Toys ‘R’ Us Trims Losses by Making a Hamster Hot

New York Times, By STEPHANIE ROSENBLOOM

Long before stockings were hung and Christmas trees twinkled in windows, the chief of Toys “R” Us threw his company’s weight behind an odd bet.

It was early summer, and Gerald L. Storch had a fake hamster on his desk. His buyers, the executives who study and order merchandise, were predicting it would be a holiday hit. Mr. Storch laughed as the rodent scurried around and plopped off a table, then he turned serious: “How big can we make it?”

So big, it turned out, that mothers are now lying in wait in Toys “R” Us parking lots all over the nation, desperately hoping to score fake hamsters for Christmas.

Mr. Storch’s big order for Zhu Zhu Pets was the latest achievement for a man who, in the midst of a recession, has begun to pull off a retailing turnaround. Only five years ago, Toys “R” Us was in grave trouble. Sales had shrunk and the chain had fallen under the shadow of Wal-Mart, the behemoth discounter. Retailing professionals said the beleaguered toy industry was losing ground to flashy electronic gadgets.

When Toys “R” Us was sold, in 2005, for $6.6 billion to two private equity firms and a real estate developer, analysts thought it was only a matter of time before the chain would be carved up and sold.

They were wrong. The toy company’s new owners hired the bespectacled Mr. Storch, a longtime Target executive, to help Toys “R” Us get its sparkle back.

In the last year, Mr. Storch has taken bold steps. He snapped up nearly every well-known specialty toy chain and Web site, including F. A. O Schwarz and KB Toys. As mall retailers went out of business, Mr. Storch opened more than 80 temporary holiday toy shops in their vacant storefronts. He is opening supercenters, with Toys “R” Us and Babies “R” Us stores together under one roof. And he kicked off the holiday shopping season earlier than ever, opening his stores at just after midnight on the Friday after Thanksgiving, instead of hours later.

Recently, Mr. Storch stood at the flagship Toys “R” Us store in Manhattan and gazed at a replica of the Empire State Building made of Legos. “While it would be easy to get into a very defensive hunker-down mode during these economic times,” he said, “history has shown that the future rewards companies which are aggressive during economic downturns.”

Toys “R” Us has not gone unscathed in this economy; the chain said in its most recent reporting period that sales declined from last year. Even so, Mr. Storch has managed to make it the last big specialty toy retailer left in the nation, and one whose prospects are looking up.

Where consumers used to shop at KB Toys in malls throughout the country, they are now shopping at Toys “R” Us holiday boutiques. When tourists buy wide-eyed dolls at F. A. O. Schwarz, their dollars go into the coffers of Toys “R” Us. Even a search for the word “toys” on the Internet inevitably leads to a Web site owned by Toys “R” Us: Toys.com, eToys.com, BabyUniverse.com, FAO.com or ePregnancy.com.

Wal-Mart overtook Toys “R” Us as the largest toy seller in the country more than a decade ago. Mr. Storch’s fundamental strategy is not to try to compete by matching Wal-Mart’s prices, a battle he would surely lose. Instead he is trying to outfox Wal-Mart by focusing on service and especially on selection, perceiving the next hot toy trend and locking in big orders before his competitors even see it coming.

“Now our competitors are left competing purely by making price claims,” Mr. Storch said, adding that he would not reinforce “a rush to the cheap.” He pointed out that his competitors could not cut prices on toys they did not have.

Mr. Storch, 53, joined Toys “R” Us after 12 years at Target, where he rose to vice chairman and was widely considered to be one of two contenders for the top job. But in 2005 he abruptly left the company, never giving a reason. Retailing professionals said they think it became clear inside Target that Mr. Storch, known as more of an operations man than someone with a flair for merchandising, was not going to ascend to chief executive.

Four months after leaving Target, Mr. Storch was named chairman and chief executive of Toys “R” Us, where from his early days he held the chain accountable for its poor results and invoked the mantra, “We are not victims.”

Industry veterans praised Mr. Storch for his intelligence (he has a bachelor of arts, a master’s and a law degree from Harvard), and for bringing Toys “R” Us back from the brink. At the same time, Mr. Storch has been described as being obstinate and of not having a particularly warm personality. Industry professionals said he had gone through several senior executives.

At Target, Mr. Storch worked in areas as varied as supply chain operations and financial services, and led the development of the company’s grocery strategy and its Target.com business. “I remember when I was giving a presentation,” said Mr. Storch, “one of the board members saying, ‘Well, we can’t do a Web site at Target because, you know, you have to be specialized in something the way eToys is.’ ”

Today, Toys “R” Us owns eToys. All of the recent acquisitions are meant to differentiate Toys “R” Us from its value-priced rivals, especially the purchase of F. A. O Schwarz, which enabled Toys “R” Us to offer exclusive, high-end toys.

Toys “R” Us posted a loss of $67 million for the three months ended Oct. 31, an improvement over a loss of $104 million last year. The company typically makes large investments in the third quarter to prepare for the holidays. Net sales were $2.7 billion, down from $2.8 billion last year. Sales at United States stores open at least a year declined 9.3 percent year-over-year. Still, Sean McGowan, a toy industry analyst with Needham & Company, said Toys “R” Us had lately gained market share.

“The profitability of the company is better than it’s been in a decade,” he said.

Also, Toys “R” Us, which is owned by the private equity firms Kohlberg Kravis Roberts and Bain Capital, and a real estate developer, Vornado Realty Trust, refinanced its debt so that no major payments are due for two years. Last month, Moody’s Investors Service upgraded the chain’s outlook.

Retailing professionals said Toys “R” Us — which has 849 Toys “R” Us and Babies “R” Us stores in the United States and more than 700 international stores — will probably file for a public stock offering in the next year or so. Toys “R” Us declined to comment on that.

Buyers at Toys “R” Us were first introduced to fake hamsters, known as Zhu Zhu Pets, almost a year ago, at the Hong Kong Toys and Games Fair.

“We saw the potential,” said Lisa Harnisch, a vice president and divisional merchandise manager for Toys “R” Us. Ms. Harnisch and her colleagues knew children adored hamsters — and they sensed that mothers would like fake hamsters that required no care.

By May, Toys “R” Us had partnered with Cepia, the small company that created the hamsters, to do a test run in a few stores in Arizona. Sales were off the charts. “At that point we knew this was going to be really big,” said Ms. Harnisch, adding that Mr. Storch trusted her and her team to find the season’s hottest toys but “at the same time he’s very challenging and he’s very aggressive.”

“From his perspective it was less about that item,” she continued, and more about “how do we make it big for Christmas?”

Toy’s “R” Us spent the summer talking to Cepia about how many fake hamsters could be manufactured and what exclusive variations could be made for Toys “R” Us. In August the chain began placing orders for the holidays. This week, Toys “R” Us promised it would have more than a million Zhu Zhu Pets and accessories available through Christmas eve.

Mr. Storch boasts “vastly more Zhu Zhu inventory than anyone else,” and other people in the toy trade confirm that claim. That buzz is what has mothers camping out in the parking lots of Toys “R” Us.