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Here’s what sunk Toys R Us

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Another round of Toys R Us clearance sales was underway in late March, even as a fundraising campaign to save the toy company launched online, and defunct competitors announced their comebacks.

The future of the 70-year-old business might still be in flux, but what can be learned from its past mistakes? Two MIT Sloan experts weigh in.

Don’t get eaten.  The role of any CEO is threefold, said Peter Kurzina, senior lecturer in work and organization studies. Make sure the company doesn’t run out of money, figure out what’s next for the company and its industry, and prepare the company for changes.

“None of these three jobs was successfully done by the leadership of Toys R Us,” Kurzina said. “Retailing CEOs have been particularly bad at doing all three of these jobs. Fifty U.S. retailers filed for bankruptcy in 2017, and more bankruptcies are on the horizon.”

The common denominator, Kurzina said, is that all of them ignored Amazon “eating their lunch,” and thus failed to prepare and meet the challenge of competition.

“But that does not mean they cannot meet Amazon and succeed,” Kurzina said. “Best Buy is an example of one that did adapt and change and is succeeding despite the challenges of Amazon.”

The New York Times reported that under the leadership of CEO Hubert Joly, Best Buy has introduced price matching and lowered product costs, expanded its Geek Squad to include pre-purchase advisers, and incorporated its stores into the shipping and delivery of online purchases.

Debt is risky.  While Amazon didn’t help the toy giant’s situation, it was the company’s “huge debt burden” that sealed its fate, associate professor of finance Andrey Malenko said.

“A huge debt burden made the firm very sensitive to a moderate decline in sales and profitability, and a complex debt structure made it difficult to renegotiate the terms with creditors,” Malenko said. “If Toys R Us had half of the debt they had, the firm would have been profitable and totally fine now.”

Toys R Us was acquired in 2005 by a group of investors through a leveraged buyout. That acquisition required a lot of debt, and while that’s not atypical of a leveraged buyout, Malenko said, it was a significant amount to take on. The company filed for bankruptcy in the fall, citing $5 billion in debt.

“I think that the main lesson is that taking a lot of debt is risky,” Malenko said. “It’s kind of obvious in hindsight; any company that issues a lot of debt with significant, complex debt structure has to understand it is risky, and there are costs and benefits of doing that. If you’re running a business that might be sensitive to e-commerce, to the recession, then loading up on debt as much as [Toys R Us] did, it’s very risky and you probably shouldn’t do it.”

The debt was renegotiated after the 2008 financial crisis, but the damage was done. The firm was making money, but not as much as predicted, Malenko said, and additional debt negotiation meant having to get a number of stakeholders with varying levels of seniority and buy-in, on the same page.

It’s hard to reach an agreement with all of those people, Malenko said, but he said he was most surprised that the company chose liquidation over another attempt at negotiation.

“Now is not a good time to liquidate big box stores,” Malenko said. “How many buyers can buy big box stores? Only other big retailers, and they’re not doing well right now.”

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