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'Smurfs' vs. 'Cars 2': Who's Winning the Toy Wars?

Stuart Minskoff/Jakks Pacific Inc.

Licensed merchandise becomes more critical and studios search for the secret to extending a franchise's shelf life.

Look for a crush of little blue characters -- say, a plush 14-inch talking Clumsy Smurf wearing a designer T-shirt -- to invade the holidays this year. As The Smurfs did better at the box office than anticipated, Smurf toys have been dancing into consumers' carts.

"Smurfs is selling through very well," says Jeremy Padawer, executive vp marketing and business development at Jakks Pacific, the Malibu-based toy manufacturer with the master license for The Smurfs.

PHOTOS: Toy Wars -- Merchandise from a Blockbuster Summer

Competing against two of the biggest toy-related franchises ever -- Cars and Transformers -- Smurfs has broken out in what is arguably the most competitive summer in movie history for blockbuster family movies that generate domestic and international licensing and retail merchandising revenue. This summer served up 17 films that amount to toy business bait, including Thor, Captain America: The First Avenger, X-Men: First Class, Pirates of the Caribbean: On Stranger Tides, Green Lantern and Winnie the Pooh -- up from the 10 or so in previous summers.

Jakks Pacific, with revenue last year of $747 million, competes against industry giants Mattel and Hasbro (with $5.9 billion and $4 billion in 2010 sales, respectively). The largest merchandising program in history is being staged for Cars 2 by Disney, which expects the Pixar movie to surpass the Toy Story 3 licensing bonanza last year of $2.8 billion sales and to eclipse Star Wars: Episode III -- Revenge of the Sith record in 2005 of $3.5 billion in retail. Meanwhile, Hasbro is making a competitive marketing blitz for Transformers: Dark of the Moon with 350 licensees, well above the 250 for Transformers: Revenge of the Fallen in 2009.

The nostalgia-driven success of Smurfs could be the kind of holy grail for the licensing world that all these franchises are seeking. It's the moment when the franchise becomes timeless and the toys continue to move independent of box office.

Those few franchises are the only ones that Lego looks to license for the "construction category." Their current lineup includes Harry Potter, Pirates of the Caribbean, Cars, Toy Story, Winnie the Pooh and Star Wars, the reigning king of toy licenses.

"We're taking properties that don't rely on the box office because the peaks and valleys that come with that kind of business model are pretty tough to manage in the marketplace," says Michael McNally, Lego's U.S. brand relations director. "If something only sells for three weeks out of the year, when it has big box office, then drops off completely as some properties do, that's not sustainable. So we look for properties that have a timeless quality attached to the characters."

No property in the modern era better exemplifies sustainability than Star Wars, which remains a top seller even though there hasn't been a new movie since 2008 (although there have been new TV shows). NPD ranks Star Wars as the fourth biggest seller this year and the top movie license entering summer. "Year in and year out Star Wars is popular," says Toys R Us's senior PR manager Bob Friedland.

Summer is only the opening salvo in the toy wars. About a third of the year's business will be done before Labor Day. The other two thirds of movie merchandise sales will be in the rest of the year, mostly in December. This summer the biggest displays in Kmart, Target, Wal-Mart and Toys R Us have been for Cars 2 and Transformers.

The success of the Smurfs, however, is a signal for retailers as to how to prepare for the holidays. That is why by this Christmas Papa Smurf and Smurfette expect to be sharing more shelf space and front of store visibility with Lightning McQueen and Bummblebee the Autobot.

"It's really about having the toys the kids want when they want them," says Friedland. "They know the personalities they've seen in movies and on TV."

The stakes are huge. The research firm NPD says licensed toys and games generated $6.3 billion in retail sales through the beginning of July, a one% increase over the same period a year ago.

The results this summer have already boosted Hasbro and Mattel, who both credit movie related sales for higher second quarter 2011 financial results. For the full year analyst Edward Woo of Wedbush Securities estimates Transformers will add $700 million in sales to Hasbro and Cars 2 will pad Mattel revenues by $500 million.

Although Cars 2 has more display space in stores and more products, Hasbro benefits because it doesn't just license Transformers, it owns the rights to the property first invented in Japan. That means they control the TV version, video releases and don't share product licenses and merchandising revenues with anyone else.

Drew Crumb and David Pang in a June research report for Stifel Nicolaus explained the difference: "Hasbro does NOT share the Transformers toy IP (intellectual property) with other toy manufacturers so we still think the Transformers line should post one of the biggest sales figures for an individual toy manufacturer in '11."

It used to be that toy sales were gravy for studios like Paramount, Sony and Disney. But these days licensing can be as lucrative as the movie box office and producers count on that to cover costs which often exceed $150 million.

"Licensed merchandising is no longer a side show," says Kerry Phellan, head of consumer products for DreamWorks Animation and formerly of Pixar. "It is now part of a business problem and whatever they count on has to be there in order to get the revenue needed to cover the issue, expense and all this marketing."

The shift in the role of licensing can be traced to 2000 when Disney first established a franchise management team, a move Andy Mooney, Chairman, Disney Consumer Products Worldwide, said at an investors conference in February was "truly a game-changer."

Mooney said that was when Disney began a "uniquely active approach to licensing."
What he means is that until 2000, they had just focused on deal making while providing minimal input. "Passive licensing is a highly efficient business model in terms of (profit) margin," Mooney told investors, "but it's also highly ineffective at creating sustained growth."

So Disney with Cars 2 was actively managing not just the licensing, but also creation of more than 300 toys, down to the product mix at key retail outlets. For Toys R Us, for example, they coordinated 20 different licensees to provide 70 exclusive items.
For the wooden toy category Disney couldn't find a licensee they liked so they designed their own line using a private label supplier to execute and deliver the products.

This aggressive form of product line management, Mooney said, is "unique to entertainment industry licensing and it has really been a key contributor to growth at (Disney) over the last decade."

So for Cars 2 that meant making an extra special effort to create characters that serve the movie but also work for retail. "They did an amazing job inventing that world for us," says Doug Wadleigh, Mattel's senior vp, global entertainment. "Within the film there are over 600 new characters, many in the background, but they provide a wealth of opportunities to create toys from."

Movie toy and game royalties averaged 9.4% last year, according to Licensing Letter publisher Ira Mayer, adding: "Cars 2 is going to get several points beyond that because they can command a premium."

Stifel Nicolaus estimates Cars 2 commanded a lofty 15% royalty.

That premium is largely because the brand will continue even after the movie is released in theaters and home video. By Disney's estimate since the original Cars in 2005, consumer product sales have exceeded $10 billion - before Cars 2.

Sales have been strong even though the movie hasn't performed as well as many of the other Pixar hits in theaters or with critics. Global ticket sales are just over $400 million worldwide, compared to over $1 billion for Toy Story 3 last year. And Cars 2 has only a 38% approval from critics on Rotten Tomatoes, the lowest for any Pixar movie. Toy Story 3 had 99% approval.

However, Cars has something else going for it in terms of toys. Its appeal is that it turned something kids did anyway into a licensable franchise. "Kids were already collecting die cast cars, and playing with them," says Friedland, "but it gave a very friendly personality to these vehicles."

That is also an attribute that has helped Hasbro. "Transformers is a classic play pattern for boys," says Mayer. "It tests well outside the movie. In fact, Hasbro says the toys are really about a franchise and not connected to the movie, although particular toys are. It's about the whole idea of Transformers."

Not every movie becomes a franchise, as Smurfs aspires to be, and some even fail to generate toy sales. The Universal release Hop sold movie tickets at Easter but not many licensed toys. Weinstein Company's Hoodwinked Too! Hood vs. Evil didn't sell tickets or toys.

Universal's 1990 Jetson's feature famously grossed only $20 million domestically despite name recognition, huge marketing, fast food tie ins and extensive licensing. It was the retailers who made a huge bet on the associated toy line upfront that had to bear the brunt of the losses.

Another disappointment was the early sales of Harry Potter toys when the franchise first launched 11 years ago. The movies have continued to be big hits but Warner Bros. stopped licensing kids' toys after the third movie, Prisoner of Azkaban in 2004. They dropped licenses with Mattel and trading cards from Hasbro and now say that the content of the movies "aged up" and were no longer for little kids.

So now Potter-mania is aimed at those seeking high end collectables (including art, figurines, and prop replicas) to adult collectors, So you can find Potter collectables at FAO Schwartz from scarf's, lunch boxes and hats to Hogwarts Castle for $149.99 but not nearly as much at Toys R Us (which owns FAO Schwartz).

Mayer said there was another problem: "J.K. Rowling was very specific in limiting how much merchandise there could be, so there was never an array of merchandise you would expect from that kind of movie."

Warner's did recently license Harry Potter Jelly Belly candy; and Lego has had a Potter license since 2001 and has found success with it. "I think being able to build the scenes from the movie which are so fantasy based is awesome for anybody who has watched the movies," says McNally. "It's a story that appeals to both boys and girls, and mini figure versions of the characters are always collectable so we have had an adult audience as well."

Some movies succeed by limiting what they license on purpose. DreamWorks Animation had success earlier this year with Kung Fu Panda 2, without licensing construction toys, for instance.

DreamWorks saw stuffed animals from Mattel's Fisher Price division as "a natural extension of what we know fans love," says Phelan. "We know they are going to want to take home a piece of the movie and our films have the benefit of being largely unisexual and equally exploit in gender appeal so we obviously do figural play so boys can live out the action and girls may want a more cute cuddly plush toy."

One trend in toys is toward high tech and Phelan said they sought digital connections. "We had great success with our mobile game ap," said Phelan. "During the movie (release) window it was the number one mobile game ap for kids and number one on the Ipad for kids."

Green Lantern fell below expectations in theaters but toy sales were robust. "Kids don't worry about what's doing well at the box office," said Friedland, who says it benefited from years as a comic book. "They just want to play with toys made for characters they like. You also have collectors interested in these toys."

Now that The Smurfs has exceeded expectations, Jakks is trying to meet the demand from retailers and strategize how to make it into a franchise with legs. However, the surprise success presents a logistical challenge. "When you're dealing with an event based property, where you don't necessarily have retail's immediate understanding of the potential impact," says Padawer, "chasing it right away is really difficult for a manufacturer because it takes 100 days to order materials and another 20 days to ship it from Hong Kong."

The goal of creating a lasting franchise is what drives Hollywood and retailers. "Clearly we want to maximize the property when it's on the big screen," says Mattel's Wadleigh, "but it's more important for us to bring our brand management skills to it to make sure that brand, that property, stays on the shelf long after its life on the big screen."

Georg Szalai contributed to this report.