Few customers are more passionate and valuable than the dedicated hobbyist. These high, recurring spenders act as a top-of-filter recruitment mechanism for new customers entering their hobby.
Moreover, a passionate customer base can be a valuable resource driving a firm’s sustainable competitive advantage. Passion latches onto intellectual property and creates long-term value that makes investors take notice.
Wander into any hobby games store and you’ll find a handful of brands take up the majority of shelf space. Most store managers will tell you their highest-selling product is Magic: The Gathering or Warhammer. These games usually represent over half a store’s sales and when including Dungeons & Dragons (D&D) and Pokémon, that number is probably north of 80%.
It’s no coincidence these four dominant franchises have been around since before the turn of the century. These are multi-decade stories of customer goodwill accumulation.
Network effects and winner-takes-most
It takes a long time to scale a customer base, and as investors we see both network effects and winner-takes-most dynamics in these markets.
For example, Games Workshop owns and distributes Warhammer, the table-top miniature wargame that is by far the most popular game of its kind. Players gather and act as generals moving their ‘armies’ of miniatures.
The face-to-face nature of the game matters because it means there is an extra advantage to a scaled player base that can’t be solved digitally. Importantly, you need to be able to find other people in your area to play with.
More players make this easier and make the hobby itself more attractive – the network effect. This motivates any new customer interested in tabletop gaming to take up Warhammer specifically – winner-takes-most.
Passion must be carefully managed
But this doesn’t mean companies can take these customers for granted, and history shows the missteps of testing customer loyalty at the altar of short-term profits. For companies that leverage passion for profit, there is often a conflict between maximising the short-term monetisation of a customer versus their lifetime value.
The four franchises above benefit from passion-based advantages and meaningful competitive moats. But passion still requires careful management to keep people within the ecosystem and attract players.
Wizards of the Coast (WotC), which publishes Magic: The Gathering and D&D, attracted a spate of negative headlines after news leaked that it planned to make changes to its open game license (OGL).
The OGL, which allows independent parties to publish content based on the core D&D ruleset, was to be changed in a way that significantly restricted what was allowed under the license, limited monetisation and would provide WotC with a perpetual right to third-party content.
The amendments caused widespread fan backlash, Twitter campaigns and a wave of subscription cancellations. Ultimately, WotC formally apologised and abandoned the attempted changes.
The company also caused a stir around releasing the commemorative Magic 30th Anniversary set late last year. Marked as a way for the community to celebrate their hobby but priced at $999 hobbyists felt disenfranchisement at being ‘priced out’. Both examples highlight the risk of companies losing focus on satisfying customers.
The (old) and New Games Workshop
Over its history, Games Workshop has also had periods where its relationship with customers was strained. For a decade, management pulled the price lever too hard and saw large cohorts of players leaving the hobby.
But in 2016, Kevin Roundtree became CEO and brought the necessary strategic change. The mission statement was rewritten, players were re-engaged through social media, genuine discounts were introduced to attract new players, and new editions were released with collaboration from the hobbyist base. After a stagnant decade, the company has seen a 20% compound annual growth rate of revenues over the past five years.
A clear example comes from its approach to international store rollout. Retail stores are important to the business model because they are a key channel for engaging with players. Store managers are themselves passionate hobbyists who, in effect, act as leaders of their local gaming communities.
Games Workshop is significantly under-penetrated internationally, yet our own research has consistently found that new stores generate revenue within 12 months and trade accounts in the area also increase their Warhammer sales. In effect, there is a ‘reverse cannibalisation’ rate of the trade network – a powerful attribute of competitive advantage.
And while some companies would view this as an opportunity to rapidly expand, Games Workshop only opened four net new North American stores in 2022. The limitation is not finding locations but the right store managers, to avoid the risk of ‘poisoning the pool’.
Long-term value
A passionate customer base can be a valuable, rare, and inimitable resource that underpins a sustainable competitive advantage in the eyes of investors.
However, passion is not immutable. Identifying loyal customers is only one piece of the puzzle, and holistic customer engagement is the dynamic capability required to sustain a competitive advantage – and investor value – over the long term.
Dr Manny Pohl is the founder and Justin Warton is a principal of investments at ECP Asset Management. The views expressed above should not be taken as investment advice.