It is more challenging than ever to spend precious capital to buy slot machines. There are more competitors than ever and the product has less variation in quantitative performance and qualitative measures, such as physical size, price levels, product features, technology, and performance characteristics. Executives buying slot machines have to spend more time managing vendors and assessing the product pre- and post purchase than any time in the last decade.
In addition, they are refreshing less of the floor, as prices of slot machines have risen faster than slot revenues and capital allocations. A slot machine today on average costs $15,076. In 2007, the same slot machine cost $12,539 and if you go further back an operator spent $9,000 to $10,000. In 1998, slot machines for the opening of Bellagio cost approximately $8,500, and that included titanium doors that cost an extra $1,000. Suppliers justify the 20 percent price increase from 2007 to 2010 based on technology additions to the base game, e.g., a 2nd LCD screen.
These price increases may have negatively impacted the replacement cycle because operators are not increasing their capital allocations to buy slot machines at the same rate. In a recent survey by Goldman Sachs, 72 percent of the slot executives surveyed believed that their capital to purchase slot machines will be the same or less than last year. The natural impact is that executives are not able to change their floors at the same proportional rate as they did in 2004, when IGT was the dominant supplier selling slot machines 35 percent lower than in 2010. Let’s put this into context with the broader trends occurring in the industry.
The supplier side of the gaming industry has changed along three dimensions:
The three dimensions are market concentration, business model convergence, and market size over time.
• Market Concentration: IGT is no longer the 800-pound gorilla dominating slot machine ship share. There are now five suppliers who each have earned double digit market share positions, whether you use of ship share or survey results where operators are asked to allocate share of a new floor.
• Business Model Convergence: At G2E in 2010, the differences in business models being pursued by the major, minor, or new entrants to the industry are similar. Most manufactures offer the same product with similar physical size, price levels, product features, technology design, performance characteristics, and pre/post sale support.
• Market Size: The addition of new units via market expansion is expected to improve in late 2011. Even with this improvement growth is still well below historical rates. The replacement cycle is also at a historical low point, and there is much debate about the timing and intensity of its return. It is difficult to see it returning without significant growth in top line revenue performance at casinos and/or a meaningful technology enhancement that reduces operating expenses.
Operators may want to think creatively about the new normal
Some ideas that might help operators in this challenging environment include:
• Look to partner with one or more suppliers to buy more games at a lower price. Games sold have a gross margin in the high 40s to low 50s. There is room for suppliers to cut their prices in the short-term. If the supplier gets more volume and the operator impacts more of the floor, it could be win-win for both.
• Develop a rigorous method for comparing leasing, participation, and purchase alternatives. The lifecycle risk of a game or technology platform may make other pricing models more attractive than a strict purchase. The paradigm of capping participation games can be self defeating by limiting operator’s options, particular in a time of a major market shifts and capital constraints. With leases you can choose at anytime to replace a game with a better game: the supplier effectively bears content and technology risks. Purchases remove flexibility in managing capital and the operator bears these risks. Content and technology risks are not captured when using WPU as the only measure to acquire slot machines.
• Conversions are an excellent means to refresh a slot floor. They are much less expensive than a game purchase and can produce superior results for the expense. A potential additional accounting advantage for the slot executive is that these conversions are often considered an operating expense rather than a capital outlay. Executives should look to obtain conversions for free, particularly on older products that may be still performing well. Conversion kits are extremely high margin products and suppliers may have lots of room to deal.
• Reward suppliers that provide greater product differentiation along multiple dimensions e.g. pricing, physical size, product features, technology, performance characteristics, and pre/post sale support. One simple reward is taking greater risk in putting new and innovative product on the slot floor. Another reward is sharing information in evaluating product performance.
At the end of the day, without a strong vision and strategy regarding capital deployment operators may lose an opportunity to extract more from the supplier relationships given the changing dynamics in the industry. SlotManager
Jeff Jordan most recently served IGT as a director in several roles Product Strategy/Marketing Research, Corporate Strategic Planning, and Strategic Business Development. Prior to IGT, Jordan worked at Bellagio as the executive director of slot operations and marketing. At Bellagio, Jordan had the privilege of opening the property after working at The Mirage. Jordan is a principal at Jordan Gaming Consulting Group and can be reached at firstname.lastname@example.org.