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Pedestrians pass by a Mattel/Walmart Toy display in the underground PATH system near Union Station in Toronto.

Deborah Baic/The Globe and Mail

It isn't easy selling teddy bears in an Angry Birds world.

Toy makers and retailers are heading into the crucial holiday season with an unlikely challenge: children. Apps such as the wildly popular video game puzzler are capturing the attention of kids at an increasingly younger age, and they're losing interest in traditional toys such as plush toys and puzzles.

The numbers point to a clear trend for toy makers in the holiday period, which can generate more than half of their annual revenues. Sales in the $21.2-billion-a-year U.S. sector have slipped 6 per cent in the first nine months of 2012, reflecting a decade-long slide. Action figure sales are down 11 per cent, games and puzzles fell 16 per cent, and plush toys plummeted 19 per cent, according to market researcher NPD Group. This weakness comes as the popularity of tablets and smartphones ensure a non-stop flood of digital games, which are doing big business at even $1 a pop.

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"There are more changes going on in the industry now than in the past 10 years combined – it's very dramatic," said Anton Rabie, co-founder of Spin Master, which is racing to diversify through aggressive acquisitions of $100-million annually for each of the next few years. "It's definitely tougher out there and we're feeling it."

Underlying these tensions are cyberrivals putting pressure on pricing. In the U.S., is the e-commerce low-price leader with its rates being 1.4 per cent lower than those at Wal-Mart, 1.3 per cent lower than Target Corp. and 5.3 per cent lower than Toys "R" Us, according to a survey done from Oct. 24 to Nov. 14 by BMO Nesbitt Burns analyst Gerrick Johnson. (In Canada, doesn't have a separate toy shop.)

All the same, traditional toy makers are not shying away from the tech challenge. Many are betting they can bolster their businesses by building on still-popular niches while finding ways to embrace – and benefit – from the digital revolution.

Mega Brands Inc., for one, struggled through tough times with a focus on old-world construction toys – until it linked up with some hot tech-toy names such as Halo and Skylanders. And by next month, the Montreal-based toy company will begin shipping its Mega Bloks Barbie line to stores, counting on moving a classic boy toy into the girls' aisle by teaming up with one of the industry's classic pink brands.

The company's gains this year in a fast-changing sector highlight the urgency among players such as Mega Brands to reinvent and adapt their offerings to an often tech-driven industry, while still hanging on to yesteryear's play world.

"The improvement in our financial performance during the first three quarters has been achieved in an uncertain economic environment," Marc Bertrand, chief executive officer of Mega Brands, said earlier this month. "The common denominators of our good performance to date have been innovation and execution."

Retailers are branching out into products available nowhere else, so their prices can't be beaten online. Some are planning to add bricks-and-mortar stores alongside e-commerce, even as more customers use stores as "showrooms," where shoppers look at products only to buy them on their smartphones or online – often from Amazon or eBay.

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Toys "R" Us CEO Jerry Storch said he's embracing the so-called show-rooming phenomenon, partly by partnering with to sell its products on its site, while bulking up on exclusive merchandise."We love the Internet," Mr. Storch said. "If they want to come to our stores and buy online, that's great. Most of the products we sell are only available at Toys "R" Us."

Discounter Wal-Mart Canada, which is among the country's top toy sellers, is testing a pop-up virtual toy shop in Toronto that allows shoppers to buy Mattel toys, such as Barbie dolls, at the tap of a mobile phone. Toy producers, for their part, are scrounging the world for new properties or licences that will help them broaden their base, often with a tech twist.

And Indigo Books & Music, which has a toy section in all 97 of its big-box Indigo and Chapters stores, is considering standalone IndigoKids stores, said Grant Chapman, vice-president of IndigoKids. It borrowed from retailer Mastermind's traditional toy playbook for its in-store offerings, although extends them to mainstream toys in its online merchandise, where its stock is three times greater than in the stores.

The showrooming trend, which tends to be more pronounced south of the border, "in Canada is definitely a reality," said Simon Rodrigue, general manager of e-commerce at Wal-Mart Canada. "We see a lot of people showrooming us ... Probably a lot of people didn't think that Wal-Mart would be the one that had a first virtual store in downtown Toronto."

The fast pace of change means that top toys have a shorter shelf life than in the past. Mr. Rabie at Spin Master faced up to the new reality by deciding to pull its once billion-dollar-a-year Bakugan Battle Brawlers action figures out of stores after sales slowed considerably. He's preparing to relaunch it at another time to a fresh crop of children.

Now, Spin Master is chasing acquisitions aggressively to diversity in children-related areas. This week, it closed a deal estimated at $15-million to buy some of the assets of U.S.-based Wild Planet and its popular Spy Gear toys, which he said is a relatively safe purchase that fits in well its Air Hogs remote-controlled vehicles. "We'll be doing acquisitions that are riskier," he predicted.

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While the toy sector hasn't produced a holiday must-have this year, shoppers still can expect shortages of popular items such as the Wii U and Doc McStuffins doll as U.S.-based chains such as Toys "R" Us keep lean inventory levels so as not to be stuck with post-Christmas overstocks that they have to clear out at discounts.

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