EA: Wizard Behind the Curtain

When Dorthy and friends entered the wizard chamber, they are met with an giant, imposing green head. He appears powerful and all knowing, but in actuality, he is a old man behind a curtain. His presence was just a facade. The reverse is true with AAA publishers. They pled with consumers that AAA development is just too expense. If games don’t have microtransactions, they’ll go out of business and starve in the streets. You wouldn’t want that would you? But what if this is a facade? What if EA is portraying the struggling indie developer, but, in actuality, is a wealthy fat cat manipulating consumers for financial gain. Today, I’m going to pull back the curtain and show you the truth behind EA.

EA’s Financial Position

Below is a summary of EA’s income statement over the last three years. You can find all this information from the company’s SEC filings.

(in millions) 2017 2016 2015
Revenue 4,845 4,396 4,515
Cost of Revenue 1,298 1,354 1,429
Gross Profit 3,547 3,042 3,086
Operating Income 1,224 2,144 2,138
Income before taxes 1,210 877 925

 

Despite a small decline in 2016, sales and profits increased in 2017. Furthermore, cost of revenue is declining while revenue is increasing. The reason that is important because you recognize the cost of products when the product is sold (due to the matching principle). Typically, cost of revenue increases when revenue increases. However, we see it declining. To understand, let’s look at a break down in revenue.

(in millions) 2017 % of total 2016 % of total
Product 2,640 54 2,497 57 2,568 57
Digital 2,205 46 1,899 43 1,947 43
Net Revenue 4,845 4,369 4,515

As a percent of total revenue, digital sales made up a greater portion of revenue in 2017/ Moreover, despite revenue declining in 2016, digital revenue saw a smaller decline ($48 million) than products did ($71 million). This shift is the reason for the decline in cost of revenue. Essentially, EA gets more revenue for less work. And, to illustrate, here are the figures for cost of revenue for product and digital

Cost of Revenue (millions) 2017 % of related revenue 2016 % of related revenue
Product 893 33.8 938 37.6
Service 405 18.4 416 21.9

 

Services cost quite a bit less than products for EA. EA spends 34 cents for every dollar it makes for products, yet EA only spends 18 cents for every dollar it makes for services. Better yet, cost of revenue declined as a percent of revenue from 2016 to 2017. Moreover, this unravels EA narrative. Despite the claims of AAA development being so expensive, products still have a profit margin of 66 percent. The reason EA wants to focus on microtransactions has nothing to do with games being too expensive. It has everything to do with EA wanting to make more money.

Additionally, the decrease in cost relative to sales could be evidence of EA overcharging consumers. With products, a decrease in cost of revenue represents an increase in efficiency. But a decrease in cost of revenue as a percent of sales could just mean EA is simply charging more. For instance, how much more does it cost to make a star card in Star Wars Battlefront II. Looking at EA’s 10-K, cost of revenue consist of things such as credit card fees, server cost and operating web-based games on third-party platforms. There doesn’t seems to be much in the way of tangible cost. The market (if you want to call it that) for Microtransactions is still new, so consumers haven’t yet determined what is a fair price. With that in mind, I suspect EA is making you pay more for the same product.

All in all, EA is not telling you the whole truth. To analyst and investors, the story is that services are where the money is at. Perhaps this is why investors were hostile to consumer outrage over Star Wars Battlefront II. To consumers, the story is that EA needs microtransaction to remain afloat. Before I close, here are a few ratios to show that EA is far from being in financial trouble.

2017 2016
Current Ratio 2.15 1.80
Quick Ratio 2.00 1.70
Debt to Equity 0.90 1.08

 

If it wasn’t clear before, it should be clear now that EA is not at risk of shutting its doors. In fact, EA is doing better year over year.

Conclusion

I hope that I could shed some light on how EA is actually doing. I’ve said before on this site that I think it’s wrong to charge customers for extra after asking for $60. Clearly, companies like EA treat their consumers like ATMs rather than people. They’d rather you pay for extra than shrink their budgets or make better titles.

I’ve shown that the AAA publishers aren’t being honest with their customers. They play the poor struggling company, yet their financials show prosperity. But telling customers that microtransactions are extremely profitable is bad PR. So, like the wizard of Oz, they hide behind a curtain and pull some levers. Now we know that EA’s postering is just a facade. It’s more reason consumers shouldn’t be expected to put up with EA’s poor business practices.

 

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