February 1, 2005, 12:00 AM

Playing in a bigger sandbox

Like a classic toy re-discovered, eToys has gone from dot-com bust to new toy-selling powerhouse.

Like a classic toy rediscovered, eToys has gone from dot-com bust to new toy-selling powerhouse

By Paul Demery

Snuffed out of business three years ago by the bust of the early dot-com euphoria, eToys has re-emerged as a formidable player in the toy business. Operating since last May as eToys Direct Inc., it`s on course to do $100 million in revenue for the first full year in its reincarnation as both an innovative retailer and a toy-selling services provider to some of the best-known names in retail-Sears.com, Macy`s and QVC, to name just three.

EToys is no longer the brash upstart of its early dot-com days, when it spent lavishly on advertising and a state-of-the-art warehouse without securing a critical mass of customers. Armed now with a deep-pocketed parent, an experienced team of toy industry managers and multiple revenue streams, it`s primed to grow in a market that offers opportunities along with challenges, says CEO Mike Wagner, a veteran of former eToys owner KB Toys Inc. "We believe this will our first profitable year," he says. "We`re bringing people back into the toy business."

Extremely competitive

Yet the new eToys faces large challenges in an industry that has not been kind to several toy retailers in recent years. Noodle Kidoodle is no longer around; FAO Schwarz went into bankruptcy in late 2003; KB Toys slashed its number of stores in the past year to 600 from 1,300; toy sections have become scarce in large department stores; and all retailers face tough price and volume competition from Wal-Mart Stores Inc. and eBay Inc.`s eBay.com.

And the once-dominant player, Toys R Us Inc.-whose CEO and chairman John Eyler referred in a financial statement last month to a 5% year-over-year industrywide decline in traditional toy sales in 2004--is considering a sale of its toy business, while its online operation is squabbling over contract terms regarding exclusivity in toy merchandising with its partner and platform provider Amazon.com Inc.

"The toy business is extremely competitive," says Kent Anderson, president of Macys.com, which introduced toy sales through eToys Direct just before Thanksgiving. "When Toys R Us says they can`t compete--and they`re the category killer--obviously it`s a very challenging market."

Online toy retailers face extra challenges. For one, effective online displays of toys often require bandwidth-absorbing rich-media, still a turn-off to many consumers on dial-up web connections that result in painfully slow loading of graphic-rich web pages.

New opportunities

But in challenges lie new opportunities, Wagner says. "As more stores close, more consumers will buy toys online," he says. The steady move by consumers to broadband web access, he adds, will make it easier for online toy merchants to set their sites apart with progressive merchandising.

Indeed, eToys is taking an aggressive approach to both its own direct retail operations and its services business. It has made several improvements to its own two retail web sites, eToys.com and MyTwinn.com, while increasing circulation of their complementary catalogs; it has landed deals to license the retail operations of KBtoys.com and the Sears Wish Book toy catalog; and it has continued to add big-name retailers to its stable of toy-selling clients. Since starting with Sears.com and Kmart.com in 2002, it has added services clients each year and now handles online toy-selling operations for QVC.com, Circuit City.com, FAO.com, Buy.com and SmartBargains.com in addition to Sears, Kmart and Macy`s.

Patti Freeman Evans, retail industry analyst for Jupiter Research, says eToys is making a smart move in expanding its market reach in association with other established retailers even if they`re competitors--a strategy that could go a long way toward helping it reach a broader base of consumers. "Partnering with competing retailers is an emerging trend online and it`s what eToys can do to reach customers they wouldn`t normally reach themselves," she says. "It`s like a beefed-up affiliate program."

And by landing big-name clients for its services business, Freeman Evans adds, eToys is gaining valuable reference points for expanding multiple revenue streams with additional retailer partners, some of whom may still need to overcome the early dot-com image of eToys as a failed retailer. "There is still some hesitancy in the market regarding some of the early demises in online retail," she says. "So partnering with solid retailers like Macy`s adds the endorsement that they`re still going to be around and be a trustworthy partner."

The flow of events

So how did a company, whose name still conjures up memories in the retail industry of the excesses and failures of the early dot-com days, become a rising star of retailing that some of the biggest names in the industry have latched onto? The answer lies in several turns of events, starting with the acquisition of the eToys brand by retail chain KB Toys Inc. in 2001.

KB Toys` online business, KBtoys.com, launched for the 1999 holiday season through a joint venture with BrainPlay.com, an early educational toy e-retailer. Two years later KB Toys acquired most of the assets, including the brand name, of eToys.com, which like BrainPlay had catered to the market for higher-end toys.

KB Toys sold its online operations and the eToys trademarks last May to New York investment firm D. E. Shaw & Co. LP, with a large minority interest held by Wagner and three other former executives of the former KB Online Holdings LLC. The new owners renamed the old KB online operation as eToys Direct. With a $20 million line of credit from the Shaw organization, eToys Direct didn`t take long to make a new place for itself in the online toy business.

It quickly formed an agreement with KB Toys to license the operation of KBtoys.com as a general toy site, and relaunched eToys.com as an upscale site with more expensive and educational toys. In April, eToys Direct acquired the assets of the struggling My Twinn Doll Co., and launched MyTwinn.com as a unique shopping destination where children use My Virtual Model technology to design dolls that look like them.

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