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Mattel: Sold in China

Mattel can boost global toy sales by acquiring media content from the emerging markets.

For over 70 years, Mattel Inc. has been a global powerhouse in the toy industry. With a portfolio that includes several of America’s most iconic brands and spans 150 countries, Mattel has captured 57% and 28% of the North American and international toy markets respectively. However, as the first quarter of 2016 draws to a close, Mattel faces financial and competitive challenges that threaten to destabilize its historically stable leadership position.

Mattel’s profitability has been declining at an alarming rate over the past several years. Most recently, profits nosedived from $498.9M in 2014 to $369.4M in 2015. The company has also posted three consecutive years of declining sales. These poor financial results have decreased the company’s share price from a peak of $46.99 in December 2013 to $24.98 in January 2016 and caused the resignation of CEO Bryan Stockton in January 2015. Conversely, Hasbro, Mattel’s primary competitor, has seen an 8% increase in net earnings in 2015 alone. This has converted into an increase in the company’s share price from $55.01 to $74.28 within the same span.

Trouble in the Playground

Given the high level of fixed selling costs, Mattel’s profitability issues stem from the revenue decline of its core product offerings. Barbie has experienced double-digit revenue decreases over the past five years, with a 15% decline in 2015. The company lost the manufacturing rights to its Disney Princesses license, worth $500M in revenue, to Hasbro effective as of 2016. Fisher-Price has also been underperforming, posting a 12% revenue decline in 2014, amongst steady decreases over the past five years. Furthermore, other major Mattel business segments such as the corporation’s “Entertainment” division, which consists of the Superman Man of Steel and CARS brands, has experienced double-digit declines over the past four quarters.

Changing Social Contextmattel1a

A distinct social shift towards a more progressive view of toys is one of the driving forces behind a disappointing performance from Mattel’s girls segment. Parents have strongly advocated for more diversified Barbie images to match the qualities of the broader population. This has translated into a stagnation of the traditional Barbie product line and contributed to the stronger sales performance of newer female characters that emphasize female empowerment, including Disney Princesses such as Elsa and Anna from the new Frozen franchise.

Rise of Technologymattel1b

The rise of technology-based entertainment has shifted the overall direction of the toy industry, as consumers become exposed to new technologically advanced ways of interacting with entertainment. This new trend is encapsulated by a 13% growth in the Youth Electronics category of the US toy market during the first half of 2015, a rate that far outpaces any of the traditional toy categories.

Role of Media Content Partnerships

Examining the correlation between the release of media content and associated merchandise sales illustrates the huge impact media content has on the toy industry. In the US, 22-29% of all toy sales are derived from licensed media content products. In 2014, Hasbro experienced a 20% increase in revenues for boys’ toys, which includes licensed products from Marvel, Transformers, and Nerf, through the release of recent Marvel and Transformers films. Comparatively, Hasbro experienced a 22% decline in revenues in 2013 in the same category when no film or significant media content was released.

Rebuilding the Dollhouse

Mattel faces a crossroads with its strategic decisions moving forward. While Mattel’s girls toys segment has been struggling due to Barbie’s decline and the loss of the Disney Princess license, the company has made efforts to address changing social attitudes towards female body image in order to improve performance. In January 2016, Mattel released a new line of Barbie dolls with different body types, straying away from the doll’s homogenous design. Mattel has also responded to the emergence of technological toys. In February 2015, Mattel partnered with Google to develop the View-Master Viewer DLX and in 2016 Q3, Mattel will release the Thingmaker, a 3D toy printer. While the success of Mattel’s new girls toys and technology products remains to be seen, Mattel is addressing these two root causes. However, with media content being a major revenue driver for the industry, Mattel’s underdeveloped media content capabilities will continue to contribute to its underperformance.

Bringing Toys to Life

The high rate of media content output from Hasbro’s licensed franchises has driven growth in most of its product lines. The consistent release of films from licensed franchises such as Star Wars and Marvel generates steady demand for Hasbro toys. Comparatively, Mattel’s media content partnerships have been less lucrative, with a decline in nearly all product lines due to less media content output from its partner franchises. This can be attributed to poor strategic decision-making, as Mattel’s management has not prioritized acquiring and maintaining valuable franchise licenses.

In the North American market, Mattel has made recent efforts to improve its media content portfolio. Mattel is pursuing contracts with smaller media content players to cater to the long tail of the media-related toy segment. Its recent deal with the Halo video game franchise is an example of this. In addition, Mattel is creating content for its current product lines through its in-house film studio and media partnerships. This February, Mattel announced an agreement with Amazon Prime Video to produce media content for its American Girl brand, further reflecting the company’s long tail media strategy.

Mattel2A New Hope

To take full advantage of media content’s influence on demand, Mattel should pursue media content partnerships that strengthen its international presence. In the past year, the emerging market toy industries grew over 20% while the domestic US toy industry grew by 7%. However, Mattel is under-indexed in international markets with no individual country outside the US comprising of more than 6% of revenues in 2014. Given their rapid growth, there is considerable upside to be captured in emerging markets. Mattel should seek foreign licenses for popular media content within regional markets to complement its domestic portfolio.

While Mattel has an existing presence in emerging markets, it currently sells mostly American toys in these markets. Mattel should instead begin producing toys related to locally-produced media content. The largest toy industries in the emerging markets are China ($12B), India ($1.4B), and the Persian Gulf countries ($1.3B). While China’s expected annual growth rate of 8.9% is lower than other emerging markets, the sheer size of the Chinese market compensates for this. Additionally, the average annual wage in China is also increasing 15% annually while total toy spending increased by 34% from 2010 to 2014.

In emerging markets, large portions of sales are generated through unofficial channels such as street markets. These unofficial sales channels generate difficulties in establishing relationships with retailers, leading to significant expansion barriers. Therefore, Mattel must also choose a market where entry and retailer management is feasible. An indicator of street vendor prevalence is the “Street Market Index” (SMI), which is measured by the market share of established “modern grocery retailers”, over the total grocery market. China’s low prevalence of street vendors is indicated by its SMI of 65%. Therefore, the Chinese toy industry has the optimal balance of emerging market growth potential, with comparatively fewer obstacles in retail management. This is important because Mattel relies heavily on traditional retailers for distribution as they make up 35% of global revenues.

Children’s media in emerging markets is generally dominated by international content produced in US, Europe, and Japan. However, amongst emerging markets, China produces the largest amount of domestic content, with its $15.7B animation industry growing annually at 18.6%. China’s film market is currently the second largest in the world and China’s domestic films are starting to compete with popular foreign titles. The derivative market for these productions, of which over half are toys, grew by nearly 20% in 2014. With homegrown productions gaining popularity, the demand for toys associated with domestic media content is increasing. Mattel should ramp up investment in this market before competitors do, as Hasbro has also expressed interest in the Chinese market.

The entire Asia-Pacific market comprised 6.9% of Mattel’s revenues in 2014. To take advantage of the Chinese market opportunity, Mattel will need to look for a film production company native to the country to develop a media-content partnership with. The target company must have a strong domestic brand presence and a proven track record of successful titles within the Chinese marketplace. The partner must also possess the necessary financial flexibility and capacity to execute films suitable for a toy manufacturing contract with Mattel. It is imperative that the partner company also have rights to popular domestic media characters.

To China and Beyond

Alibaba Pictures (Alibaba), a subsidiary film company of Alibaba Group Holding Limited, satisfies the criteria of a successful media content partner. As the largest film company in China valued at $9.6B, and with involvement in the production of blockbusters such as Mission Impossible: Rogue Nation, Alibaba has a demonstrated the capacity to execute high-grossing films. Additionally, while not the producer, Alibaba distributed the Chinese animated film Little Door Gods, highlighting its experience with children-focused content.

While the collaboration with Alibaba could greatly benefit Mattel, there must be incentive for Alibaba to enter the partnership. Mattel provides industry-leading expertise in manufacturing and brand-building, neither of which are Alibaba’s core competencies. Most importantly, Mattel’s brand name provides added legitimacy to Alibaba’s products. Alibaba has faced numerous lawsuits in regards to the distribution of counterfeit products, and has already spent $161M to combat this issue since 2013. With toys manufactured by Mattel, Alibaba can boost consumer confidence in its products.

The Chinese retail market is mattel3composed of numerous regional players as opposed to national big box stores, making it a highly fragmented market. In 2012, 33% of all US retail sales were conducted through the top 100 retailers by revenue. In China, the top 100 retailers by revenue accounted for only 9% of all retail sales. Consequently, it is difficult for toy companies to secure all the distribution contracts required to comprehensively access the market. Therefore, in addition to its current presence in international big-box retailers in China, Mattel can increase market share by leveraging Alibaba’s retail distribution network to enter smaller regional retailers and better service this highly fragmented market. Moreover, as the share of retail goods sold through e-commerce platforms continues to increase, a partnership with Alibaba will strategically position Mattel to address this trend.

To quantitatively estimate the benefit of this partnership to Mattel, net retail sales of media content associated toys were calculated. Based on prior Chinese movie-based merchandise sales data, the average toy sale to box office dollar ratio of $1.80 can be used to measure the merchandising potential of past major Chinese domestic films. Alibaba Pictures’ “Journey to the West: Conquering The Demons” was the highest grossing film of 2013 in China, generating a total of $160.3M. This success suggests a potential $234.2M in toy merchandise revenue attributable to this movie for Mattel net of royalties and retailer margin. Given that this represents about 50% of the value of the recently lost Disney Princess license as well as Mattel’s 2014 revenues in the entire Asia-Pacific region, a partnership with Alibaba Pictures presents a lucrative growth opportunity if expanded to Alibaba’s line of successful films.

Continuing the Toy Story

The Chinese film industry is growing at a rapid pace, with total box office revenues expected to surpass those of the US within the decade. In addition to domestic success, Chinese productions are beginning to be exported overseas. Though Mattel has had success with household names like Batman and Toy Story, licensing opportunities for these brands are becoming increasingly scarce. With the importance of media content on toy sales, characters from China will be an excellent opportunity for Mattel to regain momentum in the global toy industry.