Even a Merger of the Toy Industry's Two Biggest Companies May Not Change Much

Mattel and Hasbro have many product lines; Lego has one way to play. Why did Lego win?

For almost half a century, the ranking of the toy giants barely moved: Mattel and Hasbro held the No. 1 and No. 2 spots worldwide. But the latest figures, for the first half of 2015, show Lego is now the world's largest toymaker by both revenue and profit. Hasbro remains second, and Mattel has slipped to third.

You probably know Lego already. If Hasbro sounds unfamiliar, you surely know Transformers, Hasbro's best-known brand in China. Mattel is the company that created the Barbie doll, and Barbie is what made it No. 1 in the toy industry.

The news that broke a little over a week ago was startling but not surprising. Citing unnamed sources, Bloomberg reported that Hasbro approached Mattel at the end of 2015 to discuss a merger. The report gave no details, and no one yet knows whether a deal will be struck.

Spokespeople for both companies declined to comment on Bloomberg's report, but investors were already stirring. According to Reuters, both stocks rose: Mattel gained as much as 8.2%, its highest price in 16 months, for a market value of US$11 billion; Hasbro rose 1.3%, for a market value of US$9.5 billion.

Look at how the fortunes of today's three toy giants have diverged, Mattel's and Lego's above all, and it is easy to see why investors are so excited about a merger.

In 2012, Mattel's sales were still nearly double Lego's. Lego turned that around in less than two years. In the first half of 2014, its sales passed Mattel's for the first time, the first change at the top of the global toy industry in 59 years. For full-year 2014, Mattel still had the highest sales, at US$6.023 billion, while Lego edged past Hasbro, both at about US$4.2 billion. But Lego's profit of US$1.053 billion was more than Mattel's and Hasbro's combined.

While Mattel was busy trying to rescue its signature brand, Barbie, and a slow-footed Hasbro seemed to realize only last year that it should do more in China, a major market that almost every multinational treats as a growth engine, Lego had grown for ten years in a row, far faster than the industry average. Its sales in the first half of 2015 rose 23% year on year. If Barbie once ruled an era, Lego bricks are opening a new one.

If Mattel and Hasbro do merge, they will certainly create a new toy giant. The more important question is whether that giant can set the industry's trends again.

Why Barbie Became Shorthand for "Objectifying Women"

When Barbie, with her long legs, slim waist and full bust, made her debut in 1959, she quickly set off a craze. She overturned the childish look of earlier dolls and showed mothers that a toy could be something else. This "young woman" with a perfect figure stood for rebellion, and she also brought a touch of fashion to toys.

Barbie's arrival sharply cut the number of other dolls on the American market and spawned plenty of imitators. She also sold in huge numbers through a new medium, television advertising. In 1959, Barbie accounted for 80% of all dolls sold. At her peak in 1994, she brought Mattel US$1.1 billion in revenue, and 95% of American girls aged 3 to 11 owned at least one Barbie. She became Mattel's core brand.

But Barbie's sales have fallen every year since 2012. In the third quarter of 2015 they dropped 21%, and for the full year they came to only US$300 million, just 15% of Mattel's sales.

Yet as Mattel's signature brand, Barbie has never had the nerve to shake off her classic image. Not long ago, a "venerable" 57-year-old Barbie appeared on the cover of Time with thick little legs and a slightly rounded belly. People marveled that Barbie had never looked so much like an "ordinary girl." It seemed to be the first time anyone had noticed the changes Mattel has made over the years to "save Barbie." And at America's biggest toy fair, which opened recently, Mattel launched a Barbie line of DC Comics superheroines.

For a toymaker like Mattel, the approval of adults sometimes matters even more. In recent years Mattel has done quite a few things to satisfy "political correctness": it added 7 skin tones, 18 eye colors and 24 hairstyles to show a wider range of women, and it shrank Barbie's bust to suit new tastes.

But none of these tweaks and additions is exciting. The fantasy the original Barbie offered children has faded. Barbie has grown old.

Lego, by contrast, has found a way into girls' toys. In 2014 it launched a Female Scientists series that stressed the creativity of building with Lego. One Lego ad puts it bluntly: "I don't want you to help me, I want to do it myself. You taught me how to think and how to imagine, and I know I will do something that makes you proud."

In response, Mattel released a Barbie ad last year built around the "career woman", telling parents above all that Barbie is not a doll who only goes on dates with her boyfriend. But in the actual product line, Barbie's 150 careers amount to little more than changes of clothes and accessories. Next to Star Wars and Frozen, Barbie has no story that grips people, and that is now her fatal weakness.

Jim Silver, editor-in-chief of the toy review site TTPM.com, says Barbie's players are getting younger and the age range narrower, shrinking from 3-9 to 3-6. "Kids grow up earlier than they used to, and they tire of toys more easily," Silver says. Other fashion dolls, including Mattel's own other lines, are taking Barbie's share.

Since Barbie, Mattel has never created another toy character on the same scale, and a string of changes that never touched real product innovation could not give Barbie new life.

Fisher-Price, Mattel's best performer today, aimed at babies and toddlers, came from a 1993 acquisition, and its youngest brand, American Girl, dates to 1986. In early 2014, then-CEO Bryan Stockton admitted that Mattel's product innovation was no longer as strong as it had been.

Barbie's decline is just one symptom of Mattel's problems.

Mattel Was Also Slow to Catch On to Licensed Products

In the past few years, licensed merchandise has become the toy industry's most important business. Every major IP (intellectual property), such as Star Wars, Frozen and the Minions, clearly lifts toy sales. In the 2014 Christmas season, after Frozen hit theaters, Elsa topped the National Retail Federation (NRF) survey as the "most popular toy among girls," displacing Barbie, which had held the top spot for 11 years.

The latest example is the BB-8 robot from Star Wars: The Force Awakens. Officially priced at US$150, it was a star of last year's Black Friday, selling 22,000 units in the United States in its first 12 hours on sale. Forbes named it the best Star Wars tie-in product. It also made an overnight name for its maker, Sphero, a company less than five years old that had been obscure until then.

Mattel was far too slow on this, or did not take it seriously enough. Fifteen years ago it commissioned a script for a Barbie movie, but the script was shelved, and only last year did Mattel release three Barbie-themed films.

That gave its competitors their opening. In fact, Hasbro changed the rules of the game: instead of fighting tooth and nail over movie licenses, a toymaker could license its own toy brands to Hollywood studios to make films, making the toys the real stars.

In 2007, the Transformers movie took in US$700 million at the global box office, and Transformers toy sales jumped fivefold. In 2006, 98% of Transformers revenue came from toys; today that figure is 76%, with the other 24% coming from film licensing, video games and theme parks. In effect, one Transformer can be sold four times.

Hasbro's Star Wars lightsabers helped push its stock up 11% last year, and the company sold nearly US$500 million of Star Wars toys in 2015.

A big reason Lego's sales overtook Mattel's in the first half of 2014 was the lift from products tied to The Lego Movie. Lego said its revenue grew 11% in those six months.

Beyond movies, Lego launches a new product line every three years and then makes an animated series for it. Lego's Ninjago series currently has 408 million views on iQiyi.

The Ninjago line also sells well in Lego's Tmall flagship store. One set, "Lightning Dragon," sold 1,077 orders in a month; a well-selling Lego product typically sells 300-400 a month. The store's bestsellers are almost all toys based on movie and cartoon characters.

Lego has, in fact, flourished alongside IPs such as Star Wars and Harry Potter, and the creativity behind them.

It is almost a replay of the days when Mattel and Hasbro were at their height.

Mattel and Hasbro pioneered advertising on children's television in the 1950s. Hasbro claims to have been the first toymaker to advertise on local television, in 1951, and Mattel sped things up by breaking the tradition of advertising toys only at Christmas. The deeper consequence for the industry was that toys could become everyday purchases, not just holiday gifts.

When children asked for the Barbie they had seen in TV ads, parents often gave in. Thanks to television, Mattel's sales rose from 6 million in 1955 to 49 million in 1961. By 1971, Mattel was spending US$20 million on advertising, and Hasbro about US$6.5 million. So when toymakers pitched to retailers back then, their most persuasive argument was a promise to spend more on TV ads.

Lego, for its part, entered the American market as early as 1962. One reason it failed to catch on was that it did not take TV advertising seriously. Its educational pitch also leaned too hard on learning, at odds with Americans' appetite for leisure and entertainment at the time. Educational toys in the United States were then confined to wealthy families and never moved beyond a niche.

Today, though, Lego wins over American consumers because of its close ties to film entertainment. In 2016 it will release a Star Wars collection, with new products including the Lego-original Star Wars: The Freemaker Adventures and The Force Awakens, plus seven all-new buildings.

The great selling tool used to be the TV screen. Now that screen is the big screen, and movies, like television, build brand loyalty. A link to the world of film also makes toys more fantastical and thrilling.

Mattel is too far from that screen.

Mattel and Hasbro Share a Problem: Neglecting China

Since it made Transformers popular in China with a cartoon series in the 1980s, Hasbro seems to have done little there. James Walker, Hasbro's vice president of brand licensing and distribution for Asia Pacific and for Europe, the Middle East and Africa, told QDaily in an interview last year that the company had set up its own team in Shanghai, along with a brand licensing team, and was working closely with retailers. Still, it is barely visible in China.

According to Hasbro's third-quarter 2015 earnings report, the United States and Canada, its traditional North American market, still accounted for nearly 60% of sales. International revenue, from Europe, Latin America and Asia Pacific, fell 6%. Excluding currency effects, Europe and Latin America grew 15% and 14% year on year, while Asia Pacific grew only 9%.

Besides Transformers, Hasbro's best-known brand in Europe and America in recent years is My Little Pony, which it has tried to pit against Barbie. Its spin-off cartoon has run five seasons since 2010, yet all of this went unnoticed in China. Only last year did Hasbro bring the My Little Pony picture books to the Chinese market.

According to iQiyi data, the My Little Pony cartoon has been viewed more than 80 million times.

Apart from Barbie, Mattel's other two core brands, American Girl and Hot Wheels, have also largely stayed at home.

American Girl, for example, opened its first two stores outside the United States, in Canada, only in 2014, the brand's first move abroad. Mattel realized five years ago that it needed to expand overseas, but with little result. In 2015, the American market still accounted for 58% of its revenue.

According to the market research firm Euromonitor, retail sales in China's toy market grew from 46.3 billion yuan in 2010 to 74.4 billion yuan in 2014, an average annual growth rate of 12.6%. Other data show that Chinese children under 16 spend less than US$30 a head on toys, against more than US$200 in the United States and about US$150 in Europe.

So any company that wants a handsome growth curve has to take China seriously, and Hasbro seems to be waking up to this only now.

"We think Asia is one of the most critical focus markets for our entire product business, across all categories, and within Asia, China is the most important," James Walker said.

But changing the minds of Chinese parents is hard. Lego, too, entered China in the 1990s, but made little headway for years, until it tied itself to education.

Lego's philosophy actually suits Asian parents better, as we explained in detail in Will Lego Be Ruined by Chinese-Style Education? Mattel and Hasbro are both too American. Mattel has tried many ways to change Barbie, for instance, but always within the context of the European and American markets.

Inefficient Traditional Retail Is Another Big Problem

From the 1980s on, Toys "R" Us, Walmart, Target and others became the main places people bought toys. In 1993, Toys "R" Us alone accounted for 21.5% of American toy sales, and the big discount chains (Walmart, Kmart and Target) shared another 25.8%.

According to filings with the U.S. Securities and Exchange Commission (SEC), in 2003 Mattel and Hasbro, the two biggest toymakers, each made 16% of their net sales through Toys "R" Us: about US$800 million for Mattel and US$496 million for Hasbro.

Now the news is dispiriting: headlines like "Toys 'R' Us closes stores."

Last July, the 154-year-old toy store FAO Schwarz left Fifth Avenue. It was the last physical store the chain had kept after years of closures. FAO Schwarz belongs to Toys "R" Us, and at its peak had nearly 40 stores across the United States.

Toys "R" Us's Times Square store also closed this January, likewise because it could not keep up with rising rent. It was a sad moment, and many people went to take farewell photos. Inside this landmark store stood a life-size Barbie dream house.

In fact, since 2010, in-store sales at retailers including Toys "R" Us, Walmart, JCPenney and Target have fallen steadily. These were once Mattel's and Hasbro's main sales channels in the United States, and now they are struggling against e-commerce themselves.

Even if Toys "R" Us closed every store, other channels would absorb most of its sales, so those sales would not vanish entirely. But Sean McGowan, a toy industry analyst at Harris Nesbitt, predicts that about 25% of the lost sales could not be made up elsewhere.

There will always be children throwing tantrums at mall toy counters, but toymakers have realized that comparing prices across three online stores is now second nature to savvy parents. And fewer and fewer people make a habit of browsing big-box stores.

On the same day this January that Mattel announced its "petite, curvy and tall" Barbies, it opened pre-orders online. You could not find these "non-standard" Barbies in traditional stores such as Walmart and Toys "R" Us until March.

In 2010, Amazon became Lego's only officially authorized dedicated channel in China, and it set up direct supply with Mattel in the United States. In 2015, Amazon moved onto Tmall, opening an official Amazon flagship store that brought more than 3,000 brands, Lego among them, to the platform. Lego's official flagship store on Tmall now has 471,000 followers.

If Mattel and Hasbro Merge, Not Much May Change

"The most important structural feature of the global toy industry today is domination by large companies, a trend that goes back to the 1980s. Of the major toy companies operating in 1976, for example, 11 had gone under by 1995 and 12 had been absorbed by Mattel and Hasbro," Eric Clark writes in his book The Real Toy Story.

If the merger goes through, a new toy giant will emerge. Hasbro is strong in boys' toys and Mattel in girls', so the two complement each other well.

Hasbro's feel for movie tie-ins could also make up for Mattel's weakness, and the new company would hold all of Disney's princess licenses, which move from Mattel to Hasbro starting this year. As movies matter more and more to toys, a partnership with Disney would be a bargain.

Mattel and Hasbro also share the same core businesses, upstream suppliers, target customers and markets, so in the ideal case they could cut overlapping costs.

But the new company still could not solve its problems with product innovation or with opening new markets. In September 2015, Goldman Sachs downgraded Hasbro's stock from "buy" to "hold." Its reasoning: although the company could sell more Star Wars merchandise over the holidays, long-term developments in technology and media would eventually hit the toy business.

The biggest threat to the global toy industry is still the invasion of smart products, and traditional toys have not yet found a sensible way to become smart. Because creativity gives them a hidden educational value, Lego and other basic building toys are, if anything, better able to resist, and at least they meet the needs of emerging markets. On this point, neither Mattel nor Hasbro has a clear advantage.

Whether a toy catches on depends not only on a push from the mass media but also on whether it fits the parenting ideas and social culture of its time. A toy, after all, has never been just a trinket.

Graphics: Lin Yuyao