Mattel: Some (Re)Assembly Required

Walk around the airy orange-and-yellow-hued loft of Rumpus Toys in New York City. Stick your hand down the throat of a plush Gus Gutz and remove his stuffed organs. Toy companies are supposed to be like this--creative places where adults dream up wacky stuff for kids. "I make the kinds of toys I love to play with," explains the 29-year-old founder, Laurence Schwarz, standing next to a showroom of Harry Hairballs, a cat whose stomach contains fish bones, slippers and hair balls. "We don't put this stuff through focus groups or watch kids play with it behind glass. This is from the guts, literally."

Even if Rumpus' toy line strikes adults as gross, it has struck a chord with children, driving revenues from $1 million in 1997 to an estimated $15 million this year. More important, Rumpus represents the kind of fun-first, marketing-second approach to toymaking that has become alien to America's corporate giants Mattel and Hasbro, which together control about 30% of the toy business. The corporations instead scheme to recoup their nine-figure licensing fees for movie characters by filling the pipeline with action figures.

Executives at Mattel, for example, can't remember the last hit toy the $4.8 billion company incubated without a movie licensing tie-in or an idea purchased from a smaller company. The days when the firm, based in El Segundo, Calif., was capable of organically growing a brand from the roots up, building Barbie or Hot Wheels into multibillion-dollar annual businesses, seem long gone.

For the past decade, the company, along with rival Hasbro, has been relying on acquisitions for sales growth. Last year Mattel purchased Learning Co., a maker of educational software with sales of $850 million, for $3.8 billion, and Pleasant Co., maker of American Girl, for $700 million. Not to be outdone, Hasbro picked up Galoob, maker of Star Wars figurines, and Micro Machines for $220 million, Furby founder Tiger Electronics for an additional $335 million and Pokemon licensee Wizards of the Coast for $325 million. When that becomes your business--buying ideas and then marketing the hell out of them--you had better be good at all the gritty, very adult details of analyzing a potential acquisition's balance sheet.

Lately that strategy has begun to look flawed for Mattel, which announced that its third-quarter earnings would be 55% lower than its projected $280 million, largely because of an acquisition gone wrong. Investors bolted, and the stock dropped to $11.69 a share from its November high of $40.50. Analysts rushed to downgrade the company as it became apparent that CEO Jill Barad, 48, the marketer who remade the Barbie line into one of toyland's most formidable franchises, was looking less capable when it came to operational details.

The immediate problem was $100 million in inventory, which Mattel thought had been sold, that mysteriously reappeared on the books at Learning Co. Oops. That turned an expected $50 million profit at the newly acquired division into a loss of $50 million to $100 million.