Toy Store Wars

Specialty toy stores are in trouble. Last December, FAO Inc., owner of the FAO Schwartz chain of toy stores, filed for bankruptcy. It was the second bankruptcy filing in less than a year. Last month, KB Toys Inc., which operates more than 1200 mall-based toy stores, filed for bankruptcy protection. FleetBoston Financial Corp. will provide $350 million in financing to fund operations during reorganization, which will include closing about a third of its stores.

Also last month, Standard & Poor's Ratings Services downgraded the short-term and long-term corporate credit ratings for Toys "R" Us based on their expectation that the company will not show recovery in performance. Although Toys "R" Us is the largest specialty toy chain, they are not expanding their store base as are Wal-Mart and Target. Therefore, the S & P assessment is that Toys "R" Us is not going to fend off the competition effectively enough to warrant an investment grade rating.

These dramatic changes in the toy market have been primarily attributed to intense price competition between the specialty toy stores and discount rivals Wal-Mart and Target. The result was a drastic reduction in sales revenue during the last quarter of 2003 for the specialty stores and they can't pay their bills. More worrisome is that it appears specialty toy stores will continue to be unable to compete with the prices offered by discount rivals. To stay in business, they have to do something different and, according to this story, they're planning to.

To protect themselves and toy retailers they see as key to their profits, some manufacturers plan to deliver fewer hot toys to Wal-Mart and to have more exclusive launches at chains like Toys "R" Us Inc.

So, to counter the competition from discount giants, the toy makers won't be sending them any of their toys to sell. Instead, specialty stores will be exclusive distributors of the toys, thereby assuring survival of the specialty stores and continuation of elevated profit margins on their products. Jim Silver, publisher of the Toy Book, an industry mag, believes action is necessary.

"Whether it is exclusive launches or controlled product shipments, they are going to do whatever they can to keep other retailers healthy," Silver said.

Apparently, collusion on distribution of products is not illegal under antitrust laws. That's news to me because it sure seems unfair.

In summary, specialty toy stores cannot compete on prices, so they will agree to deny the product to their discount rivals. Legality notwithstanding, is this a good idea? Toys "R" Us does less than $4 billion yearly while Wal-Mart does over $250 billion yearly. From a pure business relations standpoint, toy makers are at risk of receiving a less than preferential rating from Wal-Mart which could have dire consequences for future business opportunities.