Can Toys 'R' Us Stay in the Game?

If it remains in the toy biz after Babies 'R' Us goes independent, its stores must become fun-filled destinations, especially for kids

By David Kiley

Toys 'R' Us CEO John Eyler won't say what effect the disappointing holiday season will have on the chain's future. Since he announced in November that Toys 'R' Us (TOY ) will separate its global toy business from the Babies 'R' Us chain in 2005, speculation has swirled that it may exit its namesake business altogether in the face of seemingly insurmountable competition from discounters and off-price shopping clubs.

Same-store sales for the nine weeks ending Jan. 1 fell 2.2%, with traditional toys off 5% and electronic games about the same, largely because of hardware shortages across the industry. Deep discounting cleared the shelves in December's last two weeks, and intentionally lean shelf-stocking dropped inventories 20% lower than year-ago levels.


  As lackluster as the results seem, they're in line with those of most other retailers. That could be why Wall Street is finding it tough to link the holiday results with the company's pending decisions about its future.

"Holiday sales were a bit disappointing, but not close to the disasters some have come to regularly expect [from Toys 'R' Us] every first week of January," wrote Sean McGowan, an analyst with Harris Nesbitt. McGowan also noted in the Jan. 6 report that Toys 'R' Us gained a little market share and that gross margins held steady. Harris Nesbitt rates the stock, which closed at $20.47 on Jan. 7, as outperform, with a target price of $22.

For the nine weeks ending Jan. 1, same-store sales at Babies 'R' Us, which sells baby furniture, clothes, and accessories, were up just 1.6%, lower than the 5% expected by Wall Street. However, the division posted an increase of nearly 8% in net sales, from $274 million to $295 million, which may be enough impetus for the company to emphasize the baby business going forward.


  It remains unclear how Toys 'R' Us and Babies 'R' Us will separate, with questions about, say, a Babies tracking stock yet to be resolved. But other options are less opaque: closing underperforming stores, selling off the toy business, or reinventing the flagship chain's merchandising format and business plan.

After the smoke cleared from the holidays, Eyler offered no comment on his plans. Analyst McGowan says he believes the toys and babies businesses will be separated and that some 100 underperforming Toys 'R' Us locations are likely to be shuttered. He also points out that the toy chain's performance during the holiday season was strong enough to attract potential buyers, although suitors haven't come forth yet. Possible acquirer include Target (TGT ), Kmart (KMRT ), and foreign companies.

Should Toys 'R' Us decide to stay in the toy business, it has to figure out how to compete with the seemingly indomitable Wal-Mart (WMT ) and other discounters, which can sell shoppers not only a cheaper Gameboys, Barbies, and the like, but also a pair of jeans or a TV on the same visit. Coming up with a winning strategy won't be easy. On a recent visit to a suburban New Jersey Toys 'R' Us, the store was short of the compelling electronic games that grip kids' attention and imagination as soon as they hit kindergarten.


  Also, this particular store looked tired and jumbled, with high chairs and car seats -- items also sold at Babies 'R' Us -- at one end of the premises and toys at the other. With that sort of layout, is the store for kids or their parents? Indeed, its limited appeal for both sets is at the heart of the outfit's problem. By contrast, Wal-Mart and Target, with their lower prices on most toys and games, appeal to parents, while the gaming wares available at Circuit City (CC ) and Best Buy (BBY ) make a more stimulating environment for kids.

If Eyler wants to stay in the toy business, his best shot may be to cull and reformat the surviving stores -- if he can find the capital. Changing the name is also an idea. Kids want experiences, not just things. They want atmosphere, not just the latest toy or game. Toys 'R' Us seems to still think of itself as a store selling toys, rather than as a destination for kids. Chuck E. Cheese, as toxic an environment as it is for most parents, succeeds because it's a fun place for kids to go.

My 3-year-old, though, prefers a trip to Petco (PETC ) to most other options -- including Mr. Cheese. He likes to look at the animals, so it's the experience that draws him, not what Petco is selling. If Eyler wants to stay in the game, that's a lesson for Toys 'R' Us.

Kiley is Marketing editor for BusinessWeek in New York

Edited by Patricia O'Connell

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