Friday, September 28, 2018

How Game Stores Work

This is (perhaps) a series of posts about the basics of understanding how a game store works, and as it's fairly typical of retail, how most stores work. I'm going to attempt to keep this at an extremely basic level, covering things most consumers don't understand, and admittedly, some concepts I didn't understand when I started my own store. If you have concepts you're having a hard time wrapping your head around, please leave them in the comments and I may write about those next.

The purpose of the game store is to make money. When I say "money" I mean net profit. Net profit is what's left over after you pay for product (50%), rent (15%), wages (15%) and the rest of store expenses (15%).* If you just did the math, you may have realized there's a missing 5%. That's your net profit. So when you sell a customer a $100 board game, your net profit will end up being about $5. If you've got your business really dialed in, it may be as high as $10. It will never be much higher than that. Retail in general is in the 1-10% range of net profit. Most of the business world tops out at 15%.

Making money is incredibly hard. Some will look at my statement of purpose and become offended, but let me tell you, nobody accidentally makes money in retail. Look at your personal income and expenses now and how hard they are to manage. Now blow them both up by 10 to 20 times while trying to come out with that 5% excess at the end to be profitable (not at the beginning, which is how personal finance works best). You are like a millionaire who has to worry about toilet paper prices. Half the community feels sorry for you for your toilet paper problems while the other half thinks you are wealthy because of your gross income. You will be pinching pennies while being regularly asked for donations.

Money is made in the buying. Stores buy from suppliers or directly from the publisher, receiving a discount from the retail price, also called margin. So a $50 board game might cost a store $27.50, providing the retailer a 45% margin (which also equals a Cost of Goods of 55%).

You buy product based on your cost of goods. This confused me in the beginning, but if I sell $10,000 of product this week, and my costs of goods is 55%, then I have $5,500 to spend on games the next week. In fact, I very much need to spend this money to maintain sales levels and pay expenses. If I spend under this number, I am screwed as my sales will fall and I can't pay my bills. If I spend over this amount, I won't get increased sales, and I won't have money to pay my bills. You need to spend ALL the purchasing budget, no more and no less.

The hobby game store is built around a roughly 45% gross margin on product (which used to be higher). All retail is based on a particular margin with a particular level of sales acceleration (or turns) that provides a traditional gross income to cover traditional expenses. When the margins begin to shrink or the sales begin to slow, stores are forced to modify their traditional model, perhaps with weaker locations with cheaper rent, less staff, or tricks to make it all work, like selling high margin used merchandise. Store owners work harder for less. As you see the retail tier of the hobby game trade begin to falter, you see an increase in hybrid stores designed to counter changing conditions.

The traditional retail model is on shaky ground. Despite having 7-10 times as much commercial real estate as the country needs, rents seem to only go up. Minimum wage in many urban parts of the country are rising 5-10% a year with no end in sight. Energy has gotten more expensive resulting in higher electricity and shipping costs. Prices are inelastic in the game trade, so they cannot be raised to compensate for rising costs. You can only sell more, find a cheaper way to run an operation, or close. This level of crisis is baseline in retail.

Why do publishers need game stores? Publishers believe game stores get their product out to a wider swath of consumers than they could accomplish through their own marketing, which is often weak to nonexistent. They believe game stores create community and build markets, but they almost all sell direct to consumers anyway. They want it both ways.

In the game trade, publishers compete directly against the retailers. Publishers often provide customers discounts, sell early at conventions and offer unique incentives to undercut retailers and capture sales. This use of "multiple channels" has many excuses attached to it, but in general, publishers don't believe they can sit and wait for retail stores to push their products in a crowded marketplace, and they're generally correct. It's their stuff, they can do what they want.

There's a general tension in the partnership between publishers and retailers. Although nearly every relevant publisher is also a competitor, retailers let this slide, providing publishers are competing against them on only a slightly tilted playing field, often while providing some brand value protection (which protects retailers from each other). So although Games Workshop will sell direct only items on their website, they also provide enough brand value protection to make selling their front list product a profitable endeavor.

Companies like Paizo offer PDFs and a discount to subscribers that retailers can't participate in, which results in many retailers deciding not to carry Pathfinder products. Publishers will all compete against retailers, they'll all find minor advantages, but when a minor advantage becomes a huge advantage, most retailers walk. The same is true with product badly devalued online. The marketplace is big enough for retailers to shun devalued product.

The exception is when velocity overcomes margin and a product is just too good to drop. Consumers can buy D&D books on Amazon at distributor costs and Wizards of the Coast is now selling Magic boxes at very low prices. The de-facto MSRP of a Magic box is now $95, leaving a 17% margin for retailers. Is that enough to crush retailers who are Magic centric? Not if they can keep their velocity up (Pro tip: they can't, so don't be Magic centric).

But what about Amazon and the Internet? It depends. The Internet only accounts for around 12% of all sales nationwide, but it might be as high as 50% for hobby game product. There is still a lot of meat on the bone, so to speak, although those with distressed local markets, which is a godawful lot of the country nowadays, will feel Internet price pressures more than higher income, urban markets.

It's possible there may be a ratio of customers to brick and mortar retailers that falls dramatically with Internet price pressures that is felt more keenly by smaller markets with fewer customers. For larger markets it's possible to grow faster than the shrinking ratio. A bit like finding a job, you only need one customer base and what everyone else is doing is not so important.

How much do most store owners make? This is the realm of bistro math, as we don't have much data to go on. In general, most game stores are small. Lets call them $200,000 a year endeavors. A $200K a year store has a working owner who makes a small salary. Lets call it $30K a year. If they have a 5% net income, that's another $10K a year, bringing their income to $40K. This is known as a Buy a Job, and the owner can't get sick, go on vacation, retire or likewise show any value from this bought job after they decide to quit. Their businesses are valued at the liquidation number.

About 5-10% of stores are alpha locations that do over a million dollars a year in sales. The owner might make that same $30K base salary, but their net profit on $1,000,000 is $50K, meaning they make $80K as their income. As an alpha store has usually been in business 10-30 years, that might provide a reasonable lifetime salary range for a long term retailer ($40K-$80K). Neither amount is very much money, considering the skills needed to run such an enterprise, and most store owners in a Buy a Job are usually trapped without the ability to grow or expand to alpha status.

Got questions? Ask below...

* Yes, it's usually something like 55%, 14%, 13%, 13%, but you get the idea.

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