Games and toys, not any more child’s play

• The leading toy brands
• The cost of sales and what forms the major chunk of this cost?
• How Lego Group managed its cost of sales?

The 21^st century has seen a tremendous transformation in the gaming and toys industry as compared to the developments in the 19^th and 20^th centuries, gradually shifting its focus to achieve technological sophistication. Hence, playing with Barbie doll, hot wheels, board game, superhero miniature are few of the most relished childhood memories for many. But with the passage of time gaming products have become a lot more technologically advanced and visually appealing to boost the consumer demand, especially from children. Toy cars that were manually dragged, progressively transformed to remote controlled devices and lately riding electric cars for children manoeuvred by adults. The consumers have become more brand conscious with the passage of time and usually prefer products with high durability and brand image. The value of the leading toy brands worldwide (million US dollars, 2017) is shown in the chart below. Lego is the front runner with the highest brand value followed by other leading firms such as Bandai Namco, Barbie, Mattel, Hasbro, etc. 

According to the Toy Industry Association, the sale of toys was approx. $90 billion market globally (2015) with dolls, building sets and vehicles among the most popular and successful products. Presently, in the US, arts and crafts related games, which is the largest toy market exhibited a 5% negative growth in 2015 as compared to the previous year, while games and puzzles increased 18% in the same period. Notably, arts and crafts have been losing the market since 2013.

The major portion of the revenue in the industry is attributable to three leading manufacturers, Lego, Mattel and Hasbro, with a turnover of approximately USD 5.7 billion, USD 5.5 billion and USD 5.1 billion respectively. Tomy, Bandal Namco and Jakks Pacific are the other key players in the industry. However, the industry consists of many small and private players. The statistics depicted in the chart below reflect the revenue pattern of the industry since 2007 and show a low CAGR of 1.23%. The overall revenue figures have been constant despite rising volumes with an increase in population owing to low selling price and an increase in competition.

The cost structure of toys and gaming industry gets significantly affected by the economies of scale through production, efficient marketing and distribution, research and innovations. A shift in toy manufacturing, which was earlier concentrated in the United States, but saw a gradual transformation to other regions such as Mexico, Eastern Europe, Brazil and South-East Asia due to a lower cost advantage. This geographical expansion led to increased products being readily available to more consumers at low cost. The below chart shows the percentage and cost of sales, which consists mostly of material and related components cost and accounts for a sizeable portion of the total cost in the industry. The major component is the material cost that is used in making toys and gaming products are plastic, paper, wood and clay and electronic components like breadboard, capacitor and resistor. The utilisation of materials varies across companies and depend on the type of toys and gaming products that a firm produces. 

Moreover, research and development and marketing expenses are other key components of the cost structure within the industry, these determine a product’s ability to capture newer market amid global competition. The cost of sales was the highest across the industry as a percentage of sales followed by marketing, research and development expense, this was approximately 46%, 13% and 3% and can be seen in the graph below. Significantly, Lego Group is the market leader, it had the highest revenue and a very high percentage of advertising and marketing expenses, an average of approximately 27% while its cost of sales was surprisingly lower at around 28%. The primary reason for this was an efficient supply chain management and use of renewable or recycled material, hedging of currency exposure for future cash flow transactions with respect to materials and other commercial exposures (and not for trading or derivative purposes). This was in contrast to other major players in the market, whose cost of sales formed a bulk of their cost structure.

The toys and gaming industry has seen a steady rise in revenue, specifically in the past couple of years. The average revenue for the four largest players (Lego, Mattel, Hasbro and Tomy Co.) gradually grew from USD 3.87 billion (2012) to USD 4.33 billion (2016). While the average gross margin was around 45% due to a high cost of sales (except for LEGO with an average of around 70%), the EBITDA margin neared 20%, this was pulled down majorly by marketing expenses. The EBIT margin dropped down by about 5% as shown in the below chart, this meant a presence of high fixed assets in the balance sheet of companies. The non-cash depreciation expenses of the firms were high and lowered the operating margin within the industry.

The industry seems to be less leveraged as the EBT margin remained unchanged as compared with the EBIT margin. The EBT margin for the year 2015 and 2016 was around 14% and 13.5%. This was only 1.4% and 0.8% less than the EBIT margin for the same period. However, the industry’s net profit margin was grossly affected by the high tax rates in the respective countries of operations for the firms. This can be verified from the net profit margin of the industry that fell sharply when compared with the EBIT margin of the industry. The fall in the margin was approx. 5%, which manifest a higher proportion of tax expenses borne by the industry. In terms of the sole performer, Lego Group outperformed the other major firms with higher operating margin. Its EBITDA, EBIT and net profit margin were 36.42%, 33% and 24.87% respectively (FY 2016), while its closest competitor Hasbro, Inc. had margins of 19.50%, 15.74% and 10.62%.

The key manufacturers have been the ‘movers of the industry’ and are expected to retain their position in the market. Additionally, there will be more pricing pressure from the retailers to lower the markups as they have more options to purchase their goods from increasing number of operators and low-cost imports. The living style and playing habits of new age generation kids will also play an important role in deciding the future of the industry. Innovations will bring in new opportunities, the ever-increasing digital lifestyle of consumers worldwide and exposure to technology at an early stage are pushing manufacturers to develop smart and engaging electric and electronic toys and games. Furthermore, rising disposable income is a crucial factor that drives the sales of toys and games in the emerging markets. According to the Global Industry Analysts, Inc. Asia-Pacific, China is expected to outstrip the United States as the largest market for games and toys industry in 2017. Only time will tell whether this holds true or not. 

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