Market Begins Squeeze on Web Toy Merchants

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A succession of developments that occurred last week within the online toy retailing market indicates that the fun and games in that sector may be over:


• eToys.com, Santa Monica, CA, raised $100 million by selling stock to private investors, preferring that route instead of another round of open-market funding.


• KBkids.com, Denver, contacted the Securities and Exchange Commission to withdraw its planned $210 million IPO.


• CEO Judith Harrison of ZanyBrainy.com, King of Prussia, PA, resigned only seven months after the educational toy retailer went live. The reason for her sudden departure was not specified.


For many, this flurry of deals is a last shot at survival. Only last month, Toysmart.com had to close after parent company The Walt Disney Co. refused to inject more cash. A few weeks later, ToyTime.com shut down. Although it had customers, it did not have the money to retain them or to acquire new business.


On a less-drastic scale, KBkids.com copied myriad cash-strapped online retailers in other markets and opted to fire some of its staff, including the vice presidents of marketing and merchandising, instead of closing down.


"I think the toy market is an example of something that's going to happen in all [online] markets and that's the idea of what we call singularity," said Laura Ries, president of focusing consultants Ries & Ries, Roswell, GA.


"Most likely, the Internet is going to have one big player in every category that's going to have an overwhelming dominant position, like Amazon does in books," she said.


Seema Williams, senior analyst at Forrester Research, Cambridge, MA, agreed. According to Williams, it's an inevitable round of consolidation in a market that had far too many players for its size.


"For the most part, they weren't differentiated enough or didn't have enough traffic or they were facing some pretty overwhelming competition from larger incumbents like eToys, Amazon and Toysrus.com to really last," Williams said. "So, that's why some of them have gone away and for the rest that have survived, it's a question of jockeying for position."


However alluring the category, the Internet toy store will take a while to become a formidable foe to bricks-and-mortar toy retailers.


Forrester estimates that the Internet last year accounted for only $253 million, or 0.9 percent of toys and video games sold across all channels. This year, online sales are projected at $210 million, or 2 percent of all sales. Next year, online sales may go up to $1.098 billion, or 4 percent of all sales. Even in 2002, Forrester expects online sales to account for $1.74 billion, or only 5 percent before it almost doubles in 2004 to $3.67 billion, or 10 percent.


Still, such sluggish growth -- compared to other categories like media, leisure travel, electronics and computers -- hasn't dampened the ardor of start-ups and multichannel toy retailers alike.


But in the rush to acquire customers, inexperienced online retailers forgot that toys are a cyclical business. Players such as Toysrus.com, Paramus, NJ, acknowledge that the holidays accounted for 50 percent of annual sales. The rest of the year, fixed costs for warehousing, fulfilling and employees are on full tap.


And then, there's the nature of the toy business itself.


"It's a little bit of a hit business," Williams said. "You have to have the latest and greatest toys available, otherwise consumers won't buy anything."


The winnowing of online toy retailers is to the advantage of traditional retailers. But that doesn't mean companies like KB Toys, which controls KBkids.com, stand to immediately gain.


"The problem with KBkids is that KB Toys as a retailer was always dependent on the traffic that happened to pass by their door in malls," Williams said. "So, it was never a destination store offline and it's not going to become a destination online either. That's a marketing challenge that they continue to face."


However, Wal-Mart.com -- whose owner, Wal-Mart Stores Inc., the largest bricks-and-mortar retailer of toys, has an 85 percent share -- and Toysrus.com will gain from the visibility of their stores, a strong brand name and fresh venture capital funding. And these retailers are learning from past mistakes.


Take Toysrus.com, for example. Despite its Web site crashes and fulfillment gaffes over the last holiday season, Toysrus.com has now become the No. 2 online retailer of toys after eToys. It has added three more fulfillment centers to gain extra capacity for this year's holiday season.


Toys 'R' Us Inc. soon will launch Babiesrus.com, adding to its rivalry with Internet-only players such as eToys and Amazon.com and bricks-and-mortar rival Wal-Mart.


"Again, venture capital funding is going to make all the difference for them, but Wal-Mart's a little bit like KBToys in that you don't think of Wal-Mart when you have to buy toys despite the fact that it's the largest retailer," Williams said.


"And, at the same time, Wal-Mart's not where you naturally go as a consumer when you think that you have to buy toys," she added. "So, the opportunity here is that Toys 'R' Us can flip that balance back into their favor online even if they couldn't have done it offline."
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