A "GameStopper" Of A Problem in Video Games
Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The video game industry's moving rapidly into cloud computing for more than just gameplay. While that's great news for most game and console makers, it could spell disaster for another company.
The traditional method for a video game sale was that a customer would buy a physical copy of a game, bring it home, and play, usually for hours at a time, on a personal computer or a dedicated game console. The game maker got paid, the game retailer got paid, and the console maker got its cut from the game maker. Moreover, the individual had their physical copy of the game which could be used as a trade in when he or she grew tired of it.
The Used Market
The used game market is an important part of the video game ecosystem. While more diversified retailers can't really tap into that market, dedicated video game store GameStop (NYSE: GME) has in a big way. In fact, over 25% of its top line is tied to used games and gear. That's the second largest source of revenue at the company, after the sale of new games, which represents about 40% or so of the top line. GameStop's focus, however, makes the company most at risk to changes in technology and customer behavior.
A Changing Market
Unfortunately for GameStop, the coming changes can't be stopped and it knows it. From the 2011 annual report: “We expect that future growth in the video game industry will be driven by the sale of video games delivered in digital form and the expansion of other forms of gaming.” And “Our financial results depend on our ability to take trade-ins of, and sell, used video game products and used mobile devices within our stores.” Basically, a move to digital distribution is going to be a big issue for the 40% of revenue earned from new product sales and the 25% or so of revenue that comes from used items.
Not an Attack
The thing about the coming shift is that it is less about an attack on GameStop than it is about changing customer patterns. The move to online play has been happening for years, with massive multiplayer games sold by Activision Blizzard and Electronic Arts (NASDAQ: EA) making use of the Internet to allow gamers to play with and against each other for quite some time now. This has gotten gamers very comfortable with the use of the Internet as it relates to their hard-core gaming.
This shift will be good for the game makers, with Electronic Arts' CFO Blake Jorgensen explaining why in a recent quarterly conference call, highlighting that digitally delivered products “have no physical goods costs, and there is no associated price protection. Eliminating these expenses provides greater savings resulting in higher margins.”
Still, both Activision and Electron Arts are working to make the digital shift happen because their customers desire it. The game console companies, meanwhile, are also working toward that same end, with Sony's (NYSE: SNE) new PlayStation a prime example. Its likely use of the so-called “cloud” was telegraphed by the purchase of Gaikai, a cloud gaming network, in 2012. All of these companies are set to benefit from this change.
Sony's Shuhei Yoshida, for example, recently explained the potential to the Guardian: “PS4 will be similar to PS Vita in that every game will be available as a digital download, and some will also be available as a disc... we can have more small games that might be free or available for a couple of dollars, or different services like free-to-play or subscription models.” Clearly the company's aspirations for a shift to the cloud are big and open to growth.
GameStop has been working to defend the sale of physical product by going to the game companies with research and data. It highlights such facts as the small percentage of new games that are traded in within the first three months of release (used games are, thus, not a competitive threat to new games) and that trade ins provide customers a means to purchase new games.
In addition, GameStop is expanding its used platform to include other devices, notably Apple products. The iPads and similar devices that are increasingly in demand are a great way to help maintain the used business. So long as there is hardware needed to play games the company can support a secondary market of some sort.
These are great blocking and tackling exercises that will probably help in the near term. They won't change the long-term trend.
GameStop is also moving online. It runs an online video game platform called Kongregate.com, a digital PC distribution platform called Impulse, and Spawn Labs, a streaming technology company. Management sees the writing on the wall and is acting. That's a good sign, the only problem is that the company really can't change the ultimate outcome, which is the likely removal of the physical middle man.
The Elephant in the middle of the Room
GameStop could survive, of course, but it will be a vastly different company. With so many stores, GameStop has a big weight around its neck. Investors should watch from the sidelines to see if it can successfully follow its customers into the digital realm.
Reuben Gregg Brewer has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Apple. The Motley Fool owns shares of Activision Blizzard, Apple, and GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!