Tuesday, February 24, 2015

Repost: Five Unseen Costs that Threaten Game Stores

It seems like cost has been the topic du jour here at The Backstage Pass, so this may be an ideal time for me to revisit the fourth of the five articles I wrote for GameHead back in 2012.

I'll actually editorialize directly within the content this time, because I think I hit all five cost topics correctly but my analysis today is a bit better informed.  I also think that while those five are still extremely important, I missed at least two other critical unseen costs: Stock Underperformance (both breadth and depth) and Labor-To-Product Efficiency.  I'll discuss both at the end.

Five Unseen Costs That Threaten Game Stores
by Michael Bahr
Originally published 25 September 2012

Pete Proprietor, owner of the fictitious Rocky Mountain Gamesters (RMG) in remote northeastern Arizona, is an intelligent game store owner who came to town with a thick bankroll and a great business plan. Pete opened RMG in a great shopping plaza with a beautiful fixture buildout and cutting-edge point-of-sale infrastructure. RMG grew a solid community of players and has regular traffic providing consistent cash flow. The part-time employees keep RMG clean and attractive. Pete's rent and utility bills are reasonable, and he even gets free haircuts from the barber shop next door in exchange for referrals. RMG has been open for six months and everything appears to have gone according to plan.

And Pete is about to go bankrupt. 

Somehow, it hasn't added up. Despite good margins and income, RMG is bleeding cash. It started as a blip on the radar in the early months, a net return figure 10% lower than it should have been. Then it snowballed. Pete's net shortfall actually got worse in the month of the highly anticipated new Magic: The Gathering “Risen Empires” expansion. Every month, the shortfall grew larger. Pete missed payroll for the second time in a row and his two part-timers quit. Pete had to use inventory seed money for bills, and the shelves began to thin out. JHC Distribution cut Pete off on his net terms, and now every order is “COD--Cashier's check.” New releases have stopped showing up on time, and just this week the store ran out of Magic “Persian Nights” boosters before draft night, prompting grumbles from RMG's loyal player base. The Arizona Department of Revenue is fining Pete for being late paying his sales tax. RMG is falling apart at the seams. How can this all have happened, when Pete was doing everything right?

Pete had control of the costs he knew about, the costs that are “seen.” The costs that are causing Pete's demise with RMG are the ones that customers, and even many owners, fail to see. Pete Proprietor, for all his acumen, failed to see these costs until it came time to reconcile the books.

1. Shrinkage

Everybody knows about shrinkage, but few have experienced just how pernicious it can be. Shrinkage is particularly bad in hobby gaming retail, where too many store owners use a “dumb” cash register and manage inventory by pencil and paper and the vagaries of proprietor memory. A game store cannot protect what it cannot measure, and it cannot measure what it cannot track. The necessity for a proper point-of-sale software infrastructure cannot be emphasized enough. (This writer would go one step further and assert that only Microsoft RMS for Windows and Light Speed Retail for OS X are really adequate to the task, and QuickBooks 2012 on the back end is not optional.) 

Software goes a long way toward controlling internal shrinkage (employee theft), but only really helps identify external shrinkage (shoplifting) after the fact. Other factors play a larger part. For store layout, are expensive small, easy-to-pocket items out where customers can handle them? No customer is going to walk out the door with a copy of Ascension: Shuffling of the Thousand under his shirt, but a booster pack of Pokémon Mauve & Orange is much more “portable.” High-risk items have to be out of arm's reach, no matter the slight diminishment in sales interest that results. What about visibility? A single employee standing at the cash/wrap till should be able to see every single product display in the store without leaving that spot. Are there dark corners? Or dense product stacks in high-traffic corridors? For that matter, is there a security camera system in place?

Unfortunately, a shopkeep cannot even count on the goodness of humanity. That kid wearing the “Jesus Loves You” t-shirt? The one who would never, ever, ever pocket so much as a candy bar without paying for it? Yeah, he has an entire squad of Space Marine Deathbreathers distributed among the pockets of his cargo shorts. He nicked them when you let your guard down for that split second. And he'll do it again. 

Shrinkage can never fully be eliminated, but good tracking, good store layout, good security equipment, and good vigilance can reduce it. Shrinkage at mainstream retail has been estimated anywhere from 2% to 7% depending whose figures you believe; I would be shocked if hobby gaming shrinkage were less than double digits.

2015 observation: Shrinkage has been a factor at Desert Sky Games and Comics despite our having excellent point-of-sale and security infrastructure.  Without giving away too much sensitive information, I have had to reconfigure the retail area to a great extent to mitigate loss-heavy regions and make lossy product groups less physically accessible.  This is particularly frustrating because in retail you get far more sales when the product is out where the customer can pick it up and examine it.  We have received complaints about the inaccessibility of some items.  Unfortunately, we just don't have a feasible deployment to put those items floor-first... yet.  This remains a work in progress.

An interesting sidenote: the ComicSuite point-of-sale system is Diamond's custom build of Microsoft RMS.  For a new comic-centered store opening, I would recommend that system to the exclusion of all others, including our own Light Speed.  Also, QuickBooks Online is slower than the client software, but far better in virtually every other respect, especially when it comes to paying payroll and taxes.  Oh Lord, I'll never go back to brewing my own on those tasks.

2. Freight charges

Modern point-of-sale systems such as the aforementioned RMS and Light Speed allow every product SKU to have its costs listed by supplier, so that purchase orders can be tailored to achieve the greatest savings. However, until the invoices are entered into QuickBooks, the freight charges don't figure into the equation. Many distributors waive freight for orders over a certain amount, but good inventory management often means ordering lesser amounts from multiple sources to assure that the games and accessories customers want are always on the shelf on time. My store, Desert Sky Games, has a few distributors that get large weekly orders, but deals with dozens more on a regular basis. At the end of the day, freight has to get paid by somebody, and when the price of fuel goes up, game stores feel the pinch.

Overcoming freight cost issues generally takes planning ahead and proper capitalization. For example, for small orders of concessions, a one-person trip to Costco keeps overhead to a minimum, but when supplies are low overall and specialty flavors are running out, it can be worth it to pay slightly more for PepsiCo to send out a truck with a few dozen cases rather than paying an employee to accompany you on a large Costco run and another employee to keep shop while you are gone. Ordering early and in higher quantities can allow a game store to wait out a ground shipment from across the country for arrival the following week at a much lower cost. Desert Sky Games is in Arizona, but does business with distributors on the east coast sometimes and has to ensure the logistics will work out. And sometimes a game store can get lucky: one distributor that performs well enough that it would have earned our business anyway, happens to have a warehouse in Phoenix only 20 miles from the store. When the manager grabs an order in the morning before opening the store, the only freight cost is the price of a few gallons of gas. That savings means we can acquire more inventory for our customers.

2015 observation: Fuel costs haven't been inordinate these past few years, so freight normalized for the most part since my 2012 article.  Ultimately, the effect of freight costs was a consolidation of distributors, since distributors tend to waive freight when you meet a weekly order minimum, and it became far more feasible to do so in slow weeks when dealing with fewer of them.  This works against our original principle of not wanting to depend on any given truck.

3. Merchant fees

Merchant fees mostly means credit card interchange fees, but also applies to bank account service fees, eBay and PayPal fees, and anywhere else there is a hand in the store owner's pocket that cannot be avoided if the store wants to have access to an adequate payment platform. This is a particularly dangerous area because most store owners fail to realize how bad even competitive merchant fee schedules can be, especially on small sales tickets.

A typical competitive merchant fee schedule for a boutique-volume store (such as a hobby game store) will charge around 2% of the sale price for a credit card sale, plus around a tenth of a percent in fees passed through from VISA's, MasterCard's, or Discover's national interchange network. However, that percentage is against a minimum swipe charge of anywhere from 22 to 42 cents in many cases. Remember that the typical net profit of a game store on any given sale is 7% to 9%. There is the margin on the product, ranging usually from 30% to 50%, and most of the margin ends up allocated to pay a portion of overhead: the store's rent, payroll, utilities, and so forth. If only 7% to 9% of the final sale price is actual net profit for the store, even on the low end of the merchant fee range, a sale of $2.50 or less ends up being a net loss for the store.

I am going to repeat that because it is critically important. A store making a credit card sale of $2.50 or less actually loses money. Not just “makes no profit,” but does not even fully pay the bills with that marginal amount. Depending just how small the ticket is, the store might even fail to cover cost of goods on it, after merchant fees are applied. No matter how friendly your local game store is, it is clearly not in their best interest to sell you that can of Mountain Dew for less than they paid for it.
Debit cards using a PIN entry are both better and worse: from many providers the charge is 55 to 70 cents per transaction with no percentage fee. So for a $110 box of Magic boosters, a debit sale is a great ticket to swipe, but it's a potential loss of money on any ticket less than six dollars. American Express charges even higher interchange fees than the other credit card companies, and many stores simply don't accept AMEX as a result. 

Mammoth companies like Kroger and Wal-Mart can accept credit or debit cards any time without these concerns, not only because of efficiency from volume and velocity, but because they get better terms from the banks than neighborhood boutiques like Rocky Mountain Gamesters would.

A number of potential solutions exist: not accepting credit cards for sales tickets under a certain amount, surcharging for such a ticket, or simply raising prices on the least expensive items in the store (such as concessions) so that even the smallest possible ticket is certain not to lose money. Depending on a store's location, customer demographics, and local laws, any or none of these options might be viable. Ultimately the best long-term solution is to grow sales volume to the point that the store can get a merchant account on better terms.

Minimizing eBay and other fees takes time and labor and is often realized only by stores with sufficient focus on that sales channel to tailor their workflows to the specific requirements for fee reduction. For example, eBay requires that a certain percentage of orders be shipped with a tracking number within one business day of payment, as a metric to be met to achieve a better fee tier. A store taking only hodgepodge orders from eBay once in a while may not have an efficient workflow to drop everything and pack eBay orders every day. A store running hundreds of auctions every week probably can.

2015 observation: Well, Magic booster boxes are more than $110 now, heh.  Over time and by volume with a real bank providing interchange services -- not a third party siphoning from the stream -- interchange fees go down.  DSG now pays an average of about 1.2% per swipe.  Spread out across an entire month, we don't concern ourselves overmuch with any individual transaction.  However, we do encourage players to open tabs rather than swiping three times in the evening for each of their three cans of soda for a dollar each.

4. Labor costs

Eight dollars per hour, more or less, right? That's what it costs for an employee. Figure 20 hours per week for a part-timer, and as long as you can spare $700 in a month, you've got coverage. Alas, those numbers are filthy lies. Payroll taxes, unemployment insurance, OSHA compliance, ADA compliance, and other factors typically inflate the price of an employee to somewhat less than double their hourly rate of pay. 

Fortunately, hidden labor costs become unhidden very quickly, though a lot of damage could be done by the time this happens. It is up to the store's owner or manager to determine whether or how to keep a given number of staff employed. In some cases, staff can be hired as independent contractors, removing some tax implications but creating others. Extra help may be available from “regular” customers on an ad-hoc basis, but beware of this; even paying them in store credit may technically constitute income for them and labor expenditure for the store, depending on local laws. Also, in some localities, duration limits, job category exclusions, or other requirements may apply to labor procured on a basis other than regular employment.

2015 observation: I've written at greater length as recently as last week about labor costs, but mostly the efficiency of a labor dollar spent is a function of the effectiveness of the store's workflows and management oversight.

5. Turn underperformance

This is the trickiest of unseen costs because its impact is so difficult to measure without breaking out the Frederic Bastiat and charting alternate scenarios until you pull out your hair in madness. In brief, turn underperformance comes from sinking too much money into inventory that does not sell fast enough. That money is, in a sense, “rotting on the store shelves,” rather than multiplying through sale and resale as it should.

In standard retail, a turn rate of 12 is the bare minimum for consideration. A product has to turn over at least once per month or no major national retailer will stock it. Some products turn far more quickly: cigarettes at convenience stores might turn on a weekly or even daily basis for popular brands. Business school apocrypha whispers of Philip Morris recording astronomical turn rates of 365 – a daily sellout of a store's full regular stock – for Marlboro “Reds” at convenience stores in central New York, Chicago, and Detroit in the 1970s. In the realm of less disgusting products, soft drinks and snacks tend to turn extremely fast at retail, while big-ticket items like motorhomes and boats may barely turn once per quarter. The rest of all commerce falls generally in between.

The hobby gaming industry, depending whom you ask, has an average turn rate for its array of products somewhere between three and four turns per annum. Gary Ray of Black Diamond Games has written at length on his efforts to increase his store's average turn rate through careful pruning of underperforming products and deep stocking of evergreen sellers. Mr. Ray's approach is precisely the correct one for a game store proprietor to take, but most owners fail to invest the time, the capital, or the infrastructure to create and utilize such analytics. It takes time and software to track turn rates effectively, and it takes capital to take risks on deep stocking items that appear to be hot sellers at the risk of overstocking a product that has saturated its demographic.

The wild card in gaming retail turn rates is Magic: the Gathering. A good supply of MTG booster packs, several cases worth, will sell out for a store in anywhere between one and three weeks, depending on the amount of organized play that store supports. This high turn rate means good cash flow and good revenue coming in. What this also means is that stores focused heavily on MTG will not as easily see which other product areas they have that are underperforming their turn rate. By analogy, everybody got rich in the summer of 1999 when Pokémon was the hottest thing going, but it was a rude awakening when the craze died down in early 2000 and stores were forced to rein in profligate spending habits.

The worst turn rates in the hobby industry belong to out-of-print role-playing game media, out-of-print board games, and non-investment-level out-of-print TCG singles. The common aspect of these products is that they are “back catalog.” A store should generally not endeavor to stock them at all – even at a dime on the dollar, the investment “rots on the shelves.” Money that could be spent for new releases instead languishes in an illiquid state. Through the normal ebb and flow of new releases, the back catalog in a game store will build up naturally over time. A canny owner will hold periodic clearances to recover retail footage for future releases and get a decent return out of low-turn product before it becomes completely worthless. This is another category where Mr. Ray's tradecraft provides excellent guidance: aggressive, relentless clearance of underperforming product is the key to keeping the store's average turn rate up and the store's cash flow optimal.

2015 observation: I wouldn't change a word of it.

…So, there are five unseen costs that take away from a game store's bottom line and ultimately threaten its health and viability. What about Pete Proprietor and Rocky Mountain Gamesters? 
All is not lost. Pete may yet manage to scrape together some emergency working capital, to the tune of $30k-40k. With that, he can settle his debts, buy a good camera system, rearrange his fixtures to reduce exposure, and allocate funding to higher-turning inventory while liquidating some deadwood on eBay. He can find better banking terms and switch his merchant services accordingly. His next part-time hires can be brought on under different terms to contain payroll costs, possibly as independent contractors. 

2015 observation: You pretty much can never have an independent contractor performing the work of an employee, under 2013-2014 IRS guidelines.  Just hire the person or don't.  There is no try.

Still, it may take months to years to undo the damage that unseen costs did to RMG over six months, and there is no guarantee that RMG will ever fully recover. If Pete Proprietor makes it to a kick-out point on his lease, a clause in some commercial leases that allows an underperforming store to terminate its rental period early, unless RMG's resurgence has been particularly strong, Pete would probably be wisest to close down. Despite being clean and well-located, Rocky Mountain Gamesters may end up just another failed hobby game store.

Hopefully, your Friendly Local Game Store will prepare for unseen costs and fare better than RMG did!

[End of original article]

Seems reasonable, right?  Here are the two factors I think I missed, and discovered only after more development of DSG: Stock underperformance (both breadth and depth) and Labor-to-product efficiency.

Stock underperformance is when you have product on the shelves, and it is failing to translate into sales and customer retention because something is wrong with the product mix.  In breadth, a store can fail if the customer believes there are too few options, in particular with "product pyramid" items like dice, sleeves, or trade paperbacks.  When a customer sees only a few of these things, they absorb a message that you don't care about what they like, so they shop elsewhere.  When they see a huge assortment, however, they absorb a message that this is the place to get dice/sleeves/TPBs, so they shop with you first.  It is tricky because there are product categories and families where this is a money sink and a trap.  Pathfinder RPG, I'm looking at you.  In depth, a store can fail if it constantly runs dry on in-demand product.  As with breadth, it can be a money trap.  You can't order fifty of everything or you'll choke on the overstock.  Product history and turn reports are most of what you have to guide you, presuming you don't want to depend on the horribly unreliable "how many customers have asked about it" metric.  For many board games, you just have to sit out -- a surprising number have no real market reach.  My final gut criterion is whether I'd eat the dog food if I had to -- would I be willing to buy this off the shelf myself to clear the stock if it didn't move?  If not, I have to have a compelling case to stock the item.

Labor-to-product efficiency is when a product line requires an inordinate amount of labor relative to its transaction value to maintain.  TCG singles are the primary culprit, though comics are a cautionary category as well.  Ultimately you don't want to waste your time or your staff payroll having somebody move sand from one pile to another.  I finally implemented strata-based pricing for TCG singles to, among other outcomes, eliminate the staff time spent adjusting singles in tiny increments based on the online price levels of the week.  Every time I saw a huge stack of price tags atop the gem cases in my singles cabinet, I wanted to cry.  Such waste!  With tiered price strata, singles move about the same as they ever did, providing about the same revenue level they ever did, and most importantly, they are much faster to replenish and triage.  We know the principles but still have not yet mastered our comics stock on this -- the initial pass-through is a labor loss that you hope leads to the ability to spot-check spec books later.  However, for any spec book that's only going to sit around in the $5-$10 range, honestly, I'd rather have just sold it on opening day at the $3.99 cover.  Turn speed wins over the incremental price, because the incremental price will cost me logistical labor and time to administer.  Console video games, used, definitely fall into this category as well.  Profitable and healthy and a great draw -- if you have your triage, deployment, and maintenance workflows utterly mastered.

So there is my 2015 reprise of my 2012 look at unseen costs a game store (or similar small retail store, really) faces.  I hope this explanation gives you a keener perspective at what's going on when you visit small stores -- once you've been doing enough of this, honestly, you can walk into any retail establishment and look around and it's like you're seeing the rainfall of green numbers from the Matrix code.  You comprehend the entire mechanism.  It's pretty neat.

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