Not too long ago, the future seemed fairly bright for GameStop (NYSE:GME). Analysts touted the company's encouraging sales figures and were optimistic as to the company's prospects going into the release of a new generation of consoles by Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT). Now, the stock just can't seem to catch a break. After a hefty drop following the news of Sony's cloud gaming service, the stock was decimated on its most recent earnings report. What does the future hold for the video game retailer?

Digital creeping up 
To say that GameStop's most recent earnings report disappointed investors would be a bit of an understatement, the stock sinking more than 20% following the release. Most of the beating was due to the weakness in software sales, which declined some 22.5%. Partly, GameStop blamed the weakness on the release of the Xbox One and PlayStation 4, but according to many analysts, this does not account for the whole decline. Rather, the rise of digital distribution of video games is seen finally taking its toll.

Only a week before this report, GameStop shares were slammed following Sony's announcement of its streaming game service, called PlayStation Now. The shocking news released at the Consumer Electronics Show rocked the gaming industry, and according to many commentators the service has the potential to permanently change the way video games are sold. The cloud-based service allows users to access PS, PlayStation 2, and PlayStation 3 games on the PS4 and handheld consoles as well as a range of other devices.

In terms of hardware, GameStop didn't have a bad time at all, managing to capitalize on the release of Sony and Microsoft's new line of consoles. Total global holiday sales of $3.15 million were up 9.3% year over year, with US and international comps up 7.1% and 17.4%, respectively. Largely, this was due to the release of the new consoles, which contributed to the 99.8% increase in hardware sales revenue. So far, the PS4 has sold around 4.2 million units in total, quite a bit more than the Xbox One's 3 million.

Game changer?
While it may to be too early to announce the demise of brick-and-mortar video games retailers, the popularity of a service like Steam represents a serious threat to the company's growth prospects. With Microsoft and Sony especially now aiming to take digital distribution into their own hands, the outlook is fairly grim. GameStop has now trimmed its full-year forecast, coming in well below analyst expectations.

One of GameStop's most profitable activities, buying and reselling used games, is also in peril due to the shift toward online distribution. Streaming games can obviously not be resold, and neither can downloaded titles. With PlayStation Network and Xbox Live both growing in popularity, and beginning to compete with GameStop on price, the video game retailer is going to have to come up with something very clever, and preferably online, in order to stay relevant.

The bottom line
After a savage beating not too long ago following the announcement of Sony's streaming game service, GameStop shares were absolutely thrashed following its holiday season numbers. While hardware sales put up a good performance, software sales dropped dramatically and severely disappointed analysts and investors. Many are now left questioning the company's ability to keep up with an increasingly digital sales environment. In any case, the company will have to take a good look at its business in model in order to find ways of stabilizing its sales situation.

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Daniel James has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and Microsoft. 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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