Amazon and Toys 'R' Us Play Together

Amazon.com and Toys 'R' Us have agreed to establish a co-branded online toy store. The deal exploits each company's strengths: inventory management for Toys 'R' Us, site development and fulfillment for Amazon. Both companies will benefit from access to one another's customer bases. It looks like a win-win deal.

By Brian Lund (TMF Tardior)
August 10, 2000

It's nice to see companies recognize their deficiencies and move to correct them. Today's announcement that Amazon.com (Nasdaq: AMZN) and Toys 'R' Us (NYSE: TOY) will create a co-branded online toy store solves a number of systemic problems for both companies.

The 10-year pact primarily addresses three areas: 1) inventory management; 2) site development, fulfillment, shipping and customer service; and 3) customer acquisition and leveraging.

1. Inventory management
Under the agreement, Toys 'R' Us will purchase and manage inventory for the store, while Amazon houses the inventory in its warehouses. This solves a big problem for Amazon. It took a $39 million inventory charge in the fourth quarter of 1999 because it carried deep inventory in its new businesses, principally toys and electronics. Toys 'R' Us has much more experience determining demand in the toy business, which should allow more efficient inventory management.

Both companies benefit from using Amazon's warehouses. For Toys 'R' Us, it means that they don't have to build warehouses to handle growing online sales. For Amazon, it means that they can make better use of their underutilized storage capacity. The company built eight new distribution centers last year in anticipation of future growth.

2. Site development, fulfillment, shipping, and customer service
The deal calls for Amazon to handle these four aspects of the new store. They are Amazon's specialties. Toys 'R' Us launched its online store in June 1998, but had to undergo a major site redesign. The new site went up in May 1999, but still suffered from slow performance because the company underestimated demand. The company's inability to handle the unexpectedly high demand resulted in "less than optimal order fulfillment during the 1999 holiday season," according to the most recent 10-K. By handing these duties to Amazon, Toys 'R' Us rids itself of a major headache.

Amazon is famously obsessive about order fulfillment and customer service. Their increased distribution capacity allowed them to meet heavy demand last holiday season. In their fourth-quarter earnings press release, the company bragged that it delivered an order placed at 8:05 PM on December 23 in time for Christmas. It devoted such energy to fulfillment, in fact, that the company lost money in shipping. Under this deal, in exchange for handling fulfillment, Amazon will receive periodic fixed payments, per unit payments and single-digit percentage of revenue, plus warrants to purchase 5% of Toysrus.com.

Though the companies disclosed no precise figures, these set payments should help Amazon bring the shipping portion of its toy business to profitability.

3. Customer acquisition and leveraging
Amazon recorded $95 million in sales of children's products in 1999, most of which were toys. Toysrus.com had revenue of $49 million last year, but carries a strong brand name for toys. By combining the two, Toys 'R' Us gains access to Amazon's large customer base, while Amazon can cross-sell its other products to Toys 'R' Us shoppers.

All three of these areas offer win-win propositions to the two companies. The agreement doesn't guarantee that the venture will succeed, of course, but it seems to make each company's toy business more likely to remain viable.

Your Turn:
Check out what other Fools think of the deal and let us know your take on it on the Amazon discussion board and the Toys 'R' Us discussion board.

Related Links:

  • Amazon toys & video games home page
  • Toys R Us home page
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