Wal-Mart's Impact on the Toy Industry and Distribution Channels

Introduction: Market Consolidation in the Toy Industry

The toy industry is experiencing premature market consolidation due to the pricing, distribution, and marketing strategies of Wal-Mart. The low-cost retailer's approach to competing aggressively on price — particularly over the holiday season — continues to have a significant financial impact on Toys-R-Us profitability. Following Thanksgiving, Wal-Mart has historically launched an aggressive loss-leader campaign to capture the majority of holiday toy sales each year. This strategy has been very successful for Wal-Mart and is considered by many industry and financial analysts to be a primary reason for Toys-R-Us's declining sales and profits.

Competing aggressively on price and availability of a select set of toys every holiday season, Wal-Mart directly impacts the manufacturers it purchases from as well. Hasbro, LeapFrog, Mattel, and many other manufacturers — having fewer distribution partners to rely on for sales — are forced to accept lower prices for their new products in exchange for broad distribution through Wal-Mart's network. While none of these manufacturers originally intended to sell the majority of their products at the lower prices Wal-Mart demands, many have no choice but to negotiate and hope to earn enough gross margin to cover their costs. Wal-Mart has become the most powerful toy distributor in the United States, which remains the toy industry's largest market.

Brown (2004), in her New York Times article "Imagining Toyland Without One of Its Giants," makes three fundamental points regarding the impact of Wal-Mart on toy manufacturers and Toys-R-Us specifically. First, Wal-Mart's loss-leader pricing is forcing Toys-R-Us to drastically reduce prices, worsening the company's financial condition and leading to potential store closures. The impact of Toys-R-Us closing stores has an immediate effect on manufacturers' marketing strategies and their ability to showcase entire product lines, test-market new products, and secure shelf space for innovative and unconventional concept toys. Second, Brown argues that in a consolidating distribution channel, manufacturer branding becomes more critical. Third, toy manufacturers who have grown increasingly dependent on Wal-Mart within a consolidating distribution channel must look to alternative channels for distributing and selling their products. Brown mentions electronics stores, bookstores, and online merchants as potential alternatives. Industry analysts also note that many manufacturers are turning to Web-based selling strategies on their own websites, exploring the direct-to-consumer online channel.

Wal-Mart's Loss-Leader Strategy and Its Effects on Distribution

Wal-Mart's use of loss-leader pricing strategies in its toy retailing operations is detrimental to the long-term viability of the toy industry and, ironically, to Wal-Mart itself. This loss-leader approach — pricing toys below cost to drive retail foot traffic — is flattening the elasticity curve of newly introduced toys and causing manufacturers to second-source production and often move manufacturing offshore, where quality and safety standards are not nearly as rigorous as in the United States.

Wal-Mart's purchasing economies of scale and focus on supply chain efficiencies all contribute to its ability to price toys below the wholesale price available to other retailers. The flattening of pricing elasticities for new toy products greatly impacts the profitability of toy manufacturers. Taking a loss-leader approach to selling toys also forces other retailers either out of business entirely or into significantly reduced operations.

The broader consequence of this strategy is to push an entire industry into premature consolidation. On the supply chain side, toy manufacturers are pressured to demand lower prices on raw materials and, at times, sacrifice quality. On the distribution and selling side, this dynamic also forces significant consolidation of retail outlets. The intent of this analysis is to demonstrate how Wal-Mart's loss-leader pricing on toys significantly diminishes manufacturers' ability to produce high-quality, safe, and innovative toys for global markets.