BUSINESSWEEK ONLINE : DECEMBER 4, 2000 ISSUE
COVER STORY

Toy Story
Old stores, new rivals, and changing trends have hammered Toys 'R' Us. Can CEO John Eyler Fix the Chain?

For now, the interior of the building at 44th Street and Broadway in the heart of New York's Times Square is a dusty demolition site. But as John H. Eyler Jr., the latest chief executive of long-troubled Toys 'R' Us Inc. (TOY), strides through in his hard hat and shirtsleeves, what he sees is a retailing phoenix ready to emerge from the rubble. Or maybe it's going to be more of a peacock.

His plans for the site, which will open as the new Toys 'R' Us flagship next fall, are massive. The store's outsize attractions will include a 30-foot-tall animatronic dinosaur, a two-story Barbie townhouse with its own elevator, an indoor Ferris wheel able to take 600 people a day for a spin, and a life-size version of the Candy Land board game that doubles as a candy store. Add in personal shoppers and, for VIPs, a skybox balcony from which they can survey all this from on high. To make sure that none of it is lost on passersby, a 30-foot-tall glass wall facing Broadway will feature scrolling technology that switches it from a window into a billboard in three seconds flat.

If this doesn't sound like the Toys 'R' Us you remember--the store of unhelpful sales clerks, warehouse-length aisles done in dismal gray and blue, and Christmas-eve frustration--that's just how Eyler wants it. Recruited from upscale toy vendor FAO Schwarz last January, Eyler has gone from the Ritz to the Motel 6 of toy retailers. Part of his plan is to bring along a bit of the Schwarz magic but at a price Toys 'R' Us can afford. ''All of retail has become more theatrical,'' says Eyler, 53. ''It's about making it fun. What's fun about going to a warehouse?''

Not much. And that, in a nutshell, is what's behind a string of sales and earnings disappointments and management turmoil at the once high-flying Toys 'R' Us, based in Paramus, N.J. In his first 10 months in command, Eyler has been a whirlwind of activity, mostly focused on revamping the poor customer service and layout of the chain's 707 U.S. toy stores. Don't expect a giant T. rex at your local branch, but Eyler is beefing up staffing and training, greatly increasing the chain's supply of exclusive products, and striving to keep toys in stock and on shelves that people can actually reach. The hope is that by showing shoppers a friendlier, more helpful face and lining shelves with great toys not available elsewhere, Toys 'R' Us can break out of the low-price supermarket approach that hyperefficient Wal-Mart Stores Inc. (WMT) does much better. Two years ago, the Bentonville (Ark.) giant overtook Toys 'R' Us as the No. 1 U.S. toy seller.

Eyler is the third Toys 'R' Us CEO to try to stop the onslaught of the discounters since founder Charles Lazarus retired in 1994. And his store overhaul is the company's third since 1996. Toys 'R' Us has found that offering the widest selection 12 months a year just isn't enough to keep customers happy. The chain struggled so hard trying to figure out how to beat the latest challenge--online toy stores--that it finally joined them instead, linking up with Amazon.com Inc. (AMZN) last summer to create a joint Web site. ''When I started, if you had good selection and good prices, that was the key,'' says Lazarus, now 77 and still a member of the board of directors. ''There was only our price and a very high price, so customers were willing to withstand a lot. Today, our competition is very good, and we have to be better.''

If customers do respond to Eyler's changes and the chain pulls off a respectable holiday season and a strong 2001, he will have gone a long way toward proving that he has figured out how to make a 1980s-style big-box retailer attractive to today's shopper. But he faces stiff headwinds. Retailers have already begun wringing their hands, worried about the gloomy shadow that a jittery stock market, higher gas prices, and a slowing economy might cast upon consumers. Normally consistent specialty merchants such as Gap Inc. (GPS) and Home Depot Inc. (HD) have recently disappointed Wall Street.

With half of all of toy sales coming in the November-December-January quarter, toy retailers need a merry Christmas more than anyone. But this year, the lack of a must-have toy--Sony Corp.'s (SNE) PlayStation 2 is trickling into the U.S. so slowly it's unlikely to have much impact until next year--could spell fewer trips to the toy store. Combine that with the Toys 'R' Us history of slow sales growth and disappointing earnings, and it becomes clear just what a steep wall Eyler is up against. The company's total stock returns have fallen 53% since Lazarus retired, compared with a 238% rise for the Standard & Poor's 500-stock index (chart). ''Toys 'R' Us has the incredibly unpleasant distinction of missing the fourth quarter in 14 out of the last 15 years,'' says Sanford C. Bernstein & Co. analyst Ursula H. Moran. ''The big test for John Eyler is whether he can buck that trend this year.''

Still, considering the recent troubles at Toys 'R' Us, many investors figure it can only improve. The stock resisted a general retail slide to rise 61% since Eyler's appointment, and it jumped $2 a share, to 18 1/4, on Nov. 13, when Eyler announced that third-quarter sales were down only 1% at stores open more than a year. That's considered good news--because the company was up against a very strong quarter last year, when Pokemon Game Boy cartridges sold like mad.

GIANT TEDDIES. Eyler is betting that smart management of the chain's stronger assets--including Babies 'R' Us, and its international operations--plus an overhaul of its struggling U.S. stores, will spark what he calls ''a second growth period.'' The company grew at a phenomenal 26% annual pace during its heyday in the 1980s. And Eyler's formula has worked before. As CEO at Schwarz, he made his name by greatly expanding things like in-store toy demonstrations and giant Schwarz-only stuffed animals.

But Eyler knew he was making a quantum leap in scale--and problems--when he came to Toys 'R' Us. The chain posted $11.9 billion in sales last year, 50 times as much as Schwarz, and operates 1,565 stores in 27 countries. And it had just blown 1999, the best toy-selling holiday of the decade. It was caught out of stock in many store items and struggled to deliver online orders. Although the company's sales last year rose 6%, they trailed the 10% increase for the toy industry.

The Toys 'R' Us board was looking for a long-term solution. Chairman Michael Goldstein says the company had been talking with Eyler on and off for more than a decade. In 1998, Goldstein's successor, Robert C. Nakasone, had tried to recruit him to be his No. 2, and even started negotiating to buy Schwarz to get Eyler on board. During a four-month search after Nakasone's departure, Eyler was always on top of the list of candidates. Goldstein relied heavily on the glowing reviews that Eyler got from key suppliers such as Hasbro Inc. (HAS) CEO Alan G. Hassenfeld and the now-departed Mattel Inc. (MAT) Chief Exec Jill Barad. ''Not one person said anything but 'Mike, get him,''' Goldstein recalls.

Eyler's route to becoming a retail rescuer wasn't obvious or direct. He grew up in Seattle with an engineer father who played an important role for Boeing Co. in the Apollo 11 space mission and the Minuteman Missile program. Eyler entered the University of Washington in the 1960s as a finance major, and got his MBA from Harvard University. His interest in retailing was sparked while writing a paper about eliminating middlemen from distribution. Eyler realized the nascent computer revolution would make it possible to measure the effectiveness of each link in the retail chain and could lead to consolidation. Figuring that would create opportunities for young executives, he took a management-trainee job at May Department Stores upon graduation.

Eyler was right about predicting a period of industry tumult, and he later found himself right in the thick of it. His major accomplishments include starting a chain of lower-priced shops for Federated Department Stores Inc. (FD) called MainStreet, which Eyler says was on an annual pace of $300 million in sales and on the brink of profitability when it was sold in 1988 to help reduce debt under the new owner, Robert Campeau. Next, Eyler ran the retail arm of upscale suitmaker Hartmarx Corp. (HMX), only to see the stores eventually close down after the market shifted toward casual office wear. ''Going through a failure helps you become a much more honest assessor of reality,'' Eyler says today.

Critics point out that Eyler has yet to pull off a turnaround anything like what he faces now. Even at Schwarz, whose sales, according to Eyler, grew from $60 million in 1991 to $225 million in 1999, profits were meager. ''John has got a great reputation as a marketing and visual person,'' says one retail executive. ''But it would be hard for anyone to say he's ever posted great numbers.''

Eyler's first task upon joining Toys 'R' Us was to confront the mess of Christmas past. His analysis of the disastrous 1999 season showed that inventories had dropped to dangerously low levels, leaving the U.S. stores out of stock on 36% of items--including basics like Monopoly games. Even the strong third quarter that Toys 'R' Us thought it had enjoyed before Christmas turned out to be not nearly so good as it looked: Pokemon fervor had masked deterioration in other areas. In fact, Toys 'R' Us had lurched from having too many toys in the previous years to too few. The glut had led to painful markdowns, a $698 million restructuring charge, and a sharp tightening of inventory controls.

Too tight, it turned out. By the summer of 1999, one former executive remembers, each store manager was limited to ordering 30 rolls of Scotch tape at a time, for instance. That severely restricted promotional opportunities during the holidays, when it is not unusual for the chain to sell 1 million rolls of tape a week--at 50% gross margins--the executive says. ''Whole aisles collapsed'' because of this merchandise paralysis, he says. Meanwhile, toymakers complained bitterly that in July, 1999, they still had received only partial Christmas orders from Toys 'R' Us. That was a key reason the board moved to oust Nakasone in August.

HUFFY CUSTOMERS. Eyler wanted to get his orders in early this year to steady the business and to begin mending fences with Hasbro, maker of Tonka trucks, and Mattel, home of Barbie. His answer: more systematic stocking of the top 1,500 toys that make up two-thirds of the chain's sales. Toys 'R' Us, like every other retailer, knows it can't be sure it won't run out of the hot toys--the Pokemons and Tickle Me Elmos--the week before Christmas. But it can ensure that standbys such as Monopoly will be in stores 90% of the time. Eyler says that a one-season wonder might make $75 million in a year--sizable, but still only 1% of U.S. sales. ''We can't make a consistently profitable business on the back of a hot toy,'' he insists.

So in February, when the toy industry descended on New York's 23rd Street for its annual Toy Fair, Eyler met with all the major suppliers to assure them that he would be ordering early this year. By late April, he had already placed 78% of his Christmas orders, up from less than 40% at that time the year before.

But if suppliers were quickly mollified, customers are going to take a lot longer to bring around. Their animosity goes much deeper than not finding enough of the right toys. A recent Sanford C. Bernstein study of U.S. shoppers' opinions of 15 big retailers found that Toys 'R' Us ranked near the bottom of the list on measures such as service--only Kmart Inc. (KM) ranked lower--and value for the dollar. Overall, shoppers ranked the chain 10th out of the 15 retailers. Indeed, when Bill Nygren bought Toys 'R' Us shares for his Oakmark Select mutual fund, he was shocked by a flood of shareholder complaints. ''They'd write in saying, 'I was at a Toys 'R' Us store last year, and the store was dirty, the sales staff was unhelpful, they didn't have the merchandise I wanted. How could you be so stupid?''' Nygren marvels.

Just ask Kim J. McGinness, a 33-year-old mother of two who has been shopping in the Woodbridge (Ill.) Toys 'R' Us for years. Service at the store has improved of late, McGinness says. But she still gets angry recalling the time last year when she tried to buy an infant bathtub for her goddaughter's baby shower. After looking high and low for the item, she finally went to the customer-service booth to ask for help. The clerk replied that ''if they had it, it was on the floor. If it wasn't on the floor, I was out of luck,'' she remembers. McGinness got her to check a computer and found five bathtubs were in stock. However, McGinness was told she would have to wait several hours until someone could take one down. She left without the bathtub. ''I was ready to not go back there,'' she says. Only a call to the store manager got her an apology and a tub.

To make parents like McGinness a little happier, Eyler has launched a full-fledged remake of the stores that combines remodeling, new merchandise, and for the first time, a truly hard focus on customer service. At a cost of $200,000 to $800,000 a pop, depending on a store's condition, Eyler has remodeled 167 stores this year and will do a further 308 next year. In one test, 225 U.S. stores, including those that have been remodeled, increased their customer-service staff and upped their hours by 25% this year. Eyler also has pushed staff training, including training managers on characteristics to look for in a good hire. He has increased wages as well.

FUNNY HATS. The new design, already in place at the Livingston (N.J.) store, does away with long aisles and instead bunches products together in cul-de-sacs and displays determined largely by gender and age: Boys' action figures are next to building sets. Baby dolls are near the displays of glittering nail polish and steps away from Barbie's corner. Up front are the customer-service and returns desks--now manned by as many as nine people during peak hours, up from one or two in the past. Spaces are set up for product demos, and staff wear bright red and the occasional funny hat, a big departure from the old denim shirts that made them indistinguishable from customers.

The feel is very unlike the grab-and-run atmosphere of the old Toys 'R' Us. Shopping in a new store in Selma, Tex., Eugene Perez and his wife, Elizabeth, went to look at a $225 Barbie jeep for daughters Sophia, 3, and Alexandra, 2, and were pleasantly surprised. ''The old stores felt more like warehouses,'' he says. ''This is really open, and it's a lot easier to find your way around.'' That should bring order to the chain's impressive but widely scattered selection of toys. Indeed, the one part of the Sanford Bernstein survey where Toys 'R' Us scored high was in having a wide assortment of products. That's what has kept Christine McCoy shopping for sons Justin, 4, and Doron, 2, at an unremodeled store in San Antonio. ''No other store has this kind of selection,'' she says. ''With Wal-Mart or Target (TGT), they may have it--or they may not.''

Now Eyler just has to get the Toys 'R' Us team on board, too. Many managers and employees have emerged from the past four years with a sense of whiplash. A string of high-level executives departed, from CEO Nakasone to President Bruce Krysiak and U.S. merchandising chief Keith Van Beek. So Eyler these days attends national meetings to talk to store managers of Babies 'R' Us and clothing retailer Kids 'R' Us. He and his team have twice met with Toys 'R' Us store managers and have sat down with or talked with the seven U.S. field managers a dozen times in the past 10 months. At least once a month, Eyler e-mails employees with operations updates.

UPBEAT. Outsiders have noticed a change. ''Go back 12 months before John arrived, and there was really a very dispirited group of people at Toys 'R' Us,'' says Norman Walker, president of toymaker K'NEX Industries. ''Now, they're much more up and positive. They feel they're going in the right direction.''

In setting a tone, Eyler has borrowed heavily from his old employer. The year before he started at Schwarz in 1991, 25% of its sales came from proprietary products--that is, toys sold only at Schwarz. When he left, that had risen to 70%. At Toys 'R' Us, he has similarly upped exclusive goods from 5% of last year's assortment to 13% this year. He expects that to hit 20% in 2001.

At the top of Eyler's shopping list is stocking up on plush stuffed toys. Traditionally they haven't been a strong suit for Toys 'R' Us because they require a lot of display attention. Suppliers say clerks used to just throw them into bins and hard-to-reach shelves. As the slow sellers became shopworn, staff would keep jamming more of the stuffed animals onto the shelf, says Lee Schneider, president of Commonwealth Co., which makes plush stuffed animals for the new Toys 'R' Us label Animal Alley. ''It was a mishmash,'' he says.

In the new stores, the Animal Alley line is displayed in cubby holes close to the entrance, making them more visible and, Schneider hopes, easier to fall in love with. Suppliers say margins on private-label plush toys reach as high as 60%--far above the 10% to 15% that a store might make on a highly promoted television-advertised toy. And stuffed lions, alligators, and other creatures can accomplish something else that would be novel for Toys 'R' Us--giving it a hit that discount competitors such as Wal-Mart can't touch.

But as Eyler expands beyond stuffed animals into other proprietary lines such as animatronic wild animals for its Animal Planet line, he runs the risk of competing with his own suppliers. In late October, he inked a deal to be the master licenser for the re-release of Steven Spielberg's film classic E.T. when it hits theaters in 2002. That means kids will be able to get their E.T. gizmos only at Toys 'R' Us, but it also usurps a role that traditionally has gone to toymakers such as Hasbro and Mattel. So far, Eyler has avoided any conflict by using existing suppliers to make some of the Toys 'R' Us-exclusive goods. Hasbro chief Hassenfeld says he's fine as long as Toys 'R' Us does not compete directly with his Monopoly, G.I. Joe, and Tonka lines. ''If they went in one of those areas, then I would not be the happiest of children.''

Eyler must also manage relations carefully with his own board, which is dominated by two former CEOs, Lazarus and Goldstein (page 138). Goldstein stepped down as CEO in 1998 after a four-year term marked by erratic earnings, but he stayed on as chairman. Former insiders say he clashed with Nakasone and led the drive to oust him. Eyler, however, says he has had no problems working with the board. Goldstein did balk, though, when Eyler first suggested the lavish Times Square store. The company will not disclose its total cost, but New York real estate experts estimate that construction of the 105,000-square-foot site could easily hit $35 million. Annual rent is probably $9 million-plus a year. Goldstein considered it a sure money-loser--since many flagship stores have a way of not working out.

But Eyler eventually convinced Goldstein that there was a huge public relations benefit to the new store. It helped that his plan got rave reviews from other company executives and toy manufacturers. ''If you wanted to set up an ad campaign [to reach the same number of people], you'd spend a fortune,'' Goldstein now concedes. An estimated 1.5 million people walk through Times Square each day, and Eyler predicts that his store will be profitable in its first year of operation.

ONLINE DEAL. Eyler has been astute enough to let Goldstein remain involved in the company. Says Goldstein: ''If I think something's not a good idea, he thinks about it. He's not just doing it his way. He calls upon me.'' Eyler encouraged him to continue the spin-off of part of Toys 'R' Us Japan, for instance, which raised $315 million for the company in April and got the division's sizable debt off his balance sheet.

In August, Goldstein also helped negotiate one of the industry's boldest deals, a partnership between toysrus.com and Amazon.com, which should make the Toys 'R' Us site profitable more quickly than it would be on its own. Sanford Bernstein's Moran figures toysrus.com has cost the parent company $300 million in pretax expenses in the past two years. Amazon provides warehousing, order fulfillment, and site design. In exchange, it got warrants to purchase 5% of toysrus.com, as well as upfront cash payments--$34 million so far--and a share of the site's sales that analysts estimate at about 5%. Eyler thinks this is a fair price to pay, partly because he doesn't expect online toy sales to exceed 10% to 15% of the industry total in the long term, up from 2% to 2.5% today. Overall, retailers this year seem more sanguine about a shift to online sales. After several sites closed down, it now seems less likely that the Internet will be the threat to toy stores that it may be to music- and booksellers.

The Amazon deal also frees Eyler to concentrate on his stores. He has to show that his shakeup can produce more results than the chain's previous two efforts. Goldstein's 1997 renovation was meant to make the stores more attractive, but it wound up costing too much. Nakasone's version improved the merchandise mix at a lower cost per store. But in last year's Christmas rush, shoppers couldn't find what they needed. That design boosted same-store sales by only 3%.

Eyler's early results have been encouraging: Sales at stores that have been redone for at least three months have risen 7 to 10 percentage points above the gains of unrenovated ones. But this Christmas is the first true test. And next year at this time, Eyler will finally be able to start advertising the new look, when stores in all of the top 23 media markets will be remodeled. He'll also have the Times Square store to generate excitement. Rival retailers are withholding judgment but say that Eyler has identified the right problems. ''He seems to understand that what Toys 'R' Us should focus on is more service and creating a unique shopping environment,'' says one competitor. ''We're assuming he'll make Toys 'R' Us look as much like FAO Schwarz as he can. Time will tell whether it's smart or not.''

With stiff competition from Wal-Mart, Target Corp., and others, there's little room for mistakes. ''What Toys 'R' Us has lost is their uniqueness, and that they will not be able to recapture,'' says retail consultant Kurt Barnard. Eyler's out to prove the naysayers wrong. But with Christmas right around the corner, he has no time to play around.

By NANETTE BYRNES
With Ann Therese Palmer in Chicago and Lori Hawkins in San Antonio

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