CEO Question: Should I sell my business to a Venture Capital group?
This may seem like a question with a simple answer, but there’s lots to consider. The answer also depends on your goals as CEO. If you’re here reading this, then you’re clearly weighing all of your options. Let’s get started.
Selling Anything
A sale is a sale is a sale. Money is money is money. What these cliché statements lack in brilliance is more than made up for in realism. What these statements ultimately mean is, if the entire goal of selling your business is to make you (personally) some quick money, then it honestly doesn’t matter to whom you sell.
Selling your company to your brother, a bank, another corporation or, yes, even a Venture Capitalist group, the end result is the same: a paycheck. If your end goal is that paycheck and little else matters, then you can end your reading here and move forward with your sale. However, if your goal is to keep your hard built business, brand and product alive and allow it to move into the future, I urge you to keep reading to find out the real answer.
Selling your Company
Because you are here reading and you’ve got some level of interest in the answer to the question posed, I assume, then, that you’re here looking for more than the simple “paycheck” answer. With that assumption in place, let’s keep going.
Companies are complex beasts. Not only does a company have its own product parts that makes the company money, companies must also have staffing parts, the people who are hired to support those product parts and maintain those new sales. Basically, there are always two primary aspects of any business: product and staff. As a CEO, it’s on you to gauge the importance levels of each of these aspects to you. After all, your staff looks to you for guidance and they rely on you for continued employment. There’s also your legacy to consider and how you may want to be remembered by the business (and history): positively, negatively or possibly not at all.
Reputation
Let’s understand that in countries like China, reputation or “face” is the #1 most important aspect of doing business. I don’t mean the business’s reputation. I mean the person’s own reputation is at stake. If the person makes a critical misstep in business, that can prevent future opportunities. In the United States, however, “face” (or personal reputation) is almost insignificant in its importance, especially to CEOs. Short of being found guilty of criminal acts (i.e., Elizabeth Holmes), there’s very little a CEO can honestly do to fail their career.
Indeed, I’ve seen many “disgraced” CEOs find, start, and operate many more businesses even after their “disgrace”. It’s even possible Elizabeth Holmes may be able to do this after serving her sentence. As I said, in the United States, someone’s business reputation means very little when being hired. In fact, a hiring business only performs background checks to determine criminal acts, not determine whether the person has a success or failure track record at their previous business ventures.
Why does any of this matter? It matters because no matter what you do as a CEO, the only person you have to look at every day in the mirror is you. If you don’t like what you see, then that’s on you. The rest of the industry won’t care or even know what you’ve done in the past unless you disclose it.
Venture Capitalist Buyouts
At this point, you’re probably asking, what about those Venture Capital Buyouts? Are they good deals? That really all depends on your point of view. If you’ve put “blood, sweat, tears and sleepless nights” into building your business from literally nothing to something to be proud of and you still hold any measure of pride in that fact, then a Venture Capital group buyout is probably not what you want. Let’s understand the differences in the types of buyouts.
- Direct Business Buyouts — These are sales made directly to other businesses like Google, Facebook, Amazon, Apple and the like. These are sales where the buyer sees value in not only maintaining the brand and products under that brand, but building that brand as a sub-product under the bigger buyout company. With these kinds of buyouts, your product will live on under that new company. Additionally, the staff have the option to remain on board and continue to maintain that product for the new company for potentially many years. This kind of buyout helps maintain the product and maintains “face” among staff members. This kind of buyout rarely involves resale and, after the acquisition dust settles, is usually seen as a positive change.
- Venture Capital Buyouts — This kind of buyout is an entirely different beast. Venture Capitalists are in the purchase solely to make money off of their “investment” as a whole. The business itself is the commodity, not the products sold by the company being purchased. No. Venture Capital buyouts are a type of investor who buys a “business commodity” to “fix up” then “flip” to make their investment return. Thus, Venture Capitalists don’t honestly care about the internals of the products or solutions the company offers, only that those products / solutions become marketing fodder for their sales cap. Venture Capitalists do weigh the value in the products prior to the purchase, but beyond that and once the purchase completes, the business is treated not as an ongoing concern, but as a commodity to be leaned out, fixed up and made attractive to a buyer. This kind of buyout always involves resale. This fact means that remaining staff must endure acquisition twice in succession, probably within 1-2 years. This kind of buyout is usually viewed by staff (and the industry) as a negative change.
Thus, the difference between these two types of purchases is quite noticeable, particularly to staff who must endure them.
Undervalued
[Update 2/8/2022] Everything up to this point has only implied what this section actually states. I’ve decided to explicitly state this portion because it may not be obvious, even though I thought this information was quite obvious while writing the initial article.
Bottom Line: If a Venture Capital group is considering a purchase of your business, know that what the VC group is offering is only a fraction of what your business is actually worth. They can’t make money if they pay you, the seller, the company’s full value. Keep in mind that the VCs consider the business a “fixer upper”. That means they will invest “some” money into the business to “dress it up”. How that “dress up” manifests isn’t intended to turn your business around, however. What “dress up” means is investing money to make the business look pretty on paper… or, more specifically, so the books look better. That means they’ll pay an accountant to dress up the numbers, not pay to make your business actually better. Though, they will cut staff and then pull out the whips to make sure everyone sells, sells, sells so the business appears to have better year-over-year profits. When a prospective buyer looks at the books, the buyer will notice improved numbers and, hopefully, be willing to fork over double (or more) what the VCs paid to buy the “company” from you, the original seller.
Even the smartest, brightest, most intelligent CEOs can be taken in by the lure of a Venture Capital Group company purchase offer. Know then that what VCs have offered you isn’t what your company is actually worth.
Ultimately, it also means that you as the seller are being taken for a ride by the VCs. You can dress up your own company and do exactly as the VCs. Then, find a direct buyer willing to pay double what the VCs offered, which will make you twice as much money AND remove the VCs entirely from the picture as an unnecessary profiting middleman.
Acquisition Woes
Being the acquired company in an acquisition is hard on staff. Lots of questions, few answers and during the transition there’s practically silence. It’s a difficult process once the deal closes. It only gets worse. Typically, the then CEO becomes a lesser executive in the new firm. However, most times the CEO changes position not because they want to, but because the buyout contract stipulates a 6-9 month transition period and obviously most companies don’t want two CEOs. Though, I have rarely seen transitions that agree to co-CEOs. It’s an odd arrangement, though.
This means that the newly demoted executive is only on board to complete the transition and receive 100% of their contractually agreed buyout payment. In fact, most buyout contracts stipulate that for the CEO to receive their 100% payout, they must not only remain on board in a specific position for a specified period of time, they may also be required to meet certain key performance indicator (KPI) metrics. So long as all goals are met, the contract is considered satisfied and the former CEO receives 100% payment.
However, if some of the goals are only partially met, then reduction of payment is warranted. Such other metrics may include retaining key staff on board for a minimum of 6 months. If any general staff have ever gone through a buyout and have received a special bonus or incentive package, that’s the reason. The incentive package is to ensure the CEO’s KPI is reached so that the contractually defined buyout payment is paid at or as close to 100% as possible. This is also why these acquired executives can get both grumpy and testy when they realize their KPIs are in jeopardy.
Trust
Let me pause for just a moment to discuss a key issue, “trust”. While contracts stipulate very specific criteria, such as payment terms, not everything in a buyout is covered under the contract. For example, the acquiring company’s executives can find anything they wish wrong with the KPIs to reduce payment. Contracts usually do not contain intent clauses that hold the acquiring company execs accountable if they “make up” flaws in the agreement that don’t exist. It is ultimately the acquiring executives who decide whether the KPIs have been met, not the incoming CEO. If you trust these people to be morally and ethically sound, then you have nothing to worry about. However, because Venture Capitalists aren’t always practical in what they do and are driven by the need to see a return on their investment, they could find faults in the KPIs that don’t exist, solely to reduce payments. Basically, you’ll need to be careful when extending trust. Meaning, you must place full trust in those VCs willing to purchase your company. This means, doing your homework on these people to find out where they’ve been, who they’ve worked with and, if possible, get references. Let’s continue…
Buyouts with Strings
Every buyout has strings attached. No buyer will purchase a company outright for straight up cash without such strings. Such strings ensure the company remains intact, that key staff remain on board and that the product remains functional. These are handled via such stipulated “insurance policy” clauses in the form of KPIs applied to acquired CEO and executive team. These KPIs, when reached, allow the business seller to receive payment for reaching those KPIs. Were key staff to leave and the product have no knowledgeable or trained staff left to operate the product, then the purchase would be useless and the product would fail. For a buyer, requesting such insurance policies in the contract is always a key portion of buyout contracts. Expect them.
Saving Face
Circling back around to Venture Capital group buyouts, it’s important to understand that the point of such a buyout is for those “investors” to return their investment sooner rather than later. The sooner, the better. That means that their point in a company purchase by a Venture Capital group is not to take your business into new and bigger directions by dumping loads of money in and growing it. If they dangle that carrot in front of you, know that that’s absolutely not how these deals work. Don’t be deceived by the dangling of this carrot. This carrot is absolutely to get you to sell, but will almost just as definitely not pan out… unless it’s contractually obligated.
On the contrary. They’ve spent loads of money already simply buying the company. They’re not planning on dumping loads more cash into it. Instead, they plan to lean it out, get rid of stuff that wastes money (typically HR, insurance and such first), then move onto erasing what they deem as “useless” staff and wasteful costly third party services (ticketing systems, email systems, marketing systems, etc).
As for staff cuts, this means asking managers to identify key staff and jettisoning those staff who aren’t “key”. This usually comes down in the form of a mandate that only X people can be kept on board out of Y. For example, 10 people may be employed, only 3 may stay. Who will you pick? That then means jettisoning 7 people from the staff roster.
You won’t know this aspect going into the deal because they won’t have made you privy to these “plan” details. It also likely won’t be in the buyout contract either, unless you requested such a buyout stipulation. It’s guaranteed you’ll find out this plan within 10-20 days after the deal closes. As I said, the Venture Capitalists don’t look at it as an ongoing business to help flourish, they look at it as commodity to lean out, pretty up and hope for a high priced buyer to come along.
Venture Capitalists understand that it does cost some money to make money, but they’re not looking for a money pit. The purchase price is typically where the money pit ends. You shouldn’t expect an infusion of cash as soon as the Venture Capital firm closes the sale, unless such investment has been stipulated in writing in the purchase contract. Of course, you are free to take some of your own sale money and invest it into the business, but I don’t know why you’d do that since you no longer own the company.
What this means and why this section is labeled “Saving Face” is that eventually you’re going to have look into the face of not only the 7 people you had to fire, but the 3 people left and explain what’s going on. These situations are extremely hard on morale and makes it exceedingly difficult for those 3 who stayed on to remain positive. Surviving a huge layoff cut is not a win. In fact, it’s just the opposite. It’s also not simply a perception issue, either. Such a huge layoff places an even bigger burden on those who remain.
The 3 who remain feel as though they’ve lost the lottery. Now those 3 must work at least 10 times harder to make up the work for the 7 who are no longer there. Honestly, it’s a lose-lose situation for the acquired company. For the venture capitalists, it doesn’t matter. They’ve leaned out the company and the books now “appear” way better and the business also “appears” far less costly to operate in the short term. “Short Term” is exactly what the VCs are banking on to sell the company. This makes the “business” look great on paper for a buyer. As I said, the quicker the Venture Capitalists can flip their investment and make their money back, the better. The VCs are more than willing to endure hardship within the acquired company to make the company appear better for a buyer. As the saying goes, “It’s no skin off their noses”.
Technologists vs Venture Capitalists
Being a Venture Capitalist and being a Technologist are two entirely separate and nearly diametrically opposed jobs. It’s difficult to be both at the same time. As a technologist-founder-turned-CEO, the point is to build a business from scratch, allow the business revenues to help grow the business further and expand and build a reputation and customer base. Building a business from scratch is a slow road to a return on investment, which typically takes many, many years. That investment takes years to accrue, but can make an executive a lot of ongoing money. Just look at Jeff Bezos and Amazon. It can and does work.
As a Venture Capitalist group buying companies, the point isn’t to build a business. It’s to buy already built businesses as “commodities”, lean them out, make the books look great, then sell them for at least double the money, usually in months, not years. If the VCs dangle a “five year plan” in front of you, claiming to grow the business, please re-read the above again. To spell it out, there’s no “five year plan”, unless it randomly takes the VCs that long to line up a buyer. That’s more of an accident than a plan. The VCs would prefer to line up a buyer far sooner than 5 years. The “five year plan” rhetoric is just that, rhetoric. It was told to you, the seller, to keep you interested in the buyout; not because it is true.
If the “5 year plan” carrot is dangled in front of you, then you need to have the VCs put up or shut up. What this means is, make them write the “5 year plan” investment explicitly into the purchase contract. If they are legitimately interested in growing the acquired company, they should have no problems adding this language into the buyout contract. This will also be your litmus test. I’d be highly surprised to actually see VCs contractually agree to adding such “5 year plan” language into the purchase contract.
As I said above, these two types of jobs are nearly diametrically opposed.
One method slowly builds the company as a long term investment opportunity, the other uses the existing whole company itself as a commodity to sell quickly as a fast return on an investment. As a CEO, this is what you must understand when considering selling your business to a group of Venture Capitalists.
If you want your business and brand to continue into the future and have a legacy listed in Wikipedia, then you want to keep your business going and growing. Once you sell your business to VCs, the brand, product and, eventually, staff will all disappear. Nothing of what you built will remain. Selling to a Venture Capital group likely ensures that this process happens in less than 1 year.
Selling to a direct business, the brand naming may hang around much longer than 1 year. It’s really all about whether you care about your legacy and your resume. You can’t exactly point to producing a successful business when nothing of it remains. Selling the company makes money, yes, but has a high chance of losing everything you’ve spent loads of time building. Unfortunately, Venture Capital group purchases almost ensure the fastest means to dissolution of the brand and of that time spent building your business. Still, a paycheck is a paycheck and you can’t argue with that in the end.
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Did Toys “R” Us have to fail?
If you’ve read various articles including this Bloomberg article, you might come away thinking that all of what happened to Toys “R” Us began a decade ago (i.e., the early 00s). In fact, you would be so wrong… and so would Bloomberg. Let’s explore.
The 80s
Around 1981 or 1982, I worked at Toys “R” Us. Even at that time, Toys “R” Us ran a questionable business model. A business model that, I might add, even store managers recognized and thought was unsustainable. In fact, after having discussions with store managers at my store, I got an earful about how they thought that the chain would likely fail within a decade if they kept on using that business model. This was the early 80s.
What business model?
Toys “R” Us sowed the seeds of its own destruction at least beginning in the 80s, perhaps as early as the 70s. What questionable business model is this? The model chosen was to operate the stores in the red (otherwise known as losing money) through 80-90% of the year (aka, “90 in the red”). Then, the management hoped to recoup those losses in the final 1-2 months of the year during holiday season sales. It didn’t always work out.
While this model seemed to work to keep most Toys “R” Us stores afloat through the 80s and 90s, it served to keep the company from really turning a solid profit and, ultimately, led to the company’s massive debt load. What that model meant to the stores is fully stocked shelves every day of the year. This was readily apparent walking into any Toys “R” Us store. The stores were not only full, they were positively brimming over with the latest toys. This also meant putting itself into massive debt each year in inventory and then hoping to pay off that debt at the end of the year when most of the stores finally ran “in the black” (read, turning a profit for the year).
Keep in mind that many of the stores didn’t turn a profit, but so long as enough stores did, they could cover for the debt they had been incurred company wide, or at least so that was the idea. Even the store manager at my Toys “R” Us location could see the handwriting on the wall in the early 80s. This store’s business model was not sustainable and I was, even as an standard employee, told this by various managers. These managers didn’t hold back their thoughts.
Bloomberg, Fads and Sustainability
What Bloomberg got right was that even a decade ago, TRU’s debt load had put them underwater. What Bloomberg didn’t address was that this debt began almost 2 decades earlier of overbuying, followed by hoping that a “hit toy” would kick them over the profit line at the end of every year.
“Hit Toys” were Toys “R” Us’s hopeful thing. They needed that Tickle Me Elmo or Nintendo Wii or Lazer Tag or Cabbage Patch Kid fad toy to carry the chain into the new year with profit on the books. Throughout the 80s and 90s, there were a string of these hit toys practically every year. Fad toys which flew off the shelves and brought Toys “R” Us to profitability each year. It was a risky move for Toys “R” Us to bank on a hot fad each year, but there it is.
Unfortunately, relying on this kind of yearly toy fad to sustain a business every year was not only risky, it began to burn Toys “R” Us as these yearly fads began to die off by the late 90s. Even during mid-late 90s, these fads were much less intense than they had been just a few years earlier. By the mid-00s, these fads were practically non-existent. Sure, there were hot toys, but no where near the levels of sales that Tickle Me Elmo or the Cabbage Patch Kid fads offered to Toys “R” Us’s bottom line… particularly when Best Buy, Walmart and Amazon concurrently began diluting the toy profits of TRU.
These fading fads were responsible for killing other toy stores chains as well, such as Kay Bee Toys and even the once high flying, high end FAO Schwarz. These fading fads also left Toys “R” Us holding a huge mound of debt.
Walmart
While Walmart did usurp the title of top toy seller from Toys “R” Us, that’s primarily because Toys “R” Us prices were always on the higher side. Walmart did carry toys, but not all toys. If you wanted something you couldn’t find at Walmart, you went to Toys “R” Us and it was pretty much guaranteed they would carry it (even though it might be out of stock). Walmart didn’t even stock many of these. The toy section in Walmart was always small by comparison. Sure, you could find better deals at Walmart, but only from the toys that they chose to carry.
Walmart was also not very kind to collectors in the 90s. If a collector showed up to buy toys, Walmart would try to do everything to keep that toy item away from the collectors… sometimes even going so far as to banning them from the store simply for buying toys. Does it really matter whose dollars are buying an item? Granted, I wasn’t particularly happy that a collector had gone to Walmart to buy out all of the “good” stock leaving tons of “peg warmers” sitting around that no one wanted. But, that’s how toy collecting worked in the 90s.
The whole collector market kind of died off with the advent of places where collectors could buy case packs, like Entertainment Earth. Instead of having to rummage around Walmart at 3AM (when they stocked new merchandise), you could order a full case of figures, guaranteeing that you’ll get at least one “rare” figure. This meant that the once Walmart and Toys “R” Us shopping locations for collectors became a thing of the past. Collectors took their money online to buy cases and stopped buying at Toys “R” Us. Buying case packs is easier, more convenient and doesn’t require the hassles of dealing with surly underpaid Walmart workers.
Toys “R” Us Kids Grew Up
Kids of the 80s became collectors in the 90s and became families on the 00s. The once popular collector market throughout the 90s fell apart into the 00s because the collector market changed and Toys “R” Us failed to understand this important change. The collector market is (or at least was) also a huge market that kept Toys “R” Us afloat in addition to the end-of-year-fads. However, brands like Hasbro and Mattel didn’t grow with the collector market. Sure, Hasbro tried, but the toys they made were tiny improvements over their (sub)standard toys. Mattel also tried with its collector Barbies, but, again they failed to understand the critical quality needed for what collectors really yearned.
In essence, the toy brands themselves didn’t grow to provide what collectors wanted… which left Toys “R” Us mostly without collector money. However, collector brands did grow up for the collector market outside of Toys “R” Us, including Sideshow and Hot Toys brands. These brands are now considered the premiere collector “toy” brands for adult collectors. These “action figures” are some of the highest end, most expensive, most collectable toys out there, yet these are not sold at Walmart, Target or even Toys “R” Us (before they closed). Though, you can find them on Amazon via third party sellers. This is where Toys “R” Us failed to keep up with the kid-turned-adult collectors. Hot Toys figures cost anywhere between $150-350 per figure; a price point that collectors are more than willing to pay to get that level of craftsmanship. A price point that Toys “R” Us never carried. A quality that not Toys “R” Us nor Walmart nor Target ever carried.
While Toys “R” Us continued to sell these low-end toy products to kids, it failed to grow up and to sell high end collectibles to adults. Ironically, this runs counter to their jingle. The most prestigious type of collectibles that Toys “R” Us sold were the collector Barbies and McFarlane figures, offering price points at $15-40. A price tag that cannot provide the levels of detail, paint jobs and overall craftsmanship that goes into a Hot Toys or Sideshow figure. Adult collectors want high end figures and Sideshow and Hot Toys fill that niche. Toys “R” Us management never recognized this growing trend.
“I don’t want to grow up, I want to be a Toys “R” Us kid”
This jingle is ultimately the rationale that appears to have led Toys “R” Us management down the wrong path. Instead of singing the praises of not growing up, the toy store should have realized that kids grow into adults; adults who still want to buy collectible toys, but who don’t want the junky, low priced Hasbro and Mattel versions. They want premiere brands like Hot Toys offering highly detailed, highly realistic, meticulously crafted and painted figures… not Hasbro’s now antiquated, poorly painted, robot-style 12 inch figures. You might give these cheap toys to your kids, but you wouldn’t display them in a display case.
This collectible market began with highly detailed military figures, but branched out into licenses with Marvel, DC, Star Wars, Warner Brothers and various other large movie franchise brands. Toys “R” Us failed to latch onto this market and, thus, failed to capture the once Toys “R” Us kid who had grown into an adult and now desires these highly detailed collectible toys. As kids grow into adults, tastes change and people want more sophisticated products. Hot Toys and Sideshow found that niche for sophisticated adult tastes. Yet, Toys “R” Us failed to recognize this niche.
If Toys “R” Us had realized this mistake and had added brands like Hot Toys to its shelves, it might have been able to entice the collector’s market back into its stores and pay down some of its debt. Every discount retailer has, so far, failed to realize the adult collectible toy market. However, this lack of foresight hurt Toys “R” Us the most.
Kid Tastes
Additionally, kids tastes have also changed as a result of brands like Hot Toys and products like the iPad. Kids don’t want want to buy Leap or other “toy” or “fake” tablets when they can ask their parents for the real thing. Kids also want the higher end Hot Toys than the poorly crafted Hasbro Ironman figures. While Toys “R” Us did begin carrying Apple products, the stores really thought of these more as a toy rather than treating them as something useful. Best Buy always treated their Apple section with the best possible displays. Toys “R” Us displayed its Apple tablets right next to random other tablets as though they weren’t anything special. I’m not even sure that I’d have felt comfortable buying an Apple tablet from Toys “R” Us. Not only did they have no one versed in this technology on staff, what they carried could have been 2 or even 3 generations old. Toys “R” Us just didn’t treat these products with the respect that they deserved.
As a result of kids changing tastes and higher levels of sophistication, kids really didn’t want much of what was in that toy store after a certain age. This meant that Toys “R” Us was primarily for kids of a certain age and below (probably 8-9 or younger). Even still, these ages were growing up faster.
Toys “R” Us Closure
Did Toys “R” Us have to close? Yes, it did. Without a management team capable of fully understanding the downsides of running its stores using the “90 in the red” model throughout the year (and failing to accommodate the changing tastes of adult collectors), the stores ultimately succumbed to closure. It was inevitable.
What tipped the scale, though, was 2005’s $6.6 billion leveraged buyout of Toys “R” Us by the KKR, Bain Capital, and Vornado Realty Trust; a purchase that saddled the corporation with at least $5 billion in debt, in addition to its already mounting toy inventory debt each operating year. There was simply no way Toys “R” Us could recover from and pay down that debt considering its interest each month.
In fact, it was this very same leveraged buyout that not only trashed Toys “R” Us, it also lost its original private equity investors at least $1.28 billion. Even these private equity firms were ignorant of Toys “R” Us’s “90 in the red” model. You’d think that between three different private equity firms, one would have had brain among them. I guess not. Toys “R” Us was not worth buying strictly because of that business model… and it was especially true when considering saddling an already debt overburdened company with even more debt. It was an insanely stupid buyout made more stupid because of the lack performing even the most basic of fiduciary responsibility. Those private equity firms got exactly what they deserved out of that deal. Make the wrong deal, get the wrong results.
If I had been sitting in the room when this buyout deal was being considered, I would have put the kibosh on that deal pronto. If managers of stores could recognize how badly Toys “R” Us was operating in the 80s, why couldn’t a bunch of suits at three different private equity firms see this before plopping down $6.6 billion?
Overvaluation
If anything, 2005’s TRU sale is a cautionary tale. There are way too many buyouts that are purchased at way too high a value. I’ve seen it happen time and time again. Companies worth maybe $500 million sell for $3 billion? It’s just insane the money that’s being overspent. Would you walk into Walmart and offer to pay $25 for a $5 tube of toothpaste? I don’t think so. So, why do these investors think it’s okay to spend $6.6 billion on a company worth maybe $1 billion at its best… and it was then likely actually worth much less considering the debt that it already carried. Its insane business model should have further reduced its value.
Could Toys “R” Us have been saved?
Probably not. At least, not with its status quo business model. But, it might have been saved IF Toys “R” Us had adopted a more balanced approach to its store sales and more sane merchandise ordering in combination with letting managers actually handle full store merchandising instead of relying on nice looking, but misguided corporate-standard planograms.
Only stock enough merchandise in a specific store that that store can actually sell. Let managers move stock around on shelves and place the merchandise in their store where it’s most likely to sell. Additionally, don’t send stock to a store where the buying demographic isn’t buying that type of merchandise. If Barbies aren’t popular in a particular store’s demographic region, send limited amounts of Barbies there. It’s a waste of money and effort to stock merchandise that doesn’t sell. One of Toys “R” Us’s biggest foibles was its cookie-cutter store approach. That meant it was sending the same stock to all stores regardless of popularity in that local store’s area. It also meant that it way overspent on toys that would never sell at certain stores. Eventually, they simply had to clearance out those toys. Each store’s inventory should have been customized based on buying habits of local consumers and by the local manager. Only the local store team knows what’s the “hot sellers” in their store.
Clearance merchandise is actually a red flag in the retail business. It means that, as a store, you way overspent on merchandise that you couldn’t sell. If you have excessive clearance merchandise, then your merchandise spends are way off. It also means that your buyer is overbuying stuff that isn’t selling. It means you need to rethink your buyer and it means your new buyer needs to rethink how much to spend on similar types of products.
One of Toys “R” Us’s other foibles was its inability to recognize and stock the “hottest toys” rapidly. If you send 5 of something to a store and it sells out in 10 minutes, you need to stock more of it and you need to do it pronto. Yet, it might take Toys “R” Us 30 or more days to get that merchandise back in stock. That’s 30 days of zero sales… sales that could have been had the next day and the day after that. Missed sales were one of TRU’s biggest problems. Having merchandise in stock that you can sell day after day is a huge win. Yet, if the corporate buyers don’t even know to reorder this thing again, the store is blind. This is why the next part was so important to improving TRU.
Instead, this toy chain should have let the local managers have autonomy via cutting merchandise from their store that isn’t selling and placing rush orders on the hottest toys. By letting the managers, you know, actually manage the store’s inventory properly, the stores could have cut costs and raised profits. The managers could have done this by buying more of popular hot sellers in that area, shuffling cold merchandise to other stores that can sell it and cutting non-sellers from the inventory. In fact, managers should have actually had access to every store’s inventory throughout the chain and when that item last sold there. If a particular item is selling hot in one store, but is completely dead in other stores, the hot item store manager should be able to request stock moved from the cold stores to their store. This way, managers could have directly moved inventory from store to store instead of placing orders for more stock, thus causing more debt. Only after the existing in-store inventory was exhausted should a new order need to be placed. The buyers from the chain should have endorsed this manager autonomy.
Unfortunately, that wasn’t a priority for the very rigid corporate run TRU. I could walk into a store in Texas and find specific toys always out of stock. Then walk into a TRU in St. Louis a week later and find twenty of them sitting on the shelf with dust on the top. If stores had been able to request the hottest toys moved from other stores, the chain could have saved a lot of money on new stock orders.
This change in business model could have drastically improved Toys “R” Us’s profitability throughout the year. It probably would have cut down on orders to toy sellers, but something’s got to give when you’re running a retail store chain. If the toy manufacturers had to suffer a little to let Toys “R” Us recover and be a whole lot more profitable, then so be it.
Unfortunately, TRU’s status quo model endured. Even if the leveraged buyout hadn’t occurred in 2005, Toys “R” Us’s fate was pretty much sealed strictly by is “90 in the red” (cookie cutter) mentality. It was only a matter of time before it succumbed to its own debt burden even if it hadn’t incurred a ton more debt after that poor sale. The 2005 unwise sale simply accelerated Toys “R” Us’s already looming demise.
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