NEW YORK (Reuters) - The all-important holiday season might not end up being too happy for the toy industry, according to some early data, as discounters muscle in on traditional U.S. toy retailers.

Toy sales at toy stores, which would include Toys R Us Inc. (TOY: Research, Estimates), slipped 7.7 percent, compared with last year, according to data from MasterCard Advisors, a unit of MasterCard International.

Overall retail spending grew about 6.5 percent from a year earlier, a tally of MasterCard use during the holiday shopping season showed.

The toy sales figures do not include toys sold by discount stores, said Michael McNamara, director of research products for MasterCard Advisors. "This shows that stand-alone toy stores are having some trouble."

"It was a disappointing season for the toy business," said Jim Silver, publisher of Toy Wishes magazine. "It could have been a lot better, but the pricing of toys at cost or below cost created havoc and destroyed profit margins."

There were a number of popular toys this season, including Hokey Pokey Elmo by Mattel (MAT: Research, Estimates) unit Fisher-Price, Hasbro Inc (HAS: Research, Estimates).'s handheld video player VideoNow and LeapFrog Enterprises' educational game player Leapster. But that may not have translated into strong revenue for retailers.

The early data is the latest insult in a tough year for toy retailers. FAO Inc., parent of upscale FAO Schwarz toy stores, filed for bankruptcy twice this year, and privately held KB Toys withheld December payments from suppliers to save cash.

Discount retailers have increasingly dominated toy selling. Wal-Mart Stores Inc. (WMT: Research, Estimates), the world's largest company, is the No. 1 toy seller. Wal-Mart kicked off the holiday season by slashing prices on toys. Target Corp. (TGT: Research, Estimates) and Toys R Us also cut prices.

Competition in the toy industry is cutthroat, particularly around the holidays, and this year the price war started earlier than usual.

What's more, discounters use toys as a loss leader, selling them at rock-bottom prices, and making up the profit on sales of other items.

"Wal-Mart's pricing strategy created deflation in toy prices, killing profit margins for other retailers," Silver said.

For toy manufacturers, the low prices are likely to eat into fourth-quarter profits. And there is concern that extreme discounting cheapens brand names, and slows research and development.

Confounding the problem is this trend: It's harder to keep kids in the toy aisle after a certain age, as sophisticated young consumers become more interested in "grown up" items like cosmetics, clothes and electronics.

"Maybe Christmas isn't about the kids anymore. It's about flat-screen TVs," said MasterCard's McNamara.