GW and Price Rises: An Economic Hypothesis

[Jo-Jo]

Before I begin, I must clear a few things up. Firstly, I’ll leave my judgement upon the actual price rises themselves: this is merely looking at it from a business point of view, using basic Microeconomic theory. Secondly, I’m not going to wow you with how much, or how little, actual qualification I have in the field of economics. After all would you believe me? I merely ask you to read my argument, and then, if you think I’m a rabbling idiot, move on. Finally, all my grapths are not based on actual data, and they don’t need to be, as they are merely visual aids. I looked up few figure while writing this hypothesis, as they are unneeded: I’m merely explaining why the price rises are happening and why its good for GW and why their profits continue to rise, even with price rises. With all that out of the way, to begin:

I will start from the ground up, so don’t feel I’m insulting your intelligence with the first few paragraphs. Several misconceptions exist in the subject, so I must start at the beginning. Even if you you think you have a grasp on economics, but you’ve spent no actual time studing (over estimating your knowledge of the subject can get you lost in my hypothesis, as the first person who read this found out.) it then read on: you may learn something which can be applied outside of merely your hobby life. Otherwise skip to my following post.

One of the first rules of microeconomic theory is to assume that firms and businesses strive to achieve maximum profit. I think there is now no argument as to Games Workshops (hereafter known as GW) been amongst these firms. This not a bad thing: nearly all firms belong in this area. This is important to bear in mind though this

Supply and demand rule a free market economy (and a free market economy doesn’t truly exist anywhere, but I digress). This much is taken for granted. You likely know that high demand leads to low supply, and vice versa. Well this is simply a gross oversimplification, and I want you to forget this. Supply and demand operate independently. Here's the a basic example of a supply and demand graph that I shall use several times throughout this hypothesis, and a basic explanation:

Graph 1

This graphs shows the market for one good. It matters little which. Also, figures and scales are unnecessary for all examples in this hypothesis: the graphs are merely an aid to help me present my argument.

Firstly, you see that as the price of a good increases, the quantity supplied increases. However, the quantity demanded falls. So, if the price levels are at point X on the graph, supply exceeds demand, as companies are willing to supply more, as profits will increase for the firm. However, the amount demanded by people is drastically under the amount supplied. This leads to a supply surplus. The opposite, leading to a excess demand, is seen at price level Y.

However, point Z is the goldilocks point, known in microeconomics as the equilibrium point, this is where demand and supply meet. There is no excess supply, as all of it is used and no one is left out, as there was enough to meet everyones needs. This is the aim of free market economics: to achieve perfect allocation of resources. Generally at this point, firms will have achieve maximum profit from this good, profits of course been the amount sold multiplied by the price. Changing price to X or Y will lower this amount made, where the curve have a gradient of 1 and -1 where they are completely diagonal

We will assume that price level Z is where the good will be sold then. The position of the curves are in no way fix. A successful advertising campaign for this good can increase demand, represented by the curve moving rightward, with the same gradient. This is shown in this grapth:

Graph 2

As we can see, not only is more of the product wanted, but the price people are willing to pay for it has increased. They can charge price X and still perfectly use stock. This is what companies want. They will have larger profit, which is the aim of all firms.

This graph and set of scenarios is oversimplified. However, with basics established, I can move on to something much more relevent. A supply and demand curve for miniatures.

Ok, heres where it get allot more complicated. The last post assumed we were operating in a free market, where there was no government intervention, such as minimum wage laws. Or even no unions. Nothing. Just pure supply demand. Well, as I said before, no free market exists in the world any more. Also, the supply and demand curves are never that straight. Ready for the hobby we all know and love to get involved? Here we go:

Graph 3

Ok. Thats a big change from the example graphs, but hopefully you can see that it works in roughly the same way. So why are the curves drastically different? Both curves show that a change in price has a disproportionate effect on quantity, the change in quantity and price are not parallel, like our example graph. This particular graph shows the market for plastic 28mm miniatures, such as the ones which workshop make most profit from.

Supply show that as price increases, quantity produced does not increase as drastically. This is due to the large cost to enter this market on a large scale: plastic injection machines are well known to be a significant investment, as well as designing the miniatures for use with this takes time for smaller companies. This means that extremely high prices must be achieved for companies to start investing in this. This is shown at the higher price level, as supply begins to swing the other way, with quantity supplied beginning to increase higher than price increasing.

Demand shows that as price increases, demand for the product falls by little. Why? Because of many reasons, the main two been people enjoy and commit to their hobbies and will accept a slight price increase and that they are unwilling to swap hobbies completely, they will continue using 28mm plastic figure for one thing or another. Again, as the extremely high price levels, this begins to fade, as quantity demanded falls disproportionately to price levels increasing.

So what does this mean?

Graph 4

Well, again price level Z exsists. This is where everything is nice and fair. However, in this case, this is not where GW will achieve most profit. For you see, here we have a rare occurence which happens in few other products, the most notable example of similar correlation between demand and supply is petrol (however petrol is much more drastic). As the price increase, quantity demanded falls by so little. Let me give you a quick example with very basic figures (again, I never use official figures during this hypothesis.)

If price is 2, amount sold is 100, then profit would be 200. So, price increases to 3, however demand only falls to 95. Profit is now 285. Sure, demand has fallen but the increase in price been higher makes total profit overall higher. And I know what your thinking. What about production costs and taxes? Profit will, in this case, increase just as faster then tax levels. So point Y, with higher prices, is better for Workshop in this case, despite losing customers.

However, the future looks bright for us, the hobbyist. Why? Firstly, I refer you to the curves “flatlining” towards the head of the graph. This shows when hobbyist all start dropping out of the hobby at higher levels, but also new companies joining the market with the supply. We are beginning to see this happening. This is this theory coming to life.

So I hope this briefly shows, using economic theory, why the company is not been run into the ground, as popular opinion would have you believe, and why they continue to find profits rising (demand shifting to the right thanks to Space Marine last year also helps). I’m sure there is a much more qualified economist working somewhere with GW, with full figure able to show where the exact point to stop increasing prices is. This is why GW is continuing to be a show of perfect business and economic technique, whether you like, or believe, it.

One final note: this is simplified, and many more arguments can be made. It is impossible to put the whole argument down, so I lay down this foundation to build off, and I may return to expand this hypothesis. I encourage questions and debate over this subject.

This entire Hypothesis was authored by me, Jo-Jo, please ask before you steal it at very least.

Personally, I don’t like the prices rises, before you get the idea that I do.

TL;DR: Games Workshop is doing the right thing increasing their prices. Not the right thing for you though.

[carlisimo]

Yeah, when I think about it, it's pretty intuitive to assume that a 25% price increase wouldn't cause 25% of GW gamers to quit, or even to spend 25% less. For now, at least.

[Tresidentevil]

I'd like to congratulate Jo-Jo on a well argued post. It's also refreshing to see some positive opinions regarding the economics of our hobby. As you say you have simplified things and obviously this doesn't cover everything. Also as you say it provides a good base to start from in looking at the subject. Theory like this is heavily situational (obviously), unfortunetly outside events can't always be easy to predict (examples being: recessions, political upheaval, natural disasters).

So according to this GW is now starting to approach the stage at which increases in price stop making up for the fall in units sold? I'd actually argue GW's own financial results completly agree with this (viewable on GW corporate/shareholder website).

[Scaryscarymushroom]

Excellent post, and very well reasoned. But I have a couple of questions:

However, the future looks bright for us, the hobbyist. Why? Firstly, I refer you to the curves “flatlining” towards the head of the graph. This shows when hobbyist all start dropping out of the hobby at higher levels, but also new companies joining the market with the supply. We are beginning to see this happening. This is this theory coming to life.

...

TL;DR: Games Workshop is doing the right thing increasing their prices. Not the right thing for you though.

First question: How do you arrive at the conclusion that 28mm miniatures follow such a supply-demand pattern? It makes sense with energy sources, food, water, and shelter... but luxury goods?

Second Question: How is it good financial sense for GW to raise prices so high that competition starts to bud? Or, flower?

Assuming it follows the pattern laid out in graphs 3 & 4, It seems like GW should keep their prices just below the plateau to encourage maximum profit while offering little incentive to look elsewhere.

And a few comments: According to Graphs 3 & 4, as long as they can generate enough demand, prices could theoretically be as high as they wanted, and everyone who was interested in their product would still buy it. The leveling point doesn't mean the company won't make more profit if they don't move the demand curve to the right. So it would make sense for them to try and move the curve as far as they can to the right, despite the slowed growth in profits. Except that it poses the problem of opening up competition, which puts me back at question 2.

And how on earth (economically speaking) can they generate income with their advertisements? Why is there a demand white dwarf high enough to justify the price of $9.00 an issue? Why did THQ pay GW millions of pounds in royalties to make what is essentially an advertisement for GW's own IP? Where is THQ's economic incentive?

EDIT: I just realized the mistake I made in assuming that they generate income with their advertisements. It could cost them $9.00 to make an issue of white dwarf, for all I know.

Yeah, when I think about it, it's pretty intuitive to assume that a 25% price increase wouldn't cause 25% of GW gamers to quit, or even to spend 25% less. For now, at least.

It would be intuitive if the prices weren't already higher than demand justifies. Otherwise, it makes sense that if the prices go up by 25%, GW might even lose 40-50% of their profits. The difference between $4 and $5 is small. The difference between $66 and $74.25 is a little harder to ignore, even though it's only 12%, where the difference between $4 and $5 is a 25% increase.

Here is the question we should be asking: How much demand is there for GW's product?

[Iron Puritan]

The question becomes one of sustainability. The numbers shown in GW's financials do not show a tenable situation if issues like customer retention, their haemorrhaging B&M chain, and engaging the competition are not addressed properly. If they wait for too long, they could end up with a costly mess on their hands.

[spaint2k]

I hope you saved a copy of that so you can repost it somewhere like Dakka when this thread ends up deleted.

[ehlijen]

For generally compatible goods such as food, fuel, cars etc that might seem all straight forward. But does the theory stay the same if non compatible goods are analysed?

To put it bluntly: a 40k army is worth more to the end user if there are others near him who also have and use one. If the market is splintered by different games, wouldn't the demand for any one game be reduced?

I'm asking because I don't know such theory, but it seems to me to be an important point I didn't find the OP. If it isn't, why isn't it?

[spaint2k]

For generally compatible goods such as food, fuel, cars etc that might seem all straight forward. But does the theory stay the same if non compatible goods are analysed?

I think the word you're after is fungible.

[ehlijen]

I think the word you're after is fungible.

Could be, I've never heard it used before.

[spaint2k]

Could be, I've never heard it used before.

It's a bit tough for me to post from a phone, but basically fungibility refers to the interchangeability of commodities. You probably don't really care which brand of petrol you fill your car with, but do you care about which miniatures you use in a wargame? The answer differs from person to person. I have no idea how it affects the original point, but it's an interesting complication.

[Etienne de Beaugard]

Not a bad post. The basic theory is sound, if not expressed concisely. In fact, we've seen this implied in various posts to the pricing feedback thread.

The concern that some have expressed is GW is hitting the price point of diminishing returns. Consider, if your hypothesis holds true, any price increase that outweighs the decrease in demand should be expressed as an increase in GWs revenue for each year.

GW Continuing Operations Revenue (in millions of pounds) Source - GW Annual Reports Full Year 2010-2011 and 2008-2009 http://investor.games-workshop.com/)
2011 2010 2009* 2008* 2007* 2006 2005
123,052 126,511 125,706 110,345 109,501 114,468 135,804

As can be seen above, GW was able to increase revenue from 2007 through 2010, with a drop in 2011. The 2012 annual report will tell a lot about GW's future success with continued price increases.

[Athelassan]

As can be seen above, GW was able to increase revenue from 2007 through 2010, with a drop in 2011. The 2012 annual report will tell a lot about GW's future success with continued price increases.

I think we all know what'll happen if the 2012 annual report shows another drop in revenue.

"A drop in revenue two years running? Quick, raise prices! We can still make this money back!"

[Ebon]

I think we all know what'll happen if the 2012 annual report shows another drop in revenue.

"A drop in revenue two years running? Quick, raise prices! We can still make this money back!"

GW's response to everything is to raise prices. More customers? Raise prices. Less customers? Raise prices. New model? Raise prices. New box? Raise prices. New box art? Raise prices. Sunny? Raise prices. England win the Ashes? Raise prices.

[Athelassan]

...England win the Ashes? Raise prices.

That would at least explain why prices remained relatively stable (if high) in my youth, and have ballooned out of all recognition in the last ten years or so.

[Tresidentevil]

Spending £20.00 on 10 plastic men is elite, it's aimed at rich middle class kids and rich middle class kids who grew up with it. You can't compare Warhammer to a car. Compare a car to a car. The size of miniature war gaming is totally irrelevant. I'd argue a product such as a Rolex or Bugatti is elite, few buy it. I'd also argue an iPhone is an elite product, millions buy them. Mine just cost however many hundreds £, I COULD have got a perfectly good smartphone for a hundred £ if not less. You have to compare Warhammers eliteness against products like it, i.e. fantasy products, rpgs, other wargames maybe even computer games.

[Iron Puritan]

A quick question about the OP: how much of this hypothesis is based around optimal conditions?

I do have some concerns that the point of diminishing returns could have some dramatic consequences for the company. Even though the industry I used to work in has historically been resistant during poor economic times due to enhanced infrastructure spending (makework projects and such), the past handful of years presented a greater challenge to the company than expected. The thing that makes me think there cause for concern is that once problems started, they snowballed. One of the areas that became an issue was pricing. The company I worked for didn't go for full prestige pricing, but there was something of a "pay a bit extra and get your money's worth" mentality. That had to change, especially when more competitors started importing product from China... It was messed up. It can be cheaper to bring structural steel items items (fitted, welded, galvanized, ready for installation) from China than to have it made five minutes down the road. Customers used to pay the extra, but when the crunch came, people were suddenly fine with the Chinese stuff. This forced my old employer to adapt. It was that or perish. The crazy thing is that this all happened rather quickly. People are envisioning a slow decline, and I think that is more likely than not, but I have seen enough to make me wonder if something unforeseen could really throw GW's planning for a loop.

[ehlijen]

Interchangeability! That's the word I could have used as I did know it. Thanks for the heads up on frungible, but it seems I was understood anyway

[Mastodon]

This is a really good post. Do you think you'll be able to put some proper numbers to it when the financial report comes out next month?

[Baragash]

I’m sure there is a much more qualified economist working somewhere with GW, with full figure able to show where the exact point to stop increasing prices is. This is why GW is continuing to be a show of perfect business and economic technique, whether you like, or believe, it.

I don't have the time to write a long response, so a few snippets.

Retailers are not run like that in the real world, though ultimately their behaviour may coincide with microeconomic theory, the decision making process does not.

I would also suggest that a number of assumptions that apply to a standard supply schedule aren't valid for GW.

If annual price hikes were perfect business and economic technique, why doesn't everyone do it?

Alienating customers and not finding a way to give them what they want is not perfect business and economic technique.

TL;DR: Games Workshop is doing the right thing increasing their prices. Not the right thing for you though.

In conjunction with their current overall strategy, no they aren't. Reinholt has explained why on many occasions in other topics.

[Jezbot]

Any producer over a certain scale will undertake extensive price sensitivity studies*, and will understand quite well what drop off in demand they might expect from a given price increase. Selling a luxury consumer good and having a revenue base in excess of a hundred million pounds, I would be absolutely flabbergasted if GW doesn't undertake this kind of modelling in a very serious manner. Now, these kinds of studies are ultimately pretty subjective, and companies get it wrong fairly often, but at least their stuff is based on market research. For everyone outside of the company, any attempt at predicting the impact of another price increase is just fancy sounding guess work.


*And no, these studies aren't just asking people if they'll buy if the price goes up. That kind of study achieves exactly nothing, because consumers have absolutely no understanding of their own behaviour - look at all the people who declare this new price rise is so outragous they'll never buy GW again... and yet months later there they are, still buying.