Gerald Storch's philosophy guides Toys 'R' Us to sales growth Things are tough in Toyland at the moment, but Gerald Storch believes he can ride out the storm. The chairman and chief executive of Toys 'R' Us, the world's largest toy retailer, was optimistic while in Hong Kong last week, after seeing his company's yuletide sales beat rivals. That despite recessionary conditions in the United States foreboding fewer presents under the Christmas tree for most children. With 1,500 outlets worldwide, Mr Storch proudly presented a 1.9 per cent same-store increase in sales last month in the United States, outperforming the 1.7 per cent growth at Wal-Mart Stores and contrasting with a 27.5 per cent fall at Neiman Marcus. This is not to mention single-digit drop at Macy's, Target, Best Buy and JC Penney. Toys 'R' Us' performance, which defied gloomy forecasts, came after the chain bombarded shoppers with 50 per cent discounts, promoted hot items and kept its store at Times Square in New York open round the clock for the first time a week before Christmas. At a time when people are feeling poorer and holding back on discretionary spending, Mr Storch quips that he is lucky to be selling 'toy cars rather than real ones'. 'We have seen that in good and bad economic times, the last things parents cut back on is holiday presents for their children because they put their children first,' he said during his annual visit to Hong Kong to meet suppliers of new products. Still, clouds hang over consumer spending this year and, although he is an optimist, Mr Storch expects slow sales for most of the year. Shoppers are not expected to return in large numbers until the fourth quarter. 'It will be soft in the next few months, but I personally believe the economy will get stronger by the fourth quarter,' he said. From the upstream manufacturers to the retailing end, the toy industry has not had a joyful time recently on the mainland. Since the summer of 2007, tens of thousands of toys with toxic parts had been taken off store shelves because of they could endanger children, prompting the US and subsequently the European Union to tighten rules on safety requirements. Last year, skyrocketing costs of labour, fuels and safety tests stung Chinese manufacturers, accelerating the death of the weakest in the industry. The Toy Manufacturers' Association of Hong Kong estimates at least 500 of about 3,500 of the city's toymakers in the export powerhouse Pearl River Delta have perished. Then came the global financial crisis, which has hammered not only Chinese suppliers but also retailers in the US and Britain. A prime example was the demise of KB Toys, America's third-largest toy retailer, which filed for bankruptcy protection last month for the second time in four years, leaving as much as US$27 million in unsettled payments to suppliers including 135 Hong Kong manufacturers and trading agent Li & Fung. KB's sudden collapse ignited a bitter protest from manufacturers, which demanded that Li & Fung, as the trading agent of KB, settle the overdue payments. But Li & Fung pointed its finger at KB. Li & Fung is also a trading agent of Toys 'R' Us and runs the toy retailer's stores in Asia other than South Korea and Japan under a franchise. 'KB is an insignificant player in the US and was a troubled player long before the onset of the global financial crisis,' said Mr Storch. 'It went bankrupt before ... during the good years.' Souring demand and global credit shortages sent further shock waves to the other end of the supply chain, breaking traditional mutual trust which has been built up between buyers and suppliers and calling into question the viability of the global trade finance regime. 'Smaller players are having difficulties in getting financing, which is hardly unique and is what the credit crunch is all about,' Mr Storch said. 'In business as a whole right now, everybody is a little scared. Banks have got so much money from the government they are supposed to lend, but they just don't lend because they don't trust. Everybody has become trust-averse.' The fate of the remaining Hong Kong toymakers across the border is in doubt, as orders slow to a trickle and funding dries up. Longer term, some people are saying this calls into question the prospect of the Pearl River Delta as the world's factory and Hong Kong as the toy capital and an international finance hub. 'A smaller number of larger players will emerge from the consolidation,' Mr Storch said. 'China is still the place for toys. There are skills and expertise that other countries like India and Vietnam are unable to replace. Nobody is building new factories right now in these countries.' Toys 'R' Us, which sells US$13 billion worth of toys a year, sources about 85 per cent from major brands such as Mattel and Hasbro and the remainder directly from factories or through trading agents such as Li & Fung, according to Mr Storch. A former vice-chairman at Target, Mr Storch joined New Jersey-based Toys 'R' Us in 2006, a year after the toy company was privatised in a US$6.6 billion deal. He has taken charge of leveraging on 'Toys 'R' Us' recognised brand by expanding the firm globally through franchising. He holds Bachelor of Arts, Juris Doctor and Master of Business Administration degrees from Harvard University. Mr Storch and his wife Jacquie have five children. Do shoppers prefer cheaper toys? This is an interesting question. There is a lot of noise in the US about toys under US$10. There was a lot of noise not long ago about safety of toys. During holidays, I don't believe parents want to buy cheap toys. They want to buy quality products. What we saw in the end was they bought the toys the kids wanted and hot toys. So what really matters is cool toys. Toys with electronic components, big doll houses, a US$59 Elmo Live that talks and sings and [US$139.90] Spike dinosaurs that roar and walk are very hot for us. Consumers want value, but it doesn't mean they want cheap products. Nintendo [electronic games] continued to be very strong and for another year were sold out. They cost US$249 each, but they were hot. We have 5,000 types of products below US$10, which will sell well in the first part of the year. But when it gets to November and December, parents will want to buy really great Christmas presents for the kids. At the Hong Kong Toys and Games Fair this month, Chinese suppliers were complaining that US buyers bargained the hardest and demanded the longest payment settlement period. Is Toys 'R' Us one of them? We are doing our job. I suspect you could ask that question any year and we would tell you the same thing. It's too easy to say it is because of current times. It's our job to negotiate for the best price, and [the suppliers'] job to make the most money they can on what they sell. As a retailer, our job is to get the best price for anything for our customers. If we don't do it, our competitors will do it - Wal-Mart Stores or someone else. Have you seen that carry through to your international partnerships? Sure, one of our franchised owners opened a store in Iceland last year, and of course Iceland is one of the worst economies. Who would have guessed that? Because of the banking crisis, who would have possibly predicted that? So there is no good hope for the Iceland store right now and that could take generations to fix. There are 230,000 people who have gone bankrupt. It's very sad. England is a very soft country right now, which is very difficult. Canada and Spain are very strong. Canada has got the oil industry. We don't sell directly to China, but Li & Fung does. It is going to be tough in the short term. But over the long term, China will continue its rise. China is increasingly losing its cost advantage in toy production. A growing number of Hong Kong toymakers across the border are going out of business for various reasons. Are the days of Hong Kong as the toy capital numbered? No, I don't think so. Southern China is still the heart of the toy industry. Although we constantly look for new sources of products, Hong Kong has the sophistication in the industry and the proper cost structure for toys. It's too expensive to make toys in developed countries and there are no technologies or skills to make these products in other countries. For example, India is what you would think theoretically, but there are no technologies or skills to make toys. Vietnam has become very important to us for furniture for children and cribs. They are good at making furniture, but not toys. Yesterday, we were talking about making toy chains in China, talking about the pricing. Then I asked if we could make them in Vietnam because it makes wood products. Well, the Vietnamese industry doesn't have the skills to make the fine parts. Over many years, they may be able to do it but now, they don't have the ability although they have factories. Some toys are made in Mexico, but mostly that is assembly work. Some toys are made in Canada because some companies are based there and they are very specialised. Some are made in Eastern Europe, which may become competition some day but not now. Right now, China is the place. Safety was the number one issue in the industry last year and this affected many manufacturers in mainland China. What have you discovered about their safety standards now? I am very pleased. I believe that China responded very well to the challenge and all of us care about children. No one said safety was not important. We made strong efforts to push for change while US senators said the industry needed to embrace the change. So we all went after change. Costs related to manufacturing sky-rocketed last year, especially with extra spending on safety tests. Is your company willing to share part of the costs? Prices went up significantly as a consequence of cost increases driven by labour, the new labour regulations, the rise in fuel prices, energy prices and currency effects. Plastic and steel prices went up as well. We had many products that experienced a double-digit price increase last year. What we see this year is that most of the price pressure is gone except for labour costs, which are still high. Testing costs have gone up as we do more complex tests under new safety requirements. Inevitably, the cost of testing has to go to the cost of goods. If we have to pay more, we try to pass it on to consumers. There is a certain amount we can pass along. Certainly this is capitalism and we try to negotiate the best price from the supplier. We will charge wherever the market allows us to charge. What toys will cheer up people during the financial crisis? It depends on the age. What about toys for a 50-year-old manufacturer in trouble? I like nerf guns. In my New Jersey office, we have all these nerf guns. It's just fun. Perhaps we [manufacturers and suppliers] could take a shot at each other for a bit of fun and relaxation. If you feel sad, on a Saturday just go to the Ocean Terminal [Toys 'R' Us] store and watch the kids play the toys. They are going to sort out their stuff anyway. The economy is tough, but you have to smile and remain positive.