Over the last year or so, we’ve been hearing about retail bankruptcies almost every month. The latest is Toys R Us, which filed for Chapter 11 bankruptcy* on Tuesday this week. This is the largest specialty retail bankruptcy in the history of the US and one I view with sadness. As a child, I frequently dragged my parents to Toys R Us and recently, I became a frequent visitor again following the birth of my son.
The most common explanation for the retail apocalypse is Amazon. Why bother driving 15 minutes to a mall and wading through the aisles when you can sit in your couch and buy exactly what you want at a lower price and have it delivered for free within one day? For this reason, e-commerce sales as a share of the total retail market have doubled in just 6 years with no sign of stopping, and now make up 8.9% of total retail sales. Of this 8.9%, Amazon accounts for an astounding 43% of online retail sales.
However, there are still plenty of examples of successful retailers that are doing well in this tough operating environment. Best Buy, TJX, Ulta Beauty, H&M, Dollarama, and Costco come to mind as retailers that have clearly defined their value proposition for customers. Retailers must give customers a reason to visit them (either online or in the physical stores) and remain nimble and flexible. Sadly, Toys R Us did neither of these things and its failure has as much to do with poor leadership and ownership as it had to do with the changing retail landscape.
The seeds of Toys R Us’ bankruptcy goes back to 2005 when Toys R Us was acquired in a leveraged buyout, placing $5.3b of debt onto Toys R Us’s balance sheet. As a result of the debt, Toys R Us paid $457m of interest in 2017, money that could have been invested into the stores, marketing, or online initiatives. In its court filing, Toys R Us admitted as much, saying:
“These substantial debt service obligations impair the Company’s ability to invest in its business and future. As a result, the Company has fallen behind some of its primary competitors on various fronts, including with regard to general upkeep and the condition of our stores, our inability to provide expedited shipping options, and our lack of a subscription-based delivery service.”
Anecdotally, my wife and I found little reason to visit Babies R Us for our baby’s needs if not for the fact that we received Babies R Us gift cards from friends and family. We had visited a couple of different Toys R Us locations, and found the inventory selection to be lacking, prices to be expensive (relative to Walmart and Amazon), and staff to be disinterested and unhelpful. The main store we visit at Victoria Park and Lawrence does not even stock diapers. Although it’s certainly possible that we visited the bad apples, the news reports and financial statements support the narrative that Toys R Us stores are simply not that well-run. Here are the words of CEO Dave Brandon during a visit to a store in New Jersey in 2015:
“It kind of reminds me of a garage sale. We’re not the dollar shop. We’re a toy store.”[i]
Another example: Up until 2015, Toys R Us’s inventory system considered a toy to be in-stock if only 3 of the toys were stock; worse still, the online site was only in-stock for 62% of the top 100 toys on Black Friday in 2016.
It didn’t have to end this way. Toys R Us blew its chance to be the exclusive toy supplier for Amazon. In 2000, Amazon and Toys R Us signed a 10-year deal for Toys R Us to be the exclusive supplier of toys for Amazon under a co-branded Amazon toy store. Amazon became upset with the selection of toys and maintenance of inventory for Toys R Us and began offering other toys that were not offered by Toys R Us. Toys R Us ended up winning a lawsuit against Amazon in 2009, but ended up forfeiting their position in the dominant online retailer.
As for the bland stores and unhelpful staff, this is solely on the management and reflects the difference between a well-run and poorly-run company. These are simple things to fix that make a big difference and do not cost that much to implement. Most people have pleasant experiences inside a Starbucks or Apple Store and their results reflect their hyper-focus on the customer experience.
At Baskin, our job every day is to look for companies that are adequately investing and positioning themselves for the future and Toys R Us is a sad case study for what not to do. (We never owned the stock). Toys R Us was given the chance to succeed in the new digital era, but a combination of a lack of customer-focus with a high debt load made Toys R Us’ failure seem inevitable. Bankruptcy will give Toys R Us the chance to re-invent itself without its onerous debt burden. I hope it succeeds.
September 22, 2017
* Chapter 11 bankruptcy means the business continues to operate while the various stakeholders figure out what to do with the debt. Normally, the creditors of the business get equity in the restructured business while the existing shareholders are left with nothing.