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My concern is to prevent someone from "gaming" the fact that instead of an 8 unit formation, it is now an 11 unit formation. Don't ask me how someone "games" this situation, I don't think like that. Probably a strong tourney player might be able to come up with something.
Well, I am a regular face on the tourney circuit, and I can't see a way to game it with any kind of reliable utility.
If all you want is extra bodies to give yourself an outnumbering bonus in Engagements, then take the 75pt 4x infantry units upgrade.
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In any case, I want it to be clear that no matter what, the 8 strong formation with Cyclops upgrades is still only 8 strong.
Honestly, your concern is completely without cause.
You might as well say that taking any upgrade (Fire Support, Mortars, Infantry, Sentinels, even VALKYRIES!) should keep the formation 8 units strong.
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Also, this could have ramifications in regards to transports.
It has the same ramification all the upgrades have in regard to transports: It can't take any.
None of the upgrades can take transports. Again, this concern is a mirage.
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Since the upgrade will be handled like other unit upgrades (e.g. Ethereals, SCs, etc.),
Those are Characters, not Upgrades.
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Also agree that the attaching of the Cyclops then changes that unit to LV until used or destroyed.
And then it changes back into an Inf unit?
Frankly I think that's a very odd way indeed to go about it.
You'll need a second special rule to explain its usage!
Two special rules, just to service one unit type, is extreme.
Also, how do the infantry in that squad have the ability to move about at 20cm sometimes (With no ability to shoot) but only 15cm after they've used the Cyclops (But now they can shoot)? It's b0rked.
Either have it as a normal LV that's added to a formation (Like the Sentinels upgrade), or don't have it at all, is my advice, don't have some kind of odd in-game status swapping thing. Nothing in the game does that.