Mattel: Some (Re)Assembly Required

By Karl Taro Greenfeld

Walk around the airy orange-and-yellow-hued loft of Rumpus Toys in New York City. Stick your hand down the throat of a plush Gus Gutz and remove his stuffed organs. Toy companies are supposed to be like this--creative places where adults dream up wacky stuff for kids. "I make the kinds of toys I love to play with," explains the 29-year-old founder, Laurence Schwarz, standing next to a showroom of Harry Hairballs, a cat whose stomach contains fish bones, slippers and hair balls. "We don't put this stuff through focus groups or watch kids play with it behind glass. This is from the guts, literally."

Even if Rumpus' toy line strikes adults as gross, it has struck a chord with children, driving revenues from $1 million in 1997 to an estimated $15 million this year. More important, Rumpus represents the kind of fun-first, marketing-second approach to toymaking that has become alien to America's corporate giants Mattel and Hasbro, which together control about 30% of the toy business. The corporations instead scheme to recoup their nine-figure licensing fees for movie characters by filling the pipeline with action figures.

Executives at Mattel, for example, can't remember the last hit toy the $4.8 billion company incubated without a movie licensing tie-in or an idea purchased from a smaller company. The days when the firm, based in El Segundo, Calif., was capable of organically growing a brand from the roots up, building Barbie or Hot Wheels into multibillion-dollar annual businesses, seem long gone.

For the past decade, the company, along with rival Hasbro, has been relying on acquisitions for sales growth. Last year Mattel purchased Learning Co., a maker of educational software with sales of $850 million, for $3.8 billion, and Pleasant Co., maker of American Girl, for $700 million. Not to be outdone, Hasbro picked up Galoob, maker of Star Wars figurines, and Micro Machines for $220 million, Furby founder Tiger Electronics for an additional $335 million and Pokemon licensee Wizards of the Coast for $325 million. When that becomes your business--buying ideas and then marketing the hell out of them--you had better be good at all the gritty, very adult details of analyzing a potential acquisition's balance sheet.

Lately that strategy has begun to look flawed for Mattel, which announced that its third-quarter earnings would be 55% lower than its projected $280 million, largely because of an acquisition gone wrong. Investors bolted, and the stock dropped to $11.69 a share from its November high of $40.50. Analysts rushed to downgrade the company as it became apparent that CEO Jill Barad, 48, the marketer who remade the Barbie line into one of toyland's most formidable franchises, was looking less capable when it came to operational details.

The immediate problem was $100 million in inventory, which Mattel thought had been sold, that mysteriously reappeared on the books at Learning Co. Oops. That turned an expected $50 million profit at the newly acquired division into a loss of $50 million to $100 million.

Analysts were grumbling that Mattel paid too much for Learning Co. in an effort to make up for shortfalls elsewhere in the company. The 40-year-old Barbie franchise was finally showing its age. Sales of the doll fell 14% last year. That's critical because Barbie is Mattel's principal breadwinner, accounting for 40% of the company's profits. Worse, Barad had assured investors, already wary of the CEO's famously optimistic projections, that Learning Co.'s educational software would be leverageable throughout the company, adding a much needed high-technology luster to the traditional toy brands. The educational-toy market has been hot for a couple of years, she reasoned, and Mattel would now be at the forefront. After all, she assured investors, hadn't Mattel snapped up the hit toy licenses for Disney's Bounce Around Tigger and Tyco's Tickle Me Elmo that had driven earnings in recent years?

But the Learning Co. deal has undermined Mattel's game plan. "I don't think Mattel's management really had any idea of what the problems were or how deep they were," says Sean McGowan, analyst at Gerard Klauer Mattison. "There is not a lot of confidence that this is the end of the story." Barad has frustrated analysts and fund managers by refusing to discuss what went wrong and by maintaining upbeat earnings forecasts that seem unattainable considering Mattel's flat sales in the first half of this year. (She would not talk to TIME for this story.)

Her defenders say it's been a tough few years in toyland. Hasbro and retailer Toys "R" Us have also been struggling against shifts in preferences, in the way kids play with toys and in demographics. Americans are having fewer children, leaving toy sales flat for the past two years at $21 billion annually. The only sector that has been thriving is that of Internet retailers like eToys, which has captured more than 50% of the $53 million online market.

Part of the industry's problem may be that many kids are simply too busy for toys. Take seven-year-old Arielle Beer of Atlanta. She has a tennis lesson on Monday and Thursday, Hebrew school on Tuesday and Saturday, karate on Wednesday and a flute lesson on Friday. There are 40 minutes nightly for homework and her favorite TV show, Party of Five. Does she wish she had more time to play with toys? "Yes, no...I don't know," she answers Clintonesquely. Increasingly, kids prefer computer and video games, which in the past two years have doubled in sales, to $6.2 billion. "Something's changed," says Eric Johnson, professor of management at Dartmouth's Tuck School of Business. "Kids are growing up faster. They want toys for a shorter length of time. The traditional toys are getting nibbled at from all directions by sporting goods and high tech. And nobody ever knows where the next hit toy is going to come from."

That's bad news in an industry that relies on hits to get kids and parents into the stores. This year, for example, Hasbro and retailers were betting on products licensed from Star Wars' prequel Phantom Menace to drive sales into the crucial fourth quarter, which accounts for half of all toy sales. However, the force has not been with the Star Wars line. "It was very strong in May and June, during the movie's release," says Leslie Rauch, a senior buyer for Target stores. "But since then, it's become nothing more than a boy's action figure." Schwarz of Rumpus Toys says the response from the big toy companies will be to spend millions more dollars on licensed merchandise tied to movies. "That way, if they fail, no one can blame them for making a mistake."

But look at some of the hit toys of the past few years--Super Soakers, Air Hogs, Beanie Babies, Furby, even Gus Gutz. They came from small companies with no movie licensing tie-ins. That's bad news for Mattel's Barad. She needs a hot toy this holiday season more than any six-year-old does. Otherwise, the only thing Barad may get for Christmas is fired.

--With reporting by William Dowell/New York and Greg Fulton/Atlanta

With reporting by WILLIAM DOWELL/NEW YORK AND GREG FULTON/ATLANTA