Toys R Us' Most Important Lesson for Boards

If you are a parent of a certain age, part of you was probably a bit saddened by the recent demise of Toys R Us, a store where you probably spent a lot of time back in the day.

However, as this once great retailer prepares to go into liquidation, it also offers us valuable reminders about the causes of organizational failure – and how they can be avoided.

External Causes of Failure

In our client education courses, Britten Coyne makes the point that the external trends which give rise to strategic threats often follow a common causal pattern of four phases (albeit with multiple feedback loops between them).

The first is technological change. In the case of Toys R Us the most important included the birth of the internet, the development of online shopping businesses, the penetration of broadband, and the arrival of advanced gaming consoles in 2001, Facebook in 2004, YouTube in 2005, smart phones in 2007, Instagram in 2010, and Snapchat in 2011.

Technological change eventually leads to economic changes.

In the case of the technologies described above, these changes have been jarring. The launch of new business models has sharply increased competition and uncertainty in many industries, including toys. With their margins under increasing downward pressure, companies have had to continuously cut costs, which has left fewer employees with much more to do and less free time for non-work tasks.

Technology changes also triggered repeated shifts in children’s interest away from traditional toys and towards online entertainment, gaming, and social media that did not require a physical distribution network (the exception was toys tied to major movies, like the Star Wars and Marvel franchises).

Economic change eventually produces social changes.

In the case of Toys R Us, critical social changes included time-short parents increasingly turning to online and superstore superstore (e.g., Walmart and Target) shopping, where in one stop they could purchase both grocery and other items, including toys. This further increased the downward pressure on the margins at traditional toy retailers, even as social changes reinforced the falling economic demand for traditional toys.

At the end of this causal chain comes political change.

In the case of Toys R Us, perhaps the most important has been the taxation of online sales. For many years, these were effectively tax free, which, in addition to convenience, created another incentive to avoid purchases at physical toy stores.

Internal Causes of Failure

Our research has found three critical organizational sources of strategic failure: (1) the failure to anticipate new threats; (2) the failure to accuracy assess the dangers they potentially represent, and how fast they could materialize; and (3) the failure to adequately adapt to them in time.

The available evidence suggests that Toys R Us management anticipated the new threats that they faced. It was not as though the environment was not providing clear signals, including the disruption of book selling by Amazon’s arrival, increasing toy sales at Walmart and Target superstores, the closure of many independent toy retailers, and the bankruptcy of FAO Schwartz in 2003.

Whether Toys R Us managers accurately assessed the danger posed by these emerging threats is hard to say, as much of the evidence on this point is located in documents that remain company confidential. However, Toys R Us’ online alliance with Amazon in 2000 suggests that they appreciated the danger posed by at least some of the new threats they faced.

Unfortunately, the history of organizational failure is filled with stories of timely anticipation of new threats and accurate assessments that came to naught because of inappropriate or poorly implemented adaptations, or initiatives that were too long delayed. The public record suggests that this may well have been the case for Toys R Us.

The Amazon alliance was not successful and in 2004 Toys R Us sued Amazon to force its termination. Toys R Us launched its own website in 2006, by which time Amazon’s dominance and growing economies of scope were well-established. Toys R Us also continued to maintain a relatively large number of traditional “big box” stores, often in malls in which many other retailers were failing (which decreased shopper visits).

While media coverage has focused on the firm’s recent bankruptcy and impending liquidation, perhaps the most interesting chapter in the Toys R Us story played out in 2005 and ended with the company being sold to a trio of private equity firms for $6.6 billion, an 8% premium over its stock price.

In our work with clients, we emphasize the critical importance of boards and management teams maintaining their situation awareness of evolving time dynamics – specifically, the relationship between the remaining time before an evolving strategic risk reaches one or more thresholds and becomes existentially dangerous, and the time still required to implement adequate adaptations to it.

One underappreciated aspect of this approach is that it creates the possibility of a situation in which no more “safety margin” is left, and it is clear that an evolving strategic risk will become and existential danger before an adequate response can be implemented.

At this point, the rational choice for a board is to sell or merge the company, to maximize the value of its shareholders’ investment. This approach can be very successful (in hindsight if not always foresight), if it is undertaken while there is still considerable market uncertainty about future developments, and widely varying beliefs about the potential effectiveness of various options for responding to them.

While never an easy choice, cases like Toys R Us can help management teams and boards to better appreciate that it is sometimes the right one to make.