Toys R US vs KB Toys | Toy Hunter | 2

0:07April 1984, Walmart head office, Bentonville, Arkansas. Walmart president Jack Shoemaker storms down the corridor, his face contorted in rage. He's the man who came up with the chain's winning slogan of everyday low prices, and the man most likely to be its next CEO. But right now, he's got a beef with the current CEO, Walmart founder Sam Walton. As Shoemaker stomps toward Walton's office, Walton's secretary stands. He's busy, Jack. Yep, busy talking to me. Shoemaker bursts into Walton's office. Walton's at his desk on the phone. Behind him hangs a portrait of him and his hunting dogs. Walton scowls at Shoemaker and wraps up his call.

0:54Say, can I call you back? Something's just come up. Uh-huh. Thanks. Thanks. All right. Bye now. Yep. Bye-bye. Walton hangs up. The two men stare at one another for a moment from opposite ends of Walton's cheaply decorated office with his mismatched cupboards and turquoise carpet. Walton breaks the silence. So? Shoemaker fires both barrels. So? So? So Charles Lazarus? What are you thinking, Sam? In what world do we want Charles P. Lazarus on our board? Walton leans back into his chair and crosses his arms. You done yelling? No, I'm not. Toys R Us is a rival, and you're about to give its founder a front-row seat to our internal operations.

1:42Walton adjusts the baseball cap covering his white hair. I am, but I trust him to be a professional. Shoemaker throws up his hands. Wake up, Sam. Lazarus is a killer. Sears used to rule toy retail. Now, because of Toys R Us, it's on its knees. At some point, we're going to war with Toys R Us, and we don't need them having the inside track. Walton frowns at Shoemaker's failure to get why he's doing this. I want Lazarus on our board so I can see how he thinks. He was discounting back when I was running Five and Dimes. He's using the latest computer technology to get an edge. He's one of the smartest men in retail.

2:24We can learn a lot from him. And he can learn a lot from us. It's a conflict of interest, Sam. He's always going to be more loyal to Toys R Us than Walmart. You can't do this. Yeah, I can, and I will. Besides, if the day comes when we go gunning for Toys R Us, we can undercut them. We have plenty of other merchandise to tide us over through a price war. They don't. It's that simple. Not if he's as clever as you think he is. Well, maybe. But that is my decision. and it's my decision to make. That summer, Walmart stockholders add the Toys R Us founder to the company's board. It seems like another triumph for the toy king, but Walton's a hunter.

3:12He knows that sometimes you need patience to get your prey, and eventually Walmart will get Jeffrey the giraffe's head mounted on its wall.

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5:30From Wondery, I'm David Brown and this is Business Wars.

6:19Toys R Us

6:261989, the week before Christmas, Rochelle Park, New Jersey. In his corner office within Toys R Us headquarters, CEO and founder Charles Lazarus turns to the computer terminal on his desk. He glances at the blinking cursor on the screen, taps out a command with one finger and presses return. The screen goes blank. Then, a stream of green text appears. It's a list of today's bestsellers at Toys R Us, beamed in via satellite from its 404 stores. In first place is the Teenage Mutant Ninja Turtles video game. It's flying off the shelves and ensuring another stellar holiday season for Toys R Us. The 66-year-old Lazarus grins and turns to the company's merchandising chief, who's looking over his shoulder.

7:16Cowabunga! Tycho's Oopsie Daisy doll's doing really well, too! Wow! The merchandising chief nods. Yeah, Tyco should be here kissing our feet. They only went big on Oopsie Daisy because we told them it could be this year's big doll. If they really want to thank us, they should stop selling to warehouse clubs. Lazarus's holiday cheer melts away just thinking about it. Warehouse clubs like Costco and Sam's Club make him angsty these days. Two years ago, they weren't even on his radar. He was busy battling big-box discounters like Walmart and Target. They thought they could beat Toys R Us on price.

7:54They thought wrong. Toys R Us doesn't make its biggest profits on the best-selling toys. It prices those toys with markups as low as 20 % to maintain its low-price image and get customers through its doors. No, the real money comes from the thousands of exclusive and middling sellers that line its shelves. The profit margins on those toys are as high as 50%, and discounters like Walmart lack the shelf space to carry them. So when Walmart began undercutting Toys R Us, Lazarus responded in kind. He quit its board of directors and cut the price of the hottest toys to wipe out Walmart's price advantage.

8:35But no sooner had Toys R Us contained that threat. The warehouse clubs came marauding over the hill. These clubs make Walmart seem pricey. They first appeared in the 1970s and catered to small business owners. Now, everyday people shop there too, enduring the eyesore interiors, products on pallets, and long checkout waits in return for big savings. Now these clubs are pushing into the toy market and beating Toys R Us on price by as much as 25%. But Lazarus has no intention of trying to match these rivals on price. He's plotting a different strategy. But while he makes plans, KB Toys is upping its game.

9:24KB Toys spent the 1980s opening a new store almost every week. Now it's got 800 outlets and each one is a brightly colored trap for mall shoppers. Instead of windows and regular doors, its stores have wide open entrances with neat stacks of toys to capture the attention of passing children, and all those toys are priced low to encourage sales. Then, as shoppers head deeper into the store to reach the checkout, they're tempted by more appealing and higher-priced toys. And KB's Mall Rat Trap is proving profitable enough for it to buy out competitors. In 1990, KB buys Circus World for$95 million and gains another 330 stores.

10:06Soon after, it buys K &K toys to bring its store total to more than 1 ,200 nationwide. In tandem, KB steps up its promotional efforts with TV ads, starring a gang of toy-buying puppets made from the same nylon fleece as the Muppets. Where are you going to find all the hottest toys? On the planet Mars? No! On a mountaintop? Uh-uh! Hot We Got at KB Toy Stores. It's the place to shop. You'll see all the latest toys to choose from. Hot We Got at KB. Make KB your headquarters for hot items like the revolutionary new Game Boy from Nintendo. KB's got it. All the latest toys to choose from. Hot We Got at KB.

10:54But while the ads push hot-ticket items, KB's buyers are still out to grab closeout merchandise that can join the racks at the front of its stores.

11:081991. In an office in Pittsfield, Massachusetts, Richard Gottlieb is hoping to make a deal with KB Toys. He works for Catacombe, a small toy firm best known for the board game Advertising. But today he wants to offload a warehouse full of puzzles and puzzle glue. Catico needs to get rid of them so it can stop paying storage fees and recover as much of the cash it spent making them as possible. Trouble is, KB's buyer knows this. The KB buyer punches in a few numbers into the pocket calculator on the desk, rechecks the figures, redoes the calculation, and then looks at Gottlieb. Okay, we place a major order for several hundred thousand puzzles.

11:53Gottlieb starts to smile. But there's a but. But if, and only if, we get the puzzle glue for free. Gottlieb blinks in shock. I, uh, I can't believe you just asked for that. The two men look at each other and burst out laughing. The buyer stops laughing. Gottlieb's laugh stutters to a halt. Oh, you're actually serious. You really mean it. Hey, yep. Well, that's outrageous. KB's buyer nods. Yeah, it is. But that's the deal. You want it? We get the free glue. KB's only offering Catico a few pennies of profit per puzzle. But this order's too big to reject, so Catico makes the deal work by shrinking the size of its glue sticks.

12:46And soon after, Catico Puzzles are on sale in the bargain racks outside KB Toy Stores nationwide. But KB isn't the only retailer putting toy makers under pressure.

13:05October 1991. Mattel headquarters, El Segundo, California. In a meeting room, Mattel's white-haired CEO, John Ammerman, can feel the eyes of his top executives staring at him, imploring him to tell Charles Lazarus to take a hike. But no one tells the Toy King no. Not even Mattel, the world's biggest toy maker. Ammerman looks across the table. Lazarus is there, arms folded, waiting, flanked by top senior Toys R Us executives. That's a big ask, Charles. We've made commitments. Lazarus snaps. I don't care. I don't want Mattel doing business with warehouse clubs. Ammerman fumes. Warehouse clubs are core to Mattel's retail strategy.

13:53Their toy sales are growing fast, and Mattel wants alternatives to Toys R Us. The superstore now sells more than 40 % of the toys bought in many major cities. Chicago, Los Angeles, Detroit, New York, San Francisco, Miami, they're all Toys R Us towns. KB is the only other big toy store chain left, and its small stores mean it orders far less product. Only warehouse clubs and discounters have the heft to keep Toys R Us in check now. Lazarus grows impatient with Ammerman's hesitation. I want an answer, John. Are you going to stop selling to the clubs? Ammerman wants to say no, but he can't. Toys R Us is too powerful.

14:39It could sideline Mattel products within its stores, price them high enough to fail, delay major payments, and generally make life hell. Ammerman shoots for a compromise. We'll stop selling to clubs if our competitors do. I'm not walking away from clubs just so Hasbro can clean up. Lazarus nods. I promise you that Hasbro and every other major manufacturer will do the same. But he's bluffing. Hasbro hasn't agreed to this. Neither has anyone else. But Lazarus knows that once Mattel buckles, Hasbro won't dare say no for fear that Toys R Us will give Mattel preferential treatment. And once Mattel and Hasbro cave, every toy maker will fall into line.

15:29Ammerman looks at Lazarus. Okay, but we need clarity on what we can sell to clubs. Lazarus leans back in his chair. You can sell to clubs whatever we say you can. You show us what you want to offer to them, and we tell you if you can. The Mattel team's jaws drop. Ammerman's eyes widen. Let me get this straight. You want veto power? Yes. I don't want us stocking similar merchandise and customers being able to compare prices. You can sell them combos, Barbies with extra dresses or whatever, but Barbie on its own is ours. But encouraging Mattel to sell the club's combo packs isn't just about avoiding price comparisons.

16:15Customers don't like combos. They'd rather buy the Barbie without the extra dresses. What's more, combo packs are more expensive because toy manufacturers don't want to devalue the stand-alone toy. Toys R Us' plan is to leave the warehouses with nothing but overpriced toys that shoppers don't want. Lazarus leans toward Ammerman. So, do we have an agreement? Yes. Yes, we do. Lazarus smiles. He's forced Mattel to accept his demands. Now, every other big manufacturer will also bow down. And by the time the warehouse clubs sense something's up, their toy departments will be dying.

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18:43July 1992, Paramus, New Jersey. In Toys R Us headquarters, the company's merchandising chief accepts a call from a Hasbro sales executive. Hi, how are you? What's up? Uh, listen, we've spotted something you should know. Mattel's Air Pro hockey toy. It's on sale in Pace Warehouse Club. Uh, wait a second. The merchandising chief frowns and grabs his notepad. Okay, which stores? The merchandising chief cradles the phone receiver between his ear and shoulder as he jots down the locations. Got it. Thanks for bringing it to my attention. I'll deal with it. He puts the phone down and immediately picks it up again to buzz his secretary.

19:25Get me the head of sales at Mattel. The merchandising chief hangs up and turns to his computer terminal. He gets the sales and price data for Mattel's Air Pro hockey on the screen, and then scribbles a few figures down on his notepad. The phone rings. Yep. Mattel's on the line. Put him through. Hey, what can I do for you? You can tell me why you're selling Air Pro hockey to Pace. There's a moment of silence on the line. There must be some mistake. At your end, definitely, but not at ours. Hasbro just phoned it in. Yeah, you're not the only manufacturer tattling on the other. Uh, look, it's, uh, an order was accepted before we agreed to your policy.

20:13We tried to get Pace to take a special combo version with an extra hockey stick instead, but they wouldn't take it. We delayed shipping, but then they complained and we really had to do something, so we, uh, we shipped them part of the order. Not just part, but... Save it. Here's what's happening. We're marking down Air Pro Hockey by 20 % to match Pace. Oh, it's not that many. And Mattel's going to split the cost of that markdown with us. Oh, come on. You're overreacting. You can't. I just did. Also, I see Mattel's due a$540 ,000 payment. We're just going to sit on that just a little longer. Consider this a warning shot.

20:56Do let your boss know, okay? The merchandising chief hangs up. He's sure Mattel won't make that mistake again. And he's right.

21:11A few weeks later, Mattel stops filling the orders it took from warehouse clubs before Toys R Us imposed its policy. By 1993, Toys R Us' bullying tactics are paying off. Manufacturers who want to sell to the clubs now ask Toys R Us for permission first. Toymakers prowl the warehouse aisle so they can report infractions by their rivals. And toy sales at the clubs fade as shoppers snub all those combo packs. In 1992, clubs handled 1.9 % of toy sales and rising. By 1995, their market share had shriveled to 1.4%, even as their sales of every other type of merchandise skyrocketed. With the threat from the warehouse clubs neutralized, Lazarus retires on a high.

22:07But while Toys R Us tramples on the warehouse clubs, back at KB, the future's looking shaky.

22:21October 1995, Rye, New York. In the boardroom of Melville Corporation, the retail conglomerate that's KB's owner, CEO and Chairman Stanley Goldstein places a couple of post-it notes on the whiteboard and steps back. So we sell Wilsons as well as this end up, and the rest of the company splits into three. The rest of Melville's board of directors nod. For decades, the company grew on the back of shopping malls, but now shoppers are drifting away from the malls in favor of freestanding stores like Toys R Us. So Goldstein and the rest of Melville's managers have drawn up a bold solution. They're going to break up the company and bet everything on its most promising brand, the pharmacy chain CVS.

23:09But that leaves all its other brands in need of a new home. Goldstein runs through the plan again. So Mel Disco, Foot Action, and Tom McCann get spun off as a footwear specialist. We hang on to bobs and linens and things, but with the aim of selling them eventually. That leaves KB. KB is in a tricky spot. The price wars in toys are intensifying, and its small mall stores lack the buying power to match the super stores. The decline in foot traffic at malls threatens its entire business model. In response, it's pushed into the superstore market, opening large Toys R Us-style stores under the Toy World brand.

23:51But it's more than 20 years late to the party. Despite all this, KB still does good business with annual sales now topping a billion dollars. And that's why Goldstein thinks it can survive. KB's fundamentals are good. We should spin it out. Another board member isn't so sure. I don't think its long-term prospects are good enough to attract investors to sustain a spinoff. Walmart and Target are driving prices down and down. I say we add it to the sell pile. Toy World might change things. I mean, it's not had a chance to prove itself, really. To be successful, KB needs the capital investment that being a public company can open up.

24:32Okay, how about this? We announce it as a spinoff. Test the water. See how Wall Street responds. If they don't bite, we sell. What do you think? Works for me. Any objections? The board members shake their heads. Melville is about to be broken up. And one way or another, KB's going to a new home. But the plan to spin off KB fails to enthuse Wall Street. So in 1996, Melville switches to Plan B and offloads KB to the retail conglomerate Consolidated Stores for$300 million. As KB settles into its new digs, Toys R Us is finding itself in less cozy confines. Jeffrey the Giraffe is about to have his day in court.

25:29March 1997. In a Washington, D.C. courtroom, Toys R Us' attorney rises from his chair, ready to make the case for the defense. The toy superstore stands accused of illegally inflating prices by pressuring manufacturers into withholding popular toys from warehouse clubs. The attorney steps forward and makes his argument. Yes, Toys R Us did enter marketing agreements with toy makers. That is true. But this was only to protect itself from cherry picking by the warehouse clubs. And it is perfectly lawful. The attorney checks his notes. All Toys R Us did is simply pose a choice to manufacturers. It's us or it's them.

26:11And if you sell to warehouse clubs, we might not buy your toys. The attorney takes a sip of water. He's doing his best, but this case is looking dicey. The Federal Trade Commission sued Toys R Us for antitrust violations after a two-year investigation. It uncovered reams of evidence that the nation's top toy seller used its position to keep popular toys out of warehouse clubs. It vetoed the sale of Disney Pixar Toy Story figurines. It got Hasbro to refuse to sell Hall of Fame G.I. Joes to the clubs. When the toy maker Just Toys got caught supplying a promising new toy to BJ's warehouse stores, Toys R Us canceled its order, killing the toy.

26:54It also coerced many of the biggest names in toys, from Mattel and Hasbro to Fisher-Price, Sega, and Little Tykes. But even in the face of all this, Toys R Us is not backing down. The attorney resumes his address to the court. Toys R Us cannot dictate pricing to toy makers. Its market share is less than 20 % and in decline due to the stiff competition from Walmart, Target and others. But the judge isn't buying this story about the little down-home superstore merely trying to defend itself from marauding competitors. A few months later, the judge upholds the Federal Trade Commission's decision and orders Toys R Us to free the toy makers from its agreements and to stop asking suppliers for information about their sales to rival stores.