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Death of a Salesman

It’s official: Toys ‘R’ Us is winding down its U.S. operations with an eye towards liquidating its inventory and 800 locations. Be forewarned, however, that TRU’s swan song is just the opening act for a great retail tragedy set to unfold over the next 10 years.

Internationally, the retailer is actively pursuing a reorganization and a sale process for its Canadian stores as well as its operations in Asia and Central Europe (including GAS). According to TRU’s U.S. headquarters, its branches in Australia, France, Poland, Portugal, and Spain are still weighing their options, which include potential sale processes in their respective markets. TRU U.K. has already entered insolvency proceedings as a precursor to liquidation.

TLL estimates that approximately 15–25% of all licensed toys and games were sold through TRU, or approximately $2 billion in retail sales a year. More generally, TRU accounted for roughly 20% of toy sales in the U.S. in 2017, according to Jefferies analyst Stephanie Wissink. With NPD estimates valuing the U.S. toy industry at $27 billion overall in 2016, and TRU reporting consolidated net sales of almost $12 billion in the same year, that places TRU’s total retail share at roughly 40% in 2016.

TRU accounts for approximately 11% of sales for Mattel and 9% of annual volume for Hasbro, according to each company’s filings. For an example of a mid-sized player, Wicked Cool Toys told the Wall Street Journal that it fields approximately 15% of its sales through TRU. For even smaller manufacturers, that share can be anywhere from 40–100% of sales. Late last year, UBS analyst Arpine Kocharyan estimated that in a “worst case” scenario of 63% store closures (or 556 locations out of a total of 800), Mattel would see a 4% decline in sales and Hasbro would see a 3–4% decline. Separately, Jefferies estimates that up to 15% of the toy business could be wiped out this year because of TRU store closures.

In the U.S., TRU has already begun liquidating 180 of its 800 stores and it’s likely that the process will wrap up quickly. An analysis of TRU employees’ LinkedIn accounts, including those of marketers and buyers, shows that many are still pulling a paycheck right now, although a significant minority have joined other retailers, especially those involved in infant furniture and home goods (Bed Bath & Beyond’s headquarters is nearby). Some personnel have confirmed that they had been given 60 days notice, apparently given by the CEO in a company-wide meeting in mid-March.

What’s next for the toy industry? TRU’s death signals the potential end of a year-round toy sales cycle and a halt to the growing diversity and breadth of toy firms. It’s also a sign of what’s to come for what’s to come with many other “too big to fail” retailers.

The most likely brick-and-mortar contenders to absorb TRU’s market share in 2018 will be mass retailers like Target, Walmart, and Kmart. UBS notes that a total of 630 TRU stores are located within a 15-minute drive of a Target store, and that Walmart has a similar positioning. Walmart is the largest customer for Mattel and Hasbro, accounting for about 20% of total sales for each toy maker. In addition, both toycos get nearly 10% of their revenue from Target. On the floor of this year’s NY Toy Fair, it was interesting to note that the reverence typically only seen with TRU buyers had shifted to Target reps (with considerably less snubbing all-around of smaller or independent retailers). As retail space gets more competitive and bigger players seek to distinguish themselves among consumers, it’s quite likely that direct-to-retail and retail-exclusive deals will get much more common. It remains to be seen if mass retailers will invest in picking up all the slack—Target and Walmart are better-known for stocking only the best-selling items, not for taking risks on newcomers or for being a trends incubator.

That title is likely to go to Amazon (although other, specialty e-retailers cannot be discounted either), which has been accounting for a larger share of toy and game manufacturers’ sales over the last five years. It seems that Amazon’s dominance may be larger than previously thought—according to a former Walmart executive who has brought a whistle-blower suit against his former employer, at any rate. The former director of business development claims that Walmart overlooked basic internal controls in its quest for growth and failed to process customer returns on items totaling more than $7 million, which resulted in fraudulent reporting of inflated ecommerce sales. Walmart has emerged as Amazon’s largest competitor, but it looks like even it can’t keep up with Amazon’s double-digit growth rate.

Although purchasing will not shift entirely online, word-of-mouth marketing and digital influencers will continue to have a much larger impact on brand discovery, trend creation, and toy sales. The top trends over the last two years have not emerged from the boardrooms of toycos (they’re just trying to catch up), but from online: slime, fidget spinners, and traditional board games. Smaller players will increasingly rely on discovery through social media channels and in cultivating their own cult of personality. (The message here: If your brand’s social community management is being handled by an intern, you’re doing it wrong.)

To a lesser extent, other types of specialty retailers (gift shops, video game stores, book sellers, and grocers) as well as independent toy/game vendors (the ones that are left) are positioned to be the next launching grounds for breakout trends. Department stores like Macy’s and Bergdorf Goodman, which have long stocked high-end toys, can potentially attract new customers by deepening their offerings. And going forward over the next five years, FAO Schwartz could potentially upend the landscape thanks to its heritage as the oldest American toy retail brand.

But the most immediate impact on the toy business will be a rise in the number of M&A agreements and partnerships. Talk on the street is that Mattel and Hasbro might merge—unlikely, but they will probably snap up several enterprising startups between them. The longer-reaching trend amongst toy manufacturers is the move towards becoming independent content producers themselves, without having to rely on external entertainment licenses.

While a shake-up in the toy retailing landscape is not necessarily a bad thing—in the long run, this is just another chapter in an old story—the most frustrating part throughout all of this has been that TRU was, in most respects, seemingly doing quite well for itself.

There is talk that TRU might have survived without the over $5 billion in debt loaded on the company in a 2005 leveraged buyout by Kohlberg Kravis Roberts, Bain Capital Partners, and real estate investment trust Vornado Realty Trust. Considering its low cash balance, increasing pressure to decrease margins, and rapidly declining U.S. birthrates (that is, customers), the fact that TRU stayed above water for as long as it did is nothing short of a miracle.

Debt service and payments depleted resources the company needed to invest in itself to keep stores current and expand ecommerce offerings. And, as studies in behavioral science have shown in individuals, scarcity and depletion led also leads to bad decision-making and reduced long-term opportunities. TRU’s business strategy has not been ideal—citing “cost,” the retailer shuttered its Times Square flagship location in New York and sold off FAO Schwartz. It was slow to develop an ecommerce strategy and develop new store formats, likely because of similar concerns.

Surprisingly, there have not been any leaks concerning potential buyers willing (if not able) to snap up TRU’s brand name recognition, wide distribution, and deep talent pool. Spurred by the lack of leadership from the toy industry, one group of toymakers is being led by Isaac Larian, CEO of MGA Entertainment, in a bid to buy TRU’s Canadian arm, which includes 82 stores. Larian is also looking into buying as many as 400 U.S. stores. Maybe there’s something TRU’s largest debtors know that they haven’t been telling us, though—and the debt may be too much to handle in a restructuring.


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