Beleaguered Toy Retailers Build Web BrandsBeleaguered Toy Retailers Build Web Brands

The holiday season has not been merry in recent years for the toy business. Toy retailers have faced stiff competition, not from one another, but from the major discounters. Wal-Mart Stores, especially, has typically undercut prices of toy products that are most in demand during the holiday season, using them as loss leaders to draw more customers into its stores.

This aggressive pricing has resulted in the three major toy chains, Toys R Us, KB Toys and FAO Schwarz, facing financial hardships. Only a few years ago, Toys R Us, for example, was the No. 1 toy retailer in the U.S. Wal-Mart now has that distinction, despite carrying a far smaller selection of toys.

Americans spend over $20 billion annually on toys, but most of that money today is not going to retailers whose business it is to exclusively sell toys. Add the fact that this year consumer spending after Thanksgiving turned out to be sluggish, and it is no wonder analysts have the outlook of Scrooge toward toy retailers.

There is hope, though not with the brick-and-mortar stores of these toy chains, but, rather, with their online namesakes. Internet research firm comScore Networks reported that Americans' online spending on the day after Thanksgiving was up 41 percent, compared to last year. Correspondingly, the present owner of FAO Schwarz has been pleased with the performance of the fao.com Web store, which was relaunched in October 2004.

"We have been just absolutely delighted literally from the minute we launched the site," Kim Richmond, the executive vice president of marketing for D.E. Shaw Laminar Portfolios LLC, says. "We generated traffic and sales instantaneously."

The previous owner of FAO filed for bankruptcy twice: the first time in January 2003, the second in December 2003. After the second bankruptcy, D.E. Shaw, an investment and technology development group, purchased its assets for $41 million.

Because D.E. Shaw is a privately held company, it does not publicly disclose sales figures, traffic or other data regarding fao.com. But Richmond acknowledges that the Internet "plays an incredible key role in our strategy."

D.E. Shaw's plan for the FAO brand is much more dependent upon nurturing a stronger Internet presence than its last owner FAO Schwarz Inc. That's because what was once an upscale toy retailer with 15 stores has been whittled down to just two locations: Las Vegas and the historic New York City flagship store on Fifth Avenue. Thus, for many shoppers now, the only way to experience the FAO brand is online.

Yet FAO's online store is virtual on another level: It's not really FAO Schwarz minding the proverbial store behind-the-scenes but eToys Direct Inc. The toy e-tailer, based in Denver, Colo., handles the back-end fulfillment of merchandise for fao.com from its shipping center in Virginia.

It does the same thing for another toy retailer, the beleaguered KB Toys Inc. The kbtoys.com domain is licensed by eToys.

KB Toys, the largest mall toy-store chain, filed for Chapter 11 bankruptcy in January 2004. It plans to shut down over 200 underperforming stores in 2005.

Though KB Toys gets a cut of every sale through its domain, its web store is essentially eToys. Amazon.com and Toys R Us share a similar business relationship through toysrus.com.

eToys manages not only the online ordering for two of the major toy retailers, but also for other retailers that do not specialize in toys, like Sears, Roebuck & Co.

"Because a lot of retailers want to add toys in the fourth quarter to drive additional traffic and sales, it's hard (for them) to predict toy trends unless you're in the toy business year-round," eToys spokeswoman Sheila Gilliland says. Through eToys, these retailers can include a toy section to their online stores without taking on the risk of adding extra inventory.

Gilliland says business for eToys saw an upsurge that aligned with comScore's projections for online spending on the day after Thanksgiving. On "Black Friday," combined sales at eToys and its partner sites, which include kbtoys.com and fao.com, were up 34 percent compared with 2003. The company expects to have a successful fourth quarter this year, when 70 percent of its annual sales are made.

Discounters like Wal-Mart can still undercut the prices on the most popular toys, but the convenience of shopping online, a broader selection of items, and buyer familiarity with the names of the toy chains have so far given an edge this holiday season to the toy web stores.

FAO credits the performance of its site on the high-end status of its items, including limited-edition dolls and a child-size Mercedes for $15,000; and value-added perks for their customers, such as batteries included for free.

"The merchandise that we carry is very unique and in many cases exclusive to us," Richmond says. "So as a result, whether people go to our stores, to our Web site or to our catalog, they're finding merchandise they can't find just anywhere."

All of this has created a peculiar scenario in toy retailing. Offline, business at stores is anemic, and the extinction of the toy chains is being forecast.

On the Internet, however, the reputations of the toy retailer chains prosper, as entities managed by other companies, such as eToys and Amazon.com. For Toys R Us and KB Toys, their online alter-egos are maintaining the value of their brands, while they are closing traditional stores.

"Having a retail web site for any retailer is very, very important these days in terms of not only multi-channel retailing, but in keeping the brand front-and-center for the consumer," Gilliland says.