Consolidation Be Damned!
The Amusement Industry Is Healthier Than Most Think

by Frank ‘the Crank’ Seninsky

EAST BRUNSWICK, NJ — According to a colleague who talks to many different manufacturers, distributors, and operators, the single word he has heard most often from all three groups in the past 18 months is “scared.”

Industry members across the board are scared by the departure – or demises – of former icons like Midway and State Sales last year. (Now we hear Konami is reportedly on the brink of exiting the U.S. coin-op market this year.) Industry members are unnerved by ever-increasing competition from other types of entertainment — not only consumer video, but gambling and the Internet. Amusement professionals are also deeply disturbed by the steadily dwindling numbers of locations, machines, and operators.

Facing all these trends, many industry members are asking themselves: who’s next? And, how do I avoid becoming just another industry statistic?

The latest cry from the heart of our troubled industry comes in the form of an Aug. 14 market analysis by independent distributor and importer-exporter Brad Brown of Worldwide Video Entertainment (San Diego, CA). This document, labeled “State of the Industry 2002,” was faxed around the country. It is certainly well-written and logical. At the same time, in my view, its premise and conclusion may reflect a somewhat limited perspective (it is forthrightly labeled as being Mr. Brown’s personal opinions). Brad has occasionally found himself at the center of political controversy, but there can be no doubt he’s a thoughtful and well-informed observer of industry trends. So, as we head into the fall show season, his essay provides an excellent platform from which to examine the state of the amusements business.

As I read it, the central point of Brad’s report is that current trends are “creating a downward spiral.” Brad then continues: “I don’t see [this downward spiral] abating for at least another two years.”

Is he right?

Maybe that depends on how you define downward. I certainly agree that our industry is doomed to suffer an irreversible decline if people don’t get off their duffs and do something to improve conditions! However, I don’t perceive this to be the case. The more creative manufacturers, distributors, and operators are all working hard to diversify, increase efficiency, and expand their market share.

As for Brad’s stark predictions that additional numbers of manufacturers and distributors will exit the business, this is also quite likely. But if having fewer manufacturers and distributors is automatically assumed to be bad, then I must respectfully but strongly disagree.

I don’t believe it’s merely a self-deluding, Pollyanna view to characterize our industry’s ongoing contraction as “right-sizing.” The efficient companies are being rewarded; those with outdated business practices or less-successful products are being punished. The survivors increasingly find themselves in more stable markets, running more efficient businesses that generate greater profits out of less investment (and less revenue). The winnowing-out process can be very painful, no doubt about it. But this is how capitalism is supposed to work.

Let’s examine Brad’s specific trend analysis and predictions one at a time. He begins with the assertion that more manufacturers will merge or exit the business in the coming year. Again, I agree, this is logical. However, I’m less concerned that fewer manufacturers necessarily means a significant reduction in the number of good games that are available.

Have you noticed that even though Midway is gone, its best driving games and countertops live on, thanks to companies like Betson, Ecast, and the like? Or, have you had any trouble buying a top-earning Seidel redemption game or an Interactive Light game? No, because those products are now handled by Bay-Tek and Global VR, respectively. I could cite many more examples, and I’m sure we’ll still be able to buy the occasional great Konami piece, even after some third party takes over its U.S. coin-op marketing and sales. In fact it could even be better for the industry as stronger marketing and service companies handle these products. This is how market forces wring the fat out of an economy and create more-efficient, more-profitable businesses.

Looking at the declining demand from operators, Brad predicts that in the next year, minimum production runs may be 100 to 200 redemption games, or 200 to 400 video games. At first hearing, this may sound horrific compared to the video heyday when more than 100,000 units of “Ms. Pac-Man” were sold (over a couple of years). It even sounds bad compared to 1992 when 50,000 units of a hot video game could sometimes be achieved. So I guess if I were a distributor who made most of his money on the margins from equipment sales, I’d say that reduced machine production minimums were very bad news indeed.

But from an operating perspective, sharply restricted production of new equipment avoids saturation and helps ensure that the equipment that we buy will retain its value. Market saturation has been our downfall for 20 years, beginning with the 1982 video game crash. With smaller production runs, the industry’s supply will be considerably less than actual demand…and that’s a good thing.

The pinball industry has already achieved stability in exactly this way. I’m sure it wasn’t pleasant for the manufacturers and designers who were weeded out in the process, but what’s left is a situation where supply and demand are balanced. The surviving manufacturer, Stern, can make a profit from building and selling pins (to both the industry and to homes); and operators can make money from buying a few. That’s the equation for market stability. (Thanks, Gary, for seeing this and following through on it!)

The big picture for this industry is that the same pressures and processes are now being applied to every other market segment. We are returning to the old, healthy business model that we originally had, back when Gottlieb was making pinball machines. Today’s operating companies can see a game they like, order a few, the machines are produced, and then – production stops.

Does this mean that eventually demand and supply will dry up entirely? Does it mean the whole industry will blow away like a dusty tumbleweed, rolling through a ghost town of empty locations? No! Let me make a few predictions about coin-op manufacturing of my own.

Seninsky’s Prediction #1: there will always be demand for on-location, machine-provided entertainment because it’s efficient and profitable. There will, accordingly, always be manufacturers around to supply entertainment devices to meet that demand. But these manufacturers simply won’t do business the same way they did during the industry’s free-for-all “go-go years.”

Seninsky’s Prediction #2: as production and sales (supply and demand) come into continually closer correlation, we will continue to see the better manufacturers switch to “just in time” production and flexible assembly lines that can profitably produce short runs of game A, switch to game B, then return to game A when demand is resurgent.

Not only that, but we will see continually improved coordination of operator demand and manufacturer supply. In fact, we may see the long-discussed scenario finally happen in reality, where a group of distributors or even a group of operators will pool their payments to make sure that a minimum product run is accomplished. Sales will actually precede production, taking some of the costly (and potentially dangerous) guesswork out of manufacturing. Perhaps it’s easier for a distributor to put this type of deal together, but if distributors don’t do it, I predict that operators will! Anyway, don’t worry: the smart-thinking distributors already are thinking this way and we will all soon see the benefits.

Retuning to Brad’s essay, his next major prediction about manufacturers is that some of those who are endangered will indulge in a last-minute flurry of direct sales to locations. This is probably true, and in fact some of this is going on now. But based on past experience and long observation, I believe this will actually be a “blessing in disguise” for the operator in the long run.

Greedy, unwise locations sooner or later will find they cannot service the equipment they buy, which in many cases will be the products that educated operators wouldn’t touch. Meanwhile, the locations will still owe money on those machines to their finance companies. And it will only get harder for locations to service this equipment after the manufacturer goes out of business!

Eventually, these locations will face a desperate need for operators to come in with the right equipment to create a positive revenue stream. I’ve been through many cycles when this occurred in the 1970s and 1980s. It always ends the same way: after a couple of years (or less), the location that bought direct goes back to using an operator. Locations are simply never in a position to know which manufacturers will be around for the long haul. They can’t even figure out, in most cases, which machines will be profitable in the short term. Locations need operators, period!

Factory-direct sales to locations are probably not a major threat in the first place. Manufacturers simply don’t have the marketing resources to accomplish it on a broad scale. In addition, operators are protected by exclusive location contracts in many, perhaps most, cases. Pull-through marketing (which most operators perceive as “meddling in my business”) will also fail much of the time, through the simple expedient of the operator explaining the facts of life to the location owner. “Hey, Mr. Location Owner, don’t you realize the reason they’re targeting you is because they are about to go out of business?” That question is all it takes to put a damper on many direct sales! And don’t ever forget the close relationships that good operators have with their profitable locations!

Brad goes on to predict that more distributors will exit the business, leaving the larger, financially stronger and more diversified distributors in an even more dominant position. Again, I agree. But in today’s world I don’t believe that this will have a negative effect on the operator’s ability to obtain new equipment, nor on equipment prices. Competition through Internet communication and cross-shipping will continue to keep prices down. Brad predicts that this market pressure will take the profits out of distribution. I believe it already has in many cases!

As a matter of fact, my concern is to make sure that margins remain sufficient to keep distributors in business. Distributors are necessary to the health of the operator, so I want distributors to be strong. The operator who saves a few dollars on the purchase of a new game, in many cases, discovers later that he has only set himself up to take a larger loss on the asset/resale end a year or so later. Cheap equipment sells in bigger volume, and depreciates even faster.

Should operators worry about one distributor becoming dominant in a particular region and tying up equipment only to that dealer’s market? I doubt it. I think people in other regions will pay what it takes to get good equipment. But even if a distributor does corner the market on a particular game, operators in regions that cannot get a certain product will not suffer, in my view.

Here’s why: in the short run, there will be no competitive effect from Operator A in Region A offering a certain machine that Operator B in Region B can’t get initially. All operators in one region will be in the same boat. In the long run, if a particular machine or type of machine is so popular that everybody wants it, the free market will supply it quickly – that’s a certainty!

Brad laments the possibility of more big distributor “dumping” of equipment (at reduced prices) into other distributors’ territories in order to increase sales figures and cover manufacturer allocations. Once again, this a problem for smaller distributors but not for operators. (Anyway, a creative distributor who faces that kind of “dumping” can still compete by focusing on other products. Certain distributors are adamant about this, so I’m not the only one who thinks so!)

The possibility of distributors selling direct to locations, and/or expanding their own route operations, seems to be a more serious concern in Brad’s view. (Perhaps Brad feels this way based on recent events in his local market.) I suppose this is somewhat more plausible than worrying about factory-direct sales; at least the distributor can offer parts and in-house repair service (the location has to bring the broken game to the distributor for repair!). But in my experience, the operator continues to have a competitive advantage over distributors who dabble in operations, even if the operator must pay higher prices for games. The operator’s advantage is that he offers superior service and devotes full time to servicing his accounts.

Turning to operators, Brad predicts that video game purchases will become more difficult to execute. I wouldn’t be surprised, but does it really matter? After all, video purchases are becoming steadily less important to operators anyway. As Brad himself states, “The decline of street video games is well documented every week.” If we’re talking about uprights with fighting, driving, or shooting themes, that’s true.

Obviously it’s not the case if we’re talking about countertops. These products continue to provide stellar cash box performance on most street routes. However, I would like to remind street operators that even countertops are vulnerable. Their current strong earnings could be impacted overnight, if the government enters the tavern with lotto machines, lottery ticket venders that play like slot machines, and the like – or if a publicly owned company with a different financial agenda (like advertising) just provides the games for free to locations and the locations can keep 100% of the cashbox.

Under the circumstances, the street operator needs to defend his real estate by getting those contracts signed and by diversifying into any type of service and equipment that helps the location boost its overall business. Good operators do this already with leagues and tournaments; such marketing will become even more crucial in times to come. Many operators think of their job as “service.” All operators must learn to think of their job as “service and marketing.” Diversifying into bulk vending, merchandising machines, photo booths, novelties, or whatever is also becoming increasingly important to street operator profitability and survival.

Looking at the big picture, let me point out that all the trends listed in Brad’s “State of the Industry” analysis are secondary results of the industry’s core problem. The most important problem facing our industry today, as it has been for several years now, is the urgent need to create and produce more good, innovative, high-earning (yet low-cost) equipment.

I agree with those who say it’s hard for manufacturers to find, recruit, and retain good designers in our industry. Brad himself provides a brief explanation of the difficulties and expense that manufacturers have in translating a promising game idea into a solid, profitable product. But I continue to feel confident that ultimately, the free market will always ensure that supply meets demand.

We’ve had a lot of “gloom and doom” talk in our industry in the past few years — too much, in my opinion. It’s true we are facing challenging times, but so is the whole U.S. economy. The business cycle forces this discipline on all of us now and then; and when this happens, it is our responsibility as good businessmen and businesswomen to get aggressive about finding new ways to do business in a smarter, better, more efficient way. Indulging in “woe is me, the sky is falling” talk is worse than useless. It solves no problems and can contribute to making the market tougher than it already is, or needs to be.

In order to foster a healthy realism in the amusements industry, I believe that we must change the way we evaluate the health of our market. Any operator knows, for example, that servicing many locations does not necessarily mean he’s profitable. What if each location only generates $100 a week in gross revenues?

In the same way, we must realize that the health of the amusements industry itself cannot be measured solely – or even primarily – by a single number or a single class of numbers. We can’t get a true picture of the industry’s health just by looking at the total number of businesses it supports. Nor can we gauge the industry’s true status just by looking at yearly national gross revenues.

Our industry today can be as healthy or healthier (in terms of ROI) with far fewer manufacturers, distributors, and operators than we had five or 10 years ago. As a matter of fact, the industry definitely will grow stronger as the number of marginal industry members continues to shrink because this will indicate a steady improvement in the productivity and efficiency of the survivors.

As for guaranteeing a sufficiency of good, new, affordable products, I believe that our industry can succeed on this score in large part, without plowing millions of dollars into R&D as was done in the past. All we have to do is borrow successful concepts that already exist in other markets – and I’m not just talking about porting consumer video games into arcades, either. Perhaps the next great redemption game idea will be coming from the gaming industry.

At this time, I’m not free to cite every example that comes to mind. But to take one example – let’s just say that we are only touching the tip of the iceberg in this country when it comes to redemption. This is true, even though the average FEC or large arcade is now 70% to 80% dominated by redemption. The trouble is, we seem to think the redemption concept is restricted to FECs and larger parks. Not true! There is still huge opportunity for street operators to expand redemption into virtually untouched location classes, such as bowling centers.

Let’s take a moment to review the amusements industry’s “gross national product” for the past two decades or so. According to a study performed by Gallup in the mid-1980s, the coin-op amusement industry was a $1 billion per year industry in 1979, then exploded to a $7 billion per year industry in 1980 and 1981. The video bust led to a market reduction in 1983 as the overall industry revenues fell to $4.5 billion.

Over the next couple of years, the industry recovered. Gross revenues gradually rose back to the $7 billon range by the late 1980s. This peak was more or less sustained until the mid-1990s, when a slow but steady decline set in. That decline is still going on today.

Although the total dollar volume of today’s industry revenues is not drastically less than the 1980-81 peak, remember: compared to 20 years ago, today’s gross industry revenue represents much less real dollars because it is measured in inflation-devalued currency. Also, from those billions of quarters that operators gross today, we must also deduct much higher overhead now as compared to 1980, due to higher labor, parts, and machine costs.

No wonder so many industry members say they are “scared.” But there is no need to fear. In spite of all these (apparently daunting) facts, profitability for successful operating companies is still better in 2002 than it was in 1980. This is true because with a smaller machine base, capital reinvestment costs and depreciation are proportionally much smaller. Remember, when you are in expansion mode, you are not making a lot of money. Instead, you are incurring a lot of debt and turning a lot of dollars.

(Another very instructive look at the industry’s overall annual revenues on a comparison basis may be found in the chart that accompanies this column. Not counting jukebox income, it shows total industry-wide amusement revenue from 1979 through 2001, based on data from the VENDING TIMES Census of the Industry. Even a quick glance suggests greater stability in overall industry grosses than many of us have assumed was the case. Thanks to VT’s managing editor Nick Montano for creating this revealing graphic.)

Bottom line: this industry is not as big as it once was, and it’s going to shrink some more in terms of the numbers of manufacturers distributors and operators – but that’s okay. In the classic self-correcting mechanisms of capitalism, the amusement business simply has to right-size itself, and that is exactly what is happening.

My biggest concern, as stated above, is that we must ensure having even a minimal amount of exciting new product that comes along now and then, to give us that small but oh-so-necessary spike in earnings and player excitement. If we do that, and I believe we can, then the amusement industry may never be the easy road to riches…but for those who are willing to work hard and continually challenge themselves, this industry can provide a long and prosperous future.

Thanks to Brad Brown for his timely and provocative essay. I am pretty sure that anyone like Brad who is that thoughtful and aware of the facts of life in today’s industry is also fully aware of the opportunities out there and will take advantage of them aggressively…as you know I will.

So I look forward, five years from now, to getting Brad’s 2007 industry report and to continuing this discussion. In the near term, I look forward to talking with him, and with many of you, at this month’s co-located AMOA Expo and Fun Expo. See you all in Las Vegas.