Wednesday, 7 July 2010

Editorial: A Taxing Problem

On Tuesday 22 June 2010 George Osbourne and the Conservative / Lib Dem coalition government unveiled their emergency budget, a budget apparently designed to get business moving again, and kick-start the British economy working towards reducing our increasingly high national debt. As part of this plan the budget included both a rise in VAT from 17.5% to 20% (a 2.5% overall rise), and the announcement that tax breaks were no longer on the agenda for the games industry.

This news has seemingly deflated the industry, with retailers worried about the large dent in profits this will have for their business as they struggle to compete on price with supermarkets and chain multiples, and developers left wondering if the British government actually takes their industry seriously.

In the last couple of years much progress has been made between the UK games industry (represented by ELSPA) and the government. This resulted in the acknowledgement that the games industry was perhaps in the position to best regulate itself with regards to age restricted sales, finally making the PEGI (Pan European Games Information) system not only legal (comming into effect later this year), but also replacing the BBFC system used for the last fifteen years or so in rating software. That, and the acceptance that in order for British companies to compete in games development on a worldwide scale that they would need some kind of tax break incentive.

Whilst the budget obviously doesn’t impact on the newly reformed PEGI system, it does however completely discard the industry’s need for some kind of tax break initiative in order to bring in a constant pool of talent, and a firm reason to stay in Britain, rather than let that talent slip through their fingers and into the hands of Canadian or European software houses, thus further shrinking our regressing industry. The government however doesn’t now appear to see this as an issue, or rather it doesn’t think that the games industry ‘needs’ prioritisation - to be thought about outside the realms of every other business.

Just a few months ago the Labour Government was looking into providing some kind of support for the industry, not necessarily tax breaks, but something along those lines in order to help us become major players on the world stage. With the new government, and the budget announcement, the need for industry help has being thrown completely back into it’s face, with Osbourne stating: “We will not go ahead with poorly targeted tax relief for the videogame industry”. A clear sign of either misunderstanding of the industry, or simply the feeling that the government thinks it isn’t important enough to consider.

The result is that more publishers might well up ship and move abroad where it is cheaper to set up a development studio and make games, taking any potential talent with them. Another issue is with what happens to all the potential talent in this country. Will they be nurtured and then cultivated into the next inspiring leaders of software development, or will they simply fade away without proper training, or the right guidance in order to make this happen?

These are just some of the questions the industry is asking, and indeed worried about, something which the government should really be taking stock of given the fact that videogame sales and the industry brings in a lot of money for the British economy as a whole.

Thankfully the changes made to both Corporation Tax, and Capital Gains Tax do present a small beacon of light to British businesses, although the changes in CGT are said to make more unattractive for foreign investors to invest in British business. Any reductions in taxes bestowed upon businesses is likely to help the games industry as much as any other, and in which case the setbacks that have been felt are not the be all and end all of the issue. ELSPA will continue to campaign for greater understanding, and more help for the industry, whilst publishers, as always will take their business elsewhere sending a clear message to the British government as a whole.

Now it’s time for the organisation to once again build bridges with the government and the issue of videogames, perhaps attempting to bring about another chance at understanding our industry and what it means to the economy, and society as a whole. Only then will we see progress being made, and it’s progress that this industry needs to see.

Whatever the outcome, in the meantime it is likely that the UK’s position on the world stage of games development will further decrease, much like it has been doing these past few years. This isn’t something that will benefit our economy, not will it be something which threatens the amount of stellar games that reaxh our shores. It’s just that more of these games will be produced elsewhere, further stagnating our industry growth and creative impact in the future.

The battle on this front is far from over, that’s for sure. But what about the retail sector and the rise in VAT?

This is equally as interesting, mainly because it has so much more of an impact on the everyday consumer, than the closed, behind the scenes workings of the industry. Any changes here are easily going to felt by you and me, everyone that at least purchases videogames from the high street.

In January 2011 the government plans to increase VAT by 2.5%, from the established threshold of 17.5% to 20%. What this means is that for every sale the company will be handing over more of their profits to the taxman rather than being able to re-invest it back into their business, or as it seems with the larger chain retailers, back into executives, and shareholders pockets. Small independent retailers are likely to be hit the hardest with this decision, with RRP’s rarely being stuck to, and a massive price cutting war ensuing on almost every major release.

Most games actually carry an RRP of either £44.99 or £49.99, however, pretty much every chain retailer, games or otherwise sells these titles at either £39.99 or £44.99 reducing their amount of margin in order to compete, but at the same time making it impossible for smaller stores to even break even when selling these games. All the while the consumer thinks that its okay for the price to drop blissfully unaware that development costs are spiralling out of control, and that pretty soon the price of games ‘will’ have to go up, or perhaps the size and cinematic scope will have to drop right back down again.

Either way this particular debate is a minefield of shorts, with valid opinions on both sides, and the retailer usually the one to back down when it comes to the crunch.

So what happens when the VAT rise comes into effect? Well, the most obvious thing is the drop in revenue felt by retailers everywhere. Fewer profits mean a harder business to run, with fewer opportunities for expansion, and less of a reason to focus on the customers needs, instead pushing towards an even harder sales culture. Some may even expand more aggressively into the online sector, one which will largely be unaffected by the rise in VAT. Well, if you’re based in Jersey that is.

There are a few ways this could go. One, the retailer takes the hit keeping retail prices at the current level, ignoring the RRP given to them by the publisher. Two, they could raise the price of games in accordance with the rate of VAT. Though this would mean prising up titles to the nearest pound, rather than the nearest five pounds as historically done over the last twenty years or so. And three, the retailer adheres to the RRP set on games by the publisher, with the consumer seeing a large price hike on most software titles across the board.

The implications will be felt on choosing any of the three options above. If the retailer decides to take the hit by absorbing the additional rise in VAT, the consumer benefits by having similarly priced games, but at the cost of better customer service. With overall profits down shareholders aren’t likely to be happy, and the executives of most chain retailers are likely to demand that they keep their bonuses at the expense of customer or staff satisfaction. At the same time the age old trend of expansion and growth will be much harder to achieve resulting in a far greater push towards the hard sell.

This hard sales nature, constantly expecting the customer to buy add-ons with every purchase, to take ‘that’ warranty even if they don’t really need it, will become far more prevalent as the main driving force behind some businesses. We have already seen this trend manifest strongly with the chain multiples over the last five or six years, with the focus less on good customer service and more on getting unrealistic results every time a sale is made. If stores decide to take the hit on tax, then it seems that this course of action is far the most obvious one, though not really the best, as more and more customers have been turning away from traditional retail and into the online marketplace due to this reason, and of course the reduced prices these sites provide.

Raising the retail price on games instead, perhaps in order to preserve some of those profits, has it’s own set of problems. Namely, the online retailers, in which this 2.5% tax rise has little to no meaning other than more potential sales for them. You see, most large online retailers are based in Jersey, a region of the UK unaffected by our VAT rises and reductions, and this allows them to continuously not only compete on price, but also see them slashed in an attempt to gain valuable sales from traditional bricks and mortar outlets.

The advantage is that any potential high street stores looking for a break could well turn to online in order to achieve it. With lower prices, but also lower taxes to pay, they could still stand to compete against both online and the supermarkets.

You also have to look at how the market has changed over the last fifteen years or so, and how the customer base has changed. If prices are in fact raised, who will be happy enough to continue paying the raised amount? And for how long? If you look at how people shop it is clear that most customers expect games to become cheaper, or rather, they expect the average new release price to be no more than £40, and quite often look for it to be less than that. With this in mind raising the overall price threshold for games in accordance with the tax hike, or maybe to the nearest £5, isn’t such a good idea as many customers will instead take their business online, or to someone who isn’t doing the same.

Ultimately, today’s so-called ‘specialist’ chain retailers have very little to offer customers outside of being a ‘one-stop’ shop for games. They very rarely stock niche, or hardcore titles, and if they do it is always in extremely small numbers. Plus overall service has largely diminished over the last few years. In essence, there’s very little to keep customers coming back into stores, thus making the VAT predicament all the more difficult to deal with.

Indies on the other hand have the toughest decision to make. They largely operate on the low-margin, high-quality service model, in many cases going that extra mile to differentiate themselves from the large multiples. For them keeping prices low is going to be hard, and I can see that many simply won’t be able to compete in this area, meaning it’s down to whether or not the customer thinks the service, and shop itself, is worth them spending the extra £5 or so.

And then you have the large entertainment chain stores, ones that stock everything from music and DVD to videogames and MP3 players. This segment of the retail community is perhaps the toughest of them all, with competition from online stores and supermarkets, to the likes of digital distribution with iTunes and other download services.

Having prices go up is simply not an option, consumers already see both music and films as largely disposable, and videogames are strongly heading that way, if not already. For them I suspect that most titles will stay below the increased VAT price, with the business taking the added hit as a result. Maybe the use of promotions, and worked out deals with suppliers will negate these issues slightly. But then again, everyone will be looking to maximise margins.

Currently, it’s far too early to see how well the retail sector in general will react to this change. I’m guessing that many hours of consumer research, and cleaver marketing will no doubt help to carve out a temporary solution until something more concrete can be worked out. Either way, many are predicting that customers will be lining up to grab a bargain before the tax increase takes place in January next year, with many retailers likely to grabbing every last slice of the pie before the challenge really sets in.

In conclusion, the budget announcement has done no favours for the industry as a whole, creating yet more issues on either side of the fence. On one hand you have a lot of hard work between ELSPA and the old Labour government seemingly, if not partially wasted. And on the other, the whole retail sector if left with yet another ‘price’ problem to deal with. But perhaps it’s not all doom and gloom. Instead businesses in general have had some tax breaks (which will help the games industry), and with regards to the VAT increase, every retailer is in the same boat. Although it has to be said, that videogames and entertainment retail is amongst the toughest in the world, and this increase is hardly going to make it any easier.

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