Monday, November 13, 2017

Counting the Toys at Toys ‘R’ Us

Two months into the Toys ‘R’ Us bankruptcy, it is too soon to say whether the toy retail chain will have a strong enough Christmas season to emerge from bankruptcy relatively intact. Large numbers of toys still could be sold over the next five weeks. Early indications, though, are that toy sales are trending down this year.

There are multiple reasons for a decline in toy revenue, and it is hard to say what their relative importance is. In October manufacturers saw revenue slow from inventory consolidation that resulted from the Toys ‘R’ Us bankruptcy, and that trend could continue through the holiday season as all retailers prepare for a flood of cheap toys in a possible Toys ‘R’ Us liquidation in January or February. The depressing atmosphere of the Toys ‘R’ Us stores is part of the problem, with children and parents alike dreading the thought of being dragged around that dingy old store again. Children are also spending less time with toys as they are drawn more to games, puzzles, books, and touch-screen devices. Toy stores sell games and puzzles but at generally lower prices than toys. Selection may also be an issue with jigsaw puzzles. I’ve been told that toy stores don’t have the best puzzles.

The outlook for toys is so challenging that Hasbro is talking to Mattel again about a possible merger. The timing might not be right for the two companies most closely identified with the bankrupt Toys ‘R’ Us. It is estimated that between half and two thirds of toys sold at Toys ‘R’ Us are from these two manufacturers. I don’t know what fraction of U.S. revenue for Hasbro or Mattel goes through Toys ‘R’ Us but it could not be far below half. A merger would accomplish nothing if the merged company faces the risk of its own bankruptcy in the event of a Toys ‘R’ Us liquidation. Nevertheless the mere fact of merger talks may be an indication of how overextended the toy industry feels after seeing the early returns from this year’s Christmas shopping season.

There is another, more bizarre indication of stress around the toy sector. A new EA video game has a pricing scheme so bizarre that “a developer is apparently getting death threats.” The video game sector has been under pressure almost since the release of the iPhone ten years ago, and that kind of financial stress can lead to pricing schemes that make customers feel insulted and in the worst case, seen now with Star Wars Battlefront II, can lead to open rebellion among previously loyal customers. The stress in video games seems similar to the stress that toys are now facing, even though video games don’t provide much revenue for most toy stores.

When considering the outlook for Toys ‘R’ Us, it is important to remember that its most prominent competitors have already closed. The reduced competition has allowed Toys ‘R’ Us to keep going but has not put it on a path to profitability. So few toy stores remain that Toys ‘R’ Us cannot plan on any future boost from competitors closing.

Toys ‘R’ Us went into bankruptcy without a plan, and it apparently will not be drawing up a plan until Christmas sales are counted. As in the last four years, managers appear to be pinning their hopes on an above-average Christmas season. Everything seems to point to a down year for toys, though. The bigger the decline, the more stores Toys ‘R’ Us will have to close.