Games Workshop P3: When Geeks Create a Monster (of a) Company

Troubled Years - A Closer Look

Welcome back readers. In our last two episodes we’ve uncovered Games Workshop’s origin story, how it developed into a multinational gaming and miniatures force and its subsequent decline. In this post I want to go deeper; look closer at the Company’s struggling years from 2004 to 2015 and the man steering the ship: Tom Kirby.

Running For the Long Term

I went through all the Company’s annual letters, from the high-flying years to when Tom Kirby leaves in 2014, and there are a few observations I want to share.

I’ve read many, many annual reports from many different CEOs and companies and I can confidently say that Kirby isn’t your Joe-average CEO. Long-term building isn’t just corporate talk to schmooze investors, he means it. His annual letters are candid and to the point. He treats shareholders like he should, like fellow co-owners and not like paper tourists looking for a quick kick. He displays a deep sense of responsibility towards the owners, a group he is serving, not the other way round.

He talks about what sucks, what went wrong and where things need to improve. He doesn’t duck away or blames others for failures. There’s just no BS in his reports. I would encourage you to look at them, at the style. Considering that this is a fantasy gaming company producing miniature and pains, the Company has no pictures in the report, zero. Have you been through an entire Fortune 500 annual report? A picture parade of kids singing Kumba Ya with the CEO – I kid, but you get my point. GW’s reports are black and white, to this day. You can read it from start to finish without puking. Every page, except the ones mandated by the regulator perhaps, is worth reading. Very Buffett-esque. Kirby even talks about Buffett. Not a bad role model to have.

When sales and margins declined from 2004 to 2008, GW still enjoyed a strong moat around its business and there are many reasons why Nick Sleep at Nomad Capital become their largest shareholder in 2007/08, but I’m sure one of them was Kirby – his approach and shareholder letters resonate. For all the criticism Kirby got, some deservedly, he’s always maintained to build GW for long-term success; he cared about profitability and intervened when things were sliding, perhaps with delay, but still, he closely watched return on capital, watched costs, watched customer service. He ensured that products were of the highest standards and yes, he didn’t push hard enough on product extensions, didn’t push enough on the creation of exciting new worlds. Unlike Ian and Steve, or even Brian Ansell, Kirby wasn’t a hardcore gamer, not the creative type. He was more of a businessman. Yes, it is his job to keep the creative talent around and motive them, provide them with creative freedom so that new and exciting words and characters can be created, but that’s easy to criticize from the outside. After all, as CEO, his fiduciary duty is to care about the economics. But most importantly, and I think it’s easy to underappreciate this element when building an organisation , a franchise, a fanbase for decades to last, is the fact that things simply take time. And a lot of trial and error. To give you a better feel of those years, from 2006 to 2015, and Kirby as a leader, I will use extracts from the reports going chronologically.

Own the Mistakes

Right after the boom years when sales and profits start to deteriorate Kirby admits that they have become complacent, relying too much on their past success. In 2007 he writes “Like everyone else I wonder about the decisions I took and the things I said over the last few months and years.”… “we grew fat and lazy on the back of easy success”. BTW, it’s extremely rare to read an admission like that from a public CEO. He continues, “We forgot about customer service and forgot that hard work is and always has been the route to success. We forgot that we are a company which pursues profit and likes paying surplus cash to its owners. What was not expected was that it would take two poor years and a management reorganisation to get the problems taken seriously. Somewhere along the line too many of us thought that selling, sweating and saving were someone else's job. Well they aren't. That's my job and the job of all of us here at Games Workshop”…“I'm sorry we have not done as well as we should these last two years. I know our owners expect better from us in the future. I do as well.”

As I was going through the reports, one thing I’ve noticed is that when comparing them to letters from Kevin Roundtree, the CEO taking over some 10 years later, Kirby doesn’t talk as much about the games itself, the fantasy worlds they create and control, that fact that creating fun for the customer is the heart of Company. Kirby also doesn’t emphasis making use of the Company’s intellectual property as much as Roundtree later would. Instead, he’s very much focused on cost reduction programs, which given the figures are needed indeed. Operating profits drop from over 13% in 2004 to less than 4% in 2006 - almost 10% of profits are wiped out in a couple of years, that’s no joke. Operating expenses are oversized in relation to the newer and lower revenue level. As sales started to decline, gross margins remained healthy, even increased from its best sales year in 2004, operating costs didn’t decline by the same proportions, with damaging effects.

Operating leverage started working against the Company, squeezing profits. So, Kirby says: “Our efforts to restore the profitability of the business need to focus both on sales and costs. Even though we have set specific and measurable financial targets for the immediate costs and benefits of the cost reduction programme, we see this as a long-term process to ensure that the business only incurs those costs which are necessary to service our customers properly”. Notice how he doesn’t talk about investments needed to keep creating worlds of fun, but rather on costs “necessary to service” the customer. Not exactly the type of language you would expect from a content company CEO where success historically was built on excitement and engagement.

Of course, disproportionately large operating expenses must be addressed, so Kirby starts changing the management teams, especially in Europe where sales declined since 2005. Yes, Kirby talks about re-focusing energy on sales, but he doesn’t explicitly talk about creating new games, spin-off worlds, new and exciting story lines, things for the gamers to enjoy and have fun with. I am not sure if there was large emphasis on that in the background or internally, but it doesn’t shimmer through the reports and it fits with the criticism that fans had at the time – that story and games suffered during Kirby’s leadership.   

Costs & Growth

Over the next years Kirby closes unprofitable shops, drives cost reduction programs, rationalises manufacturing and the supply chain, removes unnecessary duplication of back-office functions and delivers overhead reductions. And indeed, operating margins are starting to bounce back from its low in 2007 to 7.2% in 2009 and eventually back over 12% in 2010. Great. But while sales bounces back from its low of 110 million in 2007/08, it flattens out around £125/£130 million in the years that follow. The growth just isn’t there. Sales in the US and UK improve again but continental Europe remains anemic.

Overall, Kirby’s letters are an interesting read for anyone interest in business. He talks about capitalism, corporate brokers, the stock market, about long-term building and how short-termism is one of the evils of modern society. I agree. He emphasis the importance of have the right shareholder group and his frustration with the 'City' (City of London) road shows and how it increasingly became a waste of time. He was doing roadshows every year and how he thought road shows never did help the many hundreds of small shareholders understand the Company better. He felt a strong obligation towards them and that they deserve the same info as the big institutions. In 2010 he gave an introspective view on how things were run at the Company while meeting institutional shareholders: “Not all the meetings were fun, however, particularly when we were letting our owners down recently. We got some appropriate tellings-off, not least of which was from one of our more gentlemanly interlocutors who always offers me tea. He seriously but politely pointed out to us how we should be taking cost out of the business. He was right and I knew it. I was wrestling with that very thing and frustrated because no one else seemed to be. Due to its growth and international nature the business was run federally and I was relying on those local leaders to do the right thing and remove unnecessary cost out of their businesses. It didn't happen and it took a lot of changes all across the senior management to get the improvements that were needed. That is where we are today; a leaner, more efficient business, but still not showing good growth.”

And then there is another disappointment on the usage of that phenomenal IP that GW is sitting on, even making excuses, albeit Kirby isn’t CEO but Chairman at the time. “The royalty we have earned this year is down a little [a meagre £3 million at the time] this will not surprise those of you who follow the fortunes of computer games companies. It seems they are going through another phase of change. From Sinclair ZXs, to Atari STs, to Commodore 64s to PCs to consoles and now, apparently, to Facebook and the iPhone. How different their world is to ours. In all that time we have simply carried on making miniatures and encouraging people to collect, convert, paint and play with them. I trust it is ever thus”. He continues “Our continual investment in product quality, using our defendable intellectual property, provides us with a considerable barrier to entry for potential competitors: it is our Fortress Wall.” Well, yes, but you need to keep building your IP, you can’t just keep sucking on it, you must replenish. You have to invest and reinvent, keep the worlds alive and fresh in the minds of your hobbyist. Later he states “Aside from our core business, a number of commentators have recently become quite excited about the opportunity to use Games Workshop’s intellectual property in other markets such as computer games. Indeed, we have already begun to generate royalty income from a small number of such games. Where we think we can generate additional income for our shareholders from our intellectual property we will pursue these opportunities. However, we impose a number of important conditions. First, the products have to be of a high quality in their genre: we don’t want to devalue our IP in the pursuit of short-term cash. Secondly, we must retain control of the IP. Thirdly, they must be significant enough for us to devote valuable management time to them.” I must admit, you don’t want to dilute the brand and the IP for quick buck.

Product Investments

And while there was lots of criticism for not focusing and investing enough on new games and products, GW’s leadership nevertheless understood that profits had to be earned first before they could be reinvested. “We make the best fantasy miniatures and games in the world and have developed two of the strongest fantasy and science fiction universes anywhere.” … “Our investment in tooling and production allows us to make plastic miniatures which offer incredible quality and great value for money for Hobbyists while delivering healthy margins to Games Workshop for further product development.” And regardless of weak sales growth, operating profits in 2010 are back to around £16 million from its lows of £2 million in 2007. Cost cutting, supply chain and back-office rationalising are baring fruits.

Then, in 2011, two important decisions are made. First, the Company switches from metal-based miniatures to resin ones. “The single most important factor to Games Workshop customers is the quality of our miniatures. It is for that reason we invest millions of pounds every year in developing and launching new and improved products. Over recent years Games Workshop has made huge strides in improving the quality of our plastic miniatures. However, after 30 years, the scope for improving the quality of our metal miniatures is limited and we believe that the optimum level of quality with that material has now been achieved. Metal miniatures also come with inherent disadvantages for hobbyists, as larger kits are difficult to assemble and often require pinning to support the weight of the various parts. They are difficult to convert or pose without a high degree of skill and specialist tools. They are also susceptible to paint chipping off either in transit or if they topple over while gaming.” … “For many years Games Workshop has been making a small range of highly detailed large resin kits through the Forge World business. The quality of these kits is exceptional because of the detail that is possible by using a resin manufacturing process. Compared to their metal cousins resin models are far easier to assemble, are lighter and less prone to chipping and are much easier to convert with a hobby knife and superglue. Crucially, resin miniatures provide a much higher level of detail for the customer. “

Then it goes on to say how difficult the manufacturing process is. How quality control is more difficult and that production runs are lower in comparison to metal. Bottom line its more expensive. But, importantly, this switch has strategic value to the Company. “All Games Workshop miniatures will now be made either in resin or plastic to ensure Games Workshop customers get the best quality miniatures available. From a strategic perspective, Citadel Finecast [that’s the resin line] has established an even greater quality differential for Games Workshop over other miniature makers using traditional metal manufacturing methods. Importantly, it will be difficult technically, with a high entry cost, for anyone to try to establish manufacturing facilities to replicate product of this quality in significant volume.”

Overall, it’s a good move. It provides more value for the customer and gives them a further competitive edge over competitors. In 2011 the Company also recognized that the success of its futuristic Warhammer 40,000 game had overshadowed the older Warhammer game, so the Company decides to revitalize the Warhammer game with new plastic kits, including a large number of new monsters.

One year later, in 2012, US sales start to accelerate again, a function of switching from distributors to direct retailing. Also, the Company discovers China as a new market for itself, but one think caught my attention that year that really captures well how Kirby and his team though about hiring talent: “We now have dedicated recruitment, induction, training and coaching resources for new Hobby centre managers in every territory. At each stage in this process, managers are assessed on their attitude and in particular on their ‘fit’ with Games Workshop. This is a rigorous process: we screen more than 100 applications to deliver one successful candidate. As a consequence, the quality of manager in Games Workshop Hobby centres has improved significantly”. I think it’s great. And while we are on the physical shops that GW runs itself, the Hobby centres, get this: “The one man format has proven to be the most profitable way of opening a Games Workshop Hobby centre in new locations. With lower set up and operating costs, these stores typically generate a profit within their first year of trading. Combined with the improvement in recruitment from our manager pipeline process described above, [the one we have just described] we have embarked on a new phase of openings in greenfield cities worldwide.” The Company then goes on to open new shops in Amersfort, Dordrecht, Groningen, Oldenburg, Girona, Atlanta, Cincinnati, Denver, Indianapolis, Orlando, Phoenix and San Antonio. They also open a Hobby centre in China and in Poland for the first time.

The same year, 2012, the Company extends the range of paints from 75 to 145 paints to provide Hobbyists with a more complete painting system. These are highly technical paints. They also launch a “How to Paint Citadel Miniatures” book with accompanying DVD, demonstrating each of the different techniques one can use (filmed in their own GW TV studio). Looking at all the above and the initial criticism that the Company didn’t do enough for its hobby players, I think it lacks nuance. Look how much nurture is going into the miniatures and paints, trying to find ways to deliver value for the customer.

Turning a Corner

One year later, in 2013, profits climb above £ 21 million, the highest in the Company’s history! Five years ago, it was at £ 2 million. Kirby writes: “During the year Mark Wells left Games Workshop [Tom Kirby was CEO from 1991 until the financial low point year 2007, then became Chairman while Mark Wells took on the CEO role]. After more than ten years, five as chief executive, he has gone to graze in pastures new. His tenure as CEO saw our return on capital increase from around 10% to over 50%. He is a man who truly understands about shareholder value and put that understanding into good practice.” Kirby always understood that high returns on capital is key feature of this business even if it wasn’t him who would have been best placed to bring that feature back. The following paragraph nicely captures how Kirby thought about the Company and its longevity, its products, its people, himself and the ability not to be overly distracted or scared by fads: “I have written a great deal over the years about the ‘greatest danger’ facing Games Workshop. It has usually been in response to the expression of some fear of imminent doom. When will the world tire of miniatures? (It won’t; these are not fashion items, they are hobby collectibles.) Won’t all your customers move on to computer games instead? (They didn’t; most of our current customers weren’t born when the Atari ST came out.) How about other games like Pokémon or role-playing games? (Who can remember them, now?) The evidence is there for all to see, but when it wasn’t I was seen as complacent in the face of these real dangers. I don’t think that was complacency, it’s just that we here all make a living from serving collectors and we understand them and their needs. These are paper tiger dangers. The real danger is us. The world will not tire of miniatures, nor fantasy. The world can and does play computer games, online and on phones now, not old-style computers. Other people will produce great games and products. The dangers lie not in these realities, but whether we keep making fantastic models and providing great services, in our management skills and just as night follows day, in our ability to find the right people to carry the business forward. This is why we put so much energy into our management training programmes and in particular how we recruit.”… “The knee-jerk response from outsiders is nearly always either you are doing it wrong or you will fail. Neither is true. Companies who seek out skills at the expense of attitude are destroying culture, continuity and morale and thereby shareholder value. That is wrong. And our way works well. The effort put in rewards us in knowing who we want and why, knowing how to ask for that person, how to recognise them when we see them, and how to check that they are being successful. Win, win, win, win. Sadly, it takes effort, so don’t expect to see our ways being adopted universally any time soon.”… “Hard work. Accept no substitutes.”

And while profits hit over £ 21 million, an all-time high, growth is still lackluster and just won’t trend back to the glory days of the 1990s and early 2000s. “We have written a lot and spoken a lot about how we aim to grow the business: opening good stores with well chosen staff in new places, increasing the number of independent stockists we do business with and producing an attractive and efficient online store. Finding new places at attractive rents for our stores is not plain sailing, but is not as hard as finding the right people to run them in the right quantity. We have yet to get this as right as we would like and our new store openings in the period (net 6, 46 openings and 40 closings) is a reflection of that difficulty. In an ideal world we would be opening 40 or 50 net new stores every year. If we are opening stores to pursue sales growth, then why close any? Over the past decade we had accumulated several stores that didn’t work out, usually because the rent was too high. We are closing these as fast as makes sense. Sometimes it is more cost effective to pay to be released from our lease and sometimes it is better to wait for the end of the lease. This is a process that is mostly restricted to North America (and the USA, not Canada) and should be largely complete by the end of the year to May 2014” It goes to show that real life business involves a lot of trial and error, expand and retreat, there is no magic formula of success.

Know What Makes Your Business Durable

An area of weakness continues to be IP. At this point royalty income is down to £1.0 sorrow million. That’s poor. You will later see how Kevin Rountree blows the roof off with that one. Nevertheless, I still believe Kirby, fundamentally, had the right way think about IP and its protection. At the time there was a lot of concerns around people ripping GW, their characters and miniatures off. At the time 3D printing became the new hot thing. Many thought that would revolutionise everything in manufacturing. As always, these things are blown out of proportion, nevertheless there was a fear, particularly for Games Workshop that was heavily reliant on miniatures sales. “Breach of intellectual property (IP)…..The risk is that we lose control of our IP and thus other people can take our market. There are two ways we mitigate this risk: product quality and IP protection. Product quality is the best defence. Our miniatures are of extraordinary detail and have very high costs associated with their production. We do the tooling and manufacturing here in Nottingham to ensure that quality. As it happens, even if we wanted to tool or manufacture elsewhere, we have never found anyone who can deliver the quality we need at the price we pay. In order to be able to duplicate that quality requires a level of capital investment that no one has, as yet, even tried to emulate. This also deals with the risk of counterfeit products. The few that are made are of poor quality and do not appeal to our customers. Should that change, or we meet intransigent small infringers, we have copyright, trademark and passing off law to protect our imagery and we have never been shy of using legal redress if needed. Our legal department deals with dozens of cases each year with satisfactory results. The scale upon which we do business is the biggest defence against this threat. The cases we deal with (and there are dozens each year) are nearly all single individuals or small businesses who ‘cease and desist’ as soon as they get the letter. Those who don’t should be stopped more because we need to ensure everyone knows we are serious about defending our IP rather than because of the immediate threat of damage to our profits.” And one year later, in 2014, on the threat of computer games and 3D printing Kirby says: “Because no one seems able to grasp the essential simplicity of what we do there has always been the search for the Achilles heel, the one thing that Kirby and his cronies have overlooked. These are legion. I run through the list from time to time when someone says that computer games will be the death of us – they are so much more realistic now! – again. This year it is 3-D printing. Pretty soon everyone will be printing their own miniatures and where will we be then, eh? We know quite a lot about 3-D printers, having been at the forefront of the technology for many years. We know of what we speak. One day 3-D printers will be affordable (agreed), they are now, they will be able to produce fantastic detail (the affordable ones won't) and they will do it faster than one miniature per day (no, they won't, look it up). So we may get to the time when someone can make a poorly detailed miniature at home and have enough for an army in less than a year. That pre-supposes that 3-D scanning technology will be affordable and good enough (don't bet the mortgage on that one) and that everyone will be happy to have nothing but copies of old miniatures. All of our great new miniatures come from Citadel. It is possible that one day we will sell them direct via 3-D printers to grateful hobbyists around the world. That will not happen in the next few years (or, in City-speak, 'forever') but if and when it does it will just mean that we can cut yet more cost out of the supply chain and be making good margins selling Citadel 3-D printers. At the heart of the delusion is the notion that designing and making miniatures is easy. It isn't.”

What a beautiful way to take a potentially threatening trend and use it to your own advantage. Kirby’s last words before Roundtree takes over:

“As for the future, our objective is simple: we will continue to make the best fantasy miniatures in the world and sell them globally at a profit. We intend to do this forever.”

To be continued.