Here’s What We Can Learn From The Bankruptcy At Toys “R” Us

The recent bankruptcy filing at Toys “R” Us has roiled the toy industry. Yet, struggles at the company are not new. The firm was taken private in a $6.6 billion leveraged private equity buyout in 2005 with the aim of turning the chain around, but the resulting debt has proved to be unserviceable.

The news is part of a larger trend of closings that some are calling the retail apocalypse. The rise of e-commerce, combined with a shift in consumer preference towards dining out over shopping and years of overbuilding, has made for distinctly unattractive economics in traditional retail.

Take a closer look, however, and the prevailing narrative isn’t quite right. Amazon has made a big push into physical retail, capped off by its $13.7 billion purchase of Whole Foods. Others, ranging from Apple to Warby Parker, also opened physical stores. So clearly the problem isn’t with retail itself, but the inability for legacy firms to adapt to a new model.

The Rise Of The Category Killer

As Darrell Rigby explained in an article in Harvard Business Review, every 50 years retail goes through a major disruption. The rise of urban centers led to department stores. Automobiles created suburbs and shopping malls. Toys “R” Us emerged in a wave of category killers and discount outlets that arose in the 1950s and 60s.

Then, as now, economics were shifting abruptly. As families moved out to the suburbs and Interstate highways improved distribution and logistics, a single store focused on a particular product area made a lot of sense. Massive “big box” stores providing lower prices and greater selection crushed small scale retailers in town squares and shopping malls.

This is the environment in which Toys “R” Us thrived. Most people of a certain age today remember the thrill of a visit to the endless aisles of wonderful things, each promising hours of fabulous play. Parents were drawn by the “everyday low price.” The local toy store seemed positively drab by comparison.

Today, retail is in the process of being reinvented once again and Toys “R” Us has failed to keep up as economics in the industry has shifted against it. Now, those endless aisles pale in comparison with what’s available online and rock-bottom prices can be found at Amazon, Walmart and Target.

The Big Retail Shift

On a more fundamental level, the challenge for retailers like Toys “R” Us is that the basic function of a physical location has changed. Traditionally, stores were optimized for driving transactions. Cash registers were plentiful and easy to find and success was measured with metrics like sales per square foot and average size of transaction.

Yet now a transaction can happen anyplace. From sitting at the kitchen table to waiting for a train, consumers have the power to browse, compare prices and order from thousands of retailers competing for their attention. The attraction of endless aisles has been replaced by the thrill of instant gratification.

To understand this shift, just walk into your nearest Apple store, where you will find a limited selection of products and no cash registers. As you arrive you are greeted by an actual person who has been trained to answer your questions and offer advice. The experience is far more “high-touch” than it is high tech.

The reason that Apple stores look like they do is that they are not designed solely to drive transactions, but to do everything else that can’t be done online, such as build relationships, offer service and upsell.

The E-Commerce Counter-Trend

Apple isn’t alone either. A number of successful online retailers are becoming increasingly focused on the physical world for a number of reasons. For example, Amazon’s purchase of Whole Foods gives it a much more comprehensive distribution footprint, which will help it increase the efficiency of its online model.

A more interesting development — and one more pertinent to the challenges Toys “R” Us is facing — is the emergence of “shoppable showrooms.” At places like Bonobos Guide Shops and J. Hilburn’s “The Studio,” customers can get fitted, consult a stylist and process returns just like in a standard store, but don’t stock any inventory which allows for smaller locations and saves on costs. Nordstrom is now testing a similar concept.

Imagine if Toys “R” Us followed this model by opening up small playrooms where parents could drop kids off to test out a revolving selection of the latest toys. You can imagine how by the time they came back, their little darlings would be begging them to order anything that had delighted them for the past hour. With traditional physical locations serving as a distribution center, same-day delivery could be arranged at minimal cost.

Yet instead of going “high-touch,” Toys “R” Us opted for high-tech and rolled out new features like Find it Fast, which allowed customers to locate which stores had which toys, using the loyalty program to better target ads and better “product lifecycle management.” None of these are necessarily bad ideas, but fail to address the shifting economics of retail.

Toys “R” Us will never be a technology superstar and will find it hard to compete with the logistics operations of companies like Walmart and Amazon. It’s a toy retailer. If it can’t be fun, it won’t survive.

Learning To Thrive In A Dead Sea

In their 2005 book, W. Chan Kim and Renée Mauborgne popularized the notion of a Blue Ocean Strategy, which focuses on new markets, rather than fighting it out in a “red ocean” filled with rabid competition. As MIT Professor David Robertson points out, however, the current retail environment is neither a red or blue ocean, but more like a dead sea, which kills off existing life but provides a new ecosystem in which different organisms can thrive.

He gives the example of LEGO’s Discovery Centers. A typical location is set up in an empty department store and features miniature versions of some the same attractions that can be found at the Toy giant’s amusement parks. The strategy gives LEGO a strong negotiating position with mall owners who are in dire need to fill the space.

Other retailers are taking advantage of the shifting economics of retail to experiment with pop-up shops, which can be used to test new concepts or to provide a larger footprint during key time periods. With commercial landlords far more flexible these days, more than a few merchants are learning to love the retail apocalypse.

So what we can learn from the failure of Toys “R” Us to adapt is that the answer to disruption is not to double down on a failed model and try to get better and better at things people care about less and less, but shift your efforts to what they want more. Value never disappears, it just moves to another place.

– Greg

An earlier version of this article appeared in Harvard Business Review