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Toys May Not Be All Fun and Games for J.C. Penney

J.C. Penney (NYSE: JCP) deserves credit for aggressively moving into open niches. The company scored when it decided to re-enter the appliance market and it has made inroads in home services, which it has been testing in select stores. Those are both markets with established customer demand that have been abandoned as Sears Holdings (NASDAQ: SHLD) has closed stores.

J.C. Penney's latest effort to expand its merchandise, adding toy shops to all its locations, is different. Customers probably don't feel abandoned as mass-market toys is a market well-served by Wal-Mart (NYSE: WMT), Target (NYSE: TGT), Amazon (NASDAQ: AMZN), and Toys "R" Us.

J.C. Penney sold toys during the 2016 holiday season and J.C. Penney Chief Merchant John Tighe explained the decision to bring the category back year-round in a press release:

We know that shoppers buy toys year-round and by creating a fun, inviting toy shop, with some of the biggest brands and hottest products, we will entice families to shop and spend more at JCPenney. ... Toys are an exciting product category for JCPenney and an in-store attraction that will drive traffic and sales as we continue to focus on increasing revenue per customer.

J.C. Penney is largely selling toy lines stocked by Wal-Mart, Target, and Toys "R" Us. Image source: J.C. Penney.

Toys are seasonal

The toy business, despite what Tighe said, is very seasonal. Yes, people buy toys year round, but the vast majority of toys are sold during the period between Black Friday and the end of the Christmas school vacation. In the two years I spent running the largest independent toy, gaming, and hobby store in New England (roughly 2008 and 2009) a pattern was clearly evident.

Toys sold in staggering amounts during the holiday period. They also moved at a healthy clip during the Easter season (which coincided with April school vacation) and at better-than-usual, but nothing-special volumes during the summer months with kids out of school.

During the rest of the year, toys moved in dribs and drabs. People bought birthday presents and kids came in on weekends to shop, but the volume of sales was a tiny fraction of the busy periods.

Toys are competitive

It's also worth noting that the toys J.C. Penney intends to sell are mostly the general toy lines carried by Wal-Mart, Target, Toys "R" Us, and Amazon. The company cited Barbie, Shopkins, Hatchimals, NERF, Hot Wheels, and Star Wars in its press release. That's an even more seasonal market than the specialty toy lines Barnes & Noble (NYSE: BKS) has had some success with.

Basically, the mass-market retailers carry the major toy lines everyone knows, They have action figures, dolls, and classic games like Monopoly. These are toys that require very little expertise to sell and aside from the occasional purchase made out of convenience (or to soothe a crying child) they are largely price-driven sales that return low margins for the retailer.

At the toy store I used to run, we avoided toys and games like this because it was impossible to make money selling them. We could (and sometimes did) buy classic games like Candyland or Chutes & Ladders for a lower price at Target or Wal-Mart than we could at wholesale from the manufacturer.

J.C. Penney certainly has more purchasing power than a single local toy store, but it will likely pay more for some merchandise than its bigger rivals. That puts it in a tough position because Wal-Mart and Target sell toys at very small markups while Amazon often has toys even cheaper than those two retail giants.

Toys are often a loss leader designed to bring customers into a department store. That's why Barnes & Noble, aside from selling LEGO and some younger kids toys, generally avoids the mainstream toy lines carried by the big boys. The book chain, for example, stocks more complicated games like Ticket to Ride or Settlers of Catan. These games can cost $50-$100 and require a trained staff to sell them, and explain how their various expansions work.

In general, specialty toy has been a niche served by local toy stores. Barnes & Noble fits that market because people who read for pleasure tend to have a large overlap with those who play high-end board games, collectible card games (like Magic: The Gathering), and the various collectible miniature games.

That's a harder audience to serve than the one that buys more mainstream toys, which has helped the book chain carve out a piece of the market. That's not the audience J.C. Penney's offerings last holiday season or on its website are going after.

It depends upon goals

If J.C. Penney wants to make money selling toys, then it's probably going to be disappointed 11 months or so out of the year. If the goal is to drive incremental traffic during the year while boosting Q4 sales, then the company may have a chance at success.

Kids like to look at toys and in theory having them may make it easier for mom or dad to drag them along for a trip to J.C. Penney. That's a two-edged sword because some parents will specifically avoid taking a child to a place where the presence of toys will lead to the inevitable battle over purchasing something.

Selling Barbie, Hot Wheels, and other mass-market toys won't be a direct revenue driver for the department store, aside from during the holidays (and even then, competition keeps margins down). What they could be is another reason for consumers to shop at the chain's physical stores and the company needs every one of those it can get.

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Daniel Kline has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.