MIDTERM EXAMINATION: Sample solutions
Case questions
(1)
The main competitive advantage that Toys R Us has vis a vis specialty chains is economies of scale and bargaining
power with toy suppliers. When selling an identical toy, Toys R Us is likely to have a lower cost of procuring the
toy and delivering the toy to the consumer, allowing Toys to either have a higher margin or lower price of that toy.
Approximations using the data in the tables suggest that the cost differential could be on the order of 10%.
Further, the specialty chain is likely to have a smaller footprint than a typical Toys R Us outlet, suggesting that the
Toys R Us will have a larger of selection. Some of the extra space of the Toys R Us is devoted to non-toy items
likely to be of interest to parents, such as diapers. This “one stop” convenience likely gives Toys R Us an advantage
over the specialty retailers. (Of course, neither of these advantages would be advantages over Wal-Mart or Target).
The specialty retailers have two main advantages vis a vis Toys R Us. First, their organizational structures generally
provide owner-operators or highly motivated and skilled employees who can help customers with information about
the toys. For some types of purchases, this might provide a competitive advantage over Toys R Us; it might be
difficult to incent Toys R Us employees to provide this kind of assistance (consider analogy to Home Depot –
Trygart’s Hardware). Second, as described in the articles, some toy companies will only source their toys to
specialty retailers, presumably due to the higher retail service levels. To the extent that access to these toys are
important, specialty retailers will have competitive advantages over Toys R Us.
(2)
The toy market is driven by "hits", or, very popular toys. As the case states, Wal-Mart can devote only a few aisles
to toys and still display toys that represent 80% of total toy sales. Parents only need to go to Toys R Us when they
want an unpopular toy. Although we have no data on this, it is likely that the purchases of office supply products
are more equally dispersed across products. That is, in order to display products which represent 80% of total office
supply sales, one might have to devote 60-70% of the square footage that Staples devotes to office supplies.
The strong seasonality of toy sales also renders Toys R Us more vulnerable. The case states that 50% of toys sales
take place in the last quarter of the year. WalMart can capture a large fraction of toy sales by having a large toy
display during only a couple of months of the year. During the rest of the year, that space could be devoted to
products on a different seasonal cycle, like gardening supplies. The flexibility to change the amount of space
devoted to office supplies probably does not give WalMart big cost savings relative to Staples, since there is no
natural seasonal in office supplies.
The articles argue that Wal-Mart doesn't actually make much money on toys, but uses toys as a loss leader. Of
course, we want to be skeptical of this; this can only be true if there are other items in the store (a) on which WalMart earns large margins and (b) that are likely to be purchased at Wal-Mart when a customer comes into Wal-Mart
to purchase a toy. However, whether Wal-Mart uses toys as an actual loss leader or not, Wal-Mart is likely to favor
stocking merchandise for which there are large demand externalities with other merchandise. Thus, for example, it
is likely that consumers who want to buy toys also want to buy kids' clothing, another category of merchandise that
Wal-Mart sells. These consumers are willing to pay a premium on some items for the convenience of one-stop
shopping. The externalities between office supplies and Wal-Mart's other merchandise may be much lower than it is
for toys. In particular, businesses represent a large percentage of total office supply purchases. If Wal-Mart offered
very low prices on office supplies, businesses might just send an errand person into WalMart to buy office supplies,
and that errand person wouldn't really have too much else to purchase at WalMart.
Finally, the Toys R Us shopping experience is not significantly differentiated from the WalMart shopping
experience. In particular, the case does not suggest that Toys R Us offers superior service. It is possible that
Staples has differentiated itself from WalMart in a manner which is appropriate to its market--- delivering phoneordered office supplies to businesses, arranging custom-printing of stationary, etc. In this dimension too, WalMart
might be a more credible competitor to Toys R Us than to Staples.
Grading notes: Note that the question asked was very specific. The question asked you to explain why ToysRUs is
vulnerable to competition from Walmart while Staples is not vulnerable to competition from WalMart. Thus, no
credit was given for discourse on:
(1) features of ToysRUs versus Staples that make them differentially profitable, but have no linkage to competition
from non-specialized discount stores. Example: "supplier power is less important in the office supply market
than in the toy market."
(2) characteristics of ToysRUs that made it vulnerable to competition from WalMart without an explanation for
why that particular characteristic would not be shared by Staples. Example: "WalMart charges low prices for
toys because people who come in for toys might buy other products at WalMart." That answer is insufficient if
unaccompanied by an explanation for why the same can not be said for office supplies.
(2) (30 points)
Toys R Us's strategy is far from being a sure success. Important challenges:
It may be difficult to execute the strategy. Creating/Running stores in the new format requires dramatically
different skills from those required in the "old" Toys R Us format. It is not obvious that Toys R Us's management
possesses those skills (Nakasone is a Toys R Us insider, the Toys R Us COO is from Dollar General, a deepdiscount department store). Toys R Us's employees will need to be retrained and Toys R Us may even need
different employees from their current ones to provide the level of service required in the new type of toy store.
Can Toys R Us create a fun, interactive environment, or will Media World be full of Game Boys that don't work
because their batteries are dead?
Toys R Us must overcome negative brand equity. Toys R Us has to convince consumers that visiting Toys R Us
will be fun. Toys R Us's reputation is as a low-service warehouse-style retailer with merchandise pitched to younger
customers. Changing the perception that parents and older children have of Toys R Us is a substantial hurdle,
particularly if, in the short-run, Toys R Us's execution of the new concept is less than perfect.
Will consumers value these innovations? These changes are costly; if consumers don't value the changes that Toys
R Us is making, these changes won't pay for themselves. Furthermore, for this strategy to succeed, consumers not
only have to value the "fun" aspect of Toys R Us, but this fun aspect has to induce consumers to buy more toys. It
is not inconceivable that dad will drop the kids off at Toys R Us to play while he runs to Wal-Mart to buy things
cheaply.
The one advantage that Toys R Us has over all other toy stores is selection. When one is making a shopping trip to
purchase many toys, one may considering visiting Toys R Us because it is likely that almost everything that one
wants will be there. If, however, creating these "fun" centers requires Toys R Us to convert space from selling
space to "play" space, Toys R Us may dissipate its one advantage--- one stop shopping for all of a customer's toy
needs. Of course, Toys R Us could expand some of its stores to maintain selling space and "play" space. However,
it is not clear that the cost of those expansions would be justified by increased sales.
The biggest challenge that Toys R Us faces is competition. Toys R Us is abandoning the low-price, low-service
niche because WalMart appears to do better at filling that niche than Toys R Us. However, the high-price, highservice niche has long been the stronghold of the independent toy stores and the upmarket chains like FAO
Schwartz and Noodle Kidoodle. How will these competitors respond to Toys R Us's attempt to enter their market
niches?
Grading Note: the question was very specific in asking what challenges Toys R Us faced with the particular strategy
described in the case. Thus, you were not given much credit for describing totally unrelated strategies that Toys R
Us could pursue----- internet sales, etc.