The decline of toy stores

The retail market is certainly changing and there’s a lot of consolidation in the market. But some retail categories have pretty much dried up on a national level, like toy stores. It ought to be a safe market, because new kids are born every year to replace kids who become adults. What’s behind the decline of toy stores?

While there’s been a degree of mismanagement involved in the decline of the two most recent toy store chains to go belly-up, both Toys R Us and Kay-Bee Toys had something else in common, and it wasn’t Amazon. They didn’t need to survive for their owners to make money, and that’s why they ultimately didn’t.

The Amazon threat

decline of toy stores
You can’t blame the decline of toy stores solely on Amazon and video games. 

The most common reason people say toy stores are out of business is Amazon. Why venture out to the toy store when you can just order it online at a heavy discount, get free shipping, and it shows up at your door two days later?

To that I say, do the analysts who say that actually have kids?

Some kids are just fine with that. One of mine is. The other wants to see the toys in person. It’s like a treasure hunt for him. He might see something he hadn’t thought of. And that more than makes up for the times he wants something and the store doesn’t have it. He’s glad Amazon is there as a Plan B, if the store doesn’t have what he wants. But he likes Amazon being Plan B.

Amazon is hard to compete with. But not impossible. Amazon is every bit as much of a threat to Wal-Mart and to Best Buy as it was to Toys R Us, and they learned to survive, and even thrive as Amazon ascended. Amazon is good at upselling, but they can’t replicate the experience of having candy and batteries next to the checkout aisle. People buy from people, and retail stores are staffed with people. Train them to upsell, and they’ll upsell.

It worked for Wal-Mart and Best Buy. But not for Toys R Us. The difference was the ownership. Best Buy and Wal-Mart are publicly traded companies. Toys R Us and Kay-Bee were not.

Why toy stores shouldn’t be doomed

There’s a lot of talk about how kids are more interested in video games than in toys. And yes, to a degree that’s true. But toy stores started selling video games in the 1980s. And they thrived doing it. Dedicate 15 percent of the store space to selling video games and accessories and use it to bring in traffic. It works.

But kids of all ages still want toys. Not the same ones their parents or grandparents wanted, and they don’t play the same way. But they still buy toys. Not only that, it’s socially acceptable, even encouraged, for adults to buy toys now.

You can’t blame discount stores either. The modern discount store came about in the early 1960s. They coexisted with discount stores for decades, because there’s always something the toy stores can carry that the discount stores can’t.

There’s no reason the business model can’t work. You have to get the location and store size and the selection right, but so does everyone else. Something else happened to the last two national toy stores to go under. The same thing happened to them, in fact.

Venture capitalism brought about the decline of toy stores

Both Toys R Us and Kay Bee were owned by venture capitalists. In a Utopian view, venture capitalists buy struggling companies, change the management, make other necessary improvements including changes that a publicly traded company couldn’t get away with because it has to deal with reporting quarterly results, and they turn those companies around.

That’s the theory. I can think of one time when it worked. That was with Dell Computer.

The problem is that’s frequently not how it works. A venture capital firm can buy a retailer, then stick the retailer with that debt. The VC firm then takes management fees out of the company and makes money, but in the meantime, the acquired company has to struggle with the burden of that new debt. And unlike taking on debt to open new stores or remodel existing stores, it’s not getting any benefit from that debt. It’s just a new burden it didn’t have last year.

Kay-Bee Toys

That’s exactly what happened to Kay-Bee. Kay-Bee’s business model was solid. It was the one store in the mall that kids liked. If you had kids, there was no getting out of going to Kay-Bee if you went to the mall. And unlike many mall stores, Kay-Bee sought out closeouts so it could sell discount merchandise. Sure, it had a selection of in-demand toys too, priced at retail. But it had enough bargains to make it hard to leave the store empty-handed.

Kay-Bee needed help in 2000 when Bain Capital acquired it. Instead it got a bunch of new debt and fees. Bain Capital acquired Kay-Bee using only $18 million of its own money. Kay-Bee got stuck with the rest. Bain Capital made $85 off the acquisition. Kay-Bee went bankrupt twice and went out of business, because it couldn’t handle the $300 million in debt Bain Capital palmed off onto it while trying to compete with Toys R Us, Wal-Mart and Target.

Granted, the American shopping mall was going into decline during this time period too. But I don’t think it’s coincidence that malls are lonelier places without Kay-Bee. Had Kay-Bee made it through the first decade of this century, it might have thrived on lower rents, and would give people one more reason to go to the mall. Malls need that.

Instead, the company went under, 3,400 people lost their jobs and malls had one more store space to try to fill. But Bain Capital made a buttload of money.

Toys R Us

Toys R Us thrived in the 1980s, then took a turn for the worse in the 1990s. It was a publicly traded company, and in 2004, its board of directors decided to see if the venture capital route could turn the company around. Enter KKR and Bain Capital. Yes, the same year Bain Capital drove Kay-Bee into its first bankruptcy, it took partial ownership in Toys R Us.

Once again, it was a leveraged buyout. VC firms Bain Capital and KKR and real estate firm Vornado paid $6.6 billion for the company, on paper. But they only paid $1.32 billion out of their own pockets. Toys R Us got stuck with the remaining $5.28 billion in debt. Toys R Us could have done any number of things with $5.28 billion that might have helped it. Instead, it spent $5.28 billion to sell itself and get nothing to show for it. Well, they got some new management. The same management that was wrecking its closest direct competitor.

For the next 14 years of its miserable life, Toys R Us paid $425-$517 million in interest every single year.

But there was light at the end of the tunnel. By 2017, Toys R Us was only losing $36 million a year. Yes, it’s a loss, but after buying toys and paying half a billion in interest, the company managed to sell almost half a billion dollars worth of toys.

In 2004, had Toys R Us decided to just hold on to the $2.2 billion in cash it had at the time and keep doing what it was doing, without the overhead of KKR and Bain Capital, it would have turned a $481 million profit in 2017.

Instead, 33,000 people lost their jobs. KKR, Bain Capital and Vornado made about $200 million running Toys R Us into the ground. Toys R Us proved not to be as lucrative of an investment for them as Kay-Bee had.

There’s no third national chain for them to buy, so they may not get another chance.

The decline of toy stores may reverse

As soon as Toys R Us went out of business, a company bought the rights to Kay-Bee Toys and rumors of it coming back started. Rumors of Party City launching a pop-up chain called Toy City also persisted. And at the last minute, the owners of the Toys R Us brand decided it made more sense to keep the brand and try to revive it than to auction it off.

The days of big-box toy stores as retail destinations may be over. And none of these operations got off the ground to the degree anyone wanted them to in 2018. But at the very least, the same pop-up business model that sells Halloween costumes every fall in temporary storefronts that vary from year to year could work for toys during the winter.

I think the decline of toy stores is temporary. There’s no shortage of vacant retail real estate. Nobody has tried a store format in between the old Kay-Bee and Toys R Us in size. Nobody’s tried applying the pop-up store model to toys on a large scale. Someone is going to find something that will work.

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