Toys R Us No Longer in Mood to Play
By George Anderson
Considering all the public (and it can be assumed private) acrimony between the parties, it seems almost surreal that Amazon.com is looking to have its contract reinstated with
Toys R Us.
Last month, New Jersey Chancery Court Judge Margaret Mary McVeigh ruled that Toys R Us could end its 10-year deal with Amazon because the online seller had violated an exclusivity
agreement with the toy retailer. Toys R Us paid Amazon $50 million a year to maintain exclusivity with the online giant.
Amazon is appealing to a higher court and has asked Judge McVeigh to put a stay on her ruling until the legal process plays out.
Last week, the judge said she would approve a stay, according to The Seattle Times, if Amazon removed all competitors to Toys R Us from its site.
“(Toys R Us) would be provided with that indefinable brand protection it sought, and Amazon would continue to maintain ‘the largest forum in the world for the sale of these products,’
” she wrote.
Amazon outright rejected the proposal, according to the judge.
Moderator’s Comment: Would it be in the best interests of ToysRUs.com to reinstate its deal with Amazon.com if somehow the company was willing to remove
toy competitors from its web site? When business relationships such as these go south, can they be repaired without a change in the people running the companies? –
George Anderson – Moderator
Mark pretty much nails it above. I imagine TRU’s $50MM annual commitment to Amazon was proving onerous in relation to the actual profits generated by the deal. That’s quite a hurdle to overcome, especially since the arrangement also pits online sales in competition with store sales.
Here’s a back-of-the-envelope analysis based on a quick look at the latest TRU annual report available on its Web site, FY2004: TRU net profits came to $213MM or 1.8% of $11.3B in gross sales that year, presumably after the $50MM payment to Amazon. So roughly speaking, TRU handed 1/5 of its profits over to Amazon. Assuming equal proportions, Amazon had to sell about $2.7B worth of toys for TRU in 2004 to break even on that $50MM.
Amazon’s reported total worldwide volume in 2004 was $6.9B. It also reports that US net sales of all goods other than media (books, CDs, DVDs) came to $1.26B – or less than half of our estimate of TRU’s sales hurdle. Doesn’t add up, does it?
TRU’s 2004 annual report indicates it knew by 2004 that it had made a bad deal with Amazon and it first went to court then to get out of the deal. Issues of exclusivity, it seems are just the legal basis for voiding an otherwise very badly conceived contract.
There may be bad feeling at the moment but if getting back onto Amazon’s site increases income with relatively low outgoings then it has to be the right decision. This too shall pass.
TRS proved that they could not make it as an on-line retailer and their stores are suffering at the hands of Wal-Mart and Target, so do the next best thing, sell your brand. That is about the only thing they have left. Amazon would be the most likely suitor. Selling your brand is big business these days and an excellent option when you cannot figure out how to compete in today’s marketplace.
I know this sounds negative, but when was the last time you went into a Toys R Us? I have two young children and neither my wife nor I have been there in years. Bad locations coupled with no real compelling reason to go there….
For better or for worse, Amazon is THE destination site for on-line purchases. Toys R Us, while once the predominant seller of toys, is not an on-line destination site. It would be in their best interests, provided that there was a smaller annual fee paid to Amazon, to once again be the sole supplier of toys on Amazon’s web site. It appears that Amazon violated the agreement and thus should be held accountable for their actions. Thus, Toys R Us can use that as leverage and proverbially “kill two birds with one stone.” They can be the sole toy seller and get better terms.
Neither Amazon nor Toys R Us makes money by selling low-margin toys at a high overhead. Amazon’s TRU deal has a goal: make money via service fees that TRU pays. TRU has a goal: get the fees minimized. Conflict is guaranteed since neither party is financially naive, the branded toy business has very low margins, and on-line sales require higher overheads than a discount retail price appeal can afford. Amazon faces this conundrum in numerous categories: margins are lousy; customers want free freight; and overheads can’t be reduced further. So Amazon wants service fee deals that insulate it from the Darwinian low margins of its merchandise categories. Even if Amazon gets great service fees, their business partners can’t stay solvent, so where will Amazon’s business go in the long run?
Toys R Us could not manage its own online service efficiently. Unless they have hired the right people and are geared to spend the money to do it right, they should not try on their own. Finding a way to make the deal with Amazon work is in the best interests of both parties.
TRU’s failure in internet selling had more to do with execution than website design. Just like in the store, if a customer goes to buy an item and it is not there they are disappointed. This usually leads to not shopping the store in the future. As a major player in the toy segment and by paying for exclusivity, they are entitled to get what they paid for. TRU’s problems are much deeper than a website. First on the list are poor store locations. Second are stores that are too large and thus cost too much to operate. Third is an obsolete merchandise strategy. Just like supermarkets, going head to head with Wal-Mart is a great way to go out of business. Once TRU develops a new merchandising strategy and learns to execute at retail then the internet will play a role in the company’s success. Otherwise, we are just watching another real estate play.
Amazon has always been a confusing combination of a technology company and a retail company. On one hand, their prescient entrance to the internet really got things rolling. They quickly became a household word and their service was both innovative and practical. But “imitation is the greatest form of flattery” and the imitators have jumped on the broadband network to provide competing online services. The technology is no longer innovative. Worse, it has become downright common, with hundreds of internet sights offering products online. Without the technology barrier, the online retail market can get nothing but more cutthroat as the only distinguishing feature becomes price. That is why Amazon does not want to loose the Toys R Us contract that was written when the technology was still new.
From the Toys R Us perspective, they have the advantage of physical presence. They can meet the last minute demand requirements by having the right product at the right place for the right price and supported by a knowledgeable sales staff. They still need to be online, but they also need to exploit the impulsive nature of so many toy purchases that are made by consumers “desperate for a new toy.”
This whole thing kind of masks a bigger trend that is emerging in technology. As broadband and internet services become common place the only barrier becomes scale. Well designed services built with a vision of scalability (this includes multilingual support) can literally reach all over the world by merely adding more pieces of hardware and attaching them to the network. This means that individual companies focused on their own businesses don’t have to support a technological environment that is foreign to them. They can sign up for services that meet their needs and get back to doing business.
So, when you consider this particular situation it is merely the case of Amazon having a contract that is “too good to loose.” As the cost and uniqueness of the technology has declined it has become worth it for Amazon to pay a bunch of lawyers in order to enforce their 10 year deal with Toys R Us. Meanwhile, Toys R Us should be contracting out to one of the “reasonably priced providers” and get back to emphasizing their brick and mortar presence. And this time, it should not be for more than three years.