Tuesday, April 28, 2015

COGS: The Ratios and The Squeeze

An article has been making the rounds noting that the public believes that businesses clear a 36% profit after taxes, or in other words, net of everything.

That is, of course, an order of magnitude more than businesses actually make.  This comes from people thinking, "Gee, well, I heard they double the price before they put it on the shelf, and I'm sure there's some costs in there so they don't get to pocket the whole 50%, so, I guess... 30%?  Or 40%?  Or..."  And you average out those rectally-sourced guesses and 36% is where you land.

The problem is that "I'm sure there's some costs in there" grossly underestimates the reality.  Back-of-the-napkin math, the real average take-home profit across all of retail is something resembling 5%.  Five percent.  I get a shiny nickel when you buy that dollar can of Coke.  Or, more to the point, I split a nickel with my business partners.  As Zoe Washburne said, "At last we can retire and give up this life of crime."

Different retail scale levels produce that profit differently, however, and are vulnerable to different pressures.  Due to the alignment of ratios, big retail is about equally vulnerable to changes in occupancy costs, labor costs, and the cost of goods sold (COGS).  Small retail is vulnerable to everything, but mostly to COGS, and extremely so.  These days COGS for small retail are increasing at a frightening pace, against an MSRP that's printed right on the product a lot of the time and thus cannot be changed.  Small retailers, especially in our industry, are being squeezed by manufacturers/publishers.  And eventually some of us are going to pop.  (As it happens, Funko POP! products are one of the contributors to this problem.)

Big retail has four primary buckets, each shorthanded to 25% of gross sales but in reality with some variance.  Essentially:

  • 25% of gross sales - Occupancy.  A combination of rent/mortgage, utilities, licensing, maintenance, and so on.
  • 25% of gross sales - Labor.  Total payroll, not counting capital gains for shareholders.
  • 25% of gross sales - Cost of goods sold (COGS).  This means 75% of the price tag is markup at big retail, by the way.
  • 25% of gross sales - "Bottom line."  Includes debt service, capitalization, advertising and branding, litigation, taxes, and somewhere in there, around 3% to 8% final profit.

The 25% is good for visualization but in reality occupancy is slightly less, COGS is usually slightly more, and there exists all manner of room for creative accounting in "bottom line."  Labor tends to land right at 25%, though.  I apologize that I'm not citing a source on this, it's something I've learned so repeatedly and since so long ago I couldn't answer for it, and my Google-fu is failing me on locating a primary source.

The restaurant industry, by the way, is so much simpler:

  • 33% of gross sales - Food.
  • 33% of gross sales - Labor.
  • 33% of gross sales - Everything else.

Right away looking at the big retail cost buckets, you know small retail should be sunk because small retail pays so much more for COGS.  We do make up some ground in the other areas, particularly when we rent downmarket or utilize other non-prime commercial space.  Here is how that stuff breaks out for DSG and stores like it:

  • 15%-17% of gross sales - Occupancy.  Which is why there is no game store at the Scottsdale Quarter.  Breakpoint (mall) rent is 8%, so your middle-of-the-bell-curve game store is probably paying about that, with the rest of occupancy coming from the other line items.  Renting downmarket (a dump, in other words) definitely lowers the pressure, but introduces other problems.
  • 22%-25% of gross sales - Labor.  Try what you want, it's tough to escape this figure without being a one-worker shop.  We sometimes shave a dollar here or there by virtue of attracting people who would rather make $9/hr with us than $10/hr at Wal-Mart.
  • 50% of gross sales - COGS.  More on this in a moment.
  • 8%-13% of gross sales - "Bottom line."  Which is why if you get into any significant debt as a hobby game or comic store, it's tough to see how you're going to make any money until you overcome that burden.  Between cap, advertising and branding, and taxes, and God help you if you have to sue someone or defend a suit... yeah, you maybe put 3%-4% of gross into your pocket.  You typically need a windfall to grow, expand inventory, or survive adverse finances.

So, COGS is the real ballgame, isn't it?  And this is why it's so difficult when a customer expects us to give a big discount -- after all, we bought it for around half the price, right?  What's so bad about ten percent?  Well, that's all our profit and then some.  That's a loss, actually.  Do that enough times and we won't have to worry about discounting anymore, or showing up to open the door.

The above, of course, puts forth an assumption that the retailer is keystoning, or marking up the item to double what they paid.  In an industry like hobby games and comics, where there is often an MSRP printed right on the box or book cover, the store owner cannot always do that.  When prices in distribution go up, all of a sudden profit goes down, because usually the store can't just mark the item up however much is needed.  Your local coffee shop can do this, Jim's Comics can't.

But what about buying Magic cards on the cheap?  Yes, that does happen.  So, let's explore COGS a bit further with that in mind.  With the real COGS having gone up to ~54%-56% for SKU merchandise, the store has to make that up somewhere.  For TCG singles and used comic books, there exists a curve: COGS may be as much as 75%-80% for fast-turn, red-hot Standard staples, as little as under 1% for long-tail slow-turn commons.  The mean is around 44%-46%, offsetting the SKU markup in the aggregate.  In other words, the store only paid $3 for your $10 Commander single because: (a) It will sell slowly; (b) Its value might drop; (c) It offsets higher costs elsewhere; and (d) They probably already had several in stock, so your one card has a lower probability of enabling an otherwise missed sale.

It would take another post entirely to get into the price manipulation in the cesspool that is "MTG Finance," but suffice it to say there is a great deal of abuse going on and it's enough for me to recommend stores that don't have expertise on the payroll stay out of singles entirely for now.

There is a certain equilibrium in these ratios: given a normal healthy velocity of movement of goods, you don't build up too much deadwood, you don't lose too much to the clock or calendar in overhead, and at the end of a $60,000 month, the owner gets to pocket about three grand, give or take.  Probably the owner leaves at least half of that in operating capital and gets an extra thou in savings and/or that year's Christmas fund.  But all it takes is a price hike on a major product line, with no corresponding increase in MSRP, to wipe out those gains.

At the end of 2014, Wizards of the Coast increased the COGS on Magic: the Gathering products by 4%.  (They spun this as a "2% discount reduction.")  This represents significant money for a store.  Even now, with DSG's more and more diversified offerings, Magic is the single largest product and accounts for a plurality of sales, ahead of runners-up Accessories/Supplies (itself a category tied to Magic) and Comics/Toys/Media.  Magic is a mile ahead of board games, healthily ahead of minatures, and RPGs may as well not exist.  The COGS difference cost DSG almost two grand in March 2015.  (From that you may derive some assumptions about our revenue.  Save yourself the time; there was a new release that month so it distorts the totals.)

Cue the GAMA trade show back in March, at which retailers bombarded WOTC with complaints about the price increase, along with reiterating our existing complaints that WOTC does not do enough about the devaluation of their product by online box flippers making only a few dollars per box, or about the Magic "clubhouse" stores, barely more than closets established to get some ascended player wholesale access to discounted product, that are somehow Advanced Plus stores, further undermining the efforts of diversified in-it-for-the-long-haul game and comic stores to remain healthy.  We complained at and after their Premier Presentation, we complained at the WOTC booth on the exhibition hall floor, we utterly let them have it.  If you are going to soak us like this on our COGS, we fumed, couldn't you at least raise the MSRP to $4.99 per pack?

And do you know what WOTC said?  (EDIT: Since there are some Facebook threads going around misrepresenting me on this despite my clear caveats in the previous text here, I want to be exceedingly clear that I am recounting from memory and that this is most assuredly not WOTC's phrasing, but is mine, and should be taken with a certain degree of editorial intent.)   WOTC said that they do care a lot about the devaluation of their product, both real and perceived.  They do care about the health of the industry at the front-line retail level, and they do have concerns about the clubhouse stores having a parasitic effect and the online box-flippers training the customer base to buy in volume at bottom price online rather than buying where they play.  The wholesale price increase, coupled with no change in MSRP, is expected to make it more difficult for the online box-flippers to sustain their practices, while not having as pronounced an impact on established, diversified stores.

Reading between the lines, especially if you are up to speed on the context within the industry, it is not hard to infer the full message, though now we're back to my editorial and not WOTC's explicit statements.  The powers-that-be do not believe that the clubhouses/FNM closets/corner Magic stores are a sustainable business model or healthy for the industry as a whole.  They would rather see full-spectrum game and comic stores prevailing, because in the long run that grows their business profitably and sustainably.  WOTC intends to be Apple, not Android, focusing on strong branding, product quality, and profit, not on pure market reach in a race to the bottom.  I acknowledge the legitimacy of this objective and I think it will work.  But it still takes money out of my pocket and the mouths of my children right now, so I'm grousing about it despite the fact that I support the underlying plan.

For all that, the price increase only meant WOTC's COGS went from 50% to 52% direct and only slightly more in distribution.  Look at this murderer's row of high COGS against MSRP:

  • 55% - Cryptozoic Entertainment.
  • 55% - Fantasy Flight Games.
  • 56% - IELLO.
  • 56% - Mayfair Games.
  • 57% - Funko Direct.
  • 58% - Games Workshop Direct.
  • 60% - most toy and statue manufacturers via Diamond.
  • 62% - Pokemon USA.
  • 65% - BattleFoam Direct.
  • 65% - Dark Horse Comics.
  • 65% - The Upper Deck Company.

Anyone curious to know why I don't have a deep catalog of the last ten years of Star Wars trade paperbacks, or why I order light on Firefly/Serenity books despite them being proven sellers?  Anyone curious to know why I don't mind running lean on the Legendary deckbuilding game?  Now you know.  Literally not worth carrying except as customer care/courtesy.

Importantly, a few short years ago virtually all of these were at 50% COGS or much closer to it.  This is the Squeeze.  This is where small hobby game and comic stores have been bled, despite booming volume and increasing grosses.  This is where danger, present and future, lurks, and if my company should ever go belly-up and close its doors, it will be because of COGS more than any other thing.

I should caveat all these numbers by saying that distributors tend to have pricing tiers that can affect your percentages one way or another on certain product lines; on others, there is a discount cap and no amount of volume makes things any better for a store.  Also, I may have overlooked somebody in each case, and any errors are mine.

So, who are the COGS all-stars in our industry?

  • 52% - Asmodee.
  • 52% - WizKids.
  • 52% - Wizards of the Coast Direct (Magic).
  • 50% - Wizards of the Coast Direct (non-Magic).
  • 50% - Marvel Comics.
  • 50% - Paizo.
  • 49% - Chessex.
  • 45% - DC Comics.  Sometimes better with incentive offerings.
  • 42% - Image Comics.  Sometimes much better with incentive offerings.
  • 35% - Game Salute.  Wow.  If only their games were better sellers.

Some companies are net priced, which means there isn't an MSRP and we can just keystone it regardless of what our cost is.  As long as the manufacturer itself isn't selling the item on Amazon for a miniscule markup, that works great for us, it lets us adjust to costs and have the math work out.

Net-priced heavyweights:

  • Ultra-Pro.  Oh man, Ultra-Pro.  It's probably the best thing about them.
  • EnterPlay.
  • KMC Card Barrier.
  • Rio Grande Games, kinda.  Their games ship NPI on the invoice but each has a "price."
  • USAopoly.
  • Worldwise Imports.
  • BCW Supplies.
  • Pretty much all food and drinks.

You can see all of that is in the storage, accessories, or board game categories, pretty much.  That is where we are free to adjust pricing to reflect the reality of COGS and still make payroll week in and week out.

There is one final category, of course: Not Available Through Distribution, or effectively so due to exclusives beyond merely being only Diamond/Alliance or some other channel that your typical U.S.-based game or comic store can at least readily utilize.

  • Cards Against Humanity.  Amazon and Direct only.
  • Geek Out.  Amazon and ACD only.
  • Ultimate Guard Deck Protection.  Lion Rampant Imports (Canada) exclusive.
  • LEGO.  The worst, since it's direct-only for any kind of sustainable discount, and InterLEGO is not accepting new direct accounts at this time.

As much as I can see the profit in those lines, and the turn rate especially for stuff like Cards Against Humanity, I won't ever sink too much capital into them because of how cumbersome it is to procure the goods.

Thirty-six percent.  Human beings walking around on this earth, and voting no less, think businesses pack in profit on the level of 36% take-home.  It's such ignorance I am amazed they can successfully put on their pants every morning, and yet here we are.  And that is why the jackwagon playing X-Wing keeps telling people they can get the StarViper on Amazon for six bucks less if they want to.

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