Key Mattel brands under siege from retailer knockoffs. (Up Front).

Mattel Inc., faced with declining market share and flat sales of its core toys, is also dealing with increased competition from some of its largest vendors.

Mega retailers like Wal-Mart Stores Inc., Target Corp. and Toys "R" Us Inc., which account for more than 50 percent of Mattel's sales, are increasingly offering their own low-cost versions of some of its most popular toys.

For Mattel, the increased competition comes at a difficult time. As part of its second-quarter earnings report, the El Segundo-based toy manufacturer disclosed across-board declines in its core brands.

Worldwide gross sales for Hot Wheels in the second quarter June 30 fell 16 percent from the like-year earlier quarter. Barbie sales were down 8 percent and both Fisher Price and American Girls sales were off by 3 percent for the like period. The company did not release the dollar value of the sales.

The drop-off in sales is attributed to "strong competitive incursions in key markets," Robert A. Eckert, Mattel's chairman and chief executive, said in a conference call with analysts earlier this month. Eckert said the company's key brands are "under competitive attack."

About 10 percent of Wal-Mart and Toys "R" Us toy sales are generated from their own private brands, while at Target it's closer to 20 percent, according to Jim Silver, publisher of Toy Book, an industry trade publication.

Mattel claimed an 18.8 percent share of U.S. toy sales through May of this year, down, 1.4 percent than during the same period last year.

While Mattel declined to comment on its competition, Lisa Marie Bongiovanni, a company spokeswoman, said "any new toy in any new category is part of the overall picture of competition out there. When you walk down the aisle every brand is competing for business."

Partially in response to the lost market share, Mattel plans a fall campaign that will coincide with the release of 250 new toys.

More than 80 percent of Mattel's revenues come from new products in its core brands, such as Barbie, Hot Wheels and Fischer Price, according to Eckert. At a June 17 meeting with analysts, he said shoring up those core brands is key to the company's success.

"In this business, hot toys come and go," he said. "It's premium power brands ... that make the foundation for future innovation and re-inventions."

Still, without key brands driving demand, analysts said private labels offer a low cost alternative that's attractive to many consumers during tough economic times.

"It's not a surprise to see those numbers increase," said David Unter, senior manager in Deloitte & Touche's consumer business group. "With the economy the way it is, parents are more cost conscious."

Meeting demand

And retailers are moving to provide that alternative. Wal-Mart, the nation's No. 1 toy retailer, has expanded its Kid Connection line of toys, which includes everything from dolls and action figures to train sets and remote control cars. Wal-Mart has expanded the line to include 164 toy cars that cost 58 cents each--almost half the cost of Hot Wheels.

The company would not comment directly on taking customers from Mattel with its private label goods, other than a comment from Karen Burk, a company spokeswoman, that "any offering in private label is developed to fill a void in pricing or value."

Still, Mattel's brand name awareness and its ability to develop new products quickly give it an advantage, said Jill Krutick, a research analyst with Smith Barney Citigroup.

"The industry remains a hotly competitive business," she said. "For Mattel and others, to maintain their business they need to continually update their lines to stay ahead of the curve. That's their challenge.

It's a challenge that is being compounded by the advent of the private label products, which sell for less than name brands and under cut those sales. What retailers lose in selling toys at a lower price they make up in the higher margins they get selling their own versions.

Industry-wide, retailers, on average, mark up brand name products by as much as 30 percent. But margins on private label goods can exceed 50 percent, said Unter.

"Most companies start out just trying a private label because of the margins," he said, "and then if it does well, they try to determine how much they can put in their stores before angering the name brands."

Retailers are able to make their own toys at a low cost by modeling them after the successful toys they stock on their shelves.

The move by Wal-Mart and Toys "R" Us to "add private label toys may generate higher margins, but it could also come at a cost, said Silver.

"Retailers do it for the larger margin, but at the same time they are biting the hand that feeds them," he said.

When private label toys began appearing in stores three years ago, large U.S. toy makers were pacified with contracts to manufacturer the products, according to Silver.

But that too has changed, he said. Retailers are now cutting out the middlemen and dealing directly with manufacturers in Asia.

"These retailers are so big and have so much power that they are now manufacturing the toys themselves," Silver said. "That means even bigger margins."