The Perils of a Loss Leader Strategy - More Things I Think I Think About Indomitus

It is still radio silence from Games Workshop on the fiasco that was yesterday's Indomitus launch, though the speculation and posturing on social media obviously continues unabated. Comments seem to fall into a few distinct camps, but there is the prevailing concept that Games Workshop made a huge amount of money yesterday with Indomitus selling out in minutes. While no doubt they had a banner sales day, in order for a company like Games Workshop to make money, they have to bring in more revenue than they spend on producing and marketing their product.  Based on their typical pricing model, I find it hard to believe that the new box is a real profit machine on its own. In fact, I firmly believe Indomitus was designed as a "loss leader" to bring new players into the stores, and from this perspective it likely failed miserably.

A "loss leader" is defined as "a pricing strategy where a product is sold at a price below its market cost to stimulate other sales of more profitable goods or services." At a price point of $199 US it is not hard to make the case that the Indomitus boxed set was a loss leader. The box itself included a ninth edition core rulebook ($65 retail on its own) and 61 miniatures - many of which are bikes or larger commander / elite figures. Subtracting the retail cost of the rulebook from the overall cost, each miniature ends up costing about $2.20 total at retail. In the world of Games Workshop, that is what is called "dirt cheap."

Easy to Build - but still $5 a pop!

Granted, all of the miniatures in the new set are "push fit" - which puts them more in the "easy to build" camp than the normal multi-part / multi-pose figures that make up most of the line, but even taking that into consideration, the set is cheap. For example - a set of three easy to build Primaris marines retails for $15, or $5 a pop. The "easy to build" Lord Felthius and Tainted Cohort (four elite / officer quality Death Guard figures) - retails for $40, or $10 a figure. It's therefore clear that the miniatures in the Indomitus box were being sold at a drastic discount as compared to the normal pricing scheme.

Games Workshop Revenue and Earnings, 2016-19 - Source:  Yahoo Finance

Going a bit further, one can look at Games Workshop LLC's financials for the past few years to understand what their operating margins look like. Looking at revenue for the past four years shows that Games Workshop has been on a tear with revenue doubling from 2016 to 2019 and earnings increasing by a factor of at least three. However, if one focuses on the last two years, revenue went up over 10%, but earnings for the year were almost flat. This indicates higher cost of sales, but it does give us a rough idea of what their net margins look like - in short earnings are about 25% revenue. Games Workshop will obviously earn more profit on direct sales than retail channel sales (as they charge full retail but must give the retail channel a wholesale discount - typically 30-50%, with 40% being average), but with a little creative math one can figure out what GW's costs look like. Bear in mind this is a total cost including all business operations (marketing, staff, facilities, depreciation), not the individual incremental manufacturing cost of the miniatures.

In the chart above I've taken a few different scenarios ranging from 75% of the product being sold wholesale vs. 25% retail to the opposite with only 25% of the product being sold wholesale.  Assuming the 25% net margin from the annual revenue graph above, you can get an estimate of the break even cost of various easy to build figures. The pox walkers are the cheapest with a break even of between $1.30 to $1.70 per figure depending on the mix. However, Indomitus isn't filled with pox walkers, it is at least half-filled with Primaris Marines with an estimated break-even cost of $2.63 to $3.38 a miniature.

Using the easy to build costs as a guide, I translated the miniature contents of the Indomitus box to break even costs. I tried to be fairly conservative in my estimations where I didn't have an exact 1:1 conversion, but fortunately at least half of the box is space marines - for which we have some decent comparable products to use as a guide. This calculation gives a "break even" total cost of at least $225 for the miniatures in the box alone. While you should take all these calculations with a grain of salt, they still clearly demonstrate that any margin GW is making is much lower than their normal product line, thus confirming that Indomitus is a "loss leader."

The downside here is a loss leader strategy only works if it spurs additional sales - either the same day or in the future. With the box selling out so quickly pre-order events, especially at Warhammer stores, likely wound down very quickly with a lot of disappointed customers (and potential customers). The local Warhammer store had laid out several necron and imperial goodie bags for people who came in to celebrate the launch - from the photo it appears to be 8 to 10 of each - which is sort of an indicator of how many pre-orders they expected to place that day. Based on the Facebook posts, it appears they were, in fact, only able to get 2 or 3 people pre-ordered before everything came crashing down, with those not getting sets being likely just to turn around and go home rather than spending money on other product. Therefore at least on the release day - it seems if the loss leader strategy backfired, with the only people making money are those who bought extra sets that are now selling them for 2X and 3X retail on ebay.

Where do we go from here?

The ultimate question is has Games Workshop upset enough customers to materially impact their overall business, and the jury is well and fully out there. Given the slim to possible negative margin on the set, I find it unlikely that Games Workshop will end up making more of them - though if they do it would be a really favorable gesture on their part in an effort to improve relations with their customers. Another interesting observation I've made in the past day or two is that to access the Warhammer Community or Games Workshop sites is now captcha protected. Perhaps there were concerns with bots or other automatic programs overloading the web page yesterday, and this is a response to it. It will also be worth looking at the financial markets over the next few days as events like this could have a material impact on the stock price. It will also be worth looking at sales and earnings statements going forward to understand what (if any) impact this has on the business long-term, though coming at the end of the COVID shutdown, the pandemic is likely going to have a fairly large impact on GW's numbers for the near term making a clean analysis difficult. Whether or not Games Workshop is at a strategic inflection point or not, will only become clear over the next several quarters.