GameStop Is Still a Disaster in the Long Run

Steam is an online store for PC games. It sells digital versions of popular games, and it's business model is roughly equivalent to Apple's iTunes.

During GameStop's (NYSE: GME  ) earnings call on Tuesday, management bragged about the amount of Steam gift cards the company had sold in the previous quarter. This would be like a Borders executive, back in 2009, boasting about the amount of Amazon giftcards his company sells.

GameStop will benefit from the upcoming console refresh -- demand for the next generation of consoles from Microsoft (NASDAQ: MSFT  ) and Sony (NYSE: SNE  ) should bring more consumers through GameStop's doors.

But long term, GameStop remains heavily exposed to a shift taking place in the sector. Games are going digital, and this trend is only being exacerbated by the new consoles.

GameStop looks great in the near-term

In the immediate future, GameStop's business looks great. Both Sony and Microsoft will release their next video game consoles this holiday season, and both could sell exceptionally well.

Microsoft's last console, the Xbox 360, was released in 2005, while Sony's PlayStation 3 came out in 2006. This 7-8 year console refresh cycle is unprecedented in the industry -- prior to that, new consoles had generally been released every five or six years.

GameStop has said it's seeing a tremendous amount of excitement surrounding the new consoles -- and that makes sense, there's likely some pent-up demand among gamers.

The problem is that this next batch of consoles will be unlike their predecessors. Their level of reliance on the Internet -- and hence the digital distribution of games -- will be far greater than past consoles.

The Xbox One could be the last Xbox you ever need to buy

Initially, Microsoft was planning to make the Xbox One the most digital console ever. If it had stuck to its plans, owners of the Xbox One would've had to keep their consoles connected to the Internet at all times.

Xbox One games would still exist in physical form, but the disc itself would be largely unnecessary. Games were to be installed onto the system, like PC software, and then tossed aside -- making it difficult, if not impossible, to resell games.

After widespread consumer backlash, Microsoft has backed away from these plans. The Xbox One will, like the other Xboxes before it, play disc-based games from the actual disc, and will not require a constant Internet connection.

All good for GameStop, right? Well, not really. For starters, Microsoft clearly sees the advantages in pushing digital games. It might not be able to do it right now, but it seems reasonable to expect the company to try again in the future.

But more importantly, the Xbox One could be the last console gamers ever buy. As the Official Xbox Magazine notes:

Sure, the basic hardware will date, but cloud computing offers near-limitless potential-and as broadband connections are only going to get better, by the time the Xbox One starts to look like it's running low on horsepower or storage space, you'll be able to hand the job off to the Xbox Live servers rather than having to upgrade.

With the Xbox One, Microsoft is pushing the power of cloud computing. Microsoft has invested in thousands of servers its making available to game developers. At first, utilization of these servers should be limited, but eventually, games could come to exist wholly in the cloud.

When that happens, there will be no reason to buy a physical version of the game -- it will exist purely in digital form.

Sony wants to create a Netflix of games

Sony's plans for gaming are even worse for GameStop. Rather than build a server farm for partial cloud support, Sony is diving head-first into streaming games.

Last year, the company bought streaming game start-up Gaikai for $380 million. Gaikai's technology allows for games to be streamed directly from Sony's servers to a player's console, and it will make an appearance in the PlayStation 4.

It won't work at launch, but Sony says that, eventually, players will be able to stream PlayStation 3 games to their PlayStation 4.

In an interview with The Guardian, Sony's president of worldwide studios said the company dreams of offering a subscription-based, streaming games service -- a Netflix of games. If PlayStation players are getting their games streamed to them, they aren't going to need to buy physical copies.

But that's a ways off. Sony has plans that could hurt GameStop much more in the immediate future.

Sony is planning a trade-in program of its own. Gamers who purchase multi-platform games for their old console (Madden 14, for example, will be released on both the PlayStation 3 and 4) will be able to trade that game to Sony for a PlayStation 4 version -- specifically, a digital version.

Borders, Tower Records, and Blockbuster

And this is just the existing players, not to mention reports that Apple, Google and Amazon are planning (digital) consoles of their own.

What GameStop is going through is nothing new. It's a trend that's played out countless times in the past. Companies like Borders (books), Tower Records (CDs), and BlockBuster (DVDs) ran into the same problems when their businesses went digital.

Although GameStop shares may continue to appreciate in the next few quarters, longer-term this company is existentially challenged.

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Read/Post Comments (7) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 30, 2013, at 12:17 PM, IntegrityNeffort wrote:

    If you can't hold it , you don't own it....

  • Report this Comment On August 30, 2013, at 1:12 PM, Haleos wrote:

    Game are going digital? Interesting observation, but one I am less inclined to believe.

    Steam represents a cadre of game players that is niche right now (computer gamers). If anything else we have seen recently that "console" gamers are less inclined to put up with the limitations imposed by digital games. DRM policies and such have thrown up huge arugments and forced the usually blind Microsoft to make a retraction.

    Furthermore, the argument needs to be made that as more and more of these games become more and more complex the larger the files will become. We already have many internet companies limiting total bandwidth to a certain extent. If only for posterity and in deference to those types of individuals Gamestop will live on.

  • Report this Comment On August 30, 2013, at 3:26 PM, foolgood wrote:

    @Haleos: Of course games are going digital. Every media-based type of entertainment has gone or is going digital. Gamestop may live on, but they will certainly shrink. File size and bandwidth limitations are shrinking, not growing. If this weren't true, Netflix wouldn't be thriving.

    I have no position on GME, but anybody who's long is expecting GME to buck glaringly obvious historical trends, which is a very, very risky bet.

  • Report this Comment On August 30, 2013, at 3:41 PM, breezious wrote:

    OMG, can we read anything other than pro STEAM articles, I feel like they are all the same just with different dates. I read a very similar article 1 year ago.

    We can talk about digital distribution until we are blue in the face, wont change the fact that Gamestop is still bringing in customers, and will continue to do so.

  • Report this Comment On August 30, 2013, at 4:02 PM, coprophilous wrote:

    "It sells digital versions of popular games, and it's business model is roughly equivalent to Apple's iTunes."

    How are we supposed to take you seriously when you haven't figured out how to use "its" and "it's" properly? I wouldn't take financial advice from my 16-year-old son either, but at least he can write.

  • Report this Comment On August 30, 2013, at 5:27 PM, ShadowOfTheVoid wrote:

    Console games are not "going digital," and if Sony, Microsoft, and Nintendo forced it, they would suffer tremendously, losing large amounts of revenue because they'd lose a very large chunk of their audience. First off, internet infrastructure is in a sorry state, at least in America. Most notably, fully a third of all U.S. households lack broadband access, and of those who do have it there are other problems such as bandwidth caps. The fact that tens of millions of homes lack broadband is why if MS didn't reverse their policy mandating a regular connection for the XBO it would have seriously hurt the system's sales potential by locking literally tens of millions of potential customers out of the loop altogether (the fact that it still needs to connect once for a "Day One" update will also be a huge inconvenience for many, but nothing as ruinous as the original policy).

    Also, consoles are closed platforms. When we buy digital games on a console, we can only buy from the manufacturer's "store," with their DRM rules being the standard and the console itself being a fixed piece of hardware. You spend several hundred bucks are you are locked into to their system, and with the manufacturer in full control of the one and only digital storefront on their platform, there's no competition and thus no incentive to cut prices. The PC, however, is an open platform, with various digital storefronts all competing for your business, most notably the ever-popular Steam. They all have varying DRM schemes (from strict to none), not to mention you have mods and you can customize your PC to your heart's content, not to mention that competition between them drives prices down. Consoles and PCs are as you say two totally different beasts than operate (and should continue to operate) by completely different sets of rules, including how they distribute games. Digital storefronts are fine for distributing small titles that wouldn't warrant being put on a disc all by its self, but discs are, should, and will continue to be the normal mode of distribution for $60 "AAA" console games.

    So yeah, I'm skeptical that a digital-only console would benefit us in any way. Besides, what's the point in buying a "Steam box" when I'm already typing on one right now? Also, if console manufacturers and game publishers wanted to go all-digital, they'd force it, undercutting the retailers be damned. But they don't want to — in fact, publishers often bend over backwards for retailers —, and I think they know the vast majority of console gamers don't want to, either. The demand for all-digital is not there, and as mentioned the current state of internet service & infrastructure precludes an all-digital market, and this is to say nothing about other issues revolving around digital downloads (e.g., ownership and first-sale issues). So, not only would it not benefit us, but it would also quite simply be bad for business. The very nature of game consoles almost certainly precludes them from ever going all-digital, at least not anytime soon. Hell, even on PC you can still buy physical copies of many games even though it's no longer the norm. So far, there hasn't been a single form of entertainment that's gone all-digital, not games, not movies, not books, not music. It's simply not feasible to go all-digital anytime soon without hurting business.

  • Report this Comment On August 31, 2013, at 12:20 AM, Burstedbladder wrote:

    MS, Sony, possibly even Nintendo would like to shut this company down. This way they get to make all the profits for themselves in selling new and used games to the consumers.

    This is Why I will never buy another MS or Sony product. with their newer systems, one effen update, and then you are forced to buy new games to pay on your system alone.

    I kept my older Nintendo systems, and I am glad I did.

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