MGMT Question

Please read the Harvard Business Publishing case: Toys “R” Us Japan (9-796-077), and discuss the following questions:

1. – Toys R Us’ retailing format has been successful in the U.S. Is there any reason why this selling format wouldn’t work as well in Japan as it does in the U.S? Should Toys R Us enter Japan? (are the benefits of entry worth the inevitable costs/risks)?

2. – Toys R Us’ operation in Japan is somehow different from what it is doing in the U.S. How do you assess the international entry mode adopted by Toys R Us- using strategic alliance as compared with other entry modes (ex. Franchising, greenfield, acquisition, etc.)

Harvard Business School 9-796-077 Rev. February 25, 1999

Professor Debora Spar prepared this case with the assistance of Jacqueline MacKenzie, MBA ’95, and Research Associate Laura Bures as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 1995 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.


Toys “R” Us Japan

I do not believe the Japanese have chosen freely to have these limitations. All we would have to do is open a large retail store where prices were 40% less and choices were very broad. If the Japanese consumer didn’t like products offered in that fashion, then the store would not be a success. . . .

—Carla Hills, United States Trade Representative, February 1990

In early 1991, Toys “R” Us seemed poised on the brink of a high profile entry into the world’s second largest toy market. A “category killer” that enjoyed phenomenal success in the United States and Europe, Toys “R” Us had tried for several years to crack the lucrative but forbidding Japanese market. At every step, the U.S. company had faced difficulty and opposition. Japanese retailers had tried repeatedly to block the chain’s entrance, as had small shopkeepers from the area around Niigata, site of the first Toys “R” Us store. The Japanese media had loudly denounced Toys “R” Us as the “black ship of Kawasaki,” and a host of Japanese toy manufacturers, including Nintendo, had refused to deal directly with the U.S. retailer.1 The very structure of Japan’s multilayered distribution system also seemed to conspire against Toys “R” Us, thwarting the company’s attempts and perpetuating Japan’s infamously high consumer prices.

Despite this litany of problems, though, success seemed finally within reach. Toys “R” Us had found an influential local partner, Den Fujita, and won approval from Japan’s powerful Ministry of International Trade and Industry (MITI). Management also felt confident that some of the more restrictive aspects of Japanese retail regulation were about to change. But still some basic questions remained: Would Japanese customers, accustomed to small shops and personal service, ever accept a self-service discount warehouse? Would Japanese manufacturers risk damaging long-standing relationships with wholesalers and retailers by dealing directly with Toys “R” Us? And how quickly and efficiently could the chain hope to expand in the face of protracted local opposition?

1The epithet referred to Commodore Matthew C. Perry’s four black warships that sailed into the harbor at Edo (now Tokyo) in 1854, forcing the Shogun’s government to end three centuries of self-imposed Japanese isolation. “Black ships” thus became symbolic of the opening of Japanese culture to Western influence. Reuters, December 19, 1991, and The Toronto Star, December 23, 1991.

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796-077 Toys “R” Us Japan


The Toys “R” Us Company

Toys “R” Us was the brainchild of Charles Lazarus, a shop owner who founded the chain in 1957. Born in Washington, D.C., in 1923, Lazarus had learned about the retail business from his father, who rebuilt bicycles and sold them at the family store. When Lazarus asked why the store did not sell new bicycles, his father explained that the big chain stores could sell them much cheaper—a comment Lazarus would clearly recall later in his career.2

After a wartime career as a cryptographer, Lazarus inherited the family shop and turned to selling children’s furniture in a market boosted by the post-war baby boom. Over time, he began to realize that because baby furniture did not wear out, repeat purchases of items such as cribs were rare.3 Toys, by contrast, were frequently requested. Toys, he therefore decided, created a far superior business opportunity. After studying the U.S. discounter Korvettes, Lazarus decided to experiment with a self-service, supermarket-style format. In his new Children’s Supermarket, he vowed to undercut competition and have a bigger, better selection than any single toy store. Discounting had arrived in the toy business.

Children’s Supermarket quickly grew into a thriving chain of four stores, renamed Toys “R” Us after Lazarus decided he needed better signs with “shorter words, bigger letters.”4 He sold the chain to Interstate Stores in 1966 for $7.5 million, retaining a seat on the company’s Board. When Interstate folded in 1978, Lazarus rescued his company, determined to build it into a nationwide chain. Over the next decade, Toys “R” Us sales compounded by 26% per year, with sales productivity per square foot double that of the retailer’s nearest competitor.5 By 1988, Toys “R” Us had captured 20% of the U.S. toy market, with sales surpassing the $4 billion mark.6 Sourcing directly from manufacturers, the chain used its huge buying clout to offer goods at 10-20% discounts compared to smaller toy retailers. Year-round advertising campaigns encouraged consumers to buy toys at any time, instead of just at Christmas.

A typical Toys “R” Us store brought together 8-15,000 SKUs (stockkeeping units) of toys and children’s products in a warehouse-sized (54,000 sq. ft.) self-service outlet. The presentation was simple and colorful, based on a “cookie cutter conformity” where stores resembled each other down to the layout of each aisle. Central control was a key feature of the organization, and extensive computer networks ensured almost automatic replacement of every toy sold once inventories dropped below pre-determined levels. The key to the sales and inventory formula, according to Lazarus, was that “No decisions are made in the field.”7

In 1984, the company took its retailing concept global, opening its first international outlet in Canada and then moving quickly into Europe, Hong Kong, and Singapore. As it had in the United States, the discount formula quickly proved popular with customers who flocked to the new Toys “R” Us outlets. Whenever the chain expanded abroad, however, it drew the ire of local retailers, who feared (correctly in many cases) that the giant discount stores would drive them out of business. German manufacturers, for example, refused to sell to Toys “R” Us in 1987 for fear of damaging their relationships with the thousands of small retailers and wholesalers who dominated toy distribution.

2 David Owen, The Man Who Invented Saturday Morning, Villard, 1988. 3 Ibid. 4Newsmakers, October 1992. 5Business Quarterly, June 22, 1989, and Newsmakers, October 1992. 6Tokyo Business Today, February 1990. 7Newsweek, November 11, 1991.

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Toys “R” Us Japan 796-077


And in the United Kingdom, retailers also protested, noting that the number of British toy stores had declined from 3,500 to 2,000 in the five years after Toys “R” Us first arrived.8

But Toys “R” Us regularly overcame the protests and its foreign outlets flourished. By 1991, the chain operated 97 stores abroad, with international operations accounting for 14% of the chain’s total sales. Commenting on this spectacular growth, Larry Bouts, president of the chain’s international division since 1991, suggested that the expansion of Toys “R” Us actually benefited foreign retailers as well as consumers. “Initially I think there was a fair amount of consternation from competitors,” he acknowledged, “but now the industry has grown so much, there’s really a lot warmer feeling. From the consumer’s point of view, they’re very happy . . . coming to us in droves. . . . People said it wouldn’t work, but consumers want value today.”9 Confident that this formula applied broadly, Toys “R” Us management began to contemplate an entry into one of the world’s toughest retail markets: Japan.

The Japanese Market for Toys

By any measure, Japan was an extremely attractive market for toys. Throughout the 1980s, the entire retail market in Japan had expanded dramatically, propelled by the economy’s continued strength and a long-awaited increase in consumer spending. According to the Bank of Japan, annual retail sales grew 94% during the 1980s, while Japan’s GDP grew at an average annual rate of 7%.10 Japan’s children were particularly strong beneficiaries of this boom. Despite a rigorous education system that left children with little time for play, children’s products accounted for a significant proportion of consumer spending in Japan. Perhaps to compensate for the constant pressure to excel in school, parents lavished expensive toys and clothes on their offspring.11 Japan’s falling birthrate also allowed parents and grandparents to focus their spending on fewer children; and fewer mouths to feed enabled families to spend less money on food and more on toys.12

Thus Japan’s toy market had become the second largest in the world, lagging only behind the United States’. In 1991, the Japanese toy market was worth Y932 billion ($7.1 billion), up Y26 billion from the previous year. Responding to this boom, large retailers designed special formats to appeal to children. In October of 1990, Isetan opened a special section called “Dr. Kids Town” within one of its Tokyo department stores, while Seibu’s flagship store opened a “Kids Farm,” complete with a hollow miniature mountain amidst clothing racks and toy shelves.13 A Sesame Street theme park was opened outside of Tokyo in 1990.

On the surface, these developments suggested that the Japanese toy market was ripe for Toys “R” Us. But as the chain’s management quickly discovered, the structure of Japan’s retail industry made it very difficult for new retailers—particularly foreign discount retailers—to establish a market position. Despite the rapid growth it had experienced, Japan’s toy industry remained highly fragmented and locally-focused. Though some estimates claimed that the number of toy stores had fallen from 8,000 in 1980, at least 6,000 remained in 1990.14 A typical toy store was less than 3,200

8Wall Street Journal, September 10, 1990. 9Europe, September 1992. 10Business Tokyo, May 1992, and International Marketing Data and Statistics 1995, p. 183. 11The Washington Post, February 11, 1991. 12The average number of children per family had fallen from four in the early post-war years to just two by the early 1990s. Washington Post, February 11, 1991. 13Ibid. 14Nihon Keizai Shimbun, February 10, 1990.

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796-077 Toys “R” Us Japan


square feet in area and sold 1-2,000 SKUs. Display areas were customarily cramped, inventories turned slowly, and most stores stocked very similar merchandise. Nearly all retail shops were domestically owned and bought their toys from local wholesalers, usually for 75-80% of the manufacturer’s “suggested price.”15 Retailers then sold the toys for the “suggested price,” deviating from it only rarely.16 In exchange for maintaining prices, retailers were able to return their unsold goods to the wholesaler or manufacturer for full credit. In this tightly-knit system, only two national players existed: Chiyoda, which sold through the Hello Mac and Ace formats; and Marutomi, which operated a traditional toy chain, Banban, as well as a discount format, Toy Ryutsu Center. With a combined 700-800 stores, the two chains accounted for over Y100 billion in annual sales.17

At the wholesale level, the Japanese toy industry was again marked by its characteristic pattern of fragmentation and long-standing relationships. Even such giants as Nintendo, the Kyoto- based maker of Gameboy and other popular electronic games, distributed its products through a sprawling network of 70 affiliated distributors.18 These distributors served as the key link between manufacturers and retailers, cementing long-term relationships based on personal commitments rather than competitive terms. They also served as a barrier to foreign firms, making it difficult for foreigners to achieve sufficient scale in either manufacturing or retailing to cover the costs of their investment. As a result, foreign firms were almost entirely absent from the Japanese domestic toy industry, and even imports accounted for only 9.2% of sales.19

Potentially, Toys “R” Us had the ability to change the Japanese toy industry and profit handsomely in the process. Merely by undercutting the “suggested price” it could capture the entire discount market. All it needed to do was to mimic precisely what it had done elsewhere: establish large-scale stores and use the buying power created by these stores to negotiate lower prices from toy manufacturers. Since 1987, the chain’s management had been trying to implement this strategy. But in Japan, they came to realize, the very structure of the retail sector made their customary strategy almost inconceivable.

The Structure of Japanese Retail

A “Nation of Shops”

For years, Japan had been aptly described as a nation of small shopkeepers. Though the population of the four islands was approximately half that of the United States, the number of retail outlets in Japan was almost the same, resulting in twice as many outlets per capita.20 Many of these outlets were the country’s famous “mom and pop” stores. In 1988, over half of all retail outlets in Japan employed just one or two people; less than 15% of outlets employed more than five people.21

15Nikkei Weekly, February 22, 1993. 16In 1989, 70% of toy retailers priced at the manufacturer’s “suggested price,” according to figures from Japan’s Fair Trade Commission. 17Nikkei Weekly, February 22, 1993. 18Nikkei Weekly, June 29, 1991. 19Nikkei Weekly, June 20, 1992. 20Jack G. Kaikati, “Don’t crack the Japanese distribution system – just circumvent it,” Columbia Journal of Business, Summer 1993. 21 MITI survey.

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Toys “R” Us Japan 796-077


In the early 1980s, such small stores accounted for a full 75% of retail spending. Nearly half of these outlets sold food, compared with 20% in the United States.22

The fragmentation of the retailers was matched by the fragmentation of the wholesalers who served them. Of the 436,421 wholesalers operating in 1988, less than half employed more than five people, and nearly all sold their products through a complex distribution system that typically involved between three and five layers of intermediaries. The primary wholesaler was often a subsidiary, or close affiliate, of the manufacturer. The secondary wholesaler was a regional distributor, while the tertiary wholesaler operated on the local level. As in the toy industry, prices of goods were effectively controlled by the manufacturers, who sold to wholesalers at a pre-arranged discount of the “manufacturers’ suggested price.” With the added inducements of credit and generous payment terms, manufacturers throughout the Japanese system gained guaranteed distribution of their products, while wholesalers and retailers gained some measure of protection against economic swings and fluctuations in demand.

While Western observers tended to mock the Japanese retail system as cumbersome and archaic, most Japanese consumers genuinely seemed to enjoy and appreciate its benefits. As an article in The Economist explained, “The Japanese are as sentimental about their tiny shops as the French are about their peasants and the British about their old industries. Small Japanese shops are the centers of village neighborhoods in big cities. Small stores flourished before the rest of Japan modernized because merchants were restricted by law to their local patch, and retailers were encouraged to mop up labor from the land.”23

In addition to its commercial function, small store retailing thus served a valuable social purpose. Described directly by some as a “social service,” the retail sector was “filled with under- employed workers who in other societies might well be unemployed.”24 All together, the Japanese distribution system accounted for 18% of the nation’s employees and 13% of its GNP.25 In a 1980s survey, 26% of shopkeepers reported “security in old age” as a reason for opening a shop, and 10% said they opened a shop because their husbands would soon retire.26 One quarter of owner- operators of stores were over 60. In a country with few pension provisions, small scale retailing offered a safety net for retirement.

Supporters of the Japanese system further argued that small stores were a natural reflection of the Japanese way of life, that Japanese consumers preferred to shop every day for small quantities of fresh goods.27 Small homes and kitchens allowed no space for storing large amounts of goods, and use of automobiles was impractical in Japan’s congested streets.28 High quality and personalized service, many claimed, were expected by Japanese consumers, who were willing to pay for the privilege.

Detractors, though, argued that small stores continued to exist simply because they were protected from more efficient competitors by laws restricting the construction of large stores and by

22The Economist, September 19, 1981. 23Ibid. 24Ibid, and Hugh T. Patrick and Thomas P. Rohlen, “Small-Scale Family Enterprises,” The Political Economy of Japan: The Domestic Transformation, Vol. 1, Stanford University Press, 1987, p. 350. 25Business Asia, January 4, 1993. 26Patrick and Rohlen, “Small-Scale Family Enterprises,” p. 350. 27Takatoshi Ito, The Japanese Economy, MIT Press, 1992, p. 392. 28Japanese typically had 60% of the living space enjoyed by their U.S. counterparts. Business Review Weekly January 12, 1990.

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tacit non-competition arrangements. Japanese consumers would accept less service in exchange for lower prices, they asserted, but by 1991, they had rarely been offered the choice.

Keiretsu Stores

In fact, choice of retail goods in some sectors was actively restricted by the activities of diversified conglomerates such as Matsushita and Toshiba. Working through their own distribution keiretsu (related groups of companies), these giant firms supported tens of thousands of small affiliate stores that stocked only “their” manufacturer’s brand at manufacturer-specified prices. Where these stores prevailed, customers found no benefit in comparison-shopping, since price uniformity was nearly absolute. What they did get however, and what many Japanese reportedly preferred over low prices, was personal attention from the shop-owner and guaranteed repair or replacement service for the life of their purchase.

The operators of the small keiretsu stores also effectively made a trade-off between prices and personal loyalty. Simply by becoming a store owner, one gained a position of some visibility in the community, a position symbolized by the store-front pairing of the proprietor’s name with that of a well-known manufacturer. Through the manufacturers’ many affiliates, store operators also received financial and marketing advice and even information about their competitors’ activities. In exchange for this assistance, they implicitly agreed to tie themselves closely to the keiretsu’s lead manufacturer. Storekeepers who dared to meddle with the manufacturer’s “suggested price” faced expulsion from the network and blacklisting by other manufacturers. In 1979, Yoshio Terada, a National (Matsushita) retailer in Tokyo, incurred the wrath of his supplier by discounting batteries by 20%. When he refused to remove the discount, a truck arrived instead to remove the National sign from his store and with it, his entire business.29 Terada subsequently set up a no-service discount electrical appliance business called STEP and, despite Japanese consumers’ alleged preferences for full-service stores, built a $100 million business in ten years. Yet, few keiretsu retailers at the time would have dared to defy the might of Matsushita. In 1991, over 20,000 keiretsu stores still existed, and the principle of loyalty to manufacturers remained strong in both retailing and wholesaling.

The Role of Regulation

In addition to customers’ habits and personal loyalties, Japan’s retail structure was also bolstered by a series of laws restricting the spread of larger retail stores. By sheer force of numbers, the country’s 1.4 million store owners wielded considerable voting power. For decades, they had used this power to extract concessions and explicit protection from Japan’s reigning political party, the Liberal Democratic Party (LDP). In 1990, the Chairman of the National Shopkeepers Promotion Association described the political situation succinctly: “The big stores stuff the politicians with money, but we have the power of 20 million votes.”30

The small store owners won their first victory in 1956, just after the LDP came to power. The 1956 Department Store Law required that a permit be obtained for each new department store, effectively allowing department store construction to be blocked by smaller retailers. By 1990, there were still only about 1,600 department stores in Japan—one for every 75,000 people. With the growth of department stores so severely limited, most innovation in Japanese retailing came through the emerging supermarkets—large, non-specialized, low-price stores with large grocery sections. But just as the supermarkets were starting to gain ground, they, too, encountered the shopkeepers’ force.