Will Wal-Mart Steal Christmas?

JASON TURNER/THE JOURNAL/AP
Shoppers stock up on toys at Wal-mart the day after Thanksgiving

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Longer term, there's little question that Wal-Mart has gained an edge. Its share of the $25 billion traditional toy business has grown from 10.8% in 1993 to 21% today (and some analysts estimate it's more like 25%). Toys "R" Us, KB Toys and smaller toy chains, meanwhile, have either lost share, quit the business or struggled to hold ground. Says analyst Todd Kuhrt of Midwest Research, "It's clear that consumers are voting with their wallets for Wal-Mart and Target."

One potential casualty: FAO Schwarz. The upscale chain, whose flagship Fifth Avenue store in New York City was immortalized by Tom Hanks in Big, has been losing sales to big-box retailers all year, and the chain is said to be facing a cash crunch heading into the holiday season. Parent company FAO Inc. is in default on its lending terms, creditors have signaled that they won't provide more loans, and analysts say the firm may seek bankruptcy protection before Christmas. That would mark a dismal end for FAO Inc., whose holdings include the Zany Brainy and Right Start chains. The firm emerged only in April from a previous stint under bankruptcy protection.

The trouble is FAO's high-end focus no longer appears to be paying off. "FAO's pricing is out of line," carps Ken Kasarjian, who was checking out the goods at a Toys "R" Us store in Manhattan's Times Square last week with his twin 9-year-old sons. But Kasarjian was not particularly impressed with the prices at Toys "R" Us either. For now, he's planning to place some orders online and buy some other toys at Wal-Mart. His shopping habits aren't unusual, and that's troubling for toy retailers, who must compete for business with not just Wal-Mart but also drugstores, discount Web sellers and auction sites like eBay.

Still, Eyler isn't about to admit defeat. Since the former FAO chief executive took the helm in 2000, he has aggressively restructured Toys "R" Us. He shuttered dozens of stores, consolidated support centers and freshened up the company image with a remodeling of 75% of its 680 flagship shops. The firm spent millions to improve customer service. It cut inventory from 14,000 to 9,000 items to focus on more profitable lines. And in a bid to differentiate its wares from Wal-Mart's whose selection is limited despite expansions of toy shelf space around the holidays it bolstered its exclusive merchandise and brands, adding lines like Animal Alley stuffed animals and Super Slicks radio-controlled cars. Selling more of its own brands should enable Toys "R" Us to cut costs because it can source the merchandise directly from contract factories in countries like China rather than buy from higher-priced manufacturers like Hasbro. Eyler says exclusive products account for 20% of the firm's merchandise mix, up from just 5% in 2000, and adds, "We will migrate it to 25% in the next few years."

Eyler also deserves credit for expanding in other areas. Revenues at Toys "R" Us shops overseas have risen 28% since 2000 and are expected to hit $2.4 billion this year. Meanwhile, the partnership with Amazon.com is on track to break even for the first time in 2004, after several years of losses. And sales at Babies "R" Us apparel stores are up 61% since 2000, to $1.8 billion.

But the real challenge for the company is to boost profitability in the face of relentless pricing pressure. Profit margins at Toys "R" Us stores fell from 5.7% in 1999 to just 3.2% this year, according to Jefferies & Co. Eyler knows he can't back down by letting the behemoths undercut his prices. "We won't allow [Wal-Mart] to distance itself," he vows. Geoffrey, he hopes, will prove that price isn't everything, that shoppers will warm to the charms of brightly colored jungle gyms and playpens. And he can take comfort in this: you can't find those services at Wal-Mart. Yet.