The Decision To Buy, Lease or Revenue Share
Coin Operated Games

By Frank Seninsky and Jerry Merola

Since the dawn of the coin-operated amusement industry, both owners of game facilities and game suppliers have debated the decision to buy, lease or revenue share coin-operated amusement machines. Many an owner has commented that buying the equipment out­right has put more in his coffers each year, while amusement game operators have pointed out the many benefits of revenue sharing with an experienced professional operator. Still other owners contend that leasing (with or without purchase options) is the key to success, as the risk of depreciation is eliminated while monthly liabilities are predetermined.

So you have basically three schools of thought and three solutions. Which one is best for you? It depends.

Consider the changes in the FEC industry over the last 10 years: equipment costs have skyrocketed, with the average game unit now costing between $6,000-$8,000 (mix of video, novelty, and redemption);the selection and type of units available is greater than ever; the cost of parts has increased threefold; and the cost of skilled technical labor has doubled while the low national unemployment level has led to a scarcity of qualified individuals.

To date, writers on this topic have attempted to create charts and guidelines that would closely resemble a typical facility owner's operating position. The trouble with this is, every operating position is unique, particularly when factoring in critical variables such as:

Further still, the best decision may be a blending of purchasing, leasing, and revenue sharing, but the deal must be flexible and be evaluated on at least a monthly basis so that changes in the market are balanced and controlled effectively.

Ask yourself when was the last time that you carefully studied the relationship between each game's weekly revenue generation and its current market value (what we refer to as its rubber band ratio). What about each game's current market value to its book value? What are your facility's true costs for technical labor, replacement parts, upgrades, and modifications, insurance rating increases for workmen's compensation insurance, and ancillary support equipment asso­ciated with game maintenance? The answers to all of these questions will help you determine the most appropriate current solution and establish future guidelines to follow for evaluation.

Buying Games

Effectively outfitting game areas (and constantly updating them) within a leisure entertainment complex requires vast knowledge of the game industry, foresight, and capital. First and foremost, the facility's budget and/or borrowing capacity must be examined to determine if sufficient capital is available to permit the proper level of investment in game equipment. If the subject is a new facility, care must be taken to avoid diminishing working capital funds that might be necessary for sustaining the operation during start-up and off­peak periods.

Consider also that a portion of the same portfolio may be devalued by up to 50 percent in the first 12 months, an alarming issue to those utilizing bank loans in excess of 24 months. Interest costs, increased covenant criteria by lenders, and/or investment potential of such capital must also be considered in analyzing true costs and opportunity costs.

Our games are financed over 36 months, largely because the banks question the value of these assets as they get older. It's likely that a five-year amortization of a game would cause the loan value to exceed the market value in every year that the loan was outstanding.

Next, the correct model selection, proper mix, and type of games is not only critical in attracting guests to the facility, but in protecting the facility's game investment. Just because a unit is new to the market from a well-known manufacturer with a top ranking in the trade magazine polls does not mean that it will be a shining star. Industry experts agree that many games on these polls are overrated while certain `sleepers' are underrated or may not even appear on the polls.

A game's actual performance results within the subject facility's market region is likely to be a better indicator, but can be difficult to obtain from current users. How a game's difficulty level is programmed, the price per play, and where and how it is placed in relation to other games in a facility can all have a huge effect on that game's earnings.~

Buying games at the "right" price will help to lower the overall cost basis and permit the game operation to more easily meet targeted returns. This step cannot be overemphasized, as the value of a game may drop rapidly as a result of new introductions, a manufacturer or distributor sale or `close out', unavailability of parts, chronic service problems, or diminished play experience.

After you feel confident that the correct game units have been purchased at the right price, there lies the issue of preventative maintenance and service. Many game units, particularly video simulators and redemption units, are prone to constant service, as the number of mechanical parts is significantly greater than a standard upright video. Inexperienced or under­experienced service personnel can easily damage a $5,000 PC board or a $300 power supply, which no manufacturer's warranty will cover.

The Other Side of Ownership

Buying games is one thing; selling them is another. The decision to sell game units must be based on several factors including current earnings vs. current market value (Rubber Band Ratio), performance, market value, upcoming game introductions, condition, and repair costs. The proceeds from these sales must adequately support a large portion of the upcoming purchase budget; it is therefore critical that the greatest market value be obtained. Doing so requires a strong network within the domestic and international secondary markets and the ability to recondition each unit and potentially offer payment terms and/or warranties. Without these, the trade-in value will likely pale in comparison to market value, often 25 percent below market value.

What if facility management lacks the expertise to handle each of these key variables? There remains the option of hiring a qualified industry consultant to direct such operations. For a relatively small monthly fee, an experienced equipment operating consultant can properly time and oversee the best buys and sells, hire and train qualified technical staff, provide inexpensive game upgrades, offer game modifications and improvements, properly program ticket payouts and percentaging, attractively layout games for maximum performance, and schedule equipment rotations and preventive maintenance programs. The caveat, naturally, is to choose a professional that manages equipment in every region of the country (and internationally) and maintains an infrastructure of service, technical support, parts, and large-scale purchasing/ resale power.

If you decide to own your own equipment, make sure to avoid the most common pitfall, the mindset of holding particular game units far too long, sometimes to the point where the salvage value ceases to exist, resulting in game disposal expenses. In most cases, the optimum time to sell a game, particularly video, is while the current earnings are still relatively good. Accordingly, market demand and value remain strong, allowing for easy liquidation at attractive pricing levels. Once a "close out", conversion kit upgrades, or a revised version of a sequel game hits the market, thousands of dollars in resale value can be lost overnight. Don't get caught napping.

Revenue Sharing: The Good, the Bad, and the Ugly

We also incorporated "the bad" and "the ugly" to make sure that a distinction be made between a good operator and a bad one, and a good deal and a bad deal. A bad operator is not necessarily a bad person, but may choose (or be forced) not to invest in new games and not see the benefits of maintaining his or her equipment, rotating when required, etc. If the revenue sharing deal is not fair to both parties, then the result will be bad or even ugly.

Facility owners must be aware that to get too good of a deal from an operator just makes a good situation switch to a bad one and then to an ugly one. There must be sufficient cash flow for the game operator to purchase new games and do a professional job. This is critical to having a good revenue share arrangement.

Revenue sharing is most effective for operations that lack sufficient borrowing capability or capital; operations that lack game expertise; and operations whose management is already too burdened in dealing with the balance of the major attractions and other core income sources in the facility.

As we know, the reason the large amusement parks tend to revenue share is based upon the "real depreciation" problem that occurs from using the games for only four or five months a year. By the time the next season rollsaround, those assets have lost much of their earnings power, which translates directly to hard depreciation. This often results in the need for massive investments that exceed revenue generation capabilities. Game operators that maintain routes have the ability to rotate games from their seasonal park locations to other locations, to enhance cash flow throughout the year.

A good FEC route game operator is never married to his or her equipment. Each unit is evaluated on a weekly basis to make sure that it's Rubber Band ratio is ahead of the depreciation curve. Studying the game market means knowing how many units of each model are scheduled to be manufactured, how many are in inventory in each distributor's warehouse, and how many of each have been sold to date. It also means evaluating and testing every game prototype that is going to hit the market in the next six months and determining what percentage of revenue a new game will "grab away" from other games, as this will cause a drop in value of these other games.

A good operator knows when to adjust a game to increase its earnings, when to move the game to another location to increase its revenues, and when to sell the game (at a good price) before the asset value plummets. Note that the current asset value (market value) of a game is directly related to its current earning potential through­out the marketplace, along with the amount of supply. Sometimes there is only a few days' delay throughout the country before a game's value will fall everywhere. Sometimes a game can be sold and bought back a couple of weeks later at a much lower price, much more than the game could have possibly generated on location during the time period.

The coin machine operator:

Supplies the capital to pay for the games and related equipment and for the continuous monthly infusions of new games and the removal of non-revenue producing games, throughout the term of the Agreement

Pays for all repairs and parts necessary to service the games.

Pays for his fair share of the prizes (if redemption and prize dispensing games are supplied), tickets, tokens, license fees, and any other agreed upon expenses that are negotiated between the parties.

Contributes to the cost of labor to maintain the. games (facility usually pays for floor staff to handle coin and ticket jams to keep the outside of games clean)

Provides superior knowledge of game operation and management that results in higher game revenues and increased per capita spending (guests stay longer and make additional purchases). Frees management from the time and headaches of game operations, allowing them to focus on the main business of attracting and servicing their customers.

Participates in discount and promotion packages that add value to the customer and increases repeat business.

Advises management on new trends and attractions that may benefit the facility.

Runs game contests and promotions.

The decision to revenue share must be analyzed from many angles. There are strong facilities where the game averages are high and the operator can afford to receive less than 50 percent. One of the most important criteria to measure the deal is to determine the proper number of games and the proper average market value per game.

The operator needs his games to gross an average minimum amount of revenue per week to provide at least 5 percent of a game's current market value (based on a 50/50 revenue share). The number of games does not affect game revenues so long as there is an adequate number, an appropriate mix, and quality. Once this is obtained, it is not beneficial to add more games unless it can be accomplished by keeping the total market value of the games constant, which means decreasing the average asset value per game.

Another factor is to make sure that the average number of rotations per month (and total value of the rotations) is stipulated in the agreement. This factor is critical in keeping the game mix in the facility fresh and creating the reputation that your facility always has many of the new games.

Another word of caution: refrain from attempting to revenue share just the video games and insisting on buying all the redemption, particularly if the facility is not a top industry earner. Take into consideration that the operator may not generate sufficient revenue to offset actual depreciation on the high-end video, which will result in fewer rotations and a less desirable game operation. It will also be beneficial to the owner as well, since the operator's job will be to provide new redemption games that might not have been available, or budgeted for, at the onset.

Leasing-An Alternative For The Millennium

The term "leasing" is most often heard in the automobile industry, where an increasing number of cars, particularly luxury cars, are being leased instead of purchased. The term also conjures up thoughts of "excess wear and tear," "excessive use," "capitalized cost reduction," and others. Amusement game leasing, however, doesn't have to be as complicated. Leasing is nothing more than an agreement to rent a specified unit for a specified period of time at a predetermined price.

This alternative is particularly attractive for a facility owner that has a proven track record of operating and servicing amusement games in his or her facility, but might not have the capital available for an outright purchase. The infrastructure of technicians, spare parts, and support equipment is already on site, with the only missing ingredients being, perhaps, high quality games and the expertise necessary to match game selections with the facility's market demographics.

This is the point at which a qualified game distributor or large operator can provide the equipment and the expertise, all at a predetermined rental price. In many cases, these same providers may be able to provide contracted service to maintain the leased equipment at reasonable additional cost. The top providers not only deliver, properly install, and program each game, but design a revenue-maximizing layout. Additionally, many provide options to rotate games in and out of the lease at frequent intervals for little or no additional cost.

One of the key advantages to leasing versus buying is the elimination of asset risk. Under a lease, the lessor (provider) must absorb the inherent depreciation of the game unit over the lease term, and bear the brunt of any resulting drop in value beyond the original forecast. The lease price on a new, expensive driving simulator might seem remarkably high compared to an alternate unit that has been in the marketplace for six or twelve months. As the deprecation curve begins to flatten, many quality, strong earning game units can be leased at extremely attractive prices to complement the new units currently on the game floor. This permits the facility to change its look without heavily impacting its budget.

In recent years, many national chains and even large amusement parks, have preferred to lease game equipment, rather than revenue share, as they perceive that the existing patron base will generate game revenues well in excess of two times the lease cost. The benefit, naturally, is the ability to retain a greater percentage of game revenues, as compared to a traditional 50/50 revenue share. In a high grossing location ($250-$500 gross per game per week), this could equate to a more favorable split to the FEC of perhaps 60 percent or more. While the facility may retain a greater percentage of revenue, it must also bear the cost of all expenses, such as tickets, tokens, merchandise, replacement parts, game license fees, theft, vandalism, technical labor, and workmen's compensation insurance. Here to, the facility is now 100 percent responsible for marketing and promotion for the game operation, typically a specialty of large game operators.

If leasing fits the needs of your business, try to limit lease terms to periods of 12 months or less, thereby providing the flexibility to alter your operating plan down the road. Additionally, work with a provider that is willing to allow game rotations throughout the lease term; this way the facility's game area will always look fresh and maximize its revenue potential. Some lessors will also provide related equipment such as bill changers, ticket eaters, and coin counters at greatly discounted rates or include them at no charge as part of the lease package. Be wary of leases that require the lessee to pay for the replacement of circuit boards, monitors, and power supplies that become inoperative in the normal course of operation. However, replacement parts for normal wear and tear, vandalism, or damage caused by inexperienced technicians is typically the lessee's responsibility.

Just as in purchasing equipment, the advantages of leasing equipment are subject to the facility's ability to adequately service the units, promote the game operation, train its staff, and creatively design an effective game layout. Sound like a lot? It is.

The Choice

While one of the three main options is chosen by a large. majority of owners, we believe that a balanced combination of all three options may be the best choice in the long run. The owner can `cherry pick' the base level of games that he or she feels will earn well in comparison to their current market value and whose current market value will remain constant for a year or two longer. Some of the games can be leased in a package that converts to a revenue share if certain levels are not met after an agreed amount of time. The remaining video, pinball, novelty, and even a reasonable number of redemption games can be on revenue share.

Isn't it about time you take a serious look at your games operation? Are you sure that you are maximizing your bottom line? If you own your own games, the first step should be to determine the current market value of each game you own and compare it to the book value. If your games are worth far less, your financial statement isn't really telling you the truth about your business. Hopefully you won't find the results too shocking, or, if you do, you will feel prepared to do something about it. A thorough analysis of your game operation now can mean the difference between another lackluster year and a year to remember.

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