LiL' Things, big problems

Why no one is winning the battle of the baby superstores

It's eight minutes before opening time on a chilly Sunday morning, and two suburban moms are huddled outside the locked doors of the LiL' Things store in Plano, waiting for the signal to charge.

The women peer through the doors of the 30,000-foot store, identifying their targets and paths of attack. "I hope they still have the good ones," says one mother, pointing at $60 toddler beds visible through the glass.

It's the Arlington-based retail chain's going-out-of-business sale, and the women don't let their children--a tow-headed toddler boy and a slightly older girl--get in the way of this serious mission. The moms ignore the kids, who scream at the top of their lungs and clamber over a Fisher-Price climbing set, placed just where it is to distract them. Inside are other strategically located diversions: a photographer, a barber, and an aisle designated for kids to test-ride toys.

The mothers' heads turn only when the boy makes a dash for the parking lot. "Wesley, don't!" one woman yells. By the time Wesley scrambles back to the slide, the women have been joined by almost a dozen other combat shoppers.

"I can't believe it--that they're going out of business," says one mom.
Just then, a sales clerk unlatches the doors. The women surge through with their offspring. Any thoughts of the whys and wherefores of this young chain's demise are left behind in the dust trail of bargain shoppers' feet.

The women were shocked for a moment by LiL' Things' closing--but it registered as a much greater tremor in the local retail industry. The chain once operated 20 children's superstores nationwide, employing 700 full- and part-time workers. But in late November, it announced it would close all its outlets in early 1998, including stores in Plano, Arlington, North Richland Hills, and Lewisville. The move followed the company's June bankruptcy filing.

This month at the Plano store, one of the chain's first, a onetime wide array of inventory that encompassed every major brand from Bugle Boy to Baby Dior in clothes and Barbie to Brio in toys had been whittled down to a ragtag assortment. For months, wholesalers had been reluctant to supply the cash-strapped chain.

But even retail industry veterans and local investors, who sank roughly $53 million into the failed stores, didn't anticipate the rapid disintegration of LiL' Things, a concept that came to life less than five years ago. As recently as December 1995, LiL' Things' managers had raised $28 million from investors who bought into the notion of a chain of large-scale specialty stores for the four million women nationwide who have babies each year.

Two years ago, LiL' Things executives predicted the chain would grow to 250 stores with some $100 million in sales. Instead, the company reported revenues of $22 million for the chain's remaining 16 stores in the fiscal year that ended in February 1997.

Although retail ventures always rank as risky, LiL' Things' 1993 start-up seemed to have the formula for success. The two moms who waited outside the Plano store represent precisely the suburban sorts targeted by LiL' Things' founders and financial backers, a group of successful retail veterans.

Ron Steagall, a former Tandy Corp. executive who lives in Arlington, came up with the LiL' Things concept: Build 20,000- to 30,000-square-foot stores, stuff them full of the widest variety of children's goods, keep the prices competitive (if not necessarily discount), and establish a stimulating environment for kids. The idea was to get moms hooked at their child's birth and keep them coming in till their little ones turned 6. Rather than becoming a one-stop shop for a product category--like large office-supply or linen stores--LiL' Things was designed to be a one-stop for a customer category, parents with infants and small children. The store stocked furniture, toys, clothing, disposable diapers, safety items, and--at some locations--baby foods.

When he launched LiL' Things in 1993, Steagall had already made a name for himself in retail. He'd established an impressive entrepreneurial track record by founding BizMart in the Dallas area in 1987. The office-supply superstore grew to a chain of 57 stores and reported $300 million in annual sales before it was acquired in 1991 by Intelligent Electronics, Inc., which sold out to the rival OfficeMax chain 18 months later.

To finance LiL' Things, Steagall tapped Dallas-based venture capitalists Donald Phillips and CeCe Smith, who'd also funded BizMart. Phillips and Smith have a reputation as retail magicians, boasting a string of start-up successes since they began their venture capital firm, Phillips-Smith Specialty Retail Group, in 1986. Drive into just about any Dallas strip mall, and their handiwork is evident. Among the stores the two have helped stake are PetSmart; CompUSA; GadZooks; Ulta3, a discount cosmetics chain; The Sports Authority; and A Pea in the Pod, which sells high-end maternity clothes.

Despite its initial promise, LiL' Things failed so quickly and furiously--federal bankruptcy records show the company lost $3.9 million just in August--that Steagall and his backers continue to scratch their heads about how it all happened.

"If I had all the answers, I'm sure it would have ended better," says Steagall, who estimates he personally lost $250,000.

All of the LiL' Things players agree on one thing, however: If Jack Tate didn't exist, their venture would have had a happier ending. Tate was the owner of Baby Superstores, a 70-store chain that sold out last year to Toys R Us and is now renamed Babies R Us.

The same day LiL' Things opened its doors, Tate began a campaign of plopping his outlets right next to LiL' Things shops. Tate slashed prices, but, to the consternation of the LiL' Things team, kept reporting juicy profits. Baby Superstores' performance caused a small sensation on Wall Street--which snatched up its initial public offering of stock.

Only after LiL' Things had accelerated its expansion plans in an effort to compete with the Baby Superstores phenomenon did Tate reveal that he'd--oops--grossly misstated his profits. By then it was too late for LiL' Things. Expansion plans and murderously low prices had already pushed it onto a path that ended in failure.

"We all did our homework," says investor CeCe Smith. "Unfortunately, it didn't work out."

The first several calls to LiL' Things CEO Daryl Lansdale's Arlington office fall into a voice-mail abyss. Lansdale became CEO just a few months before the company filed for bankruptcy; when he finally responds, he admits that only three people work at headquarters now.

Less than a year ago, LiL' Things had some 50 corporate employees. Now even company chairman Steagall spends little time at headquarters. Instead, he's comfortably ensconced in his vacation home in Steamboat Springs, Colorado. About his future occupation, Steagall says only half-jokingly: "I might go skiing."

But Steagall's record, even with the failure of LiL' Things, doesn't suggest someone who'd retreat forever. The 50-year-old entrepreneur got his start in the retail business behind the counter of a Radio Shack store in Tempe, Arizona, in 1970. Radio Shack's parent company, Tandy, was a start-up then. In the late '70s and early '80s, the company grew quickly, and so did Steagall's stature within it. "I was in the right place for a young guy, standing at the right corner," he says. He moved up the corporate ladder--transferring from Salt Lake City to Seattle and finally to Arlington as corporate vice president.

By the mid-'80s, Tandy had grown enough that Steagall's employee stock amounted to a small fortune. Financially comfortable, he began looking around for more challenging opportunities. "What do you want to do when you grow up?" Steagall recalls asking himself. "The last thing on my mind was to start a company. What I really wanted to do was find another company like Tandy--just 20 years earlier."

Steagall--after hooking up with Dallas investors Phillips and Smith--instead wound up building his own start-up, BizMart. He'd called on the two investors on the advice of a Goldman Sachs banker and thought the two might know a young company that needed his retail expertise. But, he recalls, Phillips and Smith told him, "'Why would you want to be No. 2?"--meaning the manager, rather than the founder, of a concept.

CeCe Smith says she was extremely impressed with Steagall's record. He'd earned a reputation for effectively managing his divisions at Tandy during a time of explosive growth, she says.

Eager to get him on their team, Phillips and Smith promised Steagall they'd raise the capital if he could start a business.

At that time, in 1986, Phillips and Smith were relatively new at their game. A Harvard MBA, Phillips served as chairman and CEO of the publicly traded Pearle Health Services for 15 years, taking it from a small eyewear enterprise into a 1,250-store worldwide chain. In the mid-'80s, Phillips sold his company to GrandMet USA for $400 million and started a venture capital firm. Smith, a CPA, had served as CFO for Pearle and S&A Restaurants, Inc., which owns the Steak & Ale chain.

Nowadays the two have several multimillion-dollar investor funds active at any one time. They review a staggering 600 possible deals each year, choosing to fund five or six. They always invest in the retail industry--which makes them unusual among venture capitalists. Many more investors looking to supply seed money pick the high-technology industry, where returns can sometimes be sky-high. Retail start-ups are riskier and generally less profitable.

Typically, Phillips and Smith expect their start-ups either to go public or merge with other companies within 10 years.

Their firm has its share of successes--as well as a few failures. Teach & Play Smart Inc. is its other recent flop. This chain, which closed last year, targeted parents who wanted to buy educational toys for their kids. "The market for educational toys was too small," Smith says.

Smith says her firm doesn't usually scout for novel retail concepts. Rather, it chooses retail businesses that have shown some promise but perhaps haven't spread regionally or nationally. The firm usually takes its stake in the form of preferred shares and puts in $1 million or more, and one of Phillips-Smith's principals usually sits on the start-up's board.

Before BizMart, Phillips and Smith were still winning confidence from their institutional investors, typically insurance companies, banks, and university endowment funds. But with Steagall's BizMart, Phillips and Smith made a name for themselves.

Phillips and Smith's confidence in Steagall had paid off handsomely. The venture capitalists raised $22.7 million to start BizMart in 1987, paying roughly $3 a share for what became $10 stock when BizMart went public two years later.

Those kinds of returns couldn't have been far from Phillips and Smith's minds when they mulled over Steagall's concept for LiL' Things. In 1993, after OfficeMax acquired BizMart, Steagall called on the venture capitalists again. This time, he had the concept. He wanted to manage LiL' Things for a while, then step back and let someone else do the work. "I no longer had an interest in running a company," Steagall recalls.

LiL' Things' hoped to suck in parents of children under 6 and turn them into loyal customers. Those parents, the theory went, were still dictating what children would buy. (Unlike in the later years when elders, it is assumed, blindly purchase whatever their kids want. How else could one explain the Tamagotchi phenomenon?)

According to the plan, LiL' Things would offer the prices of a Wal-Mart and the variety of a higher-quality department store, including its own label of children's clothes.

A wide selection was key to the stores. In each shop, Steagall supplied customers with a choice of some 60 cribs, 40 strollers, 50 car seats, and 700 feeding and safety products. The aisles were extra wide so Mom and Dad could give Junior a wide berth and still keep an eye on him. There were also the LiL' Things' haircuts and photographic portraits--frills not available at a discounter like Toys R Us.

The store's one-stop-shopping concept caught on with moms. "The attraction," recalls Tracey Houlditch, a Plano mother of a 6-year-old who shopped at the store in her town several times, "was it was all under one roof. It was convenient." Houlditch recalls being able to find Diaper Genies, Duplo blocks for her son, and PlaySkool toys.

To test his ideas, Steagall tapped what he called a "council of moms." On the advisory board was Sherry Richardson Pate, a mother who, at the time, was overseeing investments for the H. Ross Perot family. She had bought a stake in LiL' Things for the pint-sized computer service magnate--a fact that LiL' Things didn't keep a secret and that probably encouraged others to pony up some cash. Among the suggestions the moms offered and Steagall adopted were Saturday home deliveries, a policy designed to accommodate working parents.

"He had thought it out pretty well," says George Michael, the founder of NBRK, the advertising firm LiL' Things hired. Steagall won approval from his investors, led by Phillips and Smith, and acquired $14 million in financing to open 13 stores.

But despite the careful considerations of Steagall and his backers, much of the planning became moot in fall 1993 when the LiL' Things team prepared to open its first store in Town East Mall in Mesquite and discovered it would have an unwelcome--and wholly unexpected--neighbor.

Steagall had selected the site because his demographic studies indicated that the area housed the greatest number of families with children under 6. But just a few weeks before the store opened, Steagall's team learned from commercial real estate contacts that Baby Superstores, at the time a small regional chain of children's goods stores based in Greenville, South Carolina, intended to open shop literally across the street. Not only was the rival several thousand square feet bigger than LiL' Things, but it was set to open on the very same day.

Steagall had known Baby Superstores existed, but hadn't regarded them as a direct competitor. Until then, the chain had operated much smaller stores and made no noises about expanding in the Southwest.

In hindsight, the LiL' Things team had vastly underestimated Jack Tate, an idiosyncratic Harvard-trained lawyer who owned the rival company. The Baby Superstores founder not only opened in Mesquite, but in what advertiser Michael describes as the closest thing to ruinous competition he's heard about since his college economics courses--where such a destructive rivalry is defined as one in which a big chain puts a mom-and-pop store out of business with deep, profit-gouging discounts---Tate started stores in more than half the markets where LiL' Things opened. His stores were not always across the street, but were usually nearby. In Plano, Tate's store was on Preston Road, while the LiL' Things outlet is located on the east side of town.

The rivalry pitted the chains against each other in a continual price war. Steagall could no longer fashion his chain as a big boutique for mother; he had to fight a discount battle--always on price points. "Anybody that was a bargain shopper knew they could get it cheaper somewhere else--just cross the street," says a mom who frequented the Mesquite store.

Tate, whose profits showed that he was thriving amidst the competition, seemed to relish the fight. "We think their site work was very intelligently done, and we agree with Mr. Steagall," Tate told The Dallas Morning News--tongue in cheek--the week the two rival Mesquite stores opened.

Steagall, for his part, viewed Tate as a menace.
"It wasn't something we could anticipate," Steagall says. "Logically, it couldn't have happened. He was operating irrationally." Venture capitalist Smith agrees. She says Tate "ruined the market for everybody. It affected the whole economic model. It reduced gross margins."

Steagall and Tate met once. A few weeks after the Mesquite stores opened, the LiL' Things founder decided to amble across the street and check out the competition himself. To his surprise, Tate stood at the doorway to greet him. "He saw me, and I guess he recognized me," says Steagall, who recalls his rival saying with a smirk, "Welcome to my store. If you want to copy down prices, no problem."

Now a millionaire many times over, the 53-year-old Tate has a reputation as an oddball. In a story about lifestyles of the wealthy, USA Today reported in June that Tate, since selling his chain, has re-entered college, studying Spanish and piano. When he started Baby Superstores, he got some notices in the press for his quirkiness--Tate bragged about his barebones staff and nonexistent office. According to USA Today, Tate lives in a $725-a-month apartment and shuns his $1.5 million mountain estate.

It didn't take long for Baby Superstores, which had been around for several years, to make its mark on Wall Street. Less than a year after the Mesquite stores opened, Baby Superstores issued an IPO--opening at a share price of $18, closing the same day at $34.25. Within four months, the stock was trading at a high of $58.

But Tate, much to the glee of LiL' Things' founders, had only short-lived glory with investors.

"We should have been more skeptical," a Forbes magazine writer said after the stock nosedived 29 percent in February 1996. The plunge occurred after news hit that Tate had overstated the company's cash reserves by $3.9 million, and therefore needed to refigure 1995 profits--which were ultimately slashed by $2.5 million. The company described the accounting error as "human" and "procedural."

For LiL' Things, however, the revisions meant that all of Baby Superstores' sales figures were probably inflated, Steagall says. "We were operating under the assumption that he was doing 50 percent more volume that he probably was," Steagall says.

Before the more accurate picture of Baby Superstores' finances emerged, however, the LiL' Things team had completely reworked its business plan to reflect the aggressive competition. The goal became build, build, build before Tate does, primarily because they believed Baby Superstores was making money based on what was later revealed to be erroneous information.

"It forced the company to grow faster," Steagall concedes. "If you didn't grow, you were a sitting duck. You had to open stores so he couldn't keep up with you. Eventually, one hoped, his board would force him to do the rational thing."

When Daryl Lansdale arrived at LiL' Things earlier this year, no one was talking about expansion plans anymore. He simply presided over the mop-up. "I have never seen anything in quite such disarray," he says.

Lansdale won't dish the dirt on how his predecessors fouled up. But former customers of LiL' Things are eager to point out the flaws.

In fact, Tracey Houlditch remembers precisely the moment she stomped out of the LiL' Things store in Plano and swore she'd never come back. Her son, a sweet-faced brunette with a mop that could have been worn by a Beatle, had gotten a haircut at the store's barbershop. They'd done what she thought was a sloppy job. Houlditch believed the uneven cut reflected general problems with LiL' Things' service. It was "horrible," she says. "Very disorganized. No one ever knew anything. Clothes were on the wrong racks. It was a mess."

Facing such problems and knowing investors weren't ready to serve up more cash, Lansdale tried to plead for mercy from suppliers who could offer credit and keep the company operating a while longer. But by last month, all options had fallen through. Having surveyed the aftermath closely, Lansdale contends--and even Steagall doesn't really argue otherwise--that the whole concept of LiL' Things was flawed.

Charles Steinbrueck, who runs Retail Venture Partnership in Denver, also shopped the idea of starting a baby-goods retail chain to investors at roughly the same time LiL' Things began. As a onetime potential competitor of Steagall and Tate, the Denver entrepreneur characterizes the LiL' Things team's complaints about Baby Superstores as mere whining. "That's reality in the retail business," he says.

But Steinbrueck also believes Tate overstated his profits and skewed the economics of the market. "It was smoke and mirrors," he says of Tate's high-flying days.

When pressed, Lansdale will nitpick about some of the prior management's sins of omission. Too many stores were located in each designated city, for instance. LiL' Things hired clerks who were too young, alienating new parents. Who wants to hear a gum-chewing teenager expound on baby care? Precious advertising dollars also were spent unwisely. The focus of the campaigns was on price, when people wanted to see selection.

In its haste to catch up with the artificially inflated success of Baby Superstores, LiL' Things' concept had become so much of a hybrid that, in the end, there was no recognizable concept. It wasn't a high-end store, yet it wasn't a discount outlet either.

One point on which Lansdale and Steagall agree is that the baby-producing population is not a loyal bunch. They may buy an extravagant crib for the first-born--spending, on average, $6,000 to $8,000 on the first child. But they've scaled way back by the time the second one comes along.

"With the first child, we were quite successful," Steagall says. "But with the second child, reality sets in that they don't need to wear all those cute little clothes."

Despite his reckoning with Wall Street, Tate has emerged from the baby wars with many millions. In October 1996, he sold his chain to the owner of Toys R Us, personally reaping about $150 million in profits. LiL' Things team members reacted sourly to the news. They believe--and almost seem to hope--that Tate had to discount his own shares in order to make the sale because he'd previously misreported his financials. Tate did indeed sell his shares at a discount--$14.87 per share--while other shareholders received $23.45 for their stock. Even so, it wasn't a bad deal for Tate, who bought his stock at five cents a share.

The LiL' Things team concedes that a big operation like Toys R Us will have the money and time to tinker until the baby goods big-store concept works. "It still sounds like a great idea," Steagall says.

But the moms of suburbia will have the final word--and LiL' Things has already lost Houlditch.

"It's been two years since I've been there," she says at the close-out sale. "And I'm not going back.

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