Toys "R" Us Scoots Back to the Web
from Winter 2000
by Susan Caminiti
When you’re the world’s best-known toy retailer, getting customers into your stores to do their Christmas shopping should be about as easy as tickling Elmo. Getting them to buy toys on your website? Come on! It’s got to be a natural. So the folks at Toysrus.com must have thought as they approached the holiday season last year. Instead, the company’s venture onto the Web turned out to be a disaster, complete with all manner of technological breakdowns, logistical nightmares, and delivery logjams—not to mention disappointed tots and their irate parents. The Grinch couldn’t have planned it better.
But now Toysrus.com is trying again, hoping that a deal with the Internet’s largest retailer, Amazon.com, will turn defeat into victory. Under the alliance, Toys “R” Us is supposed to be buying and managing all those Barbies, Hot Wheels, and PlayStations while Amazon handles fulfillment, namely the customer service, warehousing, and shipping that crippled the Web venture last year.
Toysrus.com CEO John Barbour, 41, says the deal lets each company concentrate on what it does best. Toys “R” Us knows how to select the goods; Amazon knows how to deliver them. “I wouldn’t say that the arrangement with Amazon was a necessity,” Barbour explains. “But we definitely felt that it would make Toysrus.com a much stronger competitor in the online marketplace.”
He’s got that right. More mysterious is just who the “we” is in his statement. In an e-mail to Corporate Board Member, John Eyler, CEO of parent company Toys “R” Us, said that he and other senior executives did not want to be included in an article about their dot-com offspring. Normally loquacious company founder and chairman emeritus Charles Lazarus also chose not to weigh in, as did the six outside directors (see box on page 33 for who’s on the board). One could almost sense the exasperation and rolling eyes at even being asked. Could it be that Barbour, a chemist by training and the father of two young sons, is being set up to take the rap if the Grinch strikes again?
Regardless of who takes the high-risk point position, almost all major retailers either have launched or are eyeing ways to move part of their business onto the Web. The beauty of the Internet, or so the thinking goes, is that it allows greater communication with customers, suppliers, employees, and shareholders. For a retailer such as Toys “R” Us, the reasons for leaping into cyberspace couldn’t be any clearer (customers can shop when they want) or any more unproven (no one has yet to earn a dime doing this).
Last year’s problems proved that Barbour’s operation couldn’t fly solo. A combination of software glitches and mechanical foul-ups—the miles-long conveyer belt in the company’s Memphis distribution center went on the fritz, for example—on top of overwhelming consumer demand, caused massive delays in service four days before Christmas. When it was clear that the company was not going to be able to ship all its orders by the time Santa slid down the chimney, Barbour took the unusual step of breaking the bad news to his customers via e-mail. “Even with our fulfillment center working around the clock,” his missive started out, “we will not be able to deliver your order before December 25.... On behalf of everyone at Toysrus.com, we sincerely apologize for being unable to meet your expectations.”
For Barbour, this was a personal and professional embarrassment. He had joined Toysrus.com just three months earlier, after having served as CEO of OddzOn, a division of toy maker Hasbro that produced such hits as Koosh (soft rubber balls), Super Soaker (a popular line of water guns), and Sound Bites (noisy candy). Under Barbour, OddzOn went from a tiny start-up to a market leader, and his entrepreneurial bent made him a perfect candidate to lead Toys “R” Us’s newly hatched website, said then-CEO Robert Nakasone when he hired him for the job.
In the aftermath, the company tried to soften the news contained in Barbour’s e-mail. It processed credit card refunds for about 3% of the total online orders and mailed $100 Toys “R” Us gift money to disappointed customers. But these measures did little to wipe the pie off its face. The snafu dominated the retailing news for days, and it wasn’t only parents and grandparents who were seething. The Federal Trade Commission hit the company with a $350,000 fine for failing to notify customers sooner about the problem.
Toys “R” Us was not the only company that found itself swamped by online Christmas shoppers. Companies such as eToys and KBKids.com were flooded with orders and both fell behind. But Toys “R” Us’s sheer size and visibility gave it the kind of public relations black eye no other e-tailer had to endure. Says David Cooperstein, a research director at Forrester Research Group in Cambridge: “From a marketing point of view, Toysrus.com did things right. But when a company this big is late with the execution, that’s not good. Late just doesn’t cut it with customers at Christmas.”
Barbour is confident there will be no ghosts of Christmas past. “We’ve taken many steps in order to ensure that no similar issues come up this holiday, most notably creating the alliance with Amazon, arguably the best provider of customer service in the e-commerce marketplace,” he says. “It was one of the few e-tailers that managed to pull off last year’s holiday fulfillment without a hitch, so it brings a great deal of expertise to us this year.”
It had better. Even without the refunds, Toysrus.com’s 1999 holiday sales were little more than a third of the $107 million that eToys recorded. In all, customers spent $5.2 billion online in the fourth quarter of 1999. “Last year everyone was fighting for mind share, so the consumer was just bombarded with advertising in all forms,” says Jason Heller, CEO of Mass Transit Interactive, an online media management company in New York City. “This year companies are fighting for customers, and the way to do that is to make sure the shopping experience is flawless.”
Parent company Toys “R” Us, based in Paramus, New Jersey, has to fight for customers in its brick-and-mortar stores as well. In addition to various other problems, in 1998 it lost its position as the No. 1 toy seller to—who else?—discount king Wal-Mart. In early 1999, Nakasone promised an imminent turnaround. “Nak,” as the former Toys “R” Us CEO was widely known, said the strategy would be highlighted by the online site (“a premier e-commerce business,” he called it) and enriched by a $10 million investment in the online store by Benchmark Capital, a hot Silicon Valley venture capital firm. This all played well on Wall Street, which had been looking for signs of life from the $12 billion sleeping giant.
But it was the lullaby before the tears. Four months later, in August, Benchmark pulled its cash infusion because of disagreements about ownership of the site. That same month the board of directors, citing the standard “differing views regarding the future of the company,” gave Nakasone the boot. Former CEO Michael Goldstein, a director, moved in as acting CEO.
Thus, the once-proud company ushered in the millennium in the midst of a search for a CEO, humbled by the online shopping fiasco, and sneered at on Wall Street, which had taken its stock down to $10 from the $24 it enjoyed when Nakasone made his happy announcements.
These were clearly unpleasant times for the board, and particularly so for founder Lazarus, 76. He had built the company from a single store in Washington, D.C. into a powerhouse toy retailer for which the phrase “category killer” was all but invented. Now the company he had run for 26 years was being overseen by a board that for some time now had seemed to be little more than a rubber stamp for management. It certainly had left Nakasone to play in the sandbox too long.
The new CEO was John Eyler, 52, formerly the head of FAO Schwarz, toy retailer to the rich. His plans to get Toys “R” Us back on track included a companywide face lift, which is already under way. Each of the 707 stores will be fitted with a new educational boutique, complete with computer games and interactive books; an Animal Alley stuffed-toy zone brimming with cuddly creatures (how does a parent say no to that?); and a floor plan that is easier for customers to navigate—great progress, as anyone who has browsed a Toys “R” Us store will attest.
Investors are bullish on Eyler’s plan. The stock is gaining strength and analysts believe that a strong balance sheet and brand name will help Toys “R” Us to make a comeback. But no one is breaking out the champagne just yet. Eyler’s grand makeover plans aren’t that different from what Goldstein and Nakasone had said they’d do in earlier days. Furthermore, third quarter results show just how far the company has yet to go. It lost $65 million for the period, versus a profit of $15 million for the same three months last year, largely because of the investment in Toysrus.com. Sales fell from $2.5 billion to $2.2 billion over the same quarter. A bright spot: Toysrus.com’s sales were $23 million for the period versus $5 million for last year’s third quarter.
The earnings drag of the online venture was clearly high on Eyler’s list of priorities when he moved in. In late January he met with Barbour to discuss the company’s options. Figuring out a way to get the goods to the customers on time was a priority, but so, too, was doing it in a way that wouldn’t financially sink the business. That’s when the idea of hooking up with another company began to emerge. “I’ve always looked to Amazon as a site that provides a great overall customer experience,” Barbour says. He told Eyler he’d like to talk to Amazon about some kind of partnership.
Eyler liked the idea, and a few weeks later Barbour approached Amazon chief Jeff Bezos about a possible partnership. The two kicked the idea around for a few months, but by May, Christmas suddenly seemed very close. A deal would have to be struck soon in order to have things in place by the fall, the start of the holiday selling season.
By July all the pieces were in place. Toysrus.com agreed to pay Amazon a fixed fee plus a single-digit percentage of sales on every transaction. Toys “R” Us announced its partnership with Amazon with typical corporate hyperbole, calling it “a milestone in online shopping” and “second to none.” Bezos was just as psyched. “Joining with Toys “R” Us means we’re bringing customers even greater product selection,” he said in a statement. “This a huge win for Amazon.com customers.”
It may also have been a huge win for Amazon because Toys “R” Us gave so much away. For one thing, Toys “R” Us agreed not to use its online site to sell children’s books, music, software, or videos, Amazon’s traditional bread and butter. Presumably, customers with such items on their shopping list will now buy them from Amazon. The structure of the deal also means that Toysrus.com, not Amazon, orders and pays for the inventory. That’s as good as a visit from Santa for Amazon. When the holiday season drew to a close last year, the company took a $39 million writedown to cover the costs of unsold toys.
No matter what Barbour left on the bargaining table, however, he still brought home a deal that will exploit Amazon’s fulfillment skills. This should help Toysrus.com break even in the fourth quarter of 2001, two years sooner than expected, and show a profit in 2002, the company projects. The contract also leaves Toysrus.com well positioned for its ongoing battle with eToys. For one thing, Amazon will add 23 million online customers to the 60 million Toys “R” Us has in its database. Toys “R” Us also sends out more than 50 million advertising circulars during the holiday season. By any measure, that’s formidable marketing muscle.
In contrast, eToys has 2.1 million customers who have already bought online and four million registered users, people who have supplied information about their likely buying habits. They might have a one-year-old, for instance. The company is burning through cash and will need holiday sales of $240 million (double last year’s) if it is to keep its promise to Wall Street to turn profitable by 2002. Its stock has crashed in the past year, falling from $78 to $4 in late October.
The two big players are going up against one another on a suddenly sparse field. Online retailing is full of casualties, and the toy business is no exception. RedRocket.com, Toytime.com, and Walt Disney’s toysmart.com have all gone out of business since last Christmas, victims of inferior technology and poor execution. Meanwhile, KBKids.com lost its chief executive and nixed plans to spin off its online store.
The bloodshed may mean an end to last year’s advertising glut, which confused customers and cost retailers dearly. In fact, the online toy industry barely broke even on its ads, having spent about $200 million to sell $200 million worth of toys. “The companies just sort of canceled each other out,” says Heller of Mass Transit Interactive. This time around, the two big players are promising to invest less in slick ads and more on making their sites easy to use and shopper friendly.
There are customers out there. Despite the failures among online stores, potential buyers are still curious enough to take to their PCs for some virtual window shopping in ever-increasing numbers. Nielsen/NetRatings, which expects to see more alliances between old-line stores and the likes of Yahoo! or Amazon, is forecasting that 55 million people, 20% of the U.S. population, will visit online stores this holiday season, a 34% increase over last year’s 41 million visitors.
E-tailers hope all those visits turn into sales, and at least two Internet research firms are optimistic that many will. Jupiter Communications estimates that online sales in November and December will reach $11.6 billion, while Forrester Research projects that consumers will spend $10 billion between Thanksgiving and the end of the year. That’s almost double what was spent last year.
Whether Toysrus.com’s new Internet strategy pans out remains anyone’s guess. Asks David Leibowitz, a Burnham Securities managing director who follows Toys “R” Us: “Are there companies doing it simply because their competitors are? Of course.” But, as he points out, “No one knows how e-commerce is going to turn out, so no one wants to be left in the dust.”
If Toys “R” Us misjudges what’s hot with customers, even Amazon’s shipping expertise won’t save it—or Barbour. And the boardroom, for all the hands-off history of the directors, is where the blame will ultimately lie.
