GW Stores Are A Boondoggle [was Re: GW sales down]

My continuing efforts to determing when I should start shorting GW stock
have now confirmed something I've long suspected -- GW stores are a
boondoggle and the company should ditch them ASAP.

Personally, I believe that GW's greatest strength lies in producing cool
miniatures and engaging backgrounds. If I were CEO, I'd sell off the retail
chain and outsource the game design work -- or design the games myself
<grin>. Then I'd make miniatures and sell the hell out of them.

GW's alienation of the local hobby store owners is particularly mystifying.
While the local stores account for 42% of sales dollars (down from 50% when
sales were much higher), they must account for a huge majority of products
sold. Here's why.

1. GW sells a blister to a local hobby store for 45% of list price. So a $10
blister produces $5.50 in gross income.

2. GW sells a blister through its own stores for full price. So a $10
blister produces $10.00 in gross income.

So, GW has to sell 2 blisters to a hobby store to produce the same gross
income as it gets selling 1 blister through its own stores or website. In
2006, local hobby store sales generated £49m in gross income. GW generated
£67m in gross income from its own stores and websites. If GW averages £10 on
each item sold through its stores, (the exact amount isn't important), then
it sold 6.7 million items through those stores. Since it therefore only
averaged £5 per sale through local hobby stores, then it sold 8.4 million
items through them. The hobby stores therefore sell 56% of the products, yet
only account for 42% of sales. A percentage that is decreasing even as sales
are decreasing. Not a good sign.

Even if GW's profits had not declined because *sales volume* is down, it;s
still idiotic to undermine the section of your business that sells the
majority of your product. <shrug>

Here's why I think that the Games Workshop stores were a lousy idea.

Assume two identical stores, one a GW store, the other a locally owned store
in identically profitable locations. The GW store's operating expense will
be at least as much as the hobby store -- GW leases cost as much as local
guy's leases. Indeed, local guy, because he is exempt from many of the more
costly government regulations, will probably have lower expenses for that
reason alone. And since local guy won't eat if his store fails, he has a
very strong incentive to maximize profit and efficiency. This is why closely
held family businesses can often kick the crap out of large public
companies, especially in niche markets. The only way that GW can gain an
advantage is to sell at a discount. It can't do this on a large scale
because if it did, local stores would stop carrying it. Poof, there goes 42%
of its gross sales and 56% of its production.

So at the end of the day, the GW store costs as much or more to operate as
the hobby store. And GW shareholders are gonna require at least the same
profit margin as the hobby store owns.

Let's say that each store sells $300K in GW stuff (that's about average for
GW stores). Let's say that non inventory expenses total $120K for each one.
The hobby store must buy its inventory, so it pays $165K to GW for a net
profit of $15K. On the surface, GW is making a killing. It appears to have
made $300K - $120K = $180K in profit. However, this is an illusion. First,
GW had to pay additional costs that the hobby store didn't have to. Their
financials imply that it cost them about $100K to make the products that
were sold. Probably $40K per store is consumed by administrative costs.
Maybe more. They've now apparently made $40K of net profit.

However, these stores cost money to setup. Say 400 total stores (some have
closed) times $200K. $80 million spent on this boondoggle -- in a company
that made $26 million profit in its best year. Stunning.

That money, if invested in conservative investments, would have made about
$4.8 million per year. So each of the 338 stores effectively costs $14K per
year in unearned investment income. At a minimum. Had that money been
invested in other areas of the company, the total would have been much
higher. That $30K profit has declined to $16K.

And in the real world, local stores are usually run at a lower cost than
comparable stores owned by large chains. This is probably offset by GWs
better capitalization and advertising efficiencies.

But here is the bitter irony. GW's management failed to understand how big
chains compete in the real world! Shocking. See, the large chains win
because they offer far lower prices and better selection. But GW cannot
lower prices without losing 42% of its sales and 56% of its product volume.

Now, manufacturers have opened retail chains to provide an outlet for their
goods. But GW's stuff is carried by local hobby stores! And well stocked
hobby stores have comparable selections to the GW stores I've seen, so I'm
skeptical that a local hobby store can't carry sufficient inventory.

And HERE is the unkindest cut of all. In many cases, GW *replaced* local
retailers who carried GW products. In every such case, GW lost the profit
from those sales -- $65K per year. The same is true if a GW store
discourages someone else from opening a store that would carry GW products.
If this happened in 2/3 of the cases, GW has lost about $40K for every
single store it runs per year -- $12m per year. That mythical profit from GW
stores just evaporated. GW has spent $80m to earn...nothing. And who knows
how many tens of millions of profit dollars were lost as retailers decided
not to help GW put them out of business.

I'm staggered by the sheer scale of the ineptitude on display here. If
management can make such horrible financial decisions, then it's pretty easy
to see why their rules suck.

Ye Gods, would that I could get away with that level of ineptitude in my
business!

By the way, there's a simpler way to figure out that the GW stores are a
terrible idea. Operating costs for their stores exceeded $112m in the last
few years (most admin costs are salaries and most of them are paid to store
employees, so I attribute 80% of admin costs to the stores...it's probably
higher). The stores made $111m this year -- a net loss of $1 million. Even
in GW's best year, the stores made $140m. However, costs were that year were
$128m. But remember the loss of the hobby stores put out of business (or
discouraged from going into business) by GW stores - $12m per year. And
don't forget the opportunity cost of spending $80 million to open these
stores -- $6m per year. And I can't imagine the cost of alienating half of
their distribution network.

So in their best year, the GW stores still lost money at the end of the day.

Amazing.

If I were GW, I'd sell every single one of those GW stores to local owners.
Even if you sold them at fire sale prices, they'd have to net $8 million or
so. GW would retain its market, but would wipe out an unprofitable
boondoggle that has infuriated half their distribution chain. The company
could then focus its energy and money on what it does best. I'd bet that
this revised GW could make $160m in gross sales (only 2/3 of this year's
sales). Assuming a 50% cost of goods sold, that still leaves $80 million in
gross profit. Administrative and operating costs couldn't exceed $20
million. This GW 2.0 would make $60 million in profit -- almost 3 times its
best year. And if sales climbed to 2003 levels, the profit would be
scandalous...$120 million or so.

Anybody got about $200 million I can borrow?

--Ty


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