in the aisle, and that is also a real problem.”

Just before the holiday season, TRU hired a new CEO to steer the ship. However, the appointment of Antonio Urcelay, former head of its European operations, did little to placate investors and analysts. “It took an eight-month search for them to hire internally,” says Silver. “Right now, no one knows exactly what the new vision is.”

BMO’s Johnson says that the financial community was nonplussed by the decision. “I think people were disappointed that it wasn’t an outside thinker,” he says. “Of course, Gerry Storch was from the outside, and what he did didn’t meet with great success either.”

Stephanie Wissink, co-director of research at Minneapolis, Minnesota-based analytical firm Piper Jaffray, also questions the choice of an internal hire from the international side of the business. “TRU has fielded merchant-driven executives in the past,” she says. “But the disconnect here is that it will have to do a re-model. The model, at least domestically, has to be recalibrated. And bringing in a leader who has been in growth mode on the international side, and having him apply that logic to an overall operations strategy, might not be easy.”

Exacerbating these issues is what Hartnoll describes as the long-standing reluctance of the retailer to embrace the online marketplace and fully integrate it into its operations chain-wide. “Gerry Storch’s original comments about online retailing when he first started showed that he saw it as an ‘either-or’ situation and not an ‘and/both’ proposition,” she says. “TRU didn’t move quick enough to react to the change that was coming.”
Hartnoll says while TRU offers forward-thinking policies, such as using the physical store locations as pick-up centers for online purchases, its online experience largely falls far behind those of its competitors. “What makes a brand is the experience you have every time you interact with it,” she says. “I don’t see that online or in-store at all. There should be a consistent culture that pervades all channels and, at this point, TRU doesn’t have that.”

It’s not all bad news, though. Admittedly, these analysts are not painting a pretty picture. But it is important to remember that while TRU’s market share and profitability have been slipping—and its debt load could become more onerous with each bond downgrade—time is still on the retailer’s side. “If you look at its bond, the big debt isn’t due until 2016,” says Silver. “If the debt was due next year, you would hear more alarm bells.”
Muller concurs. He notes that although there is a danger that TRU’s debt will continue to get more expensive to service, the retailer is a long way from shuttering operations. “It will not go out of business now,” he says. “There is no danger of that.”

Another factor keeping TRU’s doors open is the open cooperation it has from its major and minor suppliers, which see the retailer as a good bet to hedge against the predominance of big-box stores. “Toys ‘R’ Us is a flagship store for all of these big toy brands,” says Spieckerman. “There aren’t that many other retailers, so for the manufacturers it’s very important that TRU stays open, or they will be further subjected to the demands of fewer retailers.”
Spieckerman says that active participation from these brands played a part in making the exclusive and private-label strategy work for as long as it did. “The brands accepted that to an extent because they need TRU,” she says.

Piper Jaffray’s Wissink agrees that the supply side of the equation will do what it can to protect a major retailer in the sector. “I think a US$20-billion toy industry and the US$14-billion infant products industry can’t necessarily just let TRU fail.”

Another valuable asset for the retailer is its extensive real estate holdings and the power that can be leveraged from more than 800 US store locations and 700-plus international ones found across 35 countries. “There is a real incentive from landlords to work with TRU and Babies ‘R’ Us,” says Wissink. “Having dormant stores in these big shopping centers is not what a real estate owner wants. No one wants to drive up to a vacant [mall].”

The physical space TRU inhabits will be a key element in any upcoming strategic transformation. In fact, using the store locations is elemental to the re-alignment of its business model. “TRU could be more experiential and offer something that kids can’t get elsewhere,” says Johnson. “It could become more of a play store than a toy store.”

Hartnoll has a similar prescription. “Don’t design a store as if you are selling products; you should design it to create an environment for people who already own the products—one that stresses the user experience.” She cites recent updates made to Harrods’ toy department at its London flagship store and John Lewis, also in London, as well as Disney and Lego stores, as good examples of the types of interactive and immersive experiences that serve to differentiate those retail outlets from big-box and online competition. “You need an exciting environment every time you go in there, and it has to be related to what you are selling,” says Hartnoll. “That way, you will become a destination for toys.”

Spieckerman says that the retailer’s early attempts at creating more experiential and immersive environments were not fully realized. “I don’t know if TRU has gone into enough depth for it to be truly experiential,” she says. In contrast, The Disney Store has crafted a narrative and a point of view—in terms of what products are going to be showcased and in what ways—in its individual locations, observes Hartnoll. “It’s basic organization,” she says. “There needs to be more of a curated feel to the product assortments.”

Wissink agrees that the experiential showcasing of products is a strategy that TRU would do well to embrace. “Instead of creating a shopping experience oriented around consumption, it has to create an experience around the products themselves,” she says. Additionally, she suggests that the retailer might use its large physical space more fully in the future to woo millennial moms by offering a number of new services, including those only tangentially related to the core product. “You can start to envision things like a Lamaze class, a clinic for immunizations, or a music class,” she says. “TRU has to start thinking in terms of getting the most out of its square footage.”

Then there’s the name, itself—it’s another asset that the retailer could exploit and build upon. After more than 60 years in business and millions of dollars spent in advertising and marketing, as a brand Toys ‘R’ Us still occupies a place in the popular consciousness of consumers. “There is a lot of brand equity in that name,” says Johnson. “Brands like that don’t just go away. They can withstand damage and loss of relevancy and then can be brought back.” He offers up Apple as a prime example of the phenomenon. Arguably the world’s most popular brand now, it went through a dormant period before developing a string of innovative products in the early 2000s that brought it back to prominence. In the retail realm, Johnson points to Macy’s as a brand that has hit some hard times but has recently rebounded to distinction. “There was a wonder and awe about going to Toys ‘R’ Us when I was a kid,” says Johnson. “You really need kids to ask, ‘When can we go to Toys ‘R’ Us?’ That is what is missing now.”

With a precarious future looming, the expectation is that TRU will send some clear signals sooner rather than later about its next steps to both suppliers and consumers. In fact, just last month, the retailer announced a partnership with US pregnancy and parenting website Bump.com to expand its gift registry offering. The move signals an interest in forging partnerships and diversification that analysts say is exactly what the retailer needs to regain relevance in the market. Of course, more announcements on further initiatives are expected.

“I would hope for some announcements around Toy Fair time in terms of new directions and new merchandising initiatives,” says Johnson.
Spieckerman, too, expects some sort of strategic plan to be announced during the traditionally slower early months of the year. “TRU has to make some bold moves, in stores and online,” she says. “The post-holiday period would be a good time for it to show some newness and put forth some great new concepts. It is going to take a lot of determination and positivity.”

However, Hartnoll is less optimistic about just how much innovation the retailer can actually afford, given its debt burden. “A total reinvention and revolution is required, and the question is whether or not TRU will have enough money available to re-invest in that,’ she says.
Silver also expects some major announcements and strategic moves to be made in order to instill confidence in vendors and consumers alike before the balance of the company’s debt comes due. “TRU has to make it better,” he says. “2016 is only two years away now—it really is right around the corner.”

This article first appeared in the February/March 2014 print issue of Kidscreen magazine.