Why GameStop Is Doomed, Part 1: Video Games Are Going Digital

Video game seller GameStop is challenged as its primary suppliers, Sony and Microsoft, embrace digital streaming.

Jan 18, 2014 at 12:00PM

The steady growth of online shopping has hit physical retailers hard over the years. Once mighty chains such as Circuit City have found themselves unable to cope, eventually closing their doors for good. Other retailers have remained resilient -- sellers of specific goods including cars, clothing, and groceries have persevered.

Most of those that have fallen by the wayside -- Tower Records, Blockbuster video, Borders Books, among others -- shared a similar characteristic: What they sold wasn't actually a physical product. When you purchase a CD, for example, you're not really buying the plastic disc -- you're buying the album it contains. Whether it was movies, books, or songs, once digital distribution became viable and widespread, many of the brick-and-mortar retailers that specialized in that media eventually were driven from business.

GameStop (NYSE:GME) fits this profile perfectly -- its primary product, video games, is going digital, and we're closing in on the tipping point. In this series of articles, I will lay out the many and varied challenges facing GameStop -- its relationship with suppliers Sony (NYSE:SNE), Microsoft (NASDAQ:MSFT), and Nintendo; the rise of digital-only consoles; the issues its new initiatives will have to overcome -- and explain why I don't believe its business (at least, at it currently exists) is viable.

Sony's bets on video game streaming
Sony is one of GameStop's top suppliers -- sales of PlayStation hardware and software compose a big chunk of the retailer's revenue and profit -- and starting this summer, it could become its single biggest challenger.

PlayStation Now, Sony's latest effort, stands to do to GameStop what Netflix did to Blockbuster. Subscribers to Sony's new service (set to launch this summer), will, for a flat monthly fee, get access to a catalog of old PlayStation games. These titles won't be shipped through the mail, but streamed over the Internet, delivered to a PlayStation 3, PlayStation 4, PC, Sony HDTV, or mobile device.

If this service catches on, it stands to wreak havoc on GameStop's used games business, which accounts for about half the retailer's profit. Admittedly, PlayStation Now will not serve up PlayStation 4 games (at least not at launch), but as the technology progresses, it isn't difficult to imagine Sony offering the latest titles. Moreover, until the PlayStation 4 has a robust catalog of games (which should take several quarters) it doesn't matter -- GameStop will remain dependent on older PlayStation 3 software. GameStop's management continued to reference sales of games released for the PlayStation 2 and Nintendo GameCube as best sellers well into 2007, even though the PS3 and Wii both launched in late 2006.

Microsoft aims at digital future
As a competitor, it's no surprise that Microsoft's Phil Spencer downplayed PlayStation Now, declaring on Twitter that he thought games played locally (not on some distant server) would be important for a "long time."

But reports have indicated that Microsoft is working on a PlayStation Now competitor, which doesn't seem so far-fetched given Microsoft's enormous investment in cloud computing. Even if Microsoft doesn't ever offer a full-on video game streaming service, the company has long supported digital distribution.

As originally designed, Microsoft's Xbox One would have been the most digitally dependent console ever. Had the company not changed its mind, Xbox One owners would have needed a regular Internet connection to use their console, and buying or selling physical games would have been difficult or impossible.

Although a widespread backlash in the gaming community led Microsoft to reverse these policies, it is quite obvious the company favors digital distribution.

But digital distribution is much more than streaming. Even if Sony's service fails, GameStop is still challenged by its suppliers in the form of digital game downloads. In part 2 of this series, I'll take a look at the evolution of digital game stores and how they challenge GameStop.

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Fool contributor Sam Mattera owns put options on GameStop. The Motley Fool recommends Netflix and Twitter. The Motley Fool owns shares of GameStop, Microsoft, and Netflix. 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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