How PC Gaming's Brightest Star Aims to Disrupt the Console Industry

Valve's Steam Machines have the potential to reshape the gaming industry landscape. Here's why the privately-owned company has giants like Sony and GameStop worried.

Jan 4, 2014 at 12:00PM

The traditional console gaming companies are facing more challenges than ever before. The emergence of set-top boxes that are gradually adapting to include better gaming functionality and the rising popularity of mobile gaming has prompted speculation that dedicated consoles from the likes of Sony (NYSE:SNE), Microsoft, and Nintendo would soon become relics of the past.

There has also been a resurgence of PC gaming, perhaps spurred on by the fact that the last console cycle proved to be abnormally long. Now, one of PC gaming's driving forces and shining innovators hopes to bring its expertise to the console sector and revolutionize the battle for the living room. Should the console manufacturers and retailers like GameStop (NYSE:GME) be shaking in their collective boots?

From software innovator to distribution giant
Valve is a privately owned corporation that was founded in 1996 by Gabe Newell and Mike Harrington, both former Microsoft employees. The studio built its early reputation by creating a line of forward-thinking first person shooters that took the world by storm and made Valve one of the most revered names in gaming. The Half-Life series was a more cerebral take on the often blast-happy genre and pioneered the use of many narrative techniques that are now common in the medium. Counter-Strike helped to popularize online gaming and was one of the first FPS games to foster massive Internet communities.

The company's software pedigree gave it great cred with PC gamers and allowed it to transition to a much more lucrative and complex business model. The company's Steam store and digital suite have made it one of the most influential entities in gaming, with estimates suggesting that it controls approximately 75% of the PC digital distribution market. Consider that downloads represent the majority of PC game sales and that the physical market is rapidly shrinking, and the magnitude of Valve's success and impact should become apparent. The service recently posted a new record of 7.6 million concurrent users. Now, Valve has set its sights on expanding into the home console sphere.

The first of the Steam-powered trains
This year will see the release of a number of Steam Machines, pre-built gaming PCs from a variety of manufacturers that will run the company's SteamOS operating system, connect easily to televisions, and broaden the reach of Valve's digital store. With conservative estimates placing the company's enterprise value at around $3 billion, Valve would not have the resources or infrastructure needed to introduce a console in the same fashion as a Sony or Microsoft. It doesn't have to. Such a move would almost certainly be counterintuitive to the company's long-term goals.

The approach to the Steam Machines flies in the face of the typical console business model. These boxes will have different hardware specs and system casings but will be unified through their use of the default Steam Machine controller and the centrality of the Steam ecosystem. This makes them unlikely to get much shelf space in stores like GameStop, so it will be interesting what approach Valve and the manufacturers of its Steam Machines take with regards to distribution channels. To say that GameStop hates the idea of these boxes would be a sizable understatement.

The best value in gaming?
Part of the reason that the Steam store has become such an incredible success is that it has shaken up the way games are monetized. The company's discounted sales have become the stuff of legend, allowing purchasers to nab entire collections of games for the price of a new retail release and giving PC gaming a major edge in the value department. Steam provides a renewed market for older titles and a visible platform for smaller indie games that eschews the front-loaded, triple-A focused model of modern-day GameStop. Given that the retailer makes scant profits on hardware sales and would receive little to no income from Valve's Steam store, it has no incentive to allot store space to Steam Machines.

Making a play for the future
Sony has stated that it cannot afford to ignore the threat that Valve's new PC/console hybrids poses to its gaming model and the success of the PlayStation 4. The importance of marketing, complex deals that govern retail floor space, and the fact that Steam represents an attack on retailers mean that the traditional consoles will continue to dominate the living room in this cycle.

There's no reason to believe that combined sales of Steam Machines will come close to those of PS4, Xbox One, or even the Wii U. If approximately 5 million Steam boxes were sold in the next five years, though, it would represent a considerable success for Valve and a troubling indicator for its newly targeted competitors.

Look to Valve
The company's disruptive strategy looks to bridge the PC-console divide by offering revolutionary value. Valve is shaping the direction of the industry. It's also one of the most exciting companies in tech. Sony, GameStop, and the rest of console gaming's stalwarts are right to be worried.

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Keith Noonan has no position in any stocks mentioned. The Motley Fool owns shares of 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.

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