The following is a Production Diary by Petersen Games Production manager Arthur Petersen talking about how we handle VAT, you can see this and other Production Diary posts here: https://petersengames.com/arthurs-production-diary/
All About That VAT
I’ve previously written about how a small publisher prices games generally (see here), as well as how we price shipping for Kickstarters (see here), and also about sales tax for US backers (see here).
Today I’ll tackle a long discussed (if not overly prominent) topic on Kickstarters: Those darned expensive European shipping costs (i.e., VAT).
Before delving too much into VAT itself, I’d like to build an initial frame for everything by pointing out a fundamental feature of Kickstarter projects that is (generally) unseen by backers, but at the forefront for creators: the distinction between known and unknown costs.
It is very easy to grasp that Kickstarters provide a huge benefit to creators: up front capital to make a project happen – indeed, that’s the entire point!
But there’s a flip side to this coin: predicting accurately the final costs of goods sold. You see, a business that follows the normal course of events has the luxury of adjusting their pricing (and doing other things with their product) AFTER they’ve seen the full costs of developing and manufacturing it. Obviously there are details and nuances (sellers don’t have ultimate control over pricing in a competitive market), but my basic point is true: that if a new product ends up costing more to make than a seller initially anticipated, they can do things before it hits the market to ensure they’ll recuperate their costs and have a decent margin (net profits), so they can continue to exist as a company.
A Kickstarter project, unfortunately, does not have any such luxury. No matter what happens or changes in terms of costs while developing and manufacturing a project, we cannot derive more revenue from the backers to make up for this. We already set our prices and received the funds – that’s it.
So, if something causes our costs to rise, doesn’t matter. We are still obligated to fulfill what we promised to backers. Period. (I could delve more into this facet of crowdfunding as it is relevant to many common backer gripes such as the idea that some KS creators launch new projects to pay for previous ones – but that’s a huge separate discussion by itself).
The following are a sampling of variable costs we nevertheless have to account for when setting prices before a new Kickstarter:
- Miniature Tooling costs
- Mass manufacturing per unit costs
- Freight shipping
- Fulfillment shipping
- Additional development (art, design, etc., if needed)
The variability isn’t necessarily super huge in each of these aspects, but even a 5 or 10% shift in several of them can mean our pricing is WAY off, as to what it should have been. For example, if we set a game to be $79 on Kickstarter, but the final costs of goods sold analysis tells us it should have been $99, that can be very bad, financially, resulting in tens of thousands in lost revenue.
(If your initial reaction is to suggest we merely always add in a buffer to our prices, there are further variables we must consider. Among them is the price elasticity of a new product – the relationship between price and sales volume. If we simply raised all our prices by, say, $20, we may reduce our total sales by an amount that more than offsets the added revenue, making it a very bad idea).
VAT – one of the few costs that can be perfectly known in advance
If you’re following all of this carefully, there is a silver lining! There is at least one type of cost that is fixed and known in advance no matter WHAT happens – The import taxes and value added taxes of each country and region.
The European Union and virtually all European countries that are not part of the EU charge a 19% value added tax to goods sold there (whether from domestic or foreign sellers). This VAT is inescapable for all goods sold into the EU, no matter where it was produced or who sold it – whether a domestic or foreign company.
Like retail or sales tax that is found in many places in the US, VAT is ostensibly “paid” by the end consumer, but it is actually reported and paid to the government by the seller (in this case, Petersen Games).
The VAT technically has a range, but hovers around 20%, and is never below 19% for any EU countries. We set it at 19% on the KS, so technically, we are subsidizing it already for the majority of EU backers! Here are official the rates so you can see for yourself.
This is inescapable. If we failed to pay it to the European Union, we could have our products seized!
Here is further reading – official information from an official website of the EU which explains everything I wrote above, as well as additional information (see here).
Why don’t other Kickstarters charge me for VAT?
Some very well might, without directly showing you that they do. Some may not. But unless they are acting illegally, they are paying the VAT to the European governments for all backers they ship to inside Europe.
Before exploring how some KS creators may be handling VAT, let’s take a step back to see how the VAT payment fits into the cost of goods sold overall.
The VAT percentage is assessed on the TOTAL sale value of the goods (even including the shipping cost***). So, a game that is sold for $100 would require a payment of $20 to the EU government the customer lives in. That means that Petersen Games really only gets $80 for this game sold into Europe. And that’s going to be cutting it very close (or possibly will be LESS than our real cost to sell each unit). When you factor into all the up front costs needed to develop and manufacturing a game – miniature sculpting, art, tooling, etc. – margins on large games are pretty slim (I went into detail on this here in which I showed how a nearly $600k Kickstarter of ours ended up losing money overall). What this means is that we really and truly don’t have $20 left over per copy sold just to give to the EU.
So how in the heck do other Kickstarter creators avoid it? Assuming they are not acting illegally, and they are also not showing you any VAT charges, there are a few possibilities they could be operating under.
Possibility 1: Having some backers subsidize others
First, they could be spreading the VAT through a combination of the sale price and/or shipping prices they charge. For example, in the example of a $100 game, with a $20 VAT, let’s say that it costs the same to ship this game to the US and Europe – $20. This would mean that the cost for a game sold to Europe is $100 (game itself) + $20 (VAT) + $20 (shipping) = $140 total. And a game sold to a US backer is $100 (game itself) + $20 (shipping) = $120 total. To even these out in order to not scare away EU backers or to make it “fair”, you could increase the shipping to $30 for both the EU and US, and not “charge” VAT at all. This would mean the US backers are paying $10 more than they really “should” and the EU backers are paying $10 less.
There are two fundamental problems with handling it this way:
1. Subsidies are not fair.
I put the word “fair” in quotes above because it merely appears to be fair – you are charging the same total price to customers in different places. But shuffling prices around in this way is actually the opposite of fair. It does not cost the same to sell the same product to different customers, and so these different buyers are often charged differentially (in the real world, outside of Kickstarter) to account for this. That’s why there even exists such an economic measure as “purchasing power parity” which would not make sense as a thing if every given product were always sold at the same price everywhere. It is not the fault of backers in other countries that the European governments impose such an extremely heavy value added tax on all goods sold there. Backers in other places should not have to subsidize them.
2. The subsidies will be wrong unless you can see the future.
It’s also a bad idea unless the KS creator can accurately predict the number of backers from each country or region. In the example above, with a single EU backer and a single US backer, it was an easy calculation to say that by simply removing the VAT charge and then adding $10 to the shipping for both they both pay $130. But what if 250 backers are from the EU and 750 are from the US? This would mean that the US backers are, overall, paying far more than is needed to cover the actual cost of the VAT!
Let’s work it out so you can see how off it would be. The VAT for those 250 backers would be 250 times $20 = $5000. But the money received to account for the VAT is 1000 backers times $10 = $10,000. The KS creator just got an additional $5,000 that does not have to go towards VAT or anything! Going back to the question of fairness – it’s not simply that non-European backers are unfairly paying for taxes they don’t have to pay, it’s ALSO a way for KS creators to possibly derive even more revenue unfairly from non-EU backers!
And of course, the KS creator could be screwed if the opposite ends up being true – what if there are 250 US backers and 750 EU backers? In this case, the VAT cost is 750 EU backers times $20 = $15,000. But the money received is still only $10,000. In this case, the KS creators will have to cough up $5,000 to cover the Europeans’ taxes. Also not fair. And it only gets more confusing and intractable to calculate the more other countries and shipping prices you add in to the equation.
The bottom line is that without knowing in advance how many backers will come from each region, you can’t possibly set the subsidized shipping price accurately. Subsidies aren’t fair in the first place, but this unfairness is compounded when the numbers are all wrong anyway!
Subsidies have the clear downside of completely removing just about the only good thing about VAT – that it is a perfectly known cost beforehand! I believe that Kickstarter creators who are shuffling it into the product and shipping prices are not only doing a disservice to non-European backers, but are also not being very careful in their budgeting and financial calculations!
(To be completely fair, though, it is possible a KS creator doesn’t set shipping prices at all until after the Kickstarter is over so they can see the mix of backer countries – but this is very rare. Backers always want to know how much shipping will be during a Kickstarter nowadays)
Possibility 2: Accepting a smaller margin
The second possibility is that KS creators are simply accepting a 20% smaller margin from all European customers without accounting for it elsewhere. This is possible, but I would consider highly unlikely. Given the fact that most products in the final analysis won’t even have a 20% margin to begin with (as noted above, and again here), this effectively means that a KS creator is basically losing money on each European backer. If that is happening, it’s because the seller didn’t properly analyze the numbers, not because they’re a charity. I regard this possibility as so unlikely that it never occurs on purpose. A KS creator who does this is much likelier to simply be unaware of the VAT (as Petersen Games itself was, when it launched Cthulhu Wars in 2013 and absolutely did not account for the VAT – which nearly bankrupted us on the eve of shipping the “wave 2” back in late 2015). Since then, we’ve always accounted for the VAT somewhere in the numbers. Not doing so is very very dangerous – 20% is a BIG portion of the cost for a product.
What about that “Friendly Shipping” thing? Doesn’t that mean I don’t have to pay VAT?
“Friendly Shipping” is a clever idea that some Kickstarter creator came up with long ago to say that you don’t have to deal with any paperwork or money at the receiving end of the KS rewards.
To understand this, there’s a dichotomy in shipping things international that used to be referred to as DDU or DDP (the terminology has changed in recent years, but these acronyms still work well for the concept). DDU means “duties UNpaid” by the shipper, which means that the recipient therefore has to pay those fees. DDP means “duties Paid” by the shipper, which means that the recipient gets the package, and doesn’t have to cough up any money to physically receive it.
“Friendly Shipping” means that the packages are sent DDP – that the sender handles the paperwork and pays the duties and taxes. But that money used to pay the duties and taxes has to come from somewhere! And in the end, it’s really going to always come from the consumer, as I outlined in my previous section.
Yes, I understand that some KS creators represent that “when it ships from within Europe, there are no VAT fees” but this is simply not true. Sellers still have to pay VAT on all those goods, even when “shipped from within the EU” (as we ourselves do – our European hub is inside Germany). All the paperwork and actual VAT payments are made by the seller on the buyer’s behalf. But it still has to be paid. The government will collect taxes even if you put a “friendly shipping” badge on your Kickstarter!
***So, if we charged $100 for a game, and $20 for shipping, a 20% VAT would actually be $24, not $20! The government includes the TOTAL sale price that the customer paid in its entirety. And based on how WE charge things, yes, this means we are paying a “VAT” on the VAT portion of the shipping that we charge to you (though we just eat this cost, obviously, since it’s minute). Yes, it’s ridiculously stupid – we are not at all fans of how the EU bureaucracy tries to stifle free business transactions.