Why Toys R Us Can’t Win Anymore

There’s a very good reason you might not have noticed something was a bit off when you were holiday shopping for toys on the Toys R Us website.

It’s because you were not doing your holiday shopping on the Toys “R” Us website. And you were probably not doing much shopping in its stores either.

Toys R Us is planning to shutter roughly 180 stores across the country, about one-fifth of its U.S. store fleet. The closings are part of the company’s bid to restructure and emerge from bankruptcy.

Word of the closings sent a jolt of sadness mixed with nostalgia through the hearts of a lot of Americans, probably more so than the somewhat abstract news that the company had filed for bankruptcy in September. Bankruptcy is a legal state that changes a company’s financial standing and mostly hurts its owners and creditors; a shuttered store changes the physical landscape in which we live, creating a landmark to the failure of another iconic American brand.

As word spread across the internet, some were quick to try to score political points. “So much #winning,” one wit remarked on Twitter, referring to President Donald Trump’s boast that America would win so much under his presidency that it would become exhausting.

“Dear Mr. Trump, please explain to all of the Toys R US employees who work at the 180 stores that are being shut down, just how beneficial your Presidency has been for working-class families,” a notorious anti-Trump twitter troll remarked.

Others were quick to fix blame on the rise of online retail, especially Amazon. Many sophisticated analysts saw the bloody hands of private equity in the mess, blaming the financiers who bought Toys R Us in 2005 for burying the company under an unsustainable debt burden.

The problem with these post-mortems, however, is that they are incomplete. They bring to mind the old saw about blind men touching different parts of an elephant and arguing about the nature of the animal based on whether they touched the tusk, the trunk, or the legs.

As a result, the standard explanations for what went wrong at Toys R Us not only miss the big picture but get even the details they describe wrong. Online shopping did not destroy Toys R Us—it likely extended its financial life by a few years. The same can be said for the role of private equity and debt: they kept the company afloat well past its natural lifespan.

What really killed Toys R Us was the transformation of America from a confident country, with a rapidly growing economy and booming middle class spread out across small cities and big towns into the land of broken middle-class dreams, hollowed-out towns, deindustrialized cities, and economic stagnation. In other words, the forces that led many Americans to support Donald Trump’s campaign to “make America great again” are the forces that brought Toys R Us down.

Toys R Us and the Baby Boom: The Original Disruptor

The story of Toys R Us begins in the late nineteen-forties. World War II veteran Charles Lazarus noticed that lots of his fellow vets were starting to have babies, lots of babies. Figuring that meant they would need lots of cribs, Lazarus founded a baby furniture store in 1948. He was 25 years old.

The shop was called “Children’s Bargain Town” and operated out of the space below his father’s bicycle shop in Washington, D.C. When parents started asking about where they could buy toys, Lazarus started stocking them in the furniture shop.

It soon became apparent to Lazarus that while he could only sell one crib to each family, families would keep coming by to buy toys year after year. Toys broke, kids outgrew the ones they had, kids wanted the latest, coolest toy on the block. So Lazarus got out of the baby furniture business—more on that later—and into the toy business.

Business was brisk. Toy manufacturing and toy sales in the U.S. had all but disappeared thanks to the Great Depression and World War II, which saw many toy manufacturers convert to war production. But the returning veterans and their families revived the market for toys and transformed it. Instead of the educational toys and mini-models of the adult world that had dominated the children’s market before the war, the baby boom families increasingly purchased pure playthings such as Hasbro’s Mr. Potato Head.

Television was transforming America. Mattel and Hasbro grabbed hold of the power of television advertising in the 1950s, with Hasbro airing an ad for Mr. Potato Head in 1951. In 1955, Mattel became a major sponsor of the Mickey Mouse Club, spending a then-record sum.

In 1957, after several attempts at rebranding his shop, Lazarus settled on the name Toys R Us, with the R written childishly backward. That year, Queen Elizabeth and Prince Philip visited a supermarket in nearby Maryland, a demonstration of the rise of the American invention of big grocery shops with long aisles, a huge variety of products, and a scale that allowed discounts to pass on to shoppers. Lazarus modeled his toy stores on these supermarkets.

The Toys R Us business model and the business model of the toy manufacturers fed off each other. Mattel and Hasbro were designing toys that were really product lines demanding multiple purchases. GI Joe and Barbie. These needed stores willing and able to shelve many more products and products that came in much bigger packages. The manufacturers wanted to sell toys all year round, instead of just in the five or six weeks before Christmas when traditional department stores would turn over precious floor space to holiday displays.

Toys R Us had the space and a unique financial proposition—it would take delivery of toys without paying for them until months later, typically after sales had generated revenue. This allowed Toys R Us to experiment, take risks, collect data on what sorts of toys were doing well. Lazarus, who had been a cryptologist in the war, set up a computerized inventory system to keep track of it all.

Lazarus’s stores were category killers. Smaller toyshops folded across America. These huge warehouses of toys, jam-packed with thousands of different toys sold at lower prices became America’s preferred shopping experience. They delivered value and seemed to symbolize America’s dynamic economy.

The Toys R Us model became the template for other sectors. Barnes & Noble and Borders big box book stores. Staples. Home Depot. Petco. Lazarus’s business acumen was so admired he was even given a seat on the board of Walmart.

Despite some stumbles, Lazarus’s toy business could not be kept down. The business was sold to a retail conglomerate that filed for bankruptcy in 1974. But Lazarus restructured the company and sold all of its nontoy business. In 1978, the company went public. Hundreds of stores opened in the 1980s. At one point, Toys R Us accounted for 25 percent of all toy sales in the U.S.

The 1990s: The Great Stagnation Begins and Online Retail Arrives

The company’s dominance began to slip in the 1990s, just as the growth of the American middle class was beginning to stagnate. After adjusting for inflation, the wages of the median American worker in 1997 were 3.1 percent lower than in 1989, according to a study by the Economic Policy Institute. The wealth of the typical middle-class family declined 3 percent over that period. And Americans were working longer hours: the typical married-couple family worked 247 more hours per year in 1996 than in 1989, the equivalent of six extra work weeks.

American tastes shifted toward one-stop mega shops that could offer even bigger discounts and fewer demands on their time. Lazarus stepped down in 1994. By 1998, Walmart was selling more toys than Toys R Us. Pretty soon Target would also surpass the pure play toyshop. Toys R Us share of toy sales would fall to 10 percent and then even lower.

Following a disastrous early attempt at online retail, which resulted in Toys R Us paying fines to the government for making consumers promises that it could not keep, Toys R Us forged an alliance with Amazon in 2000. For 10 years, Amazon agreed basically run Toys R U’s online business, devoting part of its website to Toys R Us products while Toys R Us deployed its deep knowledge of the toy business to choose which hot products to stock. If you went to toysrus.com you wound up on Amazon’s website.

Initially hailed as a model for how older “brick and motar” retailers could ally with the then young internet companies like Amazon, the deal quickly fell apart. Both companies wound up facing off in court in 2004, claiming to have been deceived by the other. Toys R Us alleged that Amazon was not living up to a promise to make Toys R Us the exclusive seller of toys. Amazon said Toys R Us was not delivering on its promise to stock an adequate selection of toys. A court ruled for Toys R Us in 2006 but the litigation dragged on for several more years. Finally, in 2009, Amazon settled the case by paying Toys R Us $51 million.

Private Equity to the Rescue?

The early oughts were brutal for Toys R Us. Its market share continued to decline thanks to the lethal combination of middle-class decline and the competition with Amazon-Walmart-Target. Its children’s clothing stores, Kids R Us, were closed in 2003.

In 2005, the company hired investment bankers who had a plan to break the company up into pieces. In a weird callback to its early days, the Babies R Us crib-and-stroller stores, launched in 1996, were still seen as bright spots but the rest of the company was widely considered a basket case. The best case scenario, according to many financial analysts, was to spin-off the viable bits and let the rest slowly wind down.

A group of financiers had what they thought was a better idea. America was in the midst of a huge real estate bubble. Private equity firms and hedge funds were enthralled with the idea of using the real estate owned by big but struggling retailers as collateral for debt that could then be used to revive the stores. This was the principle that was, in part, behind Eddie Lampert’s purchase of Kmart in 2003 and his subsequent acquisition Sears.

KKR & Co and Bain Capital teamed up with Vornado Realty Trust to buy Toys R Us for $6.6 billion in 2005, in large part based on this idea of financial engineering combined with a bet on the value of real estate. The timing was disastrous. Shortly afterwards, the real estate market collapsed and a deep recession led to Americans curtailing their shopping even further.

The combination of falling sales and real estate that was less valuable than anticipated meant that instead of being able to grow the company or invest in improving its online capacity, Toys R Us was hemmed in by its enormous debt. Although retail sales briefly recovered enough to allow the owners to plan to take the company public in 2010, poor financial performance squashed that idea. (Although even this short-lived delusion of financial success was enough to inspire fraudulent avarice on Wall Street.) In 2017, the company lost $36 million on sales of $11.5 billion.

Looked at through the lens of recent history, the story of Toys R Us resembles and closely the plight of the American middle class over the past two decades. Its growth and underlying financial health collapsed back in the 1990s but part of its decline was concealed in recent years by a real estate bubble and the related availability of cheap financing.

What finally drove Toys R Us into bankruptcy was the collapse of what had once been its most important innovation: leveraged toy purchases. Toy makers were no longer willing to supply the Toys R Us with goods to sell without receiving the cash up front. It had become too much of a credit risk. Faced with this credit crunch, Toys R Us had no choice but to seek bankruptcy protection.

A MAGA Future?

There are plenty of ideas out there for what Toys R Us should have done—or should do next. Some recommend that it focus on becoming a luxury toy brand, the Apple store of toy shops. That didn’t work out so well for JC Penney. Others say heavy investment in online retail would work—although no one seems to have a concrete idea of how it could beat back Amazon and Walmart. One out of the box idea is for Toys R Us to become a kind of digital clearing house for the direct sales of toys by small toy makers or those hoping for a better deal than they get from Amazon, a sort of e-bay for toys.

In any case, kids playing on iPads, Kindles, and game consoles will never again devote as much time to playing with dolls and games–physical toys–as earlier generations once did. Which means their parents will never spend on toys what their grandparents did. So even a revival of the American middle class—an America made great again—probably would not restore Toys R Us to its former glory. Toys R Us is not who we are anymore.