GameStop – A casualty of digitialization?

GameStop, the worlds largest video game retailer, struggles to stay alive in a digital world

GameStop’s CEO has boasted that his Company will succeed because it is “such a complex animal”. Digitalization headwinds, however, seem to be driving the complex animal to extinction.  GameStop Corp. (GME) is the world’s largest video game retailer with over 7,000 stores globally. The Company is publicly traded on the NYSE and commands a market capitalization of ~$2.5 Billion and generates an attractive return on equity. That’s about where the good news ends for the Company. GME has found itself in a slowly tightening vice, squeezed by secular trends in digital transformation. Growing e-commerce, a shift towards mobile gaming and a transformation to digital game downloading are all emerging as formidable threats to the business and leave the Company very few options to adapt.

Everything that GME sells in its brick and mortar footprint is now available online and many businesses have optimized this business better than GameStop has done with their online offering, notably Amazon. E-commerce sales totaled $342 Billion in 2015 after growing 14.6% YoY. Notably, 60% of retail sales growth occurred in e-commerce (9).  In this context, the growth in e-commerce represents a threat to GameStop going forward as it struggles to compete in that arena.

A decade ago, GameStop could not have envisioned another major threat to its business-mobile gaming. Mobile gaming revenues are poised to surpass console and PC games in 2016 for the first year ever (8). The $36.9 Billion mobile gaming market is out of reach for GameStop and so as this market continues to grow, GameStop will struggle to remain relevant. The overall gaming market is growing 8.5% YoY, however, so GameStop is seemingly participating in a large ($60 Billion) and growing market in PC and Console gaming.

So why is the company in dire straits if it can manage e-commerce and mobile changes?  Far worse than these for GameStop is the existential threat posed by digital game downloading. With widespread internet connections and faster internet speeds, consumers are increasingly able to download games straight to their computers or consoles rather than visiting a GameStop. In 2015, it is estimated that 20%-30% of all software sales were delivered through PlayStation Network or Xbox Live, which GameStop doesn’t make any revenue from (4). The movement to digital downloading is likely to continue given rising internet speeds affect of shortening download times, a frequent complaint of consumers. According to Nielsen’s law, internet connection speeds increase by 50% per year (See Exhibit 1) (7). Even worse, many games now allow early downloading, so that the game becomes available simultaneously with a new games physical release(10). An additional threat is that game makers have transitioned to selling expansion packs and add-ons online rather than selling them physically. Electronic Arts sold $1.06 Billion in digital extras in 2015, Activision cleared $1.6 Billion in digital sales, with the overall market in digital extras growing 8%(5). Ultimately this is not a market that GameStop will have access to and the game makers are more than happy to have a D2C platform that they can more profitably sell through.

Exhibit 1

game-stop-graphic

GameStop has not been idle in trying to combat these trends, but it is relying on a few old tricks that might not be sustainable. The Company has aggressively built out a new segment in aftermarket sales of mobile hardware. In 2016, GameStop aims to add 300 to 400 technology branded stores under Simply Mac or Spring Mobile banners to participate in this reseller business (1). It has also gotten into the refurbishment business for FitBit products as it aims to stay relevant in hardware. This electronics business is still quite small, representing just 6% of overall sales, so it will certainly not be GameStop’s saving grace (3). The Company is also aiming to be nimble in its video game store footprint, closing 125 underperforming locations in 2015 to boost profitability (3). Critical to GameStop’s value proposition is its resale business which it has aimed to protect and foster as a defense against the push to digitalization. GameStop’s resale business generates 27% of revenue and 44% of profit for the Company. More importantly, it provides a source of income for customers to purchase new games and it generates foot traffic into its retail locations since customers have to physically trade-in game discs(6). Both Microsoft and Sony have flirted with totally eliminating physical game discs and GameStop has pushed back so that at present GameStop can retain this business. Since the console makers and game makers see no additional revenue from this secondary market, it remains unclear how feasible this business will be in the long-term.

There aren’t any great options for GameStop on a forward-looking basis. By virtue of its young customer base, it still manages to control 30%-40% of digital add-ons and 10%-15% of full game downloads because young customers do not have credit cards to purchase the content online(6). This represents $830 million out of GameStop’s $9.6 Billion in revenue, so is meaningful but not adequate to keep the Company a going concern should it lose its physical game sales. As much as possible, GameStop has to aim to keep this market and grow with digital game downloading. A radical option that the company should employ is including console manufacturers and game makers in their resale profits as a way to keep physical sales. Although this will be detrimental to GameStop’s bottom line, this is the only way to disincentivize console makers from shifting to only digital and destroying GameStop’s business. Overall, management should realize that they will- in all likelihood – be the next Blockbuster and the best use of their cash is not to reinvest in new businesses or advertising as a way to drive store traffic, but rather they should optimize cash flow and aim to return as much profit to shareholders as possible before they ultimately have to shutter their doors.

(800 Words)

 

 

 

 

 

 

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11 thoughts on “GameStop – A casualty of digitialization?

  1. Well met, Paul. It is clear that GameStop has been able to survive an industry-wide secular decline in large part due to the monopoly it has enjoyed in the secondary market for video games. With that said; however, it is unclear to me whether GameStop will inexorably go the way of Blockbuster. One can also see certain parallels with what GameStop is facing today and what Netflix was facing not too long ago. In 2007, Netflix found itself at a critical juncture when its original DVD movie rental business was increasingly transitioning to a digital streaming model. As we now know, Netflix was able to evolve its business model to not only provide streaming, but also create its own content. In an attempt to diversify from its core brick-and-mortar business of buying and reselling used video games, the company launched in 2016 an in-house publishing label called GameTrust. In sum, while the challenges and structural headwinds posed by digitization are undoubtedly very real, I would not be too quick to declare “Game Over” for GameStop just yet. If GameStop can find a way to evolve and make itself relevant, there may still be plenty of life left in the years to come.

  2. Wow, the future of GameStop certainly looks bleak. Another trend working against GameStop is the increasing popularity of browser-based Massively multiplayer online role-playing games (MMORPGs). Some MMORPG’s, like popular World of Warcraft, require a download — which can be done from GameStop’s website or elsewhere. But others, such as Runescape, which is played completely in the browser with no download required. (1)

    Based on the trend in music and movies that favors streaming over downloading, I think it’s possible that video games will also go in this direction. I think this is even more likely to happen in light of increasing broadband speeds worldwide.

    (1) http://www.runescape.com/mmo/what-is-rs

  3. Great read Paul, but I’m not so sure the future is as perilous as you do. I believe GameStop is uniquely positioned to maintain (or even grow) it’s current customer base. As you mentioned, they claim a 30 percent to 40 percent market share in the sale of digitally licensed content. They’ve also created an in-store environment where they service the casual gamer, but cater to the hard-core customer. Their employees are deeply knowledgeable about the different products and titles, and their customers. It seems to be an almost coffee-house type feel where loyal customers come in, mill around, and spend time talking with employees who become ‘friends’.

    Additionally, GameStop makes a ton of money (27% of total revenue, 44% of profit) on their trade-in business, and competitors haven’t been able to duplicate that success. And for the younger customers especially, who don’t have their own income and are relying on their parents to provide funding for their purchases, I think that niche is here to stay.

  4. While exclusive digital download does pose an existential threat to GameStop’s business, I believe that it would be against the best interest of the console makers to cut physical media and the used market that it enables. Because of this, I believe there will be a used market for some time that will allow GameStop to maintain the levels of traffic it has been receiving, and enable the company to survive.

    Because of the shift to more social gaming, it is extremely important to game producers that people continue to play their game for a long time. Without players, these hyper social games lose their allure. A used market allows additional players access to the game universe, without the producer needing to drop the price of their game for those who want the convenience of digital downloading. Said another way, GameStop is enabling the longevity of a game by allowing price discrimination.

  5. I agree with the post that the road ahead for GameStop is tough and does not look bright. That being said, the article does not mention a valuable asset that the company does have – its brand. For gamers, GameStop is often synonymous as the destination to purchase games, even if that is less true today than it was ten years ago. With that in mind, is a possible solution to extend the GameStop destination and brand to online? The post mentions how XBOX and Sony have virtual game stores, but can GameStop do the same thing? By extending across game makers, it has the advantage of being a one stop shop for gamers, something that its brand already signals. While it will likely require new revenue sharing schemes for the game makers to agree, I do think that this could be a possible solution as it looks to take advantage of the digital trend in the gaming industry.

  6. The future certainly looks bleak for GameStop as the company’s business model currently exists. However, given the popularly of gaming and the quality of the broad of GameStop as SLA mentions above, I thought a natural extension of the company’s model could be into e-sports and video game competitions. There is a lot of money and opportunities in this relatively young category. As Brett Morris, President of Super League Gaming, questions “Why can’t gamers go to practice?”, GameStop should be the one taking advantage of this opportunity (1). The company has 6,614 stores in operation and the company should consider taking advantage of this real estate to host practices and competitions for gamers to develop their talents (2). And, this increased traffic and captive audience would likely purchase other products as well. Just as Petco started offering grooming services to its consumers to drive traffic and repeat, subscription like purchases, GameStop could consider adding video game lessons and tournaments as well.

    (1) – http://www.nytimes.com/2015/10/22/fashion/gamers-have-a-little-league-of-their-own.html
    (2) – http://news.gamestop.com/phoenix.zhtml?c=130125&p=irol-faq

  7. Greetings, Paul. To @SLA’s point, the brand of GameStop may provide strategic tailwind for the company to pivot into virtual game retail business. It is worth noting, however, that GameStop does not own any titles as in the case of XBOX and Sony, and therefore may not be able to compete with the virtual stores operated directly by game developers. In addition to negotiating revenue sharing schemes with incumbent game makers, Gamestop could also consider (1) identifying and acquiring game development and exclusive content release rights for selected future titles (i.e., similar to Netflix original), and (2) connecting with and building a vibrant indie game design and retailing community (i.e., similar to the Steam community under Valve) to potentially re-brand itself as both developer and retailer.

  8. Great analysis on the demise of the traditional GameStop business model. I would not be surprised if they shutter most retail stores in favor of the new digital models (assuming they survive the transition). One under-emphasized points transforming gaming is the concept of in-app purchases.

    In-app purchases are gaming content add-ons for purchase to enhance the base game experience (the price of the base game sometimes being free). The new content can include extra levels, more features, or purely cosmetic alterations (a more interesting looking weapon or uniform in a multiplayer game, with no additional gameplay functionality). While the in-app purchase practice is still undergoing controversial changes, at the very least we know it moves many of the economics out of the hands of the video game distributor and back to a direct communication channel between the game publisher and game player.

  9. It’s clear: to survive, GME will have to change their business model.
    An alternative can be subscription based gaming company. Their core business after all is to sell rights to reproduce games. A subscription based model will be similar to Netflix’s transformation to their current model.
    I have difficulty believing that GME will keep all of their brick and mortar stores. Possible the best performing ones can be transformed to testing places for their game offering. New technologies such as more immersive games, augmented reality, virtual reality and wearable games include a hardware aspect that can be explioted by GME.

  10. Paul-

    Wow. It’s depressing to see a once popular company go down like Blockbuster. I understand the challenge though–I used to shop at GameStop and now there’s less reason to visit the store now since you can just purchase games on the console. Blockbuster is a company that just watched this digitalization and disruptive change happen around them without adapting to the shifting trends. GameStop, I believe, is not yet in that desperate a territory and still has time to adapt if they choose to. I agree with the posts above that the company could leverage itself as an online gaming marketplace both on PC and game consoles. In order to do this they would likely need to share profits with the gaming companies but would relieve those companies of the need to manage, update, and maintain the marketplace for buying video games. The gaming companies would have to agree to let GameStop take a percentage of the game revenue in exchange for their marketplace. This is, in my mind, the only way for them to go since it is apparent that the brick and mortar store model is out of date and won’t sustain.

  11. Great post about GameStop Paul!

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