Disruption of Video Game Retailers
Issue
How will digital innovation in the video game supply chain impact traditional brick and mortar gaming retailers like GameStop?
GameStop relies on the traditional brick-and-mortar distribution model for video games
Historically, GameStop played a key role in the video game industry’s $21B ecosystem by providing game publishers access to consumers via their network of ~7,000 brick-and-mortar physical retail storefronts and a salesforce of ~20,000 sales associates. Publishers relied on retailers to drive sales, execute marketing programs, promote brand advocacy, and manage inventory & returns. In exchange for these services, retailers earned high margins on the sale of video games. In addition to the sale of new games, retailers also relied heavily on used “catalogue” game sales which represented a significant portion of earnings at ~48% of gross profit1.
In 2017, GameStop reported a 16.4% revenue decline during their peak holiday season and announced 3%-10% in operating income decline expected for 20172.
Headwinds facing GameStop and other brick-and-mortar video game retailers can be attributed to the digitization of the video game distribution model. Is GameStop destined to become the “Blockbuster” of the video game industry?
The new digital distribution model for video games
Gamers no longer need to travel to physical brick and mortar retailers to purchase new or used games. Gamers can now access games by purchasing them via digital downloads or streaming directly from game console publishers like EA, Xbox, and Playstation. Consumers can bypass the traditional retailer and unlock greater value in a more convenient way through the following digital offerings:
- EA Access: For $4.95 per month, users have access to the EA ‘Vault’ which is comprised of over 45 popular EA titles. In addition to the game library, there are also early access benefits and discounts on game purchases. EA’s Play First Trials give members of the service the chance to download and play new release EA games before anyone else3.
- Xbox Game Pass: A Netflix-style subscription service which gives access to more than 100 Xbox One and Xbox 360 games for a monthly fee of $10.95. The catalogue of games will be refreshed every month with new games added / removed. GameStop shares fell by 8 percent upon the announcement of Xbox Game Pass as it is expected to have a negative impact on GameStop’s second-hand sales4.
- Xbox LIVE and Backwards Compatibility: Online multiplayer and digital media delivery service owned and operated by Microsoft. LIVE is available as a free and fee based subscription which offers: free-to-play games, Games with Gold (access to suite of new games every month), and Deals with Gold (access to monthly discounts on games) 5.
- Playstation Plus: For $9.99 per month, users have access to Sony’s digital media entertainment service which provides an online marketplace, enhanced gaming and social features, rentals, and purchases6.
How GameStop is fighting back
- Real estate cost management: Tightening real estate cost by closing underperforming stores. In 2017, GameStop plans to shut down 150 retail store fronts7.
- Direct Shipments: Leveraging a large retail footprint allows GameStop to offer consumers a ship-from-store program for online orders, which can be delivered to consumers within 24 hours8.
- Game Rentals: Launched an in-store rental service called PowerPass. PowerPass is structured as a 6-month service for $60 in upfront cost9.
- New category assortments: GameStop purchased ThinkGeek, a specialist in collectibles, gadgets, apparel and other unique licensed products from some of the most admired pop culture brands like Star Wars, Game of Thrones, Nintendo, Marvel, Minecraft and many others10.
- Game Publishing: Entering the game publishing business through a partnership with Insomniac Games (creators of Rachet and Clanks). This will enable GameStop to bring exclusive content to their consumer base11.
Partnerships and increased consumer engagement via E-Sports and LAN are additional ways for GameStop to differentiate
- Strategic partnerships with 3rd party publishers to offer exclusive and additional value: Launch and timing exclusives for select new games, exclusive game branded hardware (limited edition consoles and accessories), exclusive in-game DLC (collectables, badges, skin, etc)
- Use physical store footprint to engage more deeply with core gamers: Host, partner, and sponsor E-Sports gaming competitions. Use select areas to foster community engagement (eg. LAN cafes).
Key things to consider going forward….
- How can GameStop extract more value from their physical retail store fronts?
- Should GameStop continue to invest in alternative categories or focus on the existing business?
Sources
1) https://www.bizjournals.com/dallas/news/2017/01/13/no-reindeer-games-gamestop-posts-16-percent.html
2) https://www.polygon.com/2017/2/9/14543872/gamestop-employees-are-not-your-friends
3) https://www.ea.com/ea-access
4) https://www.gamespot.com/articles/gamestop-shares-drop-significantly-after-xbox-game/1100-6448299/
5) https://www.xbox.com/en-US/live/gold
6) https://www.playstation.com/en-au/explore/playstation-plus/join-ps-plus/
7) Forrestor Research
8) Forrestor Research
9) http://mashable.com/2017/10/29/gamestop-powerpass-details/#LdsY_qnBsgqz
10) http://www.ign.com/articles/2015/09/14/gamestop-is-opening-a-new-collectibles-store
11) https://www.cnbc.com/2016/01/29/with-sales-declining-gamestop-gets-into-game-publishing.html
It feels like Gamestop saw what happened to Blockbuster and is rapidly pivoting its business model to adjust to the digitization of the video game industry. I think the point made about non-gaming businesses is a big area of focus for Gamestop, as the company has now spread across several different consumer categories. According to the article below, the company saw sales of collectibles rise by 28% YoY recently; Gamestop will open 35 new collectibles stores globally over the next year. Gamestop has also built its Technology Brands segment, which owns Simply Mac (Apple repair) and Cricket Wireless (cheap cellular plans) stores. Non-gaming businesses have driven the company’s profit margin expansions. It’ll be interesting going forward to see whether the growth of Gamestop’s non-gaming segments can offset the gradual decline in its physical gaming business.
Sources:
https://www.theverge.com/2017/3/25/15059380/gamestop-store-closings-2017-digital-sales-collectibles-business
I think it would be very difficult for GameStop (at least when its traditional brick-and-mortar video game retail business is concerned) to fight back against the tide of digitization, as per the increasing trend towards digital as you described. However, GameStop reports 2% increase of same-store sales this quarter, coupled with a very high 9% dividend yield. But, this 2% increase can be attributed to the increase in console and new software sales, which are least profitable for GameStop.
I believe there is little reason for customers to specifically prefer physical over digital copy of video games. In fact, many of today’s newest physical releases does not include discs at all inside the boxes; they only include a piece of paper with download code printed. At this point, there are two possible solutions to this problem. One is to invest heavily on its own .com channel and to provide better deals than its competitors, coupled with special editions and bonus in-game items. Another solution would be to focus its retail locations on video game arts and collectibles as Ryan described, which can only be obtained physically. Specifically, GameStop can form strategic partnership with game publishers to create and obtain exclusive distribution rights for collector’s edition video game titles (which often includes physical boxes, statues and artbooks).
Sources:
[1] http://www.nasdaq.com/article/gamestop-gme-q3-earnings-top-raises-comps-view-stock-up-cm881230
[2] https://www.google.com/search?q=gamestop+exclusive+collector%27s+edition&rlz=1C1CHBF_enUS757US757&tbm=isch&source=iu&ictx=1&fir=Bbu9T0-gak2cGM%253A%252Ch3HWMCDwSZk5KM%252C_&usg=__bqNTGTxJAIjO4rf2JrozAggZPro%3D&sa=X&ved=0ahUKEwjJgO_8nd3XAhUI_IMKHXO0DWEQ9QEIdjAG#imgrc=z5rvXFfeDIN6mM:
Great article and interesting topic! I guess many companies are today struggling with the same issue: how do I stay relevant in the value chain when digitalization allows my suppliers to bypass me and serve my customer directly?
I agree with above; GameStop should expand horizontally into categories (e.g. collectibles) that are less likely to be disrupted by digitalization near term. In addition, to defend their core business, I think more needs to be done to upgrade the in-store *experience* – focus should be on offering something that is difficult to replicate in online channels rather than solely on product delivery. To this point, I think the ideas around e.g. LAN cafes, e-sports competitions are very interesting. In addition, it could potentially be worth exploring/expanding the current offering of e.g. in store “test stations” for new games.
A more transformative move, which I think GameStop should pursue, is to, as you point to above, expand “upstream” in the value chain, by acquiring/partnering with 3rd party game publishers to bring exclusive content to customers. GameStop should leverage its well-known brand and x million established customer relationships, and approach especially smaller game publishers. Through GameStop, these publishers can immediately gain access to a sizeable consumer market. Win-win. In addition to the store network, GameStop should also consider launching an online platform for distribution of its games.
It’s been fascinating to watch the measures that GameStop has undertaken to deal with the hugely pervasive issue of digitization in the gaming industry. I’m actually one of the few people out there bullish on GameStop for a variety of reasons:
New Console Release: The upcoming new console releases will be highly beneficial for the entire industry as consoles drive fundamental cyclicality in the gaming industry and although I understand this is not a long-term solution for the company, it does however provide them with some breathing room in the near term to figure out their new plan of action as it relates to their business model. It’s also worth noting that physical game sales still represent 50% of the full game market which GameStop still dominates.
Virtual Reality / Product Backlog: Sony recently released brand new virtual reality software and has partnered with GameStop to be its exclusive launch partner. That includes in store demos which will certainly drive increased foot traffic and is expected to be an industry wide catalyst for demand.
Diversification: As mentioned in the above comments, they are diversifying their business to focus more on digital sales and mobile and consumer electronics where they are re selling used Apple and AT&T products within existing stores (no incremental CapEx).
Management Team: They have an experienced management team with a proven track record of turning around businesses and recognize the inevitable decline of their core business. Until they can complete their long-term transition to digital sales, they are using non-core business offerings to supplement the cash flows.
In short, GameStop will be able to use the upcoming console release growth to fuel cash flows from its existing business long enough until it fully transitions to a primarily digital and consumer electronics retailer. From an investors perspective, this is an incredibly cheap stock and you are betting on an experienced management team to transform the business and achieve multiple expansion – not an unrealistic outcome given the market will undoubtedly like the business more after it increases its digital footprint and exposure to the fast-growing digital end market.
It seems to me that Gamestop is in a truly dire position. While doubling down on non-digital strategies, such as collectibles and Technology Brands, is sensible, these strategies still represents a small percentage of overall sales [1]. Additionally, the further they wade into these waters, the further removed they are from the core identity of the company, and the less weight the brand will carry. I agree with your assertion that capitalizing on the social effect of bringing gamers together is a potential solve, but their continued downsizing of retail properties would seem to be ill-suited to that end. Ultimately, my belief is that this vertical is one where the game creators have direct access to consumers and can use the saved margin of cutting out a distributor to offer greater perks, access, and community than Gamestop ever could. Unfortunately, I think it’s Game Over for the firm in the next decade.
[1] https://seekingalpha.com/article/4128407-gamestop-turnaround-bouncing-cat
It seems as though Gamestop may be able to morph into providing a niche service in the gaming industry, but their brick and mortar locations are going to become largely obsolete. The comparison of Gamestop becoming the next “Blockbuster” is an interesting one. However, I think Gamestop is in an even more precarious position than Blockbuster was when Netflix started streaming movies. Blockbuster could have theoretically worked with movie production companies to stream their content. In the video game industry, the producers are digitizing their content and going directly to consumers with it. There is not even option for Gamestop to attempt a Netflix-like model.
I think their only option is to branch horizontally into merchandising, possibly offering some type of hardware repair service, and hosting gaming events. However, the market for all of these combined is much smaller than Gamestop’s videogame market ten years ago, and they should scale down accordingly.
Great read! Given the business today and where the industry is headed, I also have doubts about this business being a going concern.
All the measures that the management is taking to improve the business seem like short-term fixes i.e. I don’t think real-estate cost management, direct shipments, game rentals, new category assortments address the fundamental question of how this business is going to compete with digitalization.
I like your suggestion about using existing physical store footprint to engage more deeply with gamers – I believe it is the only way to continue driving foot traffic in the face of digitalization. However I question if that can generate enough volume and sales to rationalize investing in brick and motor stores?
My skepticism is compounded when I put on the hat of PlayStation, Xbox or EA. With the advent of digital distribution, I am skeptical that these players need the retail distribution channel to access their customers. Given the lower value proposition provided by retailers, I can see their margins getting squeezed further bringing into question the capital intensive nature of the business model.
I agree that Gamestop is under a lot of pressure, but I think there is nothing they can do to protect their future at this point. Outside of the challenges they are facing in the console gaming industry today which you have laid out, we can look to the past and see what happened when Steam started gaining traction with PC games. Once PC gamers were able to easily download games and have access to them from any computer in a cloud-style game library (and not to mention the massive sales that Steam offers), physical copies of PC games became virtually obsolete (https://www.forbes.com/sites/davidthier/2014/04/24/gamestop-dramatically-rolling-back-games-business/#347c4ce65e55).
Now that modern consoles have the same level of connectivity as PCs, there major benefits for gamers (cheap, easy access to games) and suppliers (eliminating the cost of physical products, cutting out distributor margins). Just as Gamestop was quickly pushed out of the PC game market, I believe they will soon be entirely out of business.
Great article! Agree with many of your points but I do think there could still be some space for video game retailers if they move away from just being a middle man between suppliers and customers and instead become a experience provider. By providing gaming events or inviting famous gamers into stores they can differentiate themselves enough from digital providers to still have appeal to customers.
Amazon’s opening of bookstores provides an example of the relevance of experience!
https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/ellenduffer/2017/09/26/amazon-is-opening-more-bookstores/&refURL=https://www.google.com/&referrer=https://www.google.com/
Lots to learn from your essay, thank you for shedding light on a trend I haven’t given much thought to. I’m curious: given the trend towards digital, why do you believe that people still buy physical games? Do you think there is a reason for GameStop to even operate brick and mortar stores, or could they become The Hub for digital game distribution? I wonder this because it’s so capital intensive for GameStop to operate their stores; if it’s a matter of catering to a shrinking audience of physical game buyers, is this enough? Or if it’s a branding / marketing play, would you advise them to shift their focus to more visible locations for marketing purposes (ala LongChamp, for luxury bags)?