Toys R US vs KB Toys: Christmas Carnage | 3

0:08May 1999, Memphis, Tennessee. In a vast warehouse, a forklift trundles past racks that stretch into the distance and tower overhead. On those racks are boxes, boxes full of toys, from Burbies and Playstations to Yo-Yos and Spice Girls dolls. On foot, employees scurry around grabbing toys and adding them to conveyor belts. The toys roll along the belts and converge to form a rushing river of playthings, flowing towards the employees in the packing area. There, the employees snatch the toys off the belts and box them up. Then they load them onto the FedEx trucks that will fan out from Memphis across the nation to deliver those toys to customers' front doors.

0:55This is the future of retail. No stores, shopping trolleys or checkout lines. Just websites, warehouses and 18-wheelers. And Toys R Us wants to own it. Last Christmas, Walmart replaced it as America's top toy seller. So now, Toys R Us' best hope is to conquer online toy sales. But while the forklifts roam the new warehouse it bought for its e-retail arm, trouble's brewing in California. In a meeting room in Silicon Valley, Bob Moog, the boss of ToysRUs.com, outlines his business plan to a bunch of executives who've flown in from Toys R Us headquarters in New Jersey. E-commerce is a land grab. The companies that get market share today will be the winners of tomorrow.

1:45So to get that market share, we undercut everyone. E-Toys, Walmart, KB, everyone. Even our own stores. A Toys R Us executive interrupts. No way. You're not undercutting our stores. Moog pushes back. Undercutting will undermine our rivals' ability to ramp up their inventory and marketing ahead of the holidays. That'll give us the edge. Forget it. You're not undercutting our stores. The stores are the real business, not online. We're talking billions, not millions. We both know your stores aren't doing very well anymore. The executive frowns. You know, I'm not a fan of ToysRUs.com being out here in California instead of New Jersey either.

2:30Moog senses that for all its talk about embracing the internet, Toys R Us is still stuck in a bricks-and-mortar mindset. So within weeks, he walks, leaving ToysRUs.com leaderless at a critical time. As a new millennium approaches, online retail's growing fast, and the competition's getting tougher. The website eToys already has 300 ,000 customers. KB Toys is pushing hard into e-commerce. And Amazon's about to join the toy wars, too. ToysRUs knows it needs to win over online shoppers this Christmas. But instead, it's going to do the exact opposite.

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5:57Toys R Us become America's top toy seller. Now, Toys R Us and KB must survive in a Walmart world, and they're closing in on the same opportunity to strike back, online shopping. But Toys R Us' voyage into cyberspace is already heading off course. This is Episode 3, Christmas Carnage.

6:27August 1999, Toys R Us headquarters, New Jersey. Robert Nakasone, the Japanese-American CEO of Toys R Us, looks up from the papers on his desk to see a man standing at the entrance to his office. That man is Toys R Us chairman Mike Goldstein, and he's got a wad of papers in his hand. Nakasone and Goldstein have led Toys R Us ever since its founder, Charles Lazarus, retired. But now, there's a gulf between them, and it's about to get wider. Nakasone watches as Goldstein shuts the door behind him. What do you need, Mike? Goldstein sits and looks at his notes. The board's executive committee is met, and it has reached a decision.

7:14Quit reading from your notes! Goldstein reads on. A decision to replace you. Nakasone glares at Goldstein. Is this because I questioned your relationship with Majesco? Majesco sells millions of dollars worth of video games to Toys R Us every year. Goldstein is friendly with its co-owner and has invested in another one of his companies. Goldstein glances up from his notes and glares at Nakasone. I told you there's no conflict of interest. This is about a lack of stock on the shelves last Christmas. Six consecutive quarters have declined and the problems with our online operations. You've lost the board's confidence.

7:56You should resign. Nakasone fumes. When he replaced Goldstein as CEO last year, he inherited a glut of inventory. Hype spent months digging the company out of the hole you left it in. But Goldstein is right about ToysRUs.com. The first man Nakasone picked to run it walked within weeks. Now the Silicon Valley venture capital firm that was going to pump$10 million into the operation has walked too. And those walkouts have caused Toys R Us stock price to tumble from$25 to$15. Goldstein looks at his soon-to-be former colleague. Believe me, I'm sad that it's come to this. Here's the draft press release.

8:43You leave with immediate effect. Nakasone scans the press release and frowns. But I'm not leaving for personal reasons. That would be a lie. Fine, call your attorney. Let the lawyers hash it out. The next day, Toys R Us announces Nakasone is leaving over differing views regarding the direction of the company. Toys R Us stock rises 50 cents on the news But ToysRUs.com is still a mess And KB's about to up the pressure Because while Toys R Us is struggling to connect KB's surfing the web like a pro At KBKids.com you'll get toys you can't find anywhere else Like the new Toy Story 2 interactive talking train set with Buzz, Woody, Jesse, and the evil Zerg.

9:36And while kids will make it, this season's gotta have toy. At least you won't have to wait in line to get it. Just click here. The Toy Story 2 interactive talking train set. Hurry. Available online only at kbkids.com. KB's spending tens of millions of dollars on its online push. It's bought out online toy seller Brainplay and struck a deal with AOL to get links to its website in front of 17 million eyeballs. It's also offering free shipping, selling exclusive toys, and spending$43 million on TV and web ads. Its 1 ,300 toy stores might be struggling as foot traffic declines and rents rise in malls.

10:22But KB senses that online is an arena where it could beat the odds. and emerge on top. But it's not the only retailer out to sell toys on the web. Amazon and Walmart are now selling toys online. Then there's the current leader of the pack, eToys, a startup valued at$1.8 billion. And they're piling pressure on Toys R Us to show Wall Street that it's still got growth to give. So as the holidays begin, Toys R Us goes on the attack. It tempts people to buy early by knocking$10 off purchases of$25 or more made before December. It opens before dawn on Black Friday and aggressively price matches Walmart.

11:10But this year, the battle for toy riches is also happening on the nation's computer screens.

11:22Late November 1999. In Los Angeles, a young dad is in front of his PC monitor and feeling smug. While others are out there in snarled-up traffic and checkout lines, he's at home, sipping fresh coffee and ready to do all his Christmas shopping with a few clicks. And now that Windows 98 is finally loaded up and his dial-up modem is connected, he's good to go. All right, first up, toys. Let's see. He points Internet Explorer to the search engine Lycos and clicks the shopping link. Once the next page loads, he clicks Toys and Hobbies. A list of online toy retailers appears. At the top is eToys, but he's heard that Toys R Us is offering$10 off every order above$25.

12:10So he clicks on ToysRus.com instead. But instead of seeing Jeffrey the giraffe, there's an error message. Service unavailable. Error 503. One's a wonder what that is. He refreshes the page. Same message. He's not alone. ToysRUs.com is collapsing under the rush of the web traffic heading its way. Visits to the website are up more than 400%. But this dad's not ready to give up on his online shopping dream. He refreshes the browser again. This time, the Toys R Us website appears. He checks his list. First up, a Nerf Wildfire Automatic Blaster. It takes an eternity to reach the Nerf Blaster's page.

12:59And then the button to buy it doesn't work. Seriously? He frowns and refreshes the page. This time it works. One hour in, one item down. Next, a Millennium Princess Barbie doll. The page loads, but it's out of stock. Unlike the retail stores, ToysRUs.com has far less inventory. And that means shoppers encounter less choice and more messages that their item is out of stock. So the dad heads to KBKids.com. It loads fast, and it's got Barbie in stock and free shipping too. which makes it cheaper than Toys R Us. Two days later, the Barbie from KB arrives at his door, but there's no sign of the Nerf blaster from Toys R Us.

13:50Weeks pass with no sign of the vital gift. He calls customer service, but the line's always jammed. As Christmas nears, an email arrives. It's from Toys R Us announcing his order might not arrive in time for the big day, But if it doesn't show up, he'll get a$100 gift certificate as an apology. It's a high-profile Christmas meltdown that leaves parents across the nation racing to toy stores for last-minute presents they thought they'd secured weeks before. Toys R Us hoped to storm to the top of the online sales league. Instead, eToys won out again. KB's website trailed, but its sales soared 400%.

14:36and many customers now rate it as the best place to buy toys online. It's a stellar performance and convinces KB's owner, Consolidated Stores, to announce an IPO for KBKids.com that values the toy site at$210 million. But then in April 2000, its plans are blown apart. It's described as nothing short of breathtaking, a points drop never before seen on the U.S. markets.

15:08This closing bell might as well have been an alarm, so Savage was the selling. The fragile technology stocks even harder hit. The Nasdaq index in freefall down nearly 10 percent. The dot-com bubbles just burst and the gull rush of the early internet is over. The crash wipes out e-toys. Amazon watches its stock price collapse from$107 to just$7. With the tech boom now a bust, Consolidated Stores' hopes of cashing in on KB's website evaporate. It cancels its IPO, fires employees by the dozen, and puts KB Toys up for sale. But while the crash kills KB's dreams, Toys R Us is about to see some upside.

15:59Because it's going to get its website into shape with help from a surprising ally, Amazon.

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17:47June 2000. In a small windowless hotel conference room, Amazon's toy chief Harrison Miller draws a line straight down the middle of a whiteboard. At the top of one half he writes the word Amazon. On the other side he scrawls Toys R Us. Miller is at the Hilton Hotel at Chicago's O 'Hare Airport and he's pitching to an audience of one. He turns to face that man Jonathan Foster the head of operations at ToysRUs.com. So, Jonathan, this is how I see it. Now here's what Amazon brings. Miller turns back to scrawl notes on the Amazon half of the whiteboard. Customer service. Technical know-how. Proven e-commerce distribution network.

18:37We also have excess capacity in that network. He checks back on Foster. Foster nods. Sure, I'll accept all that is true. What do you think we bring? Miller smiles and begins riding under the Toys R Us header. You have the brand everyone knows. The buying expertise, the merchandising expertise too. Miller grabs the whiteboard eraser and wipes away the dividing line. Now imagine if we brought our respective know-how together. Foster sits back in his chair. I already have. We approached you in February, remember? You said no thanks. Sure, sure. But we did some focus groups and found this aha moment for moms when we align our brands.

19:23We share a reputation for a deep selection of products. So we've changed our minds. We want to team up with you and dominate toys online. And not just because the bottom's fallen out of tech stocks? Okay, it's a consideration, sure. But we fit together. I propose you buy the products. We handle the tech sales distribution customer service. If we stick to our areas of expertise, we can both win here. Foster thinks for a moment. Toys R Us has invested millions lining up additional warehouses for its online operation. But to really succeed in online retail, it needs to spend many tens of millions more.

20:06And the truth is the company just doesn't have the stomach for a bet that big. Hiring the world's top online retailer to run its web store feels like the pragmatic move. Okay, we're interested. But if this deal is going to happen, it's got to happen fast. We need it up and running and delivering in time for the holidays. Amazon and Toys R Us move fast. Executives from both sides fly back and forth between the east and west coasts, hammering out a deal. In August, the deal is signed. By the end of the month, Toys R Us products are arriving in Amazon warehouses. In mid-September, the new ToysRUs.com goes live.

20:51But while Amazon and Toys R Us form a tag team to win the toy wars, KB Toys enters the holidays with a for sale sign over its doors.

21:10December 2000, South Shore Plaza Mall, Braintree, Massachusetts. Thirteen-year-old Emily skids to a halt outside the KB Toy Store. Oh my God, I have to have that. Before Emily's mom can say anything, she's gone to check out the toy that caught her eye, the Dance Diva Home Recording Studio. It's a karaoke machine, made from lavender-colored plastic. There's a spinning disco light embedded inside it, and two mics and twin cassette decks, so you can record you and your pals singing your favorite songs. There's even a button for instant applause. And for Emily, it's love at first sight. She turns to her mom.

21:54I have got to have this. Please, Mom. Please, please, please. It's going to be the best. It'll be amazing at parties. The Dance Diva is the flagship of KB's latest strategy to win Christmas. KB lacks the buying power it needs to compete with Toys R Us and Walmart on price when it comes to the hottest toys. So now it's creating its own exclusive hit toys. Toys built to appeal to the 8 - to 14-year-old mall rats that make up its customer base. More than a quarter of toys in its stores are now made by KB. but none are selling quite as fast as Dance Diva. Emily's mom looks skeptical. How much is it?

22:42Emily twirls the box around to check. $49.99. It's less than$50. I'll think about it. But it's the last one. What if it sells out? I'm sure they'll get more before Christmas. You don't know that. Emily's mom turns to a passing KB employee. Excuse me, will you be getting more of these in before Christmas? The employee shakes his head. I'm afraid not. They're selling out nationwide. That's our last one. Emily smiles. See, Mom? Please? That day, the dance diva sells out nationwide. For KB, it's a profit bonanza. But it's also a sign that despite its struggles, KB's still canny enough to hold its own.

23:27And that's enough to help it find a buyer. A few days before Christmas, Boston investment firm Bain Capital teams up with KB's management to buy the business from consolidated stores. It's a$305 million deal that sees Bain contribute$18 million towards the price in return for a majority stake in KB. Bank loans pay the rest. After almost 20 years as a subsidiary of larger companies, KB is once again the master of its own destiny. With Bain's input, the company plots out a strategy to prove that it's still a player. It carries more video games, doubles down on its strategy of releasing more exclusive toys, and teams up with Sears to open 29 KB locations inside its department stores.

24:19It's also got a plan to power up its website.

24:27It's summer 2001, and in a meeting room near Boston, a marketing executive from KB Toys is leading a focus group to explore parents' attitudes towards the nation's leading online toy stores. So what about Walmart? Has anyone bought toys on Walmart's website? The parents shake their heads, apart from one mom. I did. But it's not where I think of immediately for buying toys online. Where do you think of immediately? E-Toys. Anyone else think of E-Toys? Yeah, me too. The executive watches as everyone in the room nods in agreement. E-Toys slid into bankruptcy back in February, owing more than$270 million.

25:12But people still love it. And that's good news for KB. because last month it bought the eToys brand that was once valued at more than a billion dollars for the bargain basement price of$3.4 million. But what the KB executive really wants to understand is how best to use the eToys name. What about KBKids.com? There's a moment of silence. Then the mom replies. Um, uh, yeah. It's all right. The rest of the room feels the same. So after the focus group, KB runs with the E-Toys brand instead of KB Kids. But by then, Toys R Us' alliance with Amazon is paying off. Toys R Us is now the leading online retailer of toys, and memories of its 1999 holiday meltdown are fading.

26:10With its e-commerce efforts back on track, Toys R Us refocuses on how to shore up its physical stores and capture the hearts and loyalty of new generations. And to do that, it's going big.

26:33It's November 2001, and in Times Square, New York, Toys R Us CEO John Eiler poses for photos, accompanied by an actor in a Jeffrey the Giraffe costume. He's here to open the Toys R Us new flagship store, and it's a statement of intent and a vote of confidence in a city still reeling from the horror of 9-11. Eiler smiles at the reporters. Times Square is now the center of the toy universe, one of the journalists shouts. What about FAO Schwartz? Eiler pretends not to hear the question. He ran the toy retailer FAO Schwartz before defecting to Toys R Us. FAO's Fifth Avenue store was New York City's most prestigious, but not anymore.