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Leapfrogging Leapfrog


Once upon a time there was a small company with a neat idea. The company was called LeapFrog Enterprises Inc. (LF) and it made interactive toys that taught children, age 4 to 8, math, spelling, and geography in a really fun way. Parents whipped out their credit cards for LeapFrog's $50 LeapPad consoles and $15 content cartridges.

From its humble start in 1995, the little Emeryville (Calif.) company just grew and grew. Then one day, LeapFrog got so big it caught the eye of a giant named Mattel Inc. (MAT). The giant launched its own electronic learning product. Suddenly, LeapFrog had to spell a scary new word: competition.

LOSING TO GOLIATH?

That, kids, is pretty much where the fairy tale ends for LeapFrog. Its battle with Mattel will be one of the hardest-fought contests in toy aisles this holiday season. It's easy to see why LeapFrog caught Mattel's attention: Electronic learning aids are one of the few growth categories in the $25 billion U.S. toy industry. Sales have more than doubled in three years, from $328 million in 1999 to $735 million in 2002. Mattel's Fisher-Price unit came out slugging in July, releasing its $45 PowerTouch Learning System with the company's most expensive preschool marketing push ever.

LeapFrog countered with three new products and in mid-September slapped its rival with a patent infringement lawsuit. "It's kind of a David-and-Goliath story in reverse," says Sean P. McGowan, a toy industry analyst at Harris Nesbitt Gerard.

Indeed, LeapFrog has given Wall Street reason to suspect that David may lose this one. On Oct. 22, the company announced that third-quarter revenues came in $27 million short of expectations. The stock plunged 30% and has yet to recover. LeapFrog CEO Michael C. Wood insists the shortfall doesn't represent a slowdown in demand. He says retailers just pushed orders into the fourth quarter to reduce inventory costs. Not all analysts agree. In any case, Wood is sticking with his projection that sales will jump 25%, to $665 million, this year. "Everybody's in a mad scramble to get shelves stocked," he says.

In trying to beat LeapFrog, Mattel has endeavored to make its PowerTouch unique. While kids use a stylus pen to interact with a LeapPad, they only need to use their fingers to press on words and symbols with PowerTouch. In addition, the PowerTouch console automatically recognizes when a page is turned; LeapPad users must push a button to continue, something that can confuse small children. To create a buzz, Mattel started advertising PowerTouch on national television in mid-September, more than a month before its holiday advertising campaign usually begins.

LeapFrog has responded to the Mattel challenge with a new handheld device and a LeapPad that lets kids write on the book. In October, the company launched a finger-operated version aimed at kids as young as 18 months. Then there's the patent infringement suit, which legal experts say is too early to call. "It won't be over by Christmas," says Washington (D.C.) patent attorney Michael J. Bell.

Who will win the hearts of kids and parents? Wayne Yodzio, a vice-president at Toys 'R' Us Inc. (TOY), says that PowerTouch is "showing good velocity out of the gate." But industry insiders say LeapFrog's products are selling well, too. Maybe there is room enough on store shelves for both. That would be a happy ending indeed. By Christopher Palmeri in Los Angeles


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