Despite everyone’s best efforts, the fact remains that U.S. retail sales in 2004 weren’t exactly scorching. True, the end-of-holiday shopping season posted a slight gain between 2.7% and 3.1%; but the toy industry didn’t even score this middling advance for the year, and its sales are expected to finish roughly 5% below 2003’s US$20.7-billion take.

The reasons for the decline are the same ones that came up this time last year, when it was revealed that total sales for 2003 had dipped by 3%. Retail consolidation, price wars instigated by the major mass players, age compression, the absence of a ‘must-have’ toy… You’ve surely heard the litany before.

These disappointments aside, there’s at least one bright spot on the horizon. It seems that on-line retailing is finally coming of age, and e-tailers – including those in the toy biz – are starting to post significant gains.

U.S. consumers dropped US$23.2 billion on-line this past Christmas season alone – and that represents a whopping 25% bump over last year, according to the Holiday eSpending Report, a study released in January by Neilsen//NetRatings, Goldman Sachs and Harris Interactive. Toys and video games combined racked up an 11% share of total on-line sales at US$2.52 billion, and this number-two category has grown by 15% since 2003.

While revenues from e-tailing still pale in comparison to those of big bricks-and-mortar players, it’s definitely worth noting that on-line sales are expected to keep growing. For manufacturers and licensors alike, this surge could lead to a nice bump in ancillary channel sales and an opportunity to get fuller product lines in front of consumers; compared to the average mass store’s ability to house 200 to 300 toy SKUs, virtual shelf space is relatively cheap and has the potential to be limitless.

The e-shopping explosion explained

So what was behind last year’s boom in e-shopping? For one, Internet traffic continued to proliferate. The Holiday eSpending Report pegged the number of Internet users last year at 145 million and says more people are converting to broadband access at home and work. Broadband connections make for quicker search times and better navigability, making on-line shopping a more positive experience for the user and encouraging longer sessions. A full 58% of the study’s respondents who moved to broadband in 2004 reported spending as much or more time shopping on-line than in 2003. Moreover, these shoppers spent 22% of their ’04 holiday budget with on-line retailers, compared to 16% in 2002.

Then there’s the convenience factor. Why would parents choose to spend so much of their precious free time hunting for an elusive toy from store to store, when they can take 15 minutes out of their workday or evening to jump on-line, find it, compare prices and shipping costs at a few retailers, and have it sent directly to them?

Finally, there’s the matter of selection. You can find just about anything on-line, and that draws in a lot of would-be shoppers. The relatively early success of eBay, which began to take off in the late ’90s, was predicated on the idea of an infinite marketplace where unique and unusual goods were less difficult to acquire, and that still holds true today. According to the Holiday eSpending study, 33% of e-shoppers went with on-line because of its wider product selection, and 58% said selection was the deciding factor when they chose to make a purchase from one e-tailer over its competitors. Assuming it applies to categories across the board, this is good news for toycos. With consumers demanding wider SKU assortments, less emphasis is put on price, permitting healthier margins.

On-line action heats up for traditional toys

Faced with these persistent health indicators, toy companies and manufacturers of children’s goods are starting to get serious about on-line space. ‘We now have several on-line accounts worth more than US$1 million and have appointed account reps just for key on-line retailers,’ says Anton Rabie, president and co-CEO of Toronto, Canada-based toy manufacturer Spin Master.

But besides the sales action, Rabie says on-line retail listings feature Spin Master’s products and their key attributes in significant detail, doing double duty as ‘great sell sheets.’ Even if parents don’t end up buying on-line, it gives them an opportunity to learn about the product and get price comparisons, so they’ll head into a store knowing exactly what they’re looking for.

As for those key on-line accounts, Rabie points to the virtual counterparts of traditional retail powerhouses Wal-Mart, Target and Toys ‘R’ Us. Their dot-com stores account for a good chunk of on-line toy sales; indeed, Toysrus.com took in US$346 million in the first 48 weeks of 2004.

Traffic increased on the site by 10% during holiday ’03, and VP and GM John Sullivan says he expects similar gains for this past season when all the numbers are in. Q3 2004 revenues were up 11.6% versus the same period in 2003, but they took a 3.3% dip in Q4. Sullivan says a restructuring of Toysrus.com‘s free shipping program was largely responsible, but he believes final annual results scheduled for release in March will show the site has had a positive impact on bottom-line profitability overall.

What’s interesting is that while the website does enjoy cross-branding with bricks-and-mortar stores, it has its own buyers, a larger SKU selection (more than 10,000 items) and different buying patterns. For example, Sullivan says the site sells more higher-priced items; so if the majority of bikes sold in-store are in the US$50 to US$60 range, US$100 bikes are more popular on-line. Sullivan also says that on-line exclusives such as He Knows Your Name Elmo (US$29.99), which can be programmed to say ‘Happy Birthday’ with one of 15,000 kids’ names, are drawing parents in – as is merchandise bundling. Sullivan explains that selling four or five themed items together for US$100 has really appealed to relatives ‘looking for that complete gift’ for children on their shopping list.

But there are also some up-and-coming e-tailers to watch for, and Rabie singles out Denver, Colorado’s eToys Direct as coming on particularly strong.

The current eToys Direct storefront rose from the ashes of KBToys.com. In May 2003, New York-based investment firm D.E. Shaw, the same company that purchased FAO Schwarz last winter, bought eToys and the license to operate KBToys.com. Since then, led by former KBToys.com exec Michael Wagner, the company has been steadily rebuilding the business. In its first year of operation (from May 2003 to May 2004), the e-tailer generated US$100 million in revenues, and sales on the Etoys.com site from October to December 2004 were up 37.5% over the previous year.

What’s peaked the interest of those in the toy biz is that on top of running its own site, eToys continues to operate KBToys.com under license; the Sears Wishbook (a toy catalogue sent to all Sears credit card holders); and the toy components of Kmart.com, Sears.com, Macys.com, Circuitcity.com, QVC.com and Smartbargains.com. The e-tailing company is also active on Amazon.com, selling toys that Toysrus.com doesn’t carry. ‘Manufacturers really like us because we’re reintroducing retailers [like Macy’s, which doesn’t stock toys at its retail stores,] to the toy business,’ says Wagner.

eToys’ five buyers handle merch planning for every site serviced by the company. And although the team works with some guidelines set out by their bricks-and-mortar counterparts at the other retailers, the company ultimately assumes all inventory risk and costs. During the holiday ’04 season, Wagner says eToys’ warehouse stock fluctuated between 8,000 and 10,000 SKUs. Herein lies the strength of the business, in his opinion.

While the e-tailer carries the top 100 or so toys and ‘is all over the key licenses’ found at mass retailers that it gives up margin on, a lot of its sales are derived from moving less popular and more lucrative toys. For example, Wagner says the company’s number-four item this year was a 4.5-foot, three-story wooden dollhouse that retailed for US$79.99.

As for driving traffic to the site, eToys relies on putting storefronts up on popular search engines such as AOL, Yahoo and MSN, as well as buying keywords on these sites and the granddaddy search engine of them all – Google. (See ‘Using Google to drive e-tail traffic’ on page 60 for more on how the hub’s keywords work.)

Wagner says eToys has also struck marketing gold with catalogues, a low-tech standby for sure, but one that features glossy pics of the toys and directs mom and dad to the web. Last holiday season, eToys.com sent out a 24-page catalogue to its customer database. This year, the book grew to 124 pages, and 700,000 copies were mailed out. ‘It’s a home run,’ says Wagner. Parents pass the catalogue on to their kids, and they ‘scratch through it for weeks, marking everything they want’ and providing their folks with a ready shopping list. Wagner wouldn’t indicate how many recipients found their way back to the site, but he did say he’ll be printing a lot more catalogues next year.

Community concept drives sales on eBay and beyond

While eToys seems to be proving that there’s a lot of life in the web toy store model, brisk movement on e-tail behemoth eBay indicates there’s still a huge on-line appetite for toys beyond these traditional parameters. Toy retailers on the auction site collectively reaped US$1.5 billion in 2003, and as of Q3 ’04, sales were sitting at US$1.3 billion. Every month, more than six million people find their way to the site to buy and sell toys; and every second, 46 toys featured there find new homes. More than 40% of inventory sold is brand-new, and toycos such as Little Tikes, Wild Planet Toys, Hasbro and Lego have been using the hub to sell directly to consumers.

What moves best, says Jim Migdal, the site’s senior category manager for toys and hobbies, are products that are either at the beginning or the end of their life cycle. ‘If something is new and really hard to get ahold of, you’ll do really well…otherwise, a purely commodity product doesn’t make sense,’ he explains. However, for bigger manufacturers looking to do large production runs of an item, presales on eBay have worked well to build buzz. Hasbro has employed this strategy for several Star Wars items.

And eBay is seeking out new ways to drive more traffic to the site via exclusive toys. This past holiday, the hub featured 1,000 limited-edition Aquapets (US$15) from Wild Planet and 5,000 Star Wars Jedi Force X-wing playsets (US$30) from Hasbro. Migdal says these manufacturers didn’t pay any fees over and above what a regular seller would pay; instead, they were selected based on their unique offering and the strength of their consumer following on the site.

The thousands of sales made daily on eBay and booming e-tail stats are proof that consumers will pay a fair dollar for something they value, something they can’t find at their local superstore. And it was only a matter of time before someone figured this out and applied it to licensed kids product. Building on the notion of a community of collectors, Ty Simpson opened up Ty’s Toy Box as an on-line boutique featuring a select number of licenses in 2003. And they’re not the blockbuster licenses you would expect. ‘What we’re trying to do,’ he says, ‘is make a coordinated presentation, getting enough product out there to make the license relevant to consumers.’

It started with HIT Entertainment’s The Wiggles. Simpson scoured the licensed goods landscape and gathered all the merch the property had to offer. Encouraged by the turnover this line achieved on the site, Simpson began building similar boutiques around additional licenses. Toy Box currently features six licenses (including WB’s Teen Titans and DIC’s Strawberry Shortcake), carries more than 1,200 SKUs, and fulfilled 50,400 orders in 2004. Simpson is adding at least six more properties this year and has settled upon Breakthrough’s Atomic Betty, Nelvana’s Miss Spider’s Sunny Patch Friends and Spellbound’s Koala Brothers as the first three. He scours Toy Fair and Licensing Show for new leads and solicits feedback on potential properties from the licensees he’s established relationships with.

What’s interesting is that Simpson says people are drawn to the site because their kids and grandkids want a specific brand and they can get to related product without wading through a lot of clutter. Like Toysrus.com, one of the site’s most effective merchandising techniques is bundling products. And parents also come to the site to pick out party accessories for their kids’ birthday parties and wind up buying goods to fill loot bags – it’s the convenience of one-stop shopping. Also, ‘We have a different clientele, one that’s not so concerned about price,’ adds Simpson. ‘Our overall profit margin is at 54%, and we very rarely discount our products.’

Not surprisingly, licensors and licensees of the properties Ty’s Toy Box carries are actively involved in driving traffic to the site and adding customer names to the e-mail database that serves as an important marketing channel. This year, Simpson is looking to extend those relationships and bring exclusive, fan-oriented content to the boutiques. For example, he’s looking at hosting brand-related private auctions where signed animation cels and books will be put up for sale. He’s also working on setting up affiliate programs with fan sites whereby they’ll make a commission for driving traffic to Toy Box.

The concept is not going to move Wal-Mart-sized volumes, but Simpson says some licensees are taking their Toy Box sales results to the larger retailers as a barometric reading of marketability. He points to a line of Teen Titans Halloween costumes that weren’t picked up by mass this fall. ‘So we bought more of them,’ says Simpson. The run sold out, and the licensee is now using these stats as a selling point in its pitches to bricks-and-mortar accounts.