Toys R Us store closings is a sad situation for many who remember life before e-commerce. The big box retailer was the premier destination for kids seeking the latest toys and gadgets a few decades ago. Sadly, times change as the retailer continues to struggle post-bankruptcy. Regardless of the outcome, we can take away three key lessons from the iconic retailer’s struggles.
Lesson #1: Beware of Too Much Debt
Debt is a useful tool when times are good. But when conditions sour, it can be a major burden. Toys R Us knows this all too well- the retailer reportedly had $5.2 billion in debt when it filed for Chapter 11 protection. When its operating income dropped, the company struggled to make the $400 million annual interest payments.1 And this is with interest rates near historic lows.
Today, many small businesses are prospering amid a strong economy, easy credit, and favorable tax reform. According to a CNBC/Survey Monkey Small Business Survey, the small business confidence index hit a record level earlier this year.2
Subsequently, bank lending to small businesses has also reached a post-recession high.3 This makes sense as the decision to take on debt is generally a reflection of optimism. This is certainly true for “offensive financing” purposes such as equipment purchases and net working capital.
Still, just because you’re offered credit, doesn’t mean you should take it. Circumstances change- a sudden downturn in the economy or operational misstep can severely hamper liquidity (the ability to raise funds quickly). And the higher existing debt levels are the more challenging it is to subsequently raise funds. This is ultimately what led to Toys R Us’ 2017 bankruptcy.
Liquidity is crucial for small businesses, especially those that allow credit sales to customers. Waiting for payments can make day-to-day operations like meeting payroll or purchasing inventory a challenge. Even applying for SBA Express loans can take a couple of weeks to close, if you can qualify.
When small businesses have imminent funding needs but want to avoid debt, many should consider factoring their accounts receivable. Factoring is a transaction where outstanding invoices (typically less than 90 days outstanding) are sold off to a third-party who then collects the payment from the late-paying customer.
While the invoices are sold at a discount to face value, the transaction addresses both of the aforementioned problems. First, it provides quick funding, often within a couple of days, and incurs no additional debt (because accounts receivable are assets, it’s technically an ‘asset sale’).
Lesson #2: Utilize Assets Creatively
It’s not how big your assets are, it’s how you use them. Just ask K-Mart. According to Moody’s, when K-Mart filed for its 2002 bankruptcy, the retailer had five times more assets than liabilities.4 Toys R Us also a vast real estate portfolio and could have avoided financial trouble even with online competition creeping in.
Engage in Sale Lease-Back
First, since Toys R Us owned the majority of their store locations, it had the opportunity to engage in sale lease-back transactions prior to declaring bankruptcy but pursued the option in earnest too late. Such proactive efforts would have provided an influx of cash and may have avoided Chapter 11 until other solutions could have been reached.
Focus on Ancillary Revenues
Second, Toys R Us also had options to bring in ancillary revenues even when toy demand or economic conditions recessed-it had vastly underutilized space. Getting people in the stores should have been paramount because they know that margins are higher in-store versus online.5
For example, many Walmarts have a McDonalds, Nail Salon and Hair Cuttery right inside the store (something for mom, dad, and junior). These attractions bring substantial foot traffic into the stores. Walmart even capitalizes on seasonal opportunities with a Jackson Hewitt Tax Center near the entrance.
Bass Pro Shops also makes their store a destination. During the holidays’ kids can get a picture with Santa and even go fishing inside the store.
These two ideas could have provided an immediate cash flow boost for the toy retailer, possibly staving off bankruptcy. Cash flow management is a concern for businesses of all sizes but is crucial for small businesses. According to a study by U.S. Bank, 82% of small business failures are the result of poor cash flow management.6
Lesson #3: Really Know Your Customer
Toys R Us clearly lost track of customer preferences. Failing to innovate with the times, their digital marketing was underwhelming. There were no viral videos, social media buzz or influencer marketing campaigns with contemporaries.
They could have taken a page out of Nerf’s playbook, another brand whose best days were in the past. Their stodgy brand got rejuvenated by the ‘Dude Perfect’ crew whose fun, energetic videos made them a YouTube sensation and transported Nerf into the 21st century.
For girls, they could take a page out of numerous Bath and Body Works merchandise videos by ‘tweens exalting Mango Mai Tai and Warm Vanilla Sugar soaps. In the end, the Toys R Us nostalgia remained in the 80’s, with their marketing campaign.
It’s not only Toys R Us that misunderstood the customer- they ARE the customer for a number of toy manufacturers (suppliers). The retailer’s struggles put $450 million of receivables in jeopardy.7
While it’s understandable that smaller businesses extend generous credit terms to land enormous customers like a big box retailer, they made a series of mistakes, as well.
As soon as they got wind of Toys R Us’ financial problems, several suppliers imposed COD (Cash on Delivery) terms on new orders.8 This didn’t help either party. Suppliers could offer discounts for faster payment, such as ‘2/10 net 30’ terms. This means you are keeping the standard 30-day due date, but offer a 2% discount if the customer will pay within 10 days.
Payment won’t come in as fast as COD, but it means you are willing to work with customers in a delicate situation. This puts the onus on the account debtor to reduce their costs (and improve margins) by paying a bit earlier.
Trade Insurance vs Non-Recourse Factoring
When worrying about receiving payment, small businesses have a couple options- trade insurance and non-recourse factoring. These strategies can minimize supply chain risks.
With trade credit insurance, you actually take out an insurance policy on a particular customer’s solvency or ability to pay on time. In non-recourse factoring, the credit risk of the account debtor is transferred to the third-party receivables buyer. With both examples, the credit checks are performed by experts, not suppliers moonlighting as credit analysts.
Do Customer Credit Checks
If you operate in the B2B space, the importance of credit checks on prospective customers cannot be understated. Invest in a professional credit service or utilize a financial partner that offers in-depth credit analysis. A default by a customer representing a high concentration of revenues could have disastrous effects. And periodically monitor the credit of existing customers- just to be safe.
Toys R Us is one of several big box retailers whose story could become a case study for students in business school or online MBA programs, providing lessons on corporate strategy as well as supply chain management.