CINCINNATI — FAO Schwarz will open toy stores in nearly 700 Macy's department stores over the next two years in a move that both stores hope will drive traffic in a tough economic environment.

The two companies announced yesterday that about 75 full-size FAO Schwarz toy stores will open across the country in the fall, along with about 200 smaller shops that will be up to 300 square feet.

Macy's shareholders learned of the venture at their annual meeting yesterday.

Officials with Macy's in Hawai'i yesterday said details were still being arranged, but that they expect some of the chain's 15 stores in the state to be included in the FAO Schwarz plan.

Macy's operates 12 full-line department stores in Hawai'i, but also has three boutique resort stores. Overall, Macy's has more than 800 stores.

Macy's CEO Terry Lundgren told shareholders that FAO Schwarz will open stores in up to 275 of Macy's stores this fall, and the companies plan to expand over the next two years to include 685 Macy's stores that have children's departments.

"We expect it to drive new customers into our stores and to insert a new level of fun and excitement onto the children's selling floor," Lundgren, who is also chairman and president of Cincinnati-based Macy's shareholders, told shareholders.

Lundgren said FAO Schwarz gave its first Macy's store-within-a-store a trial run in Chicago late last year.

"Not only did it perform beyond our expectations, the entire children's apparel business performed well above our expectations," he said.

Lundgren told reporters after the meeting that the deal was one more step toward reinventing department stores — one that he said would give customers another reason to choose Macy's over its competitors.

Patricia Edwards, a retail analyst with Wentworth, Hauser and Violich, thinks the move is a good one.

"Macy's had gotten away from having a toy department, but I think that if you can incorporate more of the shopping experience and give the consumer one more reason to come into the store and keep them in your store longer, it's a good thing," Edwards said.

FAO Schwarz CEO Ed Schmults said yesterday that products in the smaller shops will be from the FAO private label collection, but the larger stores will carry a mix of private label and other brands sold by FAO Schwarz. The 146-year-old company continues to independently own and operate its own stores, including a flagship store on New York's Fifth Avenue.

FAO Schwarz now employs about 400 people, but Schmults expects that number to more than double by year's end.

The deal was appealing to the toy retailer because of the national scope that Macy's provides and the opportunity it gives FAO Schwarz to bring its stores to local communities, Schmults said.

Macy's, formerly known as Federated Department Stores Inc., operates more than 850 department stores in 45 states, the District of Columbia, Guam and Puerto Rico, under the names of Macy's and Bloomingdale's.

"I think it's a fantastic opportunity for us to drive our market share," Schmults said.

The deal is another in a growing number of strategic alliances among retailers, said Wendy Liebmann, president of WSL Strategic Retail.

"It's the strategy of the day," she said.

The choice of a toy brand was new, but it didn't surprise her.

"If people are spending anything on anything beyond groceries and gas, they're spending on their kids," Liebmann said.