In a flat to declining U.S. toy market place, Building toys have been a very noticeable exception. Between 2003 and 2013, the total market went from $22.9 billion down to $21.7 billion, whereas the Building category more than tripled from $600 million to now $2 billion. Lego has been the main driver in this success story and an article of mine, written in August last year, explained why this was the case.
With about 70% market share, Lego pretty much owns this toy category. Mega is a very distant #2 and K'Nex and Hasbro's Kre-O (NASDAQ:HAS) an equally distant #3 and #4. Mattel (NASDAQ:MAT) had launched Trio several years ago, but it never got traction and finally went away a few weeks ago. The national buyers at the major retailers have been asking ever since when the company would finally take the plunge and make a serious claim for its share of this pie as the largest toy company overall.
This is how the market shares of the major participants looked at the end of last year:
Source: Klosters Retailer Panel
Now that Mattel has bought Mega, and hence has claimed the #2 spot in the Building category, where is it going to take the brand?
It is Mattel's strategy to do whatever it takes to dominate the toy categories it considers strategically essential, and the Building category is not likely to be an exception from this core philosophy.
This is how the company stacks up in the market share stakes in the U.S.:
Source: Klosters Retailer Panel (Note: U.S. Building is Mega)
It is clearly Numero Uno in its current core competency areas. To achieve the same dominance in the Building category, it would have to halve Lego's market share, which is very unlikely to happen, at least in the short-to-medium term. Mattel is hence much more probable to focus on incremental steps, targeting untapped growth opportunities or gobbling up market shares from smaller competitors, or confronting Lego only in those demographic segments where Mattel is particularly strong and Lego is potentially at a disadvantage.
I talked to the national buyers both here in the U.S. as well as in Europe to get their take on what they think Mattel's likely strategy is going to be.
They believe that a major opportunity for Mattel is in the Girls segment of the Building Category. This segment was initially brought to life by Lego after it realized that it depended on boys for 80% of its sales. It created a girls line, Lego Friends, which it introduced in the fourth quarter 2011 and which turned into a run-away success. By the end of 2013, the percentage of Lego sales made to girls had increased to 35%, up from the 20% it had before. Mega also recognized this as an opportunity and launched a competitive line, based on the Barbie and Hello Kitty licenses, early last year. This again was successful, and in fact, nearly made up for all the sales losses the company incurred in the boys segment in 2013. The Barbie part of Mega's offering now represents about a quarter of its total Building toy sales in the U.S. There is also of late one other entrant into the Girl segment, GoldieBlox, which is not yet a factor in market share terms.
In other words, sales of Building toys for girls now account for about 28% of the total sales of the Building category. Since girls represent about half of the total consumer group, there would appear to be considerable upside for future growth.
Given Mattel's strength in the girls sector overall, and its ability to tap two so far unused licenses - Monsters and Disney Princess - the buyers believe that the first thrust will be in the girls aisle by upgrading the current Barbie offering, and later this year, introducing additional licenses into the lineup. There is no reason why this should not allow Mattel to double its market share in the girls segment from the approximately 10% today to 20% by end of this year, which would increase Mega's market share of the total Building Toy category from the 12% today to about 15%.
There is little doubt that this would not only put Lego under pressure, but would also severely affect current or future entrants into this part of the Building toy category. Currently, there is only one - GoldieBlox. The company's is an interesting story.
GoldieBlox, founded in 2012 and a maker of Building toy kits for girls, was the first small business to air an ad during the Super Bowl [February 2,2014]. Intuit footed the estimated $4 million bill for the ad, which was seen by a record 111.5 million viewers [Nielsen]. The company has wide distribution in Specialty, three SKUs at Amazon, and now has also broken into Mass [two SKUs online at TRU, and three SKUs on the shelf at Target (NYSE:TGT)]. The buyers tell me that the products started out of the gate with a bang but have since slowed down to a much more sedate pace. The problem appears to be consumer dissatisfaction, particularly as far as extended playability is concerned. In other words, the buyers think that GoldieBlox could be a one-trick pony and that consumers are beginning to react to this. In a dragout battle for shelf space and market share between Lego and Mega, GoldieBlox is likely to lose out unless it changes its product model to something that clearly trumps Lego or Mega in terms of intellectual challenge and long-term playability.
In the opinion of the buyers, there is another significant opportunity for Mattel - the 2-4 year old boy segment, which currently is dominated by Lego Duplo. Fisher-Price would be an ideal vehicle for a Mattel entry into this segment, particularly if this entry is under the Thomas label or of other HIT properties such as Mike the Knight, Bob the Builder or Fireman Sam.
This is how the sales in unit terms stacked up between Lego, Mattel, and Mega in this age group during the 4th quarter 2013:
Source: Klosters Retailer Panel
In other words, Mattel [including Fisher Price and other brands but excluding Mega] is totally dominant in this age group, at least at the mass retailers. Lego has less than half Mattel's sales and Mega, in turn, has about 30% of Lego's business. There should hence be considerable growth potential for a Mega entry buttressed by Mattel's clout and licenses.
However, at time when the major retailers are considering reducing toy space overall, these initiatives will but exacerbate the already fierce struggle for shelf space. Today, the Building space is occupied as follows:
Source: Klosters Retailer Panel
The picture for the "Others" looked as follows on March 22:
Source: Klosters Retailer Panel
There seems little question that both Lego as well as all "Other" brands will experience extensive haircuts in shelf space availability as a consequence of a Mattel-muscled Mega campaign. K'Nex and Hasbro's Kre-O will likely be able to defend their turf, and SpinMaster, particularly with its Erector entry, will try its best to expand. However, one buyer told me that the retailers could well consider enlarging the Category shelf space both in the Building and the girls aisles if this increased competitive activity results in accelerated overall growth for the Category.
While this assessment has been totally focused on mass retailers, there is also the question of what is going to happen in the Specialty toy channel. It consists typically of thousands of single-door toy stores, but also includes Learning Express, whose individually-owned stores number about 130. In addition, there are also literally tens of thousands of dollar stores, craft retailers, smaller mass merchants, and pharmacy chains, all of whom carry toys of some sort. Between them, they account for about a quarter of the toy market in dollar sales terms and their market share has been steadily declining. While this channel could be of importance for the Mega Stationery and Activity business, which Mattel also purchased, it is somewhat improbable that this will change the company's well-established policy of benign neglect towards the segment. Hence, the smaller manufacturers in the Building Toy sphere, who are traditionally very strong in Specialty, are unlikely, in this instance, to be too much affected by the change in Mega ownership.
Another natural area for sales growth is international. Mattel has nearly half of its business outside North America and a very effective infrastructure in all major toy markets, including Latin America and Asia. In contrast, Mega's international business is pretty much restricted to Europe, which accounts for about 30% of its total sales.
On balance, is the Mega acquisition a good move for Mattel? Yes, unquestionably so, provided that full-fledged due diligence is done and does not turn up problems. It gets the company into a large and growing segment of the toy market, and one that is not affected by the current trend towards electronics; it allows Mattel to fully leverage their strength in the girls and preschool market places; and it fits seamlessly into its strong international operations.
(This article was first published in the ToyDirectory on March 31, 2014)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.