Toy and Hobby Stores Consolidate to CompeteAs companies fight for business and to hold onto market share, industry concentration has been on the rise.
By IBISWorld Industry Analyst Justin Waterman
The increasingly saturated Hobby and Toy Stores industry (IBISWorld report 45112) has been a game changer for many industry operators. In this highly competitive environment, companies have scrambled to gain market share and diversify their product selections. Companies that have been unable to cope with heightened competition, volatile plastic prices and rising purchase costs, on the other hand, have been forced to exit. Tightening market conditions during the recession only exacerbated this trend. In 2009, per capita disposable income declined 3.6%, causing consumer spending to slip 1.9% that year. As consumers began spending more cautiously, they curtailed their purchases of discretionary goods, including toys; when they did shop for toys, they sought out the cheapest prices. As companies fight for business and to hold onto market share, industry concentration has been on the rise. Although some companies have expanded to meet changing consumer tastes, most have been consolidating operations or exiting the industry altogether as a result of competition, volatile input prices and rising costs.
These factors have caused revenue for the Hobby and Toy Stores industry to decline at a 0.3% average annual rate to $17.1 billion in the five years to 2012. In an effort to compete with low online prices, firms that were able to cut costs lowered prices for consumers. Many smaller firms with lower margins and modest yearly revenue figures were not able to compete during and in the wake of the recession, so they were forced to shut their doors. These closures caused the number of industry firms to fall at an annualized 2.6% to 19,133 over the five years to 2012, down from 21,782 in 2007. An exit of smaller firms from the industry has left the remaining players with a higher market share, resulting in the top four players accounting for about 87.0% of industry revenue in 2012, up from 81.9% in 2007.
What’s driving consolidation?
Hobby and toy stores must compete with discount or large department stores that offer comparable products. Stores like Walmart and Target, for example, offer heavily discounted prices by leveraging their size. In other words, their significant economies of scale allow them to negotiate contracts in which they can secure cheaper inventory and sell toys for lower prices. This advantage, combined with the convenience of being a one-stop shop for a variety of household items, has restricted growth in the Hobby and Toy Stores industry. By increasing their size, however, hobby and toy stores can offer lower prices by buying in bulk and can provide a product range that is more diverse than most of their external competitors. This strategy has gained the attention of hobby and toy retailers over recent years and is expected to turn industry revenue around, pushing it up 0.5% to $17.1 billion in 2012.
Further competition stems from online retailers of toys and hobby goods, which do not generate revenue for this industry. Online sales of toys and hobby goods have risen in popularity because they make shopping for the cheapest toys and hobby goods more convenient. First, with fewer or no brick-and-mortar establishments, overhead costs are lower and the e-tailer can pass on cost savings to consumers. In addition, customers can browse through a variety of sites for the cheapest goods.
Already, the trend has forced some smaller toy stores to exit the industry, leaving behind larger firms to fulfill consumer demand.
Volatile plastic prices trim margins
Plastic and resin materials are key inputs in the Toy, Doll and Game Manufacturing industry (IBISWorld report 33993), which produces toys and hobby items. A rise in the price of plastic and resin ripples through the supply chain, making toy production more expensive for manufacturers. These manufacturers then sell these toys for a higher price to the Toy and Craft Supplies Wholesaling industry (42392), which then charges higher prices to toy and hobby shop owners, thinning their margins.
This scenario has surfaced over the past five years, with the price of plastic materials and resin rising at an average annual rate of 3.5%, according to the Bureau of Labor Statistics. This ascent includes a 9.8% spike in 2008 that hampered industry profitability. Thinning margins rendered some firms out of commission and helped contribute to a 5.0% decline in the number of toy shops that year. Although industry firms reduced the number of stores and employees to slow margin declines, rising input costs caused industry profit to fall from 2.6% of industry revenue in 2007 to an estimated 2.0% in 2012. Greener pastures lie ahead for the industry, however; due to rising disposable income and further industry consolidation, profit margins are forecast to expand to 2.5% in 2017.
High-tech products raise purchase costs
The Hobby and Toy Stores industry provides a variety of products and services for children and adults alike. IBISWorld separates the industry’s products into four groups: traditional toys, youth electronics, other toys and games, and hobby and craft supplies. The youth electronics segment has gained popularity over the past five years with the onset of age compression, which is the phenomenon of younger children desiring toys traditionally reserved for older individuals. More advanced toys are typically electronic in nature, and thus require semiconductors. Research and development costs of manufacturing these advanced toys are significant and typically passed on to industry operators. The rapid and sudden rise of age compression significantly raised the purchase costs of smaller operators who could not leverage economies of scale. Firms without large cash reserves or access to credit could not purchase these expensive toys and thus could not properly satisfy consumer demand. Such toy stores were forced to close shop, further fueling industry consolidation.
Strategies to expand market share
Some firms, including major player Toys ‘R’ Us, have acquired other industry firms in an effort to expand their product lines, market penetration and geographic reach. While firms may have a sizeable number of products at their stores, there is always another firm that stocks different products. By acquiring a variety of stores in the industry, a firm can expand its product offerings, driving more traffic to their stores. Further, buying out stores in areas where the acquirer is not already present boosts market share by capturing customers in that region.
Organically gaining market share
Another way firms gain market share is through organic growth. During and in the wake of the recession, per capita disposable income and consumer sentiment fell. In 2008 in particular, consumer sentiment plummeted 25.5%, and in 2009, average disposable income fell 3.2%. Because toy purchases are highly discretionary, consumers curtailed their spending on these items, particularly on more expensive (and usually higher-margin) toys and hobbies. These new habits cut heavily into margins and caused underperforming firms to exit the industry. With smaller firms out of the picture, the remaining firms absorbed the market share once held by out-of-business firms, increasing the average firm’s market share.
Recent M&A activity
Toys ‘R’ Us changes its structure
In 2009, Toys ‘R’ Us, the industry’s largest player, acquired troubled competitor KB Toys. Although KB’s 460 stores were shut down that year, Toys ‘R’ Us became the owner of KB’s logo and web address. During the same year, Toys ‘R’ Us operated 849 domestic stores, with each store generating an average of $9.9 million. Since then, the company has slashed its store count by about half. This move is in line with the company’s goal of shifting to a lower ratio of seasonal stores to year-round stores, with the seasonal stores open only during heavy shopping seasons. As of January 2012, the company operated 351 domestic stores, with the average establishment generating $24.0 million, or more than double what each store generated two years prior. This phenomenon occurred because although the store count halved, demand remained relatively stable for toys and hobby goods from brick-and-mortar stores, and the remaining 351 stores satisfied this demand.
While the company is expected to be more efficient over 2012, with domestic profit rising about $6.0 million, the cut in the number of stores will slightly reduce the company’s market share to 47.7% (down from 47.8% in 2007). Only sales of toys and hobby supplies from physical store locations, as opposed to online sites, contribute to this market share. Revenue from the company’s consolidated operations, however, including online sales of toys and hobby supplies, are expected to rise 1.0% over 2012 to $14.1 billion. Larger operators across the industry are expected to follow suit and reduce their number of establishments, contributing to an expected average annual 3.0% decline in the number of toy and hobby stores in the United States in the five years to 2012.
Overall risk in the Hobby and Toy Stores industry is forecast to be moderate over 2013, with a score of 4.9 out of 9. Growth risk, in particular, is expected to be high in 2013, scoring 5.3 points and accounting for one-fourth of the score. IBISWorld estimates that revenue will grow 0.5% to $17.1 billion over 2012, slower growth than 2010 and 2011. The primary reasons for this slowdown are the rising and volatile prices of plastic and steel, and mounting external competition from the online retailing sector. Such pressures have caused industry participants to consolidate by shutting down stores to cut overhead costs. Others have downsized, reducing the square footage of each store, thereby lowering rent and utilities costs. With fewer square feet to manage, some workers in the industry have been laid off. Over the past five years, employment fell at an estimated average annual rate of 1.3% to 142,298 employees, down from 151, 606 in 2007.
Consolidation to come
In the coming years, revenue is expected to grow strongly on the back of strategic store placement in heavy-traffic shopping centers and rises in consumer spending. During the five years to 2017, industry revenue is forecast to rise at an annualized 0.6% to $17.6 billion. At the same time, the number of toy and hobby store firms is expected to fall at an average annual rate of 1.1% to 18,145. As toys become more expensive to produce (stemming from rising plastic and steel costs), smaller firms will choose or be forced to shut their doors, exacerbating the industry’s present consolidation activity. As the largest players in the industry use their reserves to open an increasing number of seasonal stores (the prime selling season), they will gain market share. Consequently, the top four companies in the industry are forecast to account for 89.3% of industry revenue in 2017, up from 87.0% in 2012.
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