Consumer

Sarah Halzack is a Bloomberg Gadfly columnist covering the consumer and retail industries. She was previously a national retail reporter for the Washington Post.

Another day, another retailer walloped by an unmanageable debt load: Toys "R" Us Inc., the privately held big-box chain, said Monday night it had filed for Chapter 11 bankruptcy. The company said its stores would continue to operate normally as it builds a healthier capital structure.  

Easier said than done. As Toys "R" Us tries to pick up the pieces, I'd argue selling more dolls and plastic light sabers isn't necessarily the place to start. The company needs to take a hard look at its baby business, which lately has been an albatross.

In a June conference call with investors, CEO Dave Brandon said Toys "R" Us has lost market share in the baby category, which includes clothing, furniture and consumable items such as formula. The company sells such goods at its Babies "R" Us outposts, and some are also available in its toy stores.

This division is crucially important to Toys "R" Us:

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The baby business accounts for the biggest share of Toys "R" Us's domestic sales. It's also something of a shock absorber for the highly seasonal toy business, with demand spread more evenly throughout the year. About 40 percent of the company's total annual sales happen during the fourth quarter, highlighting how much it depends on that holiday toy rush.

But recently Babies "R" Us has been hammered from several angles. For one, e-commerce offerings such as Amazon.com Inc.'s Subscribe & Save model have proven popular with digital-savvy millennial parents.

Meanwhile, Brandon said in the latest quarterly earnings call, Toys "R" Us has been hurt by competitors lowering free-shipping thresholds and shipping more quickly. Most importantly, Wal-Mart Stores Inc. earlier this year began offering free two-day shipping on millions of its most commonly purchased items and dropped its free-shipping minimum to $35.

And it probably doesn't help that Target Corp. has been slashing prices on everyday essentials.

Each in their own way, these competitors are upping the ante on value and convenience, and Toys "R" Us has not kept pace.

So what can Toys "R" Us do now? Brandon has talked previously about not wanting to get into a "race to the bottom," meaning he's only willing to go so far in matching rivals' prices because he is determined to protect margins.

Profit Pressure
Despite efforts under CEO Dave Brandon not to get too deep into the discounting fray, Toys R Us has struggled to protect its profit margin
Source: Bloomberg

So perhaps the company should embrace margin protection even more fully, pivoting upmarket at a moment when other mega-retailers have clearly outmaneuvered it on price. Babies "R" Us could reinvent itself as a more premium, high-touch shopping environment, ensuring it offers something truly distinctive from Amazon and other big-box stores.

In fact, Toys "R" Us has already taken some steps in that direction. It has been revamping its baby registry and loyalty program, both of which can help it catch and keep new customers.

And while fixing the baby business should be a top priority, that's not to say the toy aisles don't need some work, too. The Toys "R" Us chain is struggling to draw foot traffic, a sign it likely has too many locations for the digital era.  

The company stressed in a press release that the "vast majority" of its stores are profitable. But sales will only keep shifting online, and any retailer with a huge store portfolio should be giving serious thought to whether a store count that is sustainable today will be sustainable several years down the road. 

Huge Fleet
Toys R Us has a massive portfolio of stores that could probably use pruning
Source: Company Filings
Side-by-side is a location with 20,000-40,000 square feet of traditional toys and 10,000 to 30,000 square feet of baby products.

Uninspiring offerings from key suppliers such as Lego AS recently haven't made it easier for Toys "R" Us to boost sales. (And its bankruptcy may only amplify those toymakers' challenges.)

But there are reasons to believe Toys "R" Us can turn its toy business around if it lines up the right assortment of merchandise and does a better job of using in-store events to unlock sales. Toy industry sales are projected to grow 4.5 percent this year, according to market research firm NPD Group, showing demand is still growing in this segment. Smaller toymakers such as Spin Master Corp. have scored hits, as the Hatchimals phenomenon demonstrates.

With a focus on experiential shopping and exclusive merchandise -- and a culling of its sprawling store portfolio -- Toys "R" Us could get back in the game.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Sarah Halzack in Washington at shalzack@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net