The toy business isn’t child’s play
As Toys ‘R’ Us Canada stumbles, Mastermind Toys still finds money in fun
On Tuesday, while Toys “R” Us Canada was in Ontario Superior Court seeking protection from creditors, Mastermind Toys announced the launch of its 56th store, part of a national expansion that will see the Toronto-based chain overtake its giant competitor in two years.
Four more Mastermind locations are scheduled to open in Canada before the end of this year, for a total of 12 openings in 2017. Twelve more are scheduled for 2018 and another dozen in 2019, bringing the total number of stores to 84, with an eye to as many as 90 in three years.
Meanwhile, Toys “R” Us, crushed by debt and re- structuring while court orders hold creditors at bay, currently has 82 stores in Canada. The stores are vastly different in size — Masterminds are in the 5,000square-foot range while Toys “R” Us stores are around 35,000 square feet — but it’s an impressive feat nonetheless. When Mastermind opened in 1984, there were no Toys “R” Us stores in Toronto; the U.S. chain had just entered the Canadian marketplace with a store in Brampton, but it was already viewed as a category killer.
“That was pretty darned daunting to us, because we were in the category,” said chief executive officer Jon Levy, who founded Mastermind with his brother Andy.
“We were scared of what we knew could happen, we were scared of what we didn’t know could happen, but we just put our heads down, because we knew even then that we were a niche player, we were a specialty retailer. That means we were smaller in size, we were more hands-on with interactions with our customers, we were more fleet of foot because we could choose what we put on the shelf.”
Despite the growth of Toys “R” Us in Canada, Mastermind prospered and in 2010 launched a nationwide expansion with Birch Hill Equity Partners. At the time, Mastermind had 11 stores in the GTA.
So how did Mastermind prosper while a competitor with a global footprint —1,950 stores in 38 countries — faltered?
Canadian Toys “R” Us operations are in fact profitable, according to documents filed in Ontario Superior Court on Tuesday, and the expectation and hope is that the company will emerge from creditor protection and continue operating all its stores here.
Over the past three fiscal years, sales revenue increased at a compounded annual rate of more than 5 per cent, according to an affidavit filed by Melanie Teed-Murch, president of Toys “R” Us Canada Ltd.
Net earnings for the fiscal year ended January 28, 2017 were $75,683,000.
In fact, since 2005, Canadian operations have periodically transferred excess cash to the U.S. through loans and dividends, according to the court documents.
In June, Canadian operations paid $72.65 million to its sole shareholder, Toys Delaware. It loaned Toys Delaware an addition $101 million, which it now does not expect will be repaid, at least not in the near-term.
Blame for the U.S. company’s failure is being laid at the foot of $5 billion (U.S.) in long-term debt that it could no longer afford, but there were underlying operational issues as well, according to the documents filed in court. The company was struggling with outdated technology, a failure to adapt to market changes and above-market leases.
After news reports of a possible bankruptcy filing began to circulate, suppliers began demanding better terms, including cash-on-delivery, a cost the company couldn’t support and which triggered actual bankruptcy filings.
While there have been lean years in the toy industry since Mastermind and Toys “R” Us launched in Canada in the 1980s, and competition from technology such as gaming systems, the market trend over the past few years has been positive, according to Michelle Liem, director of toys for the NPD Group of Canada, which gathers sales data from all the big players in the category, including Amazon.ca and Walmart.
Hudson’s Bay reintroduced toys to 61 stores in 2016 and has expanded the offering this year to 80 stores. Nordstrom will also carry a selection of toys in its Canadian stores and is trying out a few new brands at its Sherway Gardens location.
The entire market in Canada is worth about $2 billion a year, according to Liem. Business between January and August was up 3 per cent in dollars and 5 per cent in units, reflecting the growth in sales of lowpriced collectible items such as Shopkins, Funko Pop! and Lego figures. Family games are selling well.
In fact, toy sales have grown every year since 2013. Tech, which used to be regarded as the enemy of toys, is increasingly being incorporated into them, instead.
Science, technology, engineering and math (or STEM) learning products are another growth category in toys, a category that has always been front and centre at Mastermind, according to Levy, and is one of the reasons for the success of the chain.
Staying small, offering a well-curated selection of fun and educational toys and books, and focusing on customer service won the day for Mas- termind, Levy says. So did being early tech adopters — they’ve been online since 1999, recently relaunching the site to add faster checkout and a giftfinding tool.
Levy said today’s shopper is too busy to spend hours online or in a store going through thousands of items at a time.
“They want curation, they want somebody to have gone through the variety of products before they got there and defined what’s good — they want to be able to choose from things that have already come from a discerning assortment.”
Levy hasn’t ruled out an IPO for Mastermind. A possible expansion into Quebec would add another 20 stores.
“We don’t claim to be experts on Toys ‘R’ Us or their business model or financial structure, so I can’t say specifically what led them to seek creditor protection in Canada and the U.S.,” said Humphrey Kadaner, president and chief operating officer of Mastermind Toys.
“It may be they are competing in a mass market where it can be a race to the bottom.”
Retail consultant Bruce Winder believes the combination of Walmart and Amazon was too much for Toys “R” Us to handle, and it failed to give customers a reason to come to visit their stores.
“Toys ‘R’ Us failed to create a strong value proposition. Stores looked tired and over time there was less of a reason to shop there.”