Cornering the market on specialty toys - Power Retailer FAO Inc - Company Profile

DSN Retailing Today, Feb 11, 2002 by Molly Prior

While most retailers look back despondently on 2001, The Right Start ceo Jerry Welch sees it as the year of opportunity. This ambitious toy visionary had his eyes fixed on specialty toy retailers Zany Brainy and FAO Schwarz for quite some time before the start of the year, and he knew that together with The Right Start these three players would create a formidable specialty toy empire. For his final act of the year, Welch realized this vision with the formation of FAO Inc., the corporate holding company of the three divisions: The Right Start, Zany Brainy and FAO Schwarz.

Both Zany Brainy and FAO Schwarz were struggling and in need of a financial bailout. In May, the 187-store chain Zany Brainy filed for Chapter 11 just 10 months after it merged with competitor Noodle Kidoodle, blaming soft sales and a dearth of hot toy product. FAO Inc., then The Right Start, stepped in to acquire the fledging chain.

Zany Brainy was a trailblazer in the early 1990s, carving out the educational toy niche and bringing it to the masses. But the retailer got too comfortable and soon cost structure became a problem, said Welch. "American retailing is a contact sport. It's brutal," he added.

Zany Brainy's initial success attracted the attention of retail behemoths. And by the start of the millennium, big-box retailers such as Wal-Mart and Toys "R" Us had cozied up to the idea of educational toys and began cleaning shelf space for companies, including V-Tech, LeapFrog and Fisher- Price. Unable to compete against the 800-pound gorillas of the toy industry alone, Zany Brainy aligned itself with fellow specialty toy retailer The Right Start. FAO Inc. now operates 170 Zany Brainy stores.

Less then four months after completing the Zany Brainy acquisition, FAO Inc. agreed to purchase FAO Schwarz, the ultimate toy store of high-end goods, from parent company Royal Vendex for between $50 million and $60 million. FAO Inc. will continue to operate 23 of FAO Schwarz' 42-store chain. Welch said the 140-year-old retailer is analogous to Herrod's Department Store of London. "FAQ Schwarz is a very special company and shouldn't be in every mall." FAQ Schwarz' ambitious expansion over the last decade came as Royal Vendex sought out a viable growth format for the chain. Shuttering the underperforming stores will allow FAQ Inc. to have a "laser focus" on the remaining 23 units. Both The Right Start and Zany Brainy have begun promoting their upscale counterpart within their stores.

"The issue with Zany Brainy and FAQ has never been customer perception, customers like both companies. But behind the scenes, it's been a challenge," said Welch. "In American retailing, it's amazing that you can have a $100 million to $20Q million company and be a little company. It's difficult because you don't have the economies at scale. But now, by putting together The Right Start, Zany Brainy and FAQ we've got a sizeable company, and we've got good economies at scale."

FAQ Inc.'s three divisions, all targeting affluent moms who choose service over price, represent a more than $660 million business of 260 stores, as well as Internet and catalog divisions.

Entering into the critical fourth quarter four times the size of its former self, The Right Start focused on creating synergies between the three divisions and held off from making any drastic front-end or backend changes until the start of the new year.

Having just closed the Zany Brainy deal in September, The Right Start was working within a compressed time frame, and in the wake of a series of extraordinary world events.

"Our whole idea with 2001 was to make sure we got through all the things we needed to do from an integration standpoint. It wasn't important to us whether we got the last dollar in sales. It was important for us to end up with clean inventories and a tight operating plan. And that's exactly what we did," said Welch. "Most of the time I like to play offense; this is a time where I said, 'Well we just don't want to drop the ball here and mess up."'

By playing "conservative offense," each of the three divisions managed to come through the holidays unscathed. And newly formed FAO Inc. began the new year with profitable stores, no inventory troubles to speak of and a rationalized cost structure in place.

"2002 is when the real game starts," Welch said. During the course of this year, FAO Inc. will migrate its three divisions to create a synthesized network of stores that together cater to each stage of a child's life. From now until the end of the summer, FAO Inc. will begin implementing merchandise changes at all three divisions.

FAO will leverage off existing real estate of its 170 Zany Brainy stores by rolling out 1,600-square-foot Right Start boutiques, filled with infant and toddler products, in every store. By introducing customers to Zany Brainy earlier in the life cycle of their child, FAO Inc. believes it will establish a continuous, long-term relationship with moms.

FAO Inc. will also add booster seats and car seats--staples in The Right Start stores--to Zany Brainy's mix. This strategic move follows reports published by the Insurance Institute of Highway Safety that older children involved in car accidents were being injured by traditional restraining systems. Welch estimates as many as 21 million children could be affected by state legislation on this issue. Zany Brainy stores will likely display the seats along a 16-foot back-wall section. To allow for the merchandise changes in Zany Brainy stores, FAO Inc. will continue to tighten the assortments of the current mix.