Zipf, a Giraffe and the Demise of a Category Killer

The Oxford Dictionary of Marketing describes a Category Killer as:

“A retailer offering a huge range of products, centralised in a single outlet, which far exceeds that of smaller outlets who cannot such a range and such a depth, or with such price discounts, or with such efficiency and which has the ability to attract a large number of buyers.  Examples of category killers include large discount toy chains, sporting goods chains, home improvement stores and office supply stores”

You will note that the first example given is that of “large discount toy chains”.  Obviously, the dictionary is trying to avoid a direct reference to a particular company but when that term is used a single company comes to mind, Toys R Us.  Or at least it did, as in recent weeks, Toys R Us has been liquidated and all its stores closed.  The firm’s liquidation was closely followed by the death of the firm’s founder, George Lazarus.

Toys R Us was the perfect example of a category killer, it led the niche toy market for almost sixty years.  It had 8000 stores, predominantly in the North America, but there were also 800 stores in its international division.  The company was the market leading toy retailer identified by its cartoon mascot, Geoffrey the Giraffe.

The reasons behind the demise of Toys R Us are many.  Prominent is the retail environment in the United Stated since 2010.  This is a period industry leaders are calling ‘the retail apocalypse’, the mass closure of traditional bricks and mortar stores.

America’s middle class has suffered an income squeeze in that period, which may partly explain the election of Donald Trump as president.  They have seen big increases in the cost of healthcare, housing and education.  As a result, they have spent less on items such as clothing and furniture.  There is a big hangover from the credit crunch recession which started in 2008 and banks are less willing to offer consumers credit.

The incomes of moderately affluent consumers isn’t the only reason for the demise of America’s traditional retail model.  It is recognised that there are too many shopping malls in the USA.  There are currently around 1200 large shopping malls in the USA.  Half are expected to close by 2023.  That amounts to nearly 12,000 individual stores.

Many long existing retail chains in the US are heavily leveraged with debt.  This is the result of the bankruptcy of leveraged buyouts.  They are facing rising rents and property taxes which reduce margins and profit levels.

Traditional retailers have not dealt well with the changing shopping habits of consumers.  They have become reliant on consumers binge spending at holiday periods such as Christmas.  Sales outside these periods have collapsed.  They have also dealt badly with the changing attitude of younger consumers.  That demographic has become less interested in the purchase of physical goods.  Instead they have a desire to purchase experiences.  Then there is the rise of internet shopping.

It is these last two factors that have significantly affected Toys r Us.

Toys R Us developed a reputation for cluttered stores and poor customer service.  Rather that being a place children and their parents could enjoy the experience of buying toys, a visit to Toys R Us became a chore; a visit to a poorly laid out warehouse within which you wanted to spend as little time as possible.  It is recognised that the longer you can keep a consumer in your store, the more they will purchase.  You can up-sell and cross-sell.  If the consumer is only popping in, grabbing a pre-selected item and then leaving, the potential for those additional sales is missed.

Toys R Us also tried two brand extensions; Babies R Us, which sold push chairs, cots and other infant products; and Kids R Us, which sold children’s clothes.  Kids R Us failed relatively quickly, and as a result the parent brand took a financial hit.  Babies R Us prevailed but in most cases it was squeezed into one corner of an already cluttered store and left less room for the brand’s main focus, the sale of toys.  These expansions clearly harmed Toys R Us’ niche dominance.

The company also failed to deal adequately with the rise of electronic and computer games.  It’s focus remained with traditional physical toys.  Toys R Us also sold bicycles but this part of the business was affected by the rise of specialist cycle retailers.  As cycling as a hobby has become more popular, those wanting to buy a bicycle for their child look to buy a junior version of the bike they ride, not a specific children’s bike.

A ten-year contract between Toys R Us and Amazon was signed in 2002.  Toys R Us were to be the sole Toy supplier through the Amazon portal.  This contract followed an embarrassing and damaging Christmas for Toys R Us in 1999 when it failed to deliver thousands of toys in time for Christmas day.

Amazon reneged on their contract with Toys R us and allowed other toy retailers access to their site.  The reason given was that Toys R Us could not provide a sufficiently wide range of toys to satisfy Amazon’s customer base.  Toys R Us successfully sued and received damages of $53 million, half the sum initially asked for, but the damage was done.

In response to the collapse of the Amazon deal, Toys R Us began a strategy of buying out loss-making competitors such as FAO Swarz and two smaller internet toy retailers including e-Toy.  The purchase of these firms added to mounting debts.

Toys R Us continued to open traditional bricks and mortar stores.  In 2014 it opened 21 new large outlets.  It also started a chain of smaller outlets called Toys R Us Express.  This at a time when internet sales were rising and sales from traditional retail outlets were falling.  It can be argued that Toys R Us should have been reducing its high street presence and transferring more resources into internet sales.  It should have been consolidating, not expanding.

In 2014, it was clear that Toys R Us was in trouble and emergency remedial action was needed.  The response from consumers was that they perceived the quality of Toys R Us’s stores and service as poor.  Managers invested in measures to improve the shopping experience, to have better inventory management, to reduce clutter in stores and to develop a clearer pricing strategy with fewer complicated offers.  It was clear that this action was too little, too late.

In the early part of the twentieth century, the Harvard professor of logistics, George Kinsley Zipf, decided to examine the frequency of words in well-known English texts.  He suddenly found that there was a startling correlation between the popularity of words in a text and the frequency of their usage.  It seemed that the Kth popular word in a text was 1/K popularity of the most frequently used word.

This correlation became known as Zipf’s Law and it was soon found to apply to texts in languages other than English.

Other phenomena also appeared to comply with Zipf’s law.  For example, the population sizes of American cities.  New York has a population of roughly eight million; Los Angeles, the second largest city 4 million; Chicago the third largest, 2.7 million; and so on.

The size of objects in the solar system also correlated to Zipf’s Law.  It was clear that the long-tail concept went beyond words in books.  It was also noticed that Zipf’s law correlated to the continuous Pareto distribution.  As we know, the Pareto Principle is that 80% of the outcome of an activity comes from 20% of the effort.

Someone then had the bright idea of examining the comparative popularity of companies in a particular market segment.  It was found that the long-tail concept applied.  There was, particularly towards the centre of the distribution, a direct correlation with Zipf’s law.  There were some differences towards the extremes of the distribution which could be explained by competition and anti-monopoly laws.  In virtually every market there were one or two popular firms and lots of smaller, less popular companies.

Internet retailers, such as Amazon leverage the long-tail concept in two ways.  First they use their ability to stock a huge number of different individual items at lower overhead costs than traditional bricks and mortar retailers.  For example,  a small independent book store may stock up to 25,000 books; larger chain bookstores such as Waterstone’s or Barnes and Noble may stock up to 50,000 books in one of their outlets;  Amazon stocks 800,000 books and e-books (not including those supplied by affiliates through Amazon Marketplace).

Amazon monetize this ability to supply a wide range through micro-differentiation (personalisation of supply) and by offering varying margins.  Amazon is willing to take a lower profit element on a highly popular book and a higher level of profit on less popular items.  It is estimated that 40% of Amazon’s sales come from less popular items.  This means that items further along the long-tail distribution of Amazon’s stock provide a proportionally higher contribution to Amazon’s sales.

The second way in which Amazon benefits from the long-tail concept is its prominence on internet search engines.  It invests heavily in search engine optimisation, paid list prominence and PPC advertising.  Amazon’s size of operations means that it will nearly always have a high Page Ranking.

Zipf’s law is often used to describe the path of least resistance.  The concept that humans will always favour a route which means they need to exert a low-level of effort.  In short, if you are near the top of a list, you are more likely to be chosen than someone further down that list.  If you aren’t one of the first links on a search engine the probability that consumers will be taken to your site is minimal.

It is clear that with firms such as Amazon spending millions on SEO, smaller local firms will not have sufficient resources to achieve list prominence by digital marketing alone.  It is crucial that Search Engine Optimisation needs to be one part of a far wider multi-channel promotional strategy.  Search Engine Optimisation alone is unlikely to be a successful strategy.

Changing customer preferences and the ability of large internet retailers are having a major effect on retailing.  We may be moving to an end game where the scale and offer of large internet retailers is going to hit the activities of traditional bricks and mortar retailers.  In the UK we may be seeing the start of our own retail apocalypse.  Perhaps this can been seen in the increasing numbers of retail store closures and the financial difficulties of firms such as House of Fraser.

However, it is clear that the firms most affected by the long-tail effect are going to be medium-sized and large traditional bricks and mortar retailers.  Small retailers still have an opportunity to thrive through the targeting of specialist niche markets and by providing unique customer experiences not provided by larger retailers.