leapfrog compiled v1
TRANSCRIPT
LeapFrog: A Strategic ReviewMGMT102: Strategy
Professor Mats Lingsblad
T2 AY2012-13
Kelly CHEW Jiawen Hazwan Aziz Bin MOHD SIDIKWONG CiAudrey YAP Kian TingAriella YEO Yun Jia
G4
1. Executive Summary
2. Company Overview
2.1 Company Background
2.2 Company Performance
2.3 Share Price Analysis
2.4 Revenue Breakdown
2.4.1 Products
2.4.2 Retailers
2.4.3 Hardware vs. Software
2.5 LeapFrog’s Value Chain
3. Industry Analysis: Global Learning Aids and Toys (Learning Aids)
3.1 Industry Definition
3.2 Porter’s 5 Forces
3.3 Key Industry Trends
4. Corporate Strategy Analysis
5. Business Unit Analysis: Multimedia Learning Platforms (MMLPs)
5.1 BU Strategy
5.2 Issues with Current and Future Business Strategies
5.2.1 Loss of value proposition
5.2.2 Entry into highly saturated apps markets
5.2.3 Brand erosion and higher fees
5.2.4 Concentration of sales
6. Conclusion
7. Appendix
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1. Executive Summary
Even though LeapFrog has demonstrated strong performance with a yearly
compounded average growth rate of 15% in net sales since 2009, there are
many signs pointing towards its inability to remain competitive in the future.
Key Considerations:
1) Loss of Value Proposition
The company’s flagship product, the LeapPad, will be unable to keep up with the
proliferation of tablets from established brands such as Apple, Google & Samsung
which provide similar offerings.
2) Entry into Highly Saturated Apps Markets
LeapFrog will be unable to compete in highly saturated content markets such as
iTunes and Google Play which already have thousands of learning apps available.
By entering these markets, LeapFrog will effectively be cannibalizing its own
hardware sales as well.
3) Brand Erosion
By shifting to becoming a content curator rather than creator, LeapFrog may tarnish
its brand reputation. By offering 3rd-party apps on its App Cenre, which carry the
labels of their content-owners, LeapFrog could be perceived to be accepting these
apps as of similar quality to its “educator-approved” content. This greatly erodes
LeapFrog’s brand value and poses a threat to the value proposition of its premium
content, which is the company’s core competency.
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SELL
2. Company Overview
2.1 Company Background
LeapFrog Enterprises, Inc. (“LeapFrog”, NYSE: LF) is a leading designer, developer
and marketer of innovative, technology-based educational products. Founded in
1995 and incorporated in 1997, the company is based in Emeryville, California and is
currently headed by John Barbour who has served as Chief Executive Officer since
March 2011. LeapFrog focuses on developing products that will provide the most
engaging, effective learning experience for children aged 0-9, in school or home,
around the world. Their philosophy is to put learning first, which distinguishes them
from their competitors and fuels the entire company. With products available in more
than 45 countries, the company has branded itself as a leader in educational
entertainment. A timeline of their achievements can be found in Appendix A.
2.2 Company Performance
In 2012, net sales were US$581.3 million, up 28% compared to 2011. This increase
was largely due to the continuous strong demand for their flagship product, the
LeapPad (Appendix B), which has been available since 2011. In August 2012, the
launch of the LeapPad 2 (Appendix B), an improved version from the previous
model, further drove sales as well.
Income from operations was US$64.1 million, up 170% from 2011, and grew 5.8
percentage points as a percentage of net sales to 11.0%. This strong performance
can be attributed mainly to increased net sales, increased gross margins and more
efficient use of higher operating expenses.
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2.3 Share Price Analysis
Compared to other toy companies such as Mattel and Hasbro, LeapFrog’s share
price has performed relatively well, with a compounded average growth rate of 25%
over the last four years.
However, despite this increase, unlike Mattel and Hasbro, LeapFrog share price has
been largely volatile. This reflects the nature of their business which is highly
dependent on their ability to adapt to ever-changing consumer preferences and
product trends, especially within the multimedia industry. With the LeapPad driving
sales and being the flagship product of the LeapPad brand, LeapFrog’s share price
has been extremely sensitive to product launches such as the iPad Mini and Google
Nexus 7 which have similar offerings. For example, with the launch of the iPad Mini
in November 2012, LeapFrog share price dropped 25% from $9.57 to $7.22
(Appendix C). Furthermore, despite reporting good earnings for Q4 2012 in Feb
2013, up 16% from the same period a year ago, share price has remained largely
stagnant since its announcement. (Appendix C). Both these signs point towards
decreasing investor confidence in their ability to remain competitive.
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Strong Financial Performance
2.4 Revenue Breakdown
2.4.1 Products
The U.S. segment represented US$424.8m (73%) of LeapFrog’s consolidated net
sales in 2012 of US$581.3m. Multimedia Learning Platforms (MMLP) accounted for
83% of net sales, whilst 16% came from learning toys, and the remaining 1% from all
others.
The international segment represented US$156.5 million (27%) of LeapFrog’s
consolidated net sales in 2012. MMLPs accounted for 52% of net sales, whilst 47%
came from learning toys, and the remaining 1% from others.
As can be seen in the figure below, Leapfrog relies primarily on Multimedia Learning
Platforms to drive sales (83% US, 52% International).
2.4.2 Retailers
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MMLP; 83%
Learning Toys; 16%
Others; 1%
U.S.
MMLP; 52%
Learning Toys; 47%
Others; 1%
International
2012 2011 2010
Wal-Mart 23% 23% 21%
Toys “R” Us 18% 18% 20%
Target 13% 14% 17%
Total 54% 55% 58%
Leapfrog is highly dependent on few retailers such as Wal-Mart, Toys “R” Us and
Target which contributed to 54% of total gross sales in 2012. Overall, they rely
heavily on large retail customers to sell their products to individual consumers.
2.4.3 Hardware vs. Software
Leapfrog does not provide a breakdown of their hardware vs. software revenue.
However, based on our calculations, with total net sales for Q4 2012 being $240m,
and analysts estimating that the Q4 2012 LeapPad 2 sales was $150m1, this shows
that hardware sales contributed to at least 60% of total sales. As such, compared to
software, LeapFrog generates significantly more revenue from hardware.
2.5 LeapFrog’s Value Chain
LeapFrog primarily focuses on R&D which includes designing and developing both
hardware and content. Manufacturing is outsourced to factories to China where costs
are much cheaper. Distribution is managed by their retail partners such as Walmart,
Toys ‘R’ Us and Target who have a large customer base. They have a small retail
presence through their online store which allows consumers to purchase both
hardware and software.
3. Industry Analysis : Global Learning Aids and Toys (Learning Aids)
3.1 Industry Definition
LeapFrog competes on an international basis in the learning aids and toys (learning
aids) category within the toy industry. While more than 50% of LeapFrog’s sales are
derived from within the United States, a substantial and increasing portion of its
1 Sramana Mitra, Feb 2012: LeapFrog’s Toy Tablet Scores Succesful Turnaroundhttp://www.sramanamitra.com/2012/02/22/leapfrogs-toy-tablet-scores-successful-turnaround/
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sales (27%) is being generated through foreign markets such as the United
Kingdom, Canada and France.
The learning aids category comprises products which facilitate learning and skill
development, by engaging the user with an element of entertainment.
The industry comprises of firms primarily involved in development of learning aids,
although more established players such as Mattel have engaged in some degree of
downstream vertical integration, entering into manufacturing and distribution. An
increasing number of firms have also engaged in direct-to-consumer distribution and
sales (mostly through company-owned online sales portals), bypassing retailers and
distributors.
3.2 Porter’s 5 Forces
An analysis of the learning aids market using Porter’s 5 forces reveals that the
industry is highly unattractive.
Supplier Power: Weak
The threat from suppliers to the industry is low. Suppliers include manufacturers,
research and development (R&D) personnel, as well as advertisers.
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Relative to the number of firms involved in the design of learning aids, there are a
large number of manufacturers available globally. This is especially so when the
materials and machinery required for the production of such toys are commoditized,
and hence easily accessible. This skews the balance of power in favour of the
learning aid product developers.
While the ability of the firm to create products with high learning content is crucial to
the survival of the firm, there are no specific skill prerequisites for the human
resource involved in the research and development of learning aids. The threat from
R&D personnel is thus low.
Firms in the industry rely heavily on marketing to bring across the non-price
differences of their products; the role of advertisers as a supplier to the industry is
thus crucial. It is likely that there are at least as many, if not more advertising firms
than the number of learning aid firms. The threat coming from advertisers is thus low.
Buyer Power: Strong
Buyers to the industry consist of distributors and mass retailers, such as Wal-Mart,
Target and Toys “R” Us in the United States, and Hamleys in the United Kingdom.
These distributors and mass retailers often have access to, or have the resources to
develop, an extensive network of distribution channels that firms in the industry do
not have within specific geographic regions. The bargaining power in the relationship
thus tends to be skewed towards the distributors and mass retailers. Compounding
on this is the fact that long-term contracts with retailers are uncommon, given the
relatively short product life cycle of less than two years.
Strong buyer power could be mitigated in some cases by the demand of end
consumers, assuming that the products prove popular with consumers, or when
learning aid firms have a proven track record of producing toys that are consistently
well-received by end consumers.
Threat of New Entrants: Moderate
The industry has no significant barriers to entry – the industry is not capital intensive,
and it is easy for new entrants to gain access to suppliers to the industry.
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Additionally, because content and pedagogy associated with learning aids are often
hard to copyright, it is also easy for new firms to enter the market offering substitutes
following the introduction of a wildly successful product. However, it is still difficult for
new entrants to convince credible distributors and retailers to carry their products
due to the lack of track record and cost constraints. The threat of new entrants is
thus moderate.
It is important to note, however, that the threat of new entrants is increasing with the
greater ease of conducting direct-to-consumer marketing and sales through the
Internet, allowing firms to bypass retailers and distributors.
Degree of Rivalry: Strong
The industry is highly fragmented with a large number of firms competing for market
share. It is not uncommon for firms in the industry to have multiple brands and
characters spanning different toy categories under their umbrella. Competition is on
the basis of the learning content, performance, features, quality, brand recognition
and price of individual products, rather than the umbrella brand. Leading players in
the industry include Mattel, Inc., with its Fisher-Price brand, Hasbro, Inc. with its
Playskool division, LeapFrog and VTech Holdings Ltd.
Rivalry is intense with the high substitutability of different products within the industry
– customer loyalty is low, and switching costs are almost negligible. This is
evidenced through the heavy marketing expenditures and a constant effort to
procure intellectual property protection where possible by firms in the industry.
The table below shows the highly fragmented nature of the global toy industry, with
the top 5 players contributing 31.9% of total market value by sales in 2011. While
data on the learning aids category is unavailable, we believe that the structure of the
learning aids category can be proxied by the global toy industry.
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Market Share by Sales, Global Toy Industry
Companies 2008 2009 2010 2011
Nintendo Co Ltd 15.5 14.6 11.7 8.8
Sony Corp 7.2 6.7 7.1 6.7
Mattel, Inc. 6.5 6.2 6.5 6.5
Microsoft Corp 4.4 4.4 5.3 5.6
Hasbro, Inc. 4.4 4.4 4.3 4.3
Source: GMID
Threat of Substitutes: Strong
A wide range of products and services exist as substitutes to learning toys. These
products do not possess the educational quality of learning aids, but yet are still able
to occupy and entertain the child. They include generic toys, mobile devices (both
gaming and non-gaming) and television programmes, just to name a few.
In particular, the rise of mobile devices such as mobile phones and tablets, along
with their educational mobile applications, has proven to be an increasing threat to
the learning aids industry. The threat of substitutes is thus strong.
Conclusion
We believe that the extremely strong power of substitutes, strong rivalry amongst
existing firms and low barriers to entry will prove to be compelling factors that create
a challenging operating environment for both incumbent firms.
3.3 Key Industry Trends
Going forward, we believe that two key trends are set to influence the growth
trajectory of the industry. The first comes from the dip in sales of products priced at a
premium arising as a result of the economic recession, and the second stems from
the increasingly prevalent use of mobile devices, such as tablets and smartphones,
as learning aids.
The recent economic recession has seen the demand for toys, and thus learning
aids, grow more price sensitive. The learning aid industry derives much of its value
and growth through mature economies such as the United States and Europe, where
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the emphasis on education and childhood development is larger, and is backed by
purchasing power. However, the economic recession has hit these mature
economies especially hard, and the general reduction in disposable income that has
come with it has led parents to view toys and learning aids as increasingly
dispensable to their child’s development.
The effects of the recession on the learning aids market have started becoming
evident, and can be estimated by using the declining growth of the overall toy
industry over the past 5 years as a proxy.
Global Toy Industry
Note: market value is by sales
We believe that recovery in this industry will lag general economic recovery and that
the effect of the economic crisis on the industry will continue at least for the medium
term. Given that the learning aids industry is more heavily dependent on the hard-hit
mature economies than the global toy industry, the impact of the recession on the
industry’s growth, both present and future, can be reasonably expected to be
amplified.
As previously mentioned, smartphones and tablets have established themselves as
potentially strong substitutes for learning toys. This can be attributed to two factors:
the rise of the digital age and age compression.
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The rise of the digital age has seen children being born into technology. As parents
are heavy consumers of technology through mobile platforms such as smartphones
and tablets themselves, these platforms are increasingly being used to double up as
edutainment devices for their children, especially with the increasing variety of
education applications available on these mobile platforms. We believe that the
convenience and low cost at which these applications can be downloaded will
continue to propagate this trend.
Age compression describes a phenomenon of children “growing old younger” – toys
which were once meant for a particular age group are being played with by younger
and younger children. In the same vein, younger and younger children now see the
technology that was once only accessible to those on the cusp of their teens as a
source of entertainment.
Learning aid developers and toymakers have recognized these threats and sought to
adapt. Toymakers are now incorporating both existing childhood brands and new
brands into smartphone and tablet applications, some with physical toys as a
necessary component to play. For example, Mattel launched Apptivity in May 2012,
a line that uses a patented Active Touch technology in which its physical toys are
recognized and can interface directly on the iPad.
However, we question the sustainability of such a move, as firms deviate from their
core competency of toy development and seek to challenge the tablet and electronic
industry. While not impossible, we believe that this will be an uphill task for toy
manufacturers as they reallocate their resources and rebuild core competencies.
4. Corporate Strategy Analysis
4.1 Use learning toys as entry point to the LeapFrog brand
LeapFrog’s corporate strategy is to use learning toys as an entry point to the
LeapFrog brand, facilitating graduation to its MMLPs. Such a strategy is logical. By
getting parents familiar with the LeapFrog brand at the beginning of their child’s
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development, given the unique educational value and methodology that their
learning toys provide, there will be a higher likelihood that parents will trust the brand
and transition to using its MMLPs.
4.2 Use of Learning Path to maintain relationship with parents
The Learning Path (Appendix D) is an online platform which allows parents to track
their child’s development as they play with LeapFrog products. This superior after-
sales service allows LeapFrog to maintain a connection with parents and
consistently remind them of the value that their products provide. This platform also
allows LeapFrog to recommend new products to parents based on their child’s
performance and this furthers the likelihood that parents will remain long time
customers with the brand.
5. Business Unit Analysis: Multimedia Learning Platforms (MMLPs)
5.1 BU Strategy
Who US: 73% of gross 2012 sales. International: 27%
1. Distributors
a. US: resale to schools, school districts
b. International: resale to retailers
2. Retailers
a. Wal-Mart, Toys “R” Us and Target are top 3
customers, forming 55% of gross 2012 sales
b. Physical stores, online stores
c. US: top 3 retailers made up 48% of gross
2012 sales
d. International: Walmart, Toys “R” Us made up
7.3%
3. Direct consumers
a. Children below 10, parents
b. LeapFrog.com, App Center, iTunes Store
What 1. Hardware
Kid-tough design and materials for rough-
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and-tumble play
a. LeapPad 2: US$100. Touchscreen tablet with
cameras, 4GB storage
b. Leapster: US$55. Handheld game system
c. Tag: US$40. Stylus-based reading system
2. Content
Educator-approved pedagogy and materials
covering subjects such as English, Math, and
reading skills
a. Game cartridges: US$25. For LeapPad,
Leapster
b. Ultra eBooks: US$20. For LeapPad
c. Apps: US$5-25, about 500 types featuring
LeapFrog-owned or licensed characters
d. Books: US$20. For Tag
How 1. Advertising and marketing
a. Direct consumers: integrated approach using
traditional and social media. Learning Path
recommendations personalized to parents
b. Retailers: well-established relationships. In-
store ads, signs, and features on promotional
newsletters
c. Public relations: brand and product-specific
media coverage, annual Toy Awards
2. Online services
Learning Path and Apps Center (AC) are key
differentiators that make LeapFrog unique
a. Learning Path: for parents to check kids’
progress, receive product advice. Available in
US, UK, Canada
b. AC: purchase of software. Available in US,
Canada and other countries with less
stringent web content control
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c. Online store: purchase of hardware, with
home delivery
3. iOS and iTunes Store
a. Free or US$1.
b. 8 basic apps currently, developed through 3rd-
parties
4. Research & Development
2012: US$36.6m expenditure (6% of sales)
a. Design: in-house team and external
consultants. R&D critical in strengthening
product portfolio. Platforms created using
licensed technology e.g. Java
b. Content development: mostly in-house, but
started 3rd-party liaisons in late 2011
c. Remaining development: outsourced
5. Content curator
a. Offer 3rd-party developed apps on AC,
alongside LeapFrog-generated content
b. 3rd-party apps labelled under developer
6. International expansion
a. Make AC and Learning Path accessible to
users in more countries
b. Create content in different languages
5.2 Issues with Current and Future BU Strategies
5.2.1 Loss of value proposition
LeapFrog’s hardware is specially designed to withstand rough-play by kids, and also
has simple kid-friendly functions and buttons. These used to be strong selling-points,
as parents did not have to worry about children spoiling these MMLPs easily,
especially given their high cost. However, the explosion of offerings in accessories
for the iPad and other tablets has seen the emergence of kid-friendly casings that
make these tablets equally kid-tough. Hence, parents may see the purchase of a
fully-functional tablet as a better investment for their kids, since these protective
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cases can be removed when the child is older, and the tablet put to other uses.
Furthermore, parents have the option to kid-proof and hand-down their old tablets
when they upgrade and purchase a new tablets for themselves.
Toymakers have also started offering more MMLPs, with Toys “R” Us and Mattel’s
Furby each creating their own line of kid-friendly tablets. Being kid-tough is thus
inadequate as a differentiating factor as these offerings have similar characteristics.
Decreased demand for LeapFrog toys from end-consumers, and potential
protectionism by retailers with in-house brands, will see a fall in orders from retailers,
which make up a substantial proportion of sales. This is especially easy since
retailers do not have long-term contracts with LeapFrog.
The value proposition of LeapFrog’s content perceived by consumers is in its
“educator-approved” label. However, the ambiguity and lack of an official standard or
regulatory body for such a label makes its true value less credible, and would also be
difficult to bring across geographical boundaries when it comes to international brand
establishment. Such a value proposition may also not be unique to LeapFrog, as
competitors can easily create similar labels for themselves. Nonetheless, the
extensive use of LeapFrog products in US schools lends some credibility to the
quality of its content, hence repeat purchases are more likely. The main difficulty
LeapFrog faces is convincing new international customers to purchase its products.
LeapFrog currently plans to release a new LeapPad in 2013, and this may be a
misallocation of R&D resources. With falling demand for higher-priced toys, stiff
competition from fully-functional tablets, and loss of hardware value proposition,
sales of the new LeapPad are expected to be dismal. It may be wiser for LeapFrog
to direct more resources into its international marketing efforts, or in online services
development.
5.2.2 Entry into highly saturated apps markets
LeapFrog has realised the inevitable need to enter the iTunes and Android apps
markets due to the widespread popularity of these platforms. Since its foray into iOS
apps in 2011, it has created 8 simple apps with the help of 3rd-party developers, 1 of
which is free and the rest at US$1. LeapFrog has noted that these distribution
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platforms are heavily populated by thousands of other apps that are mostly free.
While it can be argued that LeapFrog content is “educator-approved”, the
international market may not recognise any marginal utility over other free apps.
Apart from moving into a highly price-competitive segment, this also conflicts with
LeapFrog’s current apps on its AC, which cost US$25. These apps would
undoubtedly contain more premium content that are tailored to heightened
experiences on its hardware, but the large difference in prices may cause potential
consumers to purchase its cheaper non-AC apps instead. This is especially if they
already own tablets or other smart devices, since they would not have to purchase
additional LeapFrog hardware. Existing LeapFrog hardware users may also hold off
future purchases on the AC, in anticipation of cheaper versions for smart devices
that their families most likely already own2.
LeapFrog’s foray into creating apps for other platforms hence creates strategic
conflicts between its premium AC content and lower-priced alternative apps, which
may lead to cannibalisation of both hardware and software sales. The near-zero
contribution margins from these apps would also see a large proportion of profit
being eroded. LeapFrog may also face difficulties convincing overseas audiences to
purchase its general apps since there is little brand recognition, hence decreasing
the possibility of using these apps as teasers to encourage full-fledged hardware and
AC software purchases.
5.2.3 Brand erosion and higher fees
LeapFrog’s greatest shift in focus comes from its intention of becoming a content
curator, rather than creator. In offering 3rd-party apps on its AC, which carry the
labels of their content-owners, LeapFrog could be perceived to be accepting these
apps as of similar quality to its “educator-approved” content. This greatly erodes
LeapFrog’s brand value and poses a threat to the value proposition of its premium
content, which is the company’s core competency.
2 Deloitte, Jan 2013: 65% of 35-44 year-olds in developed countries own smartphones or tablets http://www.marketingcharts.com/wp/topics/demographics/tablet-adoption-less-age-dependent-than-smartphone-ownership-in-developed-markets-25824/
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Furthermore, LeapFrog has to compete for the attention of content developers with
iTunes and Android, which have far greater market shares and outreach in the apps
realm. Developers may hence require greater incentives to create content
specifically for use on LeapFrog hardware, since sales would be far lower in quantity.
This may translate into higher royalty or purchase fees, causing lower profit margins
for LeapFrog’s MMLP content.
5.2.4 Concentration of sales
Bulk of LeapFrog’s sales lie in the hands of 3 retailers, 2 of which are both national
and international. In 2012, Wal-mart, Toys “R” Us and Target accounted for 66% of
the US segment’s gross sales, and the former two for 27% of the international
segment as well. By having just 3 customers accounting for such a substantial
proportion of the company’s gross sales, LeapFrog exposes itself to significant buyer
risk. This risk is further compounded by the fact that no long-term agreements exist
between LeapFrog and its retailers, who make all purchases through one-time
purchase orders. Economic factors that adversely affect retailers, such as increased
competition from online retailers, reduced access to credit given the tighter bank
lending environment, and store closures, would inevitably affect LeapFrog’s sales
too. For example, the bankruptcy of one of its customers in 2012 caused bad debt
expense of US$3.1 million.
Moreover, without long-term agreements, pricing, shelf space, cooperative
advertising or special promotions with each retailer are exposed to renegotiation and
amendments periodically. Any alterations to the disadvantage of LeapFrog would
adversely affect its operating results.
6. Conclusion
LeapFrog is operating in an extremely risky environment. Their ability to survive in
the long run is largely dependent on their ability to keep consumers convinced of the
value of their hardware and unique educator approved content. However, given the
erosion of their hardware value proposition and the fact that they are moving away
from their core competency which is content creation, our groups feels that they will
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not be able to remain competitive In the long run. Taking these factors into account,
we recommend a sell call.
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7. Appendices
Appendix A
Appendix B
The LeapPad is a tablet specially designed for kids. Similar to any tablet, it allows users to download apps, play music and read e-books. More importantly, unlike other tablets, it is designed for rough play and can withstand drops and hard knocks. It is packed with educator approved content and there are several kid safe features which prevent kids from viewing age sensitive content as well.
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Appendix C
Appendix D
The Learning Path is designed to show parents how their kids are learning from LeapPad products. It gives them a visual overview of their child’s progress and recommends additional products to aid their child’s learning.
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Announcement ofQ4 earnings, increaseof 16% compared to a Q4 2011