Is This What Squashes GameStop?

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GameStop's (NYSE: GME  ) shares were hit hard yesterday after Sony (NYSE: SNE  ) hinted about a potential clampdown on the market for used console games.

The hubbub that spooked investors seems to be centered on a patent Sony filed, which could in theory kill the market for used video games. That's if it becomes a reality and if it is widely adopted.

Patently scary
The technology would work by attaching an ID code to each game disk that could be verified by the gaming console. If the game ID doesn't match to the player's ID, then the console could refuse to play the game. It's a kind of digital rights management system, only for physical disks.

Sony might use the verification process in its next generation console, expected as early as holiday 2013. Microsoft (NASDAQ: MSFT  ) may be planning to take a similar stand with its new Xbox console, which should also come out later this year. True, Nintendo's Wii U system doesn't reject used games. But if Sony and Microsoft decide to go that route, it would still carve a big slice out of the market.

It matters to GameStop because that market is a huge part of its business. In the most recent quarter, sales of used video games made up 28% of revenue and nearly 40% of the company's gross profit. The resale market has been a bright spot for the retailer, which has limped through nearly eight quarters of negative sales growth as the Xbox and PlayStation consoles age past their primes.

Not a game-changer
A lockdown on used video game selling has the potential to hit GameStop hard, but I don't think investors should be too worried about the threat. For one, it's theoretical at this point. Neither console maker has announced plans to police physical disks in their next-gen models. And even if they do, there is a wide range of possibilities for rights management. A strict "no used games" policy by Microsoft and Sony could seriously irritate their users. Is a little extra profit worth a potential firestorm of angry customers?

And digital delivery is the future of the industry, anyway. That's why GameStop has been investing heavily in that space over the past two years. If it wants to stay relevant as digital content revenue shrinks the importance of physical disks, GameStop will need to show that those investments are paying off.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the "3 Companies Ready to Rule Retail" in our special report. Uncovering these top picks is free today; just click here to read more.

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9/30/2016 4:04 PM
GME $27.59 Up +0.45 +1.66%
GameStop CAPS Rating: **
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SNE $33.21 Down -0.03 -0.09%
Sony CAPS Rating: ***