Plaupius said:
Wow, I thought we're in a sales related site, but the amount of ignorance of the basic economics is just staggering. I'm in the board of directors of a small-to-mid size company so I have some background on the subject matter. Not much, but enough to know what's important and why.
Profit is ultimately the most important number for any company that intends to stay in business. Period.
Everything else is subordinate to profits. Everything.
The following might have some errors in it as I'm writing things purely from memory, but the basic structure should be correct.
Revenue = Net sales + miscellaneous income
Operating income (loss) = Revenue - variable expenses - fixed expenses
Net earnings (loss) = Operating income +- interests and other items - taxes
Variable expenses include for example the manufacturing costs, which also include the salaries of the manufacturing personnel. They are called variable costs because the higher the revenue, the higher the variable costs will be.
Fixed expenses include for example deprecations and R&D costs, administrative costs, salaries of R&D, administration, accounting, support etc. Fixed costs are called fixed because they do not depend on the revenue.
Now, contrary to what at least Slimebeast believes, revenue in itself rarely matters. What matters is the profit potential, which is linked to revenue, but also highly dependent on the cost structure of the industry. The reason AMD, Sony or other big companies can post losses for several years is because a) either they have built up cash reserves to surf through the slim years or b) some parties are willing to finance the operation of the company. If neither of these happen, the company goes bankrupt, no matter how much revenue it brings. Of course, in the case of a looming bankrupcy, the company will desperately try everything to obtain liquid assets to continue operating, which could lead to for example selling the company for a wealthier owner. In the case of Sony, for example, it is suspected that they have had to sell assets in order to finance their normal operations.
Another misbelief of Slimebeast, it seems, is that the profits of a company only benefit the shareholders. Now, let's correct this with some real information. A company can choose to pay dividends to the share holders, a decision which is made by the board of directors of the company. Microsoft posted astounding profits for a long, long time before paying any dividends at all. Dividends are paid from the accumulated free capital the company has (at least here in Finland, don't know about the legislation in other countries). Microsoft had accumulated some 80 billion dollars, and not paid a cent of dividends, until one year they rewarded the share holders royally and paid about half of the 80 billion as dividends. However, the profits benefit the company as well, argualby even moreso than they benefit the shareholders.
If you still wonder why profits should be more important than revenue, I'll put it in simple terms:
A company that posts losses has to cut costs, which often times leads to downsizing, though not always. However, continuing losses will inevitably lead to either bankrupcy or downsizing.
A company that posts profits can use those profits to grow, hire new people, set up new facilities, start new businesses etc. It is not necessary to grow, but most companies pursue growth because, if their cost structure will stay more or less the same, meaning that their sales margin, operating margin and gross profit margins don't take a dive, they will make more money if they can increase their revenue.
A company that posts zero profits or losses can't (at least easily) grow without external money. And a company that does not grow will face the degradation of their margins as inflation increases costs pretty much every year.
Every single company that is big today is big because it has been profitable and, thus, has been able to grow.
Now onto a slightly different matter. Why are revenues talked about so much within the game industry? The answer is actually quite simple: software companies, such as game studios, have close to zero variable costs. The cost structure of the software industry is such that nearly all expenses are fixed, which means that basically all revenue that exceed the fixed costs is profit, minus taxes of course. For the console manufacturers, this is clearly not the case, and that's why sensible people talk about installed base and not about the revenue that the console brings.
Also, as has been pointed out, measuring the revenue is an indication of the growth or shrinking of the industry as a whole, or of a single company. Growth tends to correlate with a healthy business, but as in all business analysis, you have to look at the results over several years. One year is just a drop in the ocean, it might be abnormally bad or abnormally good for countless reasons, and without delving deep into IR material it's hard to say how the company actually is doing. |
Damnit, I write long posts to try to explain what I mean, and here comes a guy from the business world (!) and misunderstands the whole thing.
Remember the prerequisites by the OP for this discussion:
Lately I've noticed that (more than usual anyways), people really enjoy talking about revenue in reference to just about everything. From software & hardware sales to the discussions back and forth over the merits of which consoles developers should choose to create games for etc... |
I'm not debating the business uses of analyzing revenue guys. I just don't see how it (revenue) is useful for gamers on a website talking about specific games, or possible future games, hardware sales, and of course future hardware sales. |
First of all, you explain dividends for no use. Because from a laymans perspective that's basically the same thing as making money by trading stock.
Next, the part in red. "Fixed costs (in which you include R&D costs, administrative costs, salaries of R&D) are called fixed because they do not depend on the revenue". Are you insane? Yes, that is true for how the numbers are structured in each Fiscal report, but not in the real business world over time. R&D and all the other factors you listed are tied to revenue first and foremost. Or are you suggesting that Ford Motors has, or will have, a smaller budget for R&D than BMW, just because the former hasn't shown profits in a decade, while the latter has a 15% profit margin?
Ford is a HUGE car-maker and a $200 billion company, but one that just doesn't seem to be able to make profits no matter what they try, while BMW is one of the most profitable car-makers and a $60 billion company.
Yes, BMW makes $10 billion in profits each year, and Ford makes $0. Every single year.
But tell me which of the two has the biggest R&D budget, which has the most car models released each year, which has the biggest advertisement & sponsorship expenses (including Formula-1 and Rally)? (no, it's not BMW)
Blue part: You think Google, Amazon and Skype became world-leaders in their fields by being profitable? Nope. Generally companies grow by doing investments with external capital, at least nowadays when the risk capital mechanisms are so well-developed in the business world.
Let's take an example from real life game-related stuff, and start with the profit perspective. Every once in awhile you see an article about some obscure PC-game dev claiming they had success with their strategy game selling 100-200,000 copies and that it made a profit. Like Paradox (Europa universalis) and Stardock (Galactic Civiliz). But what do we make from this really?
Yes, it secures them a sequel, I'll give you that. What else? 200,000 copies and $25 from each copy translates into $5mill. Let's say the profit margin was 30%. So they made $1.5 mill extra and can put that into the next game. But it will still be a game in the $5 million ball-park. And no one will know that the sequel exists either. So low revenue means low budget and very little to talk about. No matter the profit.
Now we'll take an example from the revenue perspective. We have EA, which currently is showing no profit (and according to the experts on the Ninty forum, EA has a bad business model and will continue to develop high budget HD games showing no profits). EA makes strategy games too. The difference is that they sell in the millions raking high revenue. 1 million copies of C&C3 means $20 million in revenue (actually more because EA is both the dev and the publisher, but thats not the point here). But 0 profit.
What do we do with this revenue number, $20 mill? Well, it secures them a sequel too (they didnt lose money, so we'll sure see a C&C4). Also, it means that the next game will have at least a $15 million budget with hired actors, FMV between levels, high-end graphics, persistent online support etc. Further, C&C4, but not Galactic Civs 3, will be on the cover of gaming magazines, in the ads, in the mindset of us who discuss games, included in speculations about impact of console game libraries/sales and so on.
