I was trying to understand the concept of the business model of Kingdom Of Loathing They were doing stuff like selling T-shirts and cups, so basically I was wondering what are the benefits for going this model for a small website?
For one thing, assuming the first batch they purchase was 1000 units of cups and adding shipping cost and stuff each cup may cost them $1.50 (let's use the cups as example).
Adding overhead cost and everything else, the first batch may cost up to $4000.
In other words, they have to sell at least 400 units of cups to break even. Am I misunderstanding something?
Yes, there are costs you didn't assume. One is the cost of the initial capital outlay. There are also potential costs which might have been assumed too high. The print costs could have been lower. A partnership with the print shop might have resulted in a JV scenario.
In the end though your core question is remains both valid and illuminating : Is the selling of marketing material a viable business model for a niche website? The answer is rarely.
Furthermore, the answer is that the the business associated with a site selling "t-shirts and mugs" is rarely expecting the sale of marketing material to be the center of their business model. Usually it is just that-- marketing material supporting a marketing strategy.
And as a marketing strategy it can be very effective. It allows fan to visually affirm their connection to the community -- building their loyalty and leveraging their support for testimonial outreach. And -- it can either pay for itself, or at least offset the costs with revenue.
They may be using someone else like cafepress.com or any other such service to do the fulfillment.
You send them your logos and artwork, pick the shirts, cups, umbrellas etc that you want to offer and they produce it on demand for each order.
I'm not sure of your assumptions. Overheads these days are astonishingly small assuming they already have the printing equipment. Also large batches are not as necessary these days as they used to be.
Prior to current electronic printing methods, tooling was a significant cost, nowadays I can take a USB key in to a print shop and have a cup with my logo produced for under £10. The cost to produce 1000 different designs is only incrementally higher than that to produce 1000 of the same design.
If while I'm there I want the logo done in vinyl for my car door, that takes them about ten minutes at a further cost of around £50.
Inventory costs are also down, as the entire cycle is much faster.