Games * Design * Art * Culture

Friday, February 02, 2007

Are Retailers Actually Screwed?

Yesterday, both FireGameBiz and Game Daily linked to a statment from DVD Empire lambasting the game industry for screwing retailers, in explanation for why they (primarily a movie retailer) are going to stop selling games.

The crux of the argument is:

"When we sell a game we make on average 8.3% gross margin. That does not take into account any of the cost to store the video game or labor to receive/ship an item. The only way we can make a profit on an item is to sell it over the MSRP, but unfortunately we are not allowed to do this. Take a $400 console; we only make $5 on the sale--that is a 1.25% gross margin. The game companies make their profit selling to us. We make no profit selling to you."

They have a point here, although their margin is smaller than most--typically, retailers pay more like 80% of the retail price. DVD Empire says they're a "small" retailer of games, and purchase through a distributor (which takes a cut), which probably explains the discrepancy.

And I agree that the wholesaler/retail discount structure of the video game industry is about the strangest of any industry I've worked in. Here are some comparisons:

Book publishing: Retail discount is typically around 50%, although it can rise as high as 60% for non-trade outlets buying in large volume.

Hobby game industry: Standard terms are called "50 10 and 5", meaning a 50% discount off the top; an additional 10% off the remainder for purchasing in bulk; and an additional 5% for paying within 30 days, for a net discount of 57.5%.

Toy industry: There's no concept of a standard retail price--toy outlets don't like to be told what to charge. Instead, the manufacturer sells at a fixed price, and the toy store adds whatever they want onto this. (Which is why, incidentally, you shouldn't believe a toy store when it claims that something is X% off; it's X% off some notional price that they might have charged, or that they estimate some other toy store somewhere might be charging.)

In other words, the retailer's margin in the game industry is drastically lower than in most.

How do retailers survive? In two ways. First, retailers often--indeed, usually--make more money off what's called "Market Development Funds" (MDF) than they do off the actual retail sale. And what is MDF?

It's what Dan Schirlis calls channel bribery. Publishers pay for shelf-placement. They pay for front-of-store or cash-register displays. They pay to have posters or other promotional crap in the store. They pay to have staff wear t-shirts promoing a particular item. In general, when you walk into a GameStop, it isn't the manager who decided to arrange things as you see them--everything in there is positioned by negotiation with the publishers, and everything has been paid for.

Now, the same thing happens in other industries--supermarkets, in particular, are notorious for shelf-placement fees, and the front of store display you see at Borders is also paid for--but in most industries, MDF is small by comparison to net revenues received via actual sales.

DVD Empire blames "publisher greed," and there's some truth to that; essentially, as retailers gained clout, they negotiated MDFs as a way of redressing the small net margins publishers were offering. It works, sort of, but there are several unfortunate impacts.

Small Retailers Are Screwed

Why? Because they're too small to be able to negotiate an MDF deal with the publisher. In fact, they're too small for the publisher to be willing to sell direct either, so they wind up dealing with a wholesaler, who naturally takes a cut. Seen many mom-and-pop videogame stores recently? Now you know why--and why, also, the ones that remain sell mainly used merchandise.

But DVD Empire's claim that retailers as a class are screwed is wrong--Gamestop and Wal-Mart do just fine with games. It's non-chain retailers who get screwed.

Retailers Push Used Games

Publishers, and many developers, hate the fact that Gamestop pushes used games so heavily--and resent the sales they feel they're losing as a result. In fact, there's been a lot of talk over the years about how to reduce used game sales, or even find some technical way to make them impossible.

But their own discount structure push retailers toward used game sales, because the margins on them are so much higher--they typically buy a game for half or less of what they sell it for. That's why the clerk at Gamestop will always offer you a used version of a game when you take the new one to the counter, if they have a used copy in stock; you'll save a little money, and they'll make a lot more. Notice that Borders doesn't sell used books, Virgin doesn't sell used CDs, and while Blockbuster may sell its rental movies when they get old, they don't purchase used DVDs and resell them.

In those markets, it's not worth their while; if they did bother with used product, the margins would be no better than for new product, and dealing with thousands of people bringing things in to sell back and tracking all this inventory would be a nightmare. It's easier just to sell new product.

There are markets in used books, CDs, and movies, of course, but they're marginal, mostly handled by small mom-and-pop outlets.

If the game industry wants to reduce the impact of used games, there's an obvious and simple way to do it: Change the retail discount structure.

And finally....

Small Publishers Get Screwed

Why? Because they don't have megabucks to throw around on MDF. In book publishing, say, a small publisher like Four Walls Eight Windows might well be able to persuade the buyer from Barnes & Noble that a new book they're publishing is a potential best-seller, and get them to give it a little promotional push--B&N will benefit if it does indeed sell, because they make money by selling books, not by selling shelf space.

In game publishing, by contrast, the retail buyers have no incentive to make similar decisions; since their product is shelf space, the main thing they care about is selling that, and EA has bigger pockets than, say, Strategy First. Might a new game from Strategy First be a potential best-seller? It might--but unless they can scrounge up enough money to pay substantail MDF, it's pretty likely to get lost in the store.

It Reinforces the Industry's Hit-Driven Mentality

In every other industry, there's such a thing as a sleeper hit--a product that doesn't receive a lot of marketing attention at first but that, through word of mouth and good reviews, starts generating some sales velocity and ultimately--months, sometimes even years later--becomes a best-seller.

Additionally, other entertainment media try to keep older classic product around--it doesn't sell at the same level, but it's a service to customers: the browsers at the science fiction shelf like seeing classic works there, and a music fan who likes a new album will often decide to pick up a previous one from the same artist. So things stay on the shelves longer, and there's at least the possibility of letting word of mouth do its work.

This doesn't happen in games. In fact, it can't happen in games, because the retailers are selling shelf space, and if a game isn't acheiving velocity in the first few weeks after release, it needs to be removed to make room for the next title. As a result, the sales window for the game industry is vastly smaller than in most others: two weeks typically. Even mass-market paperbacks typically get six.

Conclusion

So yes, game retail is kind of screwed up. But it also works for the largest players on both sides of the equation--the chains, and the larger publishers. These kinds of business practices are very hard to change once established; indeed, because anti-trust laws prohibit collusion, the only real way they can be changed is for a dominant player to change them. EA might be able to do it, or Gamestop--but of course, both do perfectly fine off the way things work today. So it's not likely to change.

About the only thing that might change things fundamentally, really, is some fundamental disruption--like, say, a move to distribution by direct download. But of course exactly how that will play out is unclear, and there are no guarantees that the ultimate result will be better.

posted by Greg at 3:58 PM 29 comments

29 Comments:

Great info to see, broken across categories. Definitely makes stuff make more sense.

I'm very familiar with the pains of being a small press publisher with Greatest Uncommon Denominator Magazine. Small print runs, at the moment, mean we can't afford to go with a major distributor--every copy sold up front would be a loss, selling at 50-55%, and then with half of what was ordered, on average, being destroyed, unpaid.

Have to love the catch-22s.

Meanwhile, people don't seem to be picking up on electronic sales as much as I'd hope. I expect that's easier, at least, in the game field. ((We sell print + pdf))

By kaolin fire, at 5:59 PM

Thanks, Greg. That was an intriguing read both for the video game specifics and the comparisons to other industries.

By Shannon Appelcline, at 6:13 PM

Thanks for taking the time to write an intelligent article. All we wanted to do was give our customers a reason for dropping video games. Yes, we are pissed but this is only because video games was one of our prized divisions and seeing it go is disturbing. We are not on a crusade to change this industry, there is no hope for that. Also, the decision was more about not being able to provide a quality level of service to our customers, but everyone is concentrating on the inability to make money. Thanks again.

By Jeff, at 12:18 AM

A little clarification on the toy industry - there is definitely a concept of manufacturer's suggested retail price. In general, there is a 100% markup (toy manufacture sells product for $1, retailer sells it for $2). For big chains like Wal-Mart or Toys R Us, they pay less than the $1, but still charge $2, or have the flexibility to charge less than the smaller retailers. They get the better price because of the volume. Discounts based on paying within a certain amount of time, buying in bulk, or buying into certain programs are common.

By Anonymous, at 12:41 AM

Yes, they're screwed in the long term. And probably hurting in the short term.

This where they should take the hint.

Record stores are closing because of downloaded music. They didn't see the writing on the wall and start stocking MP3 player accessories or any consumer electronics.

Book stores are closing for similar reasons. Who can compete with Alibris and Amazon?

Games stores next...

By matt, at 1:35 PM

jeff, may i ask you to shut up?

we don't care about losers like you in our nice contry.
lets joust imagine the electronic arts and gamestop owners, laughing all the way to bank, and dream about these being ourselves, perhaps reinforced by some cool hollywood movie with some ferraries, big yachts and some other craps.

isn't beautiful?

By coco, at 2:32 PM

Oh, fer chrissakes, coco... He's just trying to run a business, and still be responsive to his customers. And he has a point.

By Greg, at 8:32 PM

This may just be conflation, but could a successful strategy for a small box publisher to offer a retailer a much better discount structure and a similar MSRP?

By failrate, at 3:40 AM

of course that he has a point, and in my opinion, he is right.
my highest respects to you jeff.

if it wasn't noticed, i was being corrosively ironic, subtlety making a critic about the american system, and the culture that promotes that system. I was hopefully trying to point to the root of the problem. sorry for the misunderstanding.

in my opinion this event is part of a larger scale trend, of progressively fewer elites, destroying competing groups, and concentrating an increasing amount of power.

me, for my part, doesn�t feel happy and lazy, while some x guys accumulate immense amounts of power.

it is impossible to understand, much less to visualize a solution, from an isolated case of the phenomenon, if we don�t understand the large scale trend.

its becoming time, to our society to revise his instance on the topic.

By coco, at 5:44 AM

No, Coco, you were being a twat. Perhaps rightly so, but you're talking to the wrong people about the wrong subject - if you want to go be a revolutionary, go find an appropriate forum.

I'm with Failrate here. Small shops are losing out and small distributors are losing out. Rather than try to beat the big boys at their own game, couldn't they try a new discount structure (perhaps biased more towards sales and less - if at all - towards MDF?) that would give the distributors' products fair prominence and allow the retailers better margins?

I realise it's perhaps a bit of a scary step for a single distributor to take, but surely it's better than folding?

I guess the retailers won't exactly want to tell the large distributors to go play with themselves, but then companies like DVD Empire no longer have to...

By Zild, at 8:34 AM

Minor observations... Blockbuster does actually buy used movies. You essentially trade them in for store credit.

By Anonymous, at 12:00 PM

Well, could we follow the book industry model?

The only mom-and-pop bookstores I see these days deal in rare books. Where are the "rare game" stores, where I can pick up vintage copies of NES games (or for that matter, Apple ][ games on their original floppies)?

Granted, that doesn't help small publishers.

By Ian Schreiber, at 12:07 PM

I wonder about the feasibility of a Mom and Pop distributor... Maybe that's what the small devs and small retailers need?

By Zild, at 1:05 PM

zild, the insult was not necessary. anyway, in the future I will try to be less ideologically aggressive

By coco, at 1:17 PM

Yes Coco, you are out of line altogether with your crackhead ideological thread hijacking. Stop it.

By Anonymous, at 3:11 PM

Why can't small publishers simply offer bigger wholesale discounts? A group of small publishers could form a joint distributor to cut costs and make stuff more efficient when dealing with retailers. This way, everybody wins: the small retailers get a bigger cut (and get to form a "niche" for themselves), and the small publishers may lose a bit on each title, but their titles will get better exposure and thus sell more.
I can't see why there has to be an industry standard for these discounts, and why small publishers can't just break it.

By iod, at 5:43 AM

iod: Thats a fine idea, and in a perfect world maybe it would fly, but the point I think Greg was trying to get across is that for the biggest players (the major retailers and big publishers), the system works really well. Smaller publishers just can't compete with the kind of margins they're pulling in. It's not like people haven't tried (remember G.O.D.?), it's just not feasible.

By Aurelio, at 10:53 AM

It is interesting that in my home town of San Diego, small time, ("mom and pop") retailers of computer games have disappeared.

There used to be a few of them around but now they are all gone. There is one indy board game store that I know of, but they don't sell computer games.

By Anonymous, at 2:38 PM

Another observation, this time of the exception-proves- the-rule variety.

Pokemon was a sleeper hit game.

It didn't hit the US until two and a half years after its initial release, and Europe a year after that. It's now over a decade since the original release and its still going strong, although it's now kept alive through constant 're-imaginings'.

Why did it ever catch on though? Game Boy cartridges have an unusually long shelf life for some reason (Nintendo doesn't pay MDFs? Offer better margins?) and that may well explain it.

It certainly proves that sleepers can be profitable. Very profitable.

By AndyKrouwel, at 10:46 AM

@ian schreiber:

Here in the UK we have a national chain that deals in rare and retro games, it's called gamestation. I've seen all sorts of weird and wonderful things in their windows (from vectrex to virtual boy).

They also deal in modern games, mostly second hand, probably for the reasons explained in the article. Gamestation do very well, my local store is always busy, but I get the feeling they couldn't survive on retro game sales alone.

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