BW ONLINE DAILY BRIEFING

NEWS ANALYSIS	June 7, 1999

In the war to dominate online toy sales -- which seems sure to explode next holiday season -- it's never too early to prepare for battle. At least, that's the thinking at Toys 'R' Us. Within the past month, the Paramus (N.J.) toy giant has spun off its online operations into a separate subsidiary called toysrus.com; inked a strategic partnership with venture investment firm Benchmark Capital; and bought a 500,000-square foot, automated distribution center in Memphis for $30 million.

These moves -- the first signs that the company is getting more aggressive on the Internet -- may be coming just in time. Although Toys 'R' Us has been selling on the Web since June, 1998, it has been slow to improve its site and faces increasingly stiff competition from a growing number of offline toy retailers and manufacturers. And its main online rival, eToys, boasts a $7.7 billion market cap only weeks after its initial public offering, with a near-quadrupling of its shares to $77. That puts the market valuation of this two-year-old Net retailer 35% above that of Toys 'R' Us.

The situation is temporary, Toys 'R' Us vows. It claims that by summer's end, consumers will see a new site that will operate more as a children's network of content and commerce than as a place to only buy toys. "We're going to try to create an environment [on the Web] where people can get any toy they can dream of," says Bob Moog, newly appointed chief executive of toysrus.com. "The idea is to become the largest source of toys and children's products on the Internet and to have the broadest selection in the world." The idea is also to capitalize on IPO fever with an initial public offering for the online subsidiary within the next year to 18 months, Moog says.

GOIN' TO THE VALLEY. Toys 'R' Us is initially investing $94 million in its new plan, including the fulfillment center in Memphis and an estimated annual marketing budget of $40 million. The earliest changes will be cosmetic, as operations of the current site are separated from the parent company and merged into the new subsidiary, to be located in Silicon Valley.

Visitors to toysrus.com can already link to a prototype of the new site, which features added toy categories, best-seller lists, and products listed according by the rate at which they're selling rather than alphabetically as before. Consumers can still choose from only 3,000 items, and employees must still key in orders manually at the distribution center, but the two sites should be fully integrated this month, and the fulfillment, shipping, and real-time inventory management processes should be automated within four to six weeks, Moog says.

"The starting point will be to offer at least 10,000 items by August, which is what you can expect to find in an average [offline] store, and then increase that by 20% to 30% by Christmas," Moog adds. "Consumers will also be able to make wish lists with a sophisticated gift finder and registry, use more than one credit card to make purchases, and ship to more than one address."

From there, Moog says he wants to add several channels of content, including a learning center, an area for international products in various languages, and one for exclusive products. In the learning center, products would be featured in categories such as vocabulary-building and geography. "The site will also feature products for physically challenged children," says Moog, "plus products that help develop critical thinking skills, deductive logic skills, and gross motor skills."

"VERY EXPERIMENTAL." Moog says that though he anticipates signing up content partners and product suppliers, he doesn't foresee any acquisitions. "We'll be taking products that already exist and presenting them to consumers in different ways," he adds. "We're creating a network of information and products that will be very experiential. It's a different approach than just having a bunch of toys out there and putting pressure on parents to figure out the best way to go. For instance, parents will be able to search by age and get a whole world for their child at that age."

In addition, current supplier relationships will allow toysrus.com to provide interactive sampling of video games and software, Moog says. Not even the company's offline stores feature such "buy before you try" perks. Eventually, the site will also feature products from other Toys 'R' Us units -- Babies "R" Us and Kids "R" Us.

Even if toysrus.com accomplishes all this in the next six months to a year, it's uncertain whether it can take the lead in online toy sales. For instance, eToys says it also plans a full-throttle expansion, to be completed in time for the next holiday season. It already offers 9,500 items, and sells more than 750 brands of toys, games, videos, software, and music, which it organizes in easy-to-search categories such as brand name, favorite toys by age, bestsellers, characters, and toys for under $20. It features a gift center and registry; product recommendations and reviews; online order tracking; searches by age, category, keyword, or price; and access to detailed product information including a real-time inventory check.

BARBIE HEAVEN. eToys is clearly trying to compete on the basis of choice and convenience -- both of which appeal to parents -- more than on price. On eToys, for example, the Sony Playstation version of Tomb Raider III goes for $38, a Bubble Fairy Barbie is $10, the Generation Girl Glam Barbie is $19, and Rose Barbie is $50 -- all prices that are close to or identical to those on toysrus.com. The difference, for now, is that a search for Barbie on eToys takes consumers to a page that features a Barbie of the Week, a section featuring the most popular Barbies, and one that lists the pictures and details of all 145 Barbie dolls available. Toysrus.com, by contrast, features 80 Barbie products, some without pictures -- and doesn't separate the dolls from the accessories.

eToys says it has 365,000 customers, 75,000 of whom it claims to have added in the first quarter of this year. Although the company has yet to turn a profit, its sales are growing dramatically: Revenues for the fiscal year ended Mar. 31 were $35 million, vs. less than $700,000 for the previous year. The company recorded a $73 million loss last year, the result, it says, of its pending acquisition of BabyCenter, a content and commerce Web site popular with new and expecting parents.

Moog declines to discuss toysrus.com's revenues, and says it's hard to tell how many customers the site has because the subsidiary is only a few weeks old and all previous online data for the site wasn't separated from the parent company's consolidated results. What is clear is that the company's $132 million loss after special charges on $11.2 billion in sales in fiscal 1998 has left it with a relatively modest market cap of $5.7 billion.

LOST MANTLE. "It's no secret that [Toys 'R' Us has] been letting their brand name waste away for years," says Dorothy Lakner, an analyst with CIBC Oppenheimer. "The big issue is the fate of the offline stores -- at least, that's what I'm more concerned with, because a strong store base lets a company take advantage of its synergies when it tries to go online."

Indeed, Toys 'R' Us' share of the market has fallen from 25% in 1990 to just less than 17% today -- with the mantle of market leader having passed to Wal-Mart. Fiscal 1998 sales at Toys 'R' Us rose only 1.2% over 1997 -- which had shown just a 6% increase vs. 1996. Now, CEO Rob Nakasone has started a push to remodel stores -- make them less cluttered with improved customer service -- and to synchronize the company's online and offline businesses. For instance, all items bought online can be returned to any store.

"I don't necessarily think it's too late," Lakner says of the toysrus.com effort. "They've got an impressive partner now [in Benchmark Capital], and although it was a disadvantage having not done a good job first time around, they can now simultaneously work on the problems in their [offline] stores and build up their service online."

Which online toy retailer will out-market and out-brand the others to become the leader in online toy sales? Tune in at Christmas to find out.

By Stefani Eads in New York

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