North Brunswick, N.J. ? The annual holiday war between the nation’s two largest toy sellers is well under way. Wal-Mart Stores Inc. and Toys “R” Us Inc. are cutting prices and deploying brigades of Barbie and Elmo dolls as they joust for market share.

In a move that took Toys “R” Us — and the rest of the industry — by surprise, Wal-Mart cut prices on more than a dozen hot toys in mid-October, a month earlier than normal. By selling some items below cost, the discounter is using toys as a loss leader to woo shoppers to other aisles elsewhere in the store, analysts observed.

Toys “R” Us countered with its coupon book, cutting the price gap and hoping its wider selection will make its stores the destination for holiday buyers, especially as inventories dwindle elsewhere. Still, it acknowledged in a recent conference call that Wal-Mart’s discounting hurt third-quarter results.

“Things got little more cutthroat earlier this holiday season,” says Sean McGowan, toy analyst at Harris Nesbitt Gerard.

For example, Wal-Mart slashed the price of Mattel’s Hot Wheels T-Wrecks playset to $29.74, from its original $49.88. Most retailers were selling the toy for around $50.

Key months

The struggle for holiday sales matters because about 40 percent of all toys are sold in the last two months of the year.

Fierce price cuts by Wal-Mart have already bedeviled toy operator FAO Inc., which owns FAO Schwarz, The Right Start and Zany Brainy. The chain, which emerged from bankruptcy in April, said it might not continue normal operations through the end of the year.

Analysts are closely watching how Toys “R” Us will do this holiday season, the first where all the parts of its turnaround have been in place, including store remodelings, tighter inventory management and a better-trained staff.

During the past three years, Toys “R” Us lost money in its first three quarters, then made a big profit during the holiday selling season.

Wal-Mart, the world’s largest retailer, supplanted Toys “R” Us as the nation’s biggest toy seller in 1998, and observers suspect the gap will widen this season.

Wal-Mart’s 3,000 U.S. stores account for about 21 percent of U.S. toy sales, while Toys “R” Us, with 681 U.S. stores, has about a 17 percent share, McGowan estimated. Target Corp. is next with about 9 percent, while Kmart and privately held KB Toys each have 4 percent to 5 percent, he said.

Carolyn Schnell and daughter, Avery, 7, of Robbinsville, N.J., look at Leapster items at the Toys R Us store in Lawrenceville, N.J. Wal-Mart Stores Inc. and Toys R Us Inc. are engaged in a high-stakes battle for market share.

The head-to-head competition between Wal-Mart and Toys “R” Us is only good news for consumers.

Barbara Murray of Oakland, N.J., was clutching a Toys “R” Us catalog with coupons, as she was pushing her cart at a Wal-Mart in North Brunswick, N.J.

“The coupons expire this week,” Murray said. “We just want to get the best deal.”

“Generally, I think the prices are lower here,” the former paralegal said, adding she’s buying gifts for her 1- and 4-year-old daughters.

That assessment was echoed by teacher Tamika Johnson, 25, of Somerset, N.J., who said she was checking both stores as well as Target to find gifts for her 5-year-old son. She described the Toys “R” Us store 5 miles away in East Brunswick as her “last resort.”

“I only go there when I can’t find it anywhere else, because they’re always more expensive,” Johnson said.

Bigger inventory

Toys “R” Us chairman and CEO John Eyler said the company has “made it our biz to make sure that price is not the reason to go shop at a competitor.”

“We’re in the business 365 days a year. The big discount competitors start to run out of the big sellers at the beginning of December,” Eyler said.

Independent surveys from various investment banks generally support Eyler’s assertion that Toys “R” Us has similar prices on hot toys, now that it responded with the price cuts. There’s also no disputing his company’s advantage on selection.

Kim Midgett of New Egypt, N.J., looks at the popular toy My Little Pony Celebration Castle at the Toys R Us store in Lawrenceville, N.J. She was holiday shopping on Nov. 21.

Eyler said his typical store has 9,000 different items, which he said was more than twice Wal-Mart’s expanded holiday offering. Wal-Mart declined to give a figure.

Meanwhile, Toys “R” Us has increased the number of exclusive toys, which now account for about 20 percent of its selection, up from 5 percent four years ago. Half the exclusives are part of well-known brands, such as Barbie or Bratz, and the rest are house brands, such as Animal Alley, he said.

Low-price strategy

Wal-Mart also has exclusives, including $99 radio-controlled models of the Hummer and H2 vehicles. “The Hummer’s been a big seller,” McGowan said. Wal-Mart has several private labels, as well, including the Kid K’Nex line.

Wal-Mart’s strategy is simple, said spokeswoman Karen Burk: “We strive to be the low-price leader.”

“We think Wal-Mart is a one-stop shopping destination,” Burk said. “Not only can they shop for their toys, they can get their prescriptions filled, they can get footwear and apparel.”

Max Donaldson, 3, of Hopewell, N.J., plays with a Barbie Smart Kitchen at the Toys R Us store in Lawrenceville, N.J. Retail giants Wal-Mart Stores Inc. and Toys R Us Inc. engaged in a battle in which the winner will reap the rewards of being the nation's largest toy retailer.

The season will be an ordeal for Toys “R” Us, despite having sharper prices, its freshest inventory and better displays, McGowan said.

“That’s kind of the tragic frustration,” he added. “Toys “R” Us needs a very compelling reason to get people to make another trip.

“I think the big challenge that Toys “R” Us faces is that despite having better service, which is debatable, the consumer has a lot more need to go to Wal-Mart,” he said. “It’s a hit-driven business, and both companies have them.”