By the numbers: Letter to GAME Group administrator Mike Jervis

[The UK's predominant high street video game retailer GAME Group announced it's filing for bankruptcy this Monday, meaning stores will be shuttered across the UK and Ireland and many employees will be laid off. In the letter below, I address to the administrator my opinion about what should happen to GAME.]

Dear Mr Jervis; Mr Maddison,

London, March 27, 2012

It is with great interest that I have been following GAME Group’s recent developments. Now that the chain slipped into administration last Monday March 26^th, it is up to you and your team to redirect the flailing concern, readying it for a second beginning possibly with a new owner. Notwithstanding my trust in PwC as administrator or my lack of financial expertise, I write this letter to you to provide you with what I think should be the main points of focus for GAME’s turnaround. My points of advice are subdivided into operations management, strategic considerations, and financial management.

GAME is not a spoiled concern or one without prospect. In comparison to worldwide market leader and rival Gamestop Corp., GAME extracts higher margins from new hardware (8% vs. 7%) and new software (26% vs. 21%) sales.[1] These product categories make up roughly 61% of GAME’s yearly revenue. Also GAME’s store capitalization is in good condition (in most territories at least), outperforming Gamestop’s retail space. Indeed, GAME has average annual sales per store of £1,165,184, or £1,116 per square foot, compared to Gamestop’s average annual store sales of £890,982, or £636 per square foot.[2] In the past, GAME has made good use of its assets, assets it still owns today.

Rather than a cut-throat value chain or poor asset management, GAME’s problems reside with its operations. Improvements should be sought in two broad areas; overhead costs, and international operations. Recognizing high street retail’s low profit margins, GAME’s 1.75% EBIT margin is dangerously low and non-competitive compared to Gamestop’s 6.56% EBIT margin. As my data do not provide a detailed breakdown, it is difficult for me to pinpoint where exact improvements could be made. What strikes me though is the high closure rate of stores and employee lay-offs in the United Kingdom following yesterday’s administration. With £55,308 average net annual profits per store, or £46 per square feet, UK stores by far outperform GAME’s international operations which on average have an annual net loss of £31,961 per store, or £35 per square foot. Operations in GAME’s international territories show a near 1:1 operating expense ratio of 0.98. Scandinavia and Australia appear to be apparent targets for redundancies, as should be considered the strategic relevance of the Czech Republic operations.

Additionally, for purposes of market contingency and profitability, video game retailers have increasingly focussed on pre-owned trade and online market presence. It are exactly these areas where GAME’s operations could be drastically improved. Gamestop’s profit margin on pre-owned games is roughly 7% higher than to GAME’s 40% gross profit margin, resulting in a 10% discrepancy between the chains’ bottom-line product-profit mixes. Add to this GAME’s floundering, low-margin, online operations that decreased by 67% in profit 2010-2011 and one has two departments in which operational improvements will strengthen GAME’s competitive position.

There are other, more prevalent, strategic considerations. To my understanding, GAME’s general management has not fully grasped the implications from some of the industry’s interrelated risks; seasonality; cyclical hardware development; and, the advent of digital distribution. It was not until February last year that former CEO Mr Shepherd explicated strategic intent to deal with the ‘issue’ of digital distribution by reformulating the Group’s strategy.[3] Current generation video game consoles have been equipped with digital storefronts since late 2005. In the latest Financial Earnings report there is ample mentioning of market conform representation of digital sales in GAME’s product group; 10%. GAME’s main vendors, publishers like EA and Activision, rely over 30% on digital revenues in their product mix. Not to mention all-digital new entrants in the mobile and social gaming spheres like Zynga and Rovio. GAME’s 27% year on year increase in digital sales pales before Gamestop’s 61% who is actively pursuing market share in this segment through acquisitions and store modifications.

GAME’s pre-owned trade and online business segments are strategic areas with which the concern can solidify its competitive positioning towards vendors and the risks associated with retail operations in an era of digitization. Increased emphasis on digital content from both traditional vendors and new entrants in social and mobile gaming would not only align GAME with expected market trends for the near future that predict an uptake in digital market segments (27% in Europe for 2012) and decline in physical goods (-6% in Europe for 2012), it will further help to reduce the firm’s skewed and cyclical earning patterns which contributed in part to GAME’s financial struggles. A longer than expected console cycle and disappointing Q4 sales are hard blows to take for a company that relies for 58% of its yearly profits on the Christmas period.[4] Digital initiatives will help to ‘equalize’ GAME’s profit pattern, and hereby strengthen its strategic sustainability and financial solvency.

Finally, rather than equalizing the Group’s income pattern through careful risk management, GAME has been imprudent in its debt-to-equity management, even further amplifying the concern’s miseries. While not failing to recognize the positive amplification of earnings from a high debt-to-equity ratio, general management has been careless in (not) anticipating the vicious financial circle caused by poor earnings and a high debt-equity ratio (1.06 in 2010-2011). GAME’s short term financial perspective is candidate for improvement too; an organization operating in a volatile business should not have current liabilities nearly equalling its current assets which include an inventory composite of ‘highly perishable goods’. Notwithstanding structural differences in strategic direction and operating costs between GAME and Gamestop, to my best knowledge it is this risk seeking financial strategy that put GAME in the position it is in now.

Bankruptcies are not necessarily a bad thing to all actors involved. Rather than piece-by-piece disposal of GAME’s assets, the company is worth more as a streamlined but complete entity. Provided with a fresh strategic perspective and a leaner operations management, the GAME Group is worth more than its closing market cap of £8.30 million without doubt, making it an attractive acquisition target for the likes of OpCapita, Gamestop, or even RBS. Having said that, GAME, GAME’s assets, and a fair share of its personnel deserve to rebound through a going concern acquisition. Indeed, I agree with your perception that in the United Kingdom there is room for a specialist retailer for video games.

With kind regards,

Joost Rietveld
PhD candidate in Strategy and consultant for Strategy Guide UK

[1] My data come in large part from GAME’s latest full annual report; Gamestop latest full annual report; and, industry sources.

[2] Based on the March 26^th 2012 exchange rate of 0.6273.

[3] February 16^th 2011, Strategic update – presentation by CEO Mr Shepherd.

[4] Percentage based on accurate estimations from comparing Gamestop’s quarterly profit and revenues breakdown with GAME’s yearly sales and profits assisted by factual Q4 sales data for GAME. A ‘robustness check’ was performed for 2009, results were found to be consistent.