A behind-the-scenes battle to raise the price of Barbie dolls, Legos, and other play products has landed the world's largest chain of toy stores in hot water with the Federal Trade Commission.
It's not that Toys 'R' Us wanted to hike up prices in its own stores. Instead, the retail toy giant sought to boost toy prices in competing discount warehouse clubs - and it succeeded.
An administrative judge in Washington, D.C., has begun hearings to determine whether Toys 'R' Us broke antitrust laws when it obtained agreements in 1994 from major manufacturers to supply certain hot-selling toys to the discount clubs only in more expensive combination packages.
The case holds important implications for retailers nationwide. It comes in the wake of an FTC decision this week to block the merger of Staples Inc. and Office Depot, signaling a new era of tougher scrutiny of retailing practices.
It also offers an explanation to puzzled shoppers about why some great toy bargains disappeared from the warehouse clubs.
The story begins in the early 1990s when discount warehouse clubs, like Costco and Sam's Warehouse Club, were opening across the US and offering consumers bulk purchases at low prices. Because the warehouse operations charged a membership fee and had no advertising or promotional expenses, they could offer some of the nation's most popular toys - like Barbie dolls and Hot Wheels cars - at the nation's lowest prices.
Word of the great deals spread, and the warehouse clubs became the fastest-growing segment of the retail toy industry.
Although Toys 'R' Us promotes itself as a discount toy seller, it couldn't compete with the low prices offered for the same toys at Costco and Sam's.
So executives at Toys 'R' Us took action. Instead of dropping its own prices, Toys 'R' Us presented an ultimatum to major toy manufacturers: Any individual toys supplied to the discount clubs would no longer be sold in Toys 'R' Us stores.
With 680 stores in the US and another 396 overseas, Toys 'R' Us dominates toy sales around the globe. It accounts for more than 20 percent of the $19 billion industry in America alone.
That's why many of the manufacturers did what they could to keep Toys 'R' Us happy. Lawyers for the FTC charge that the company used its market clout to prevent competition and keep toy prices artificially high.
Attorneys for Toys 'R' Us say they have done nothing improper. They say the company is merely protecting its investment in the toys it stocks, advertises, and sells.
The case is being monitored closely throughout the retail sales industry. "It is not just the toy people watching this," says John Taylor, an industry analyst at Arcadia Investment Corp. in Portland, Ore. "A decision either way is going to send a ripple effect across a lot of different areas."
The case could establish new rules governing how major retailers must deal with their suppliers. If FTC prevails, it could spark further expansion by discount warehouse clubs. A victory by Toys 'R' Us could lead the way for other retailers to take a more aggressive posture in seeking exclusive arrangements with suppliers.
Such a development would be a setback for consumers. It would limit the availability of popular products to a few big stores, reducing the opportunity to comparison shop.
Toys 'R' Us executives justify their policy by saying they spend millions each year promoting and advertising certain toys. The warehouse clubs, which provide no brand advertising, were reaping the benefits of the Toys 'R' Us ads by selling the same toys that had become popular in large part because of those ads.
"We make those investments [in advertising] in order to make the sale," says Harry Davis, a company attorney, "and we ought to be able to protect our ability to make the sale instead of losing it to someone who didn't make any investment."
FTC lawyers don't see it that way.
"Toys 'R' Us orchestrated understandings with and among its most significant toy suppliers not to sell the clubs individual toys that were sold to Toys 'R' Us," says FTC attorney Barry Costilo in legal briefs filed in the case.
"Toys 'R' Us's importance as a provider of distribution to manufacturers of toys and related products has given it the ability to exercise market power over those manufacturers, and Toys 'R' Us has exercised this power," he says in the brief.
At the heart of the FTC case is the claim that Toys 'R' Us set in motion a near-industry-wide boycott of the warehouse clubs among and between the big suppliers.
Toys 'R' Us denies the charge. "None of the manufacturers ever spoke with each other or dealt with each other," Mr. Davis says. Such contact among competitors is an essential element in proving antitrust violations, he says. There is no evidence of such contact in this case, he says.
Instead, the boycott was driven by Toys 'R' Us itself. Faced with the possibility of losing access to large shares of the market, most manufacturers agreed to abide by the Toys 'R' Us ultimatum.
But not all did. The producers of the popular Nintendo video games continued to sell to the warehouses, for example, as did the makers of Power Rangers action figures and Teenage Mutant Ninja Turtle toys. All were big sellers in the early 1990s.
But the ultimatum got the attention of the largest toy makers: Mattel, Hasbro, and Tyco. Each reached understandings with Toys 'R' Us in which they pledged to continue supplying hot-selling toys to the discount warehouse clubs only if the toys were sold in more expensive combination packages. That meant that rather than supplying a single Barbie doll, Mattel could supply the Barbie only with an accompanying Ken or several different outfits.
Toys 'R' Us warned the toymakers they would enforce the ultimatum by checking the stock at the warehouse clubs and that any individual toys found there would be dropped by Toys 'R' Us.
"Toys 'R' Us unquestionably has the right to buy, or not buy, whatever it chooses based upon what it independently has decided furthers its legitimate business interests,'' Michael Feldberg, the lead Toys 'R' Us lawyer, says in legal briefs.
A ruling in the case is not expected for many months.