Why GameStop Is Doomed, Part 2: The Push Toward Digital Downloads

In my previous article on GameStop (NYSE: GME  ) I touched on the move toward new methods of video-game distribution, most notably, Sony's (NYSE: SNE  ) forthcoming streaming service, PlayStation Now.

But PlayStation Now isn't the only thing that should concern GameStop. All of its suppliers -- Sony, Microsoft (NASDAQ: MSFT  ) , and Nintendo (NASDAQOTH: NTDOY  ) -- are emphasising digital purchases over physical sales.

Digital purchases take a giant leap forward
GameStop's supporters may allege that digital video-game purchases are nothing new. This method of distribution is now a generation old; gamers have been able to purchase and download titles to their Nintendo Wiis, Microsoft Xbox 360s, and Sony PlayStation 3s for years. While that's true, the newest generation of consoles takes it to an entirely new level. Outside of the occasional sale or digital-only game (a rapidly growing trend that is itself a threat to GameStop), there isn't much reason to buy digitally.

Both Microsoft and Sony's older consoles allowed you to purchase their games digitally, but the digital versions often went on sale weeks (or even months) after discs appeared on GameStop's shelves. This was clearly a problem, as highly anticipated games are often purchased within a few days or weeks of their initial release. (Take-Two sold 29 million copies of Grand Theft Auto V within its first two months on sale.)

It's a huge win for digital distribution, then, that both Sony's PlayStation 4 and Microsoft's Xbox One allow you to purchase games digitally the same day they go on sale at GameStop.

Meanwhile, Nintendo's Wii U represents an even bigger step forward in digital distribution -- although the Wii had a digital store, it didn't actually sell Wii Games; instead, it sold older games from past consoles, including Nintendo's original NES, and smaller, cheaper games. The Wii U's digital store, in contrast, actually sells Wii U games.

Console makers encourage digital purchases
In addition to saving gamers the time and gas it takes to drive to their local GameStop, console makers have made digital purchases more enticing in other ways this generation.

For instance, owners of Microsoft's Xbox One and Sony's PlayStation 4 can, by logging into their account, play on their friends' consoles the games they've purchased digitally. If they own a physical copy, they can still carry their games around with them, but it's much easier to have access a digital library than it is to tote around a bag of physical games.

Also new this generation is the ability to play digital purchases before the games finish downloading. On Microsoft's Xbox 360 and Sony's PlayStation 3, gamers had to wait for the game to completely download before they could begin playing. Since modern games take up dozens of gigabytes, that could mean hours of waiting for gamers with slow Internet connections -- an obvious deal-breaker. But this time around, Microsoft and Sony have rectified that problem: On their new consoles, games purchased digitally can be played almost instantaneously.

Nintendo hasn't made as much noise in terms of embracing new technology, but it, too, is pushing digital downloads. In an attempt to jump-start sales, this past fall, Nintendo bundled its Wii U console with a copy of The Legend of Zelda -- a digital copy, not a disc.

Are gamers ready for a digital future?
Of course, there are a few roadblocks standing between now and a future mostly devoid of game discs: Do consumers prefer to own a physical copy of their games? And can gamers' Internet connections handle their hobbies?

As to the first, it's clear that some gamers prefer to own a physical copy. My past articles on GameStop have drawn a chorus of comments from gamers who flatly refuse to purchase digitally. While this subset is undoubtedly out there, it is nothing more than a vocal minority. A recent survey (via The Guardian) of 16- to 24-year-olds, a key GameStop customer demographic, revealed that more than two-thirds of them prefer to purchase video games digitally. Notably, 16- to 24-year-olds preferred physical books, movies, and CDs ahead of video games.

But even if they prefer digital games, will they be able to get them? Compared with video games, song and book files are tiny -- downloading or streaming them isn't as demanding. While the country's Internet infrastructure is a concern, it's rapidly improving, and for the most part, it's already good enough.

Internet infrastructure is rapidly improving, making digital games viable
More than 70% of U.S. adults have broadband Internet connections in their home -- for the most part, the other 30% don't want them. If people in the U.S. have a PC in their house, then there's a greater than 90% chance they also have a broadband connection. Given that video gaming is a hobby that attracts technically inclined individuals (Internet providers such as Comcast market their faster Internet connections to video gamers), it's easy to assume that the vast majority, if not all, of GameStop's customers have broadband connections.

Based on statistics from Speedtest.net, the average U.S. broadband connection speed is around 20 Mbps. Last year, a study from Akamai (via PCWorld) put the U.S. average decisively lower, near 8.6 Mbps. At any rate, that's still fast enough to use Sony's PlayStation Now service, which Sony says will only require a connection speed of around 5 Mpbs for most games. At the same time, broadband connections have been getting steadily faster in recent years -- in 2011, the U.S. average was less than 6 Mbps -- and expanding services such as Google Fiber and Verizon FiOS offer download speeds of several hundred Mbps.

Bandwith caps are another issue, but not every Internet provider has them, and some (like Comcast) have suspended them in most major markets. Even with a cap in place, downloading a few games every month is still viable.

With its suppliers embracing digital distribution, GameStop's future is looking bleak. But it could be even worse if upstart rivals challenge Sony, Microsoft, and Nintendo. Next week, in Part 3 of this series, I'll look at the coming wave of digital-only consoles. Stay tuned!

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Read/Post Comments (9) | 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 January 19, 2014, at 9:49 PM, Dragonslayer wrote:

    Digital only will never be able to "take over" for console game sales until everyone has a stable very fast online connection and until the devs admit that their games shouldn't ever cost more that $40 at the most.

  • Report this Comment On January 19, 2014, at 10:08 PM, Mattenth wrote:

    Digital doesn't need to "take over" for GameStop to be in serious trouble. If 20% of the market switches to digital, that's a 20% (or more) decline in GameStop's profits. They'd be getting cut out of not only new game sales, but future used game sales and margins.

    Indeed, GameStop's days are numbered - while other retailers like Walmart, Target, Best Buy, and Amazon can adjust promotions and floor space based on software sales, GameStop doesn't have that luxury.

    Game publishers want GameStop to stop cutting them out of used game sales. Console makers want to take the retail cut of new games by being the distributor. Developers want an easier way to reach consumers.

    When every other company in the gaming industry is actively researching things that hurt GameStop's business, how can you possibly make a bullish case?

  • Report this Comment On January 19, 2014, at 10:53 PM, ff7legend wrote:

    Until internet speeds are drastically increased here in the U.S & broadband internet is available to all, no matter where you live here in the U.S, GameStop isn't going anywhere nor will digital downloads/streaming take off like some folks claim. There are still consumers who can't get anything but dial-up internet thanks to not having access to broadband in many rural/boonies locales here in the U.S. Also, the price point for digital download must come down lower than the current $60 price point for consumers to make the switch to digital. Then there's also the issue of monthly data caps on home internet service by the ISPs, which would have to be greatly increased or eliminated altogether. Fat chance of that happening though, now that internet neutrality is all but extinct here in the U.S.

  • Report this Comment On January 20, 2014, at 12:11 AM, Mattenth wrote:

    Again, the above commentator just doesn't present an adequate argument... Picking a few people who can't be in digital isn't enough for GameStop's survival.

    "Internet speeds aren't fast enough"

    - 1) You're now able to play a game BEFORE it finishes downloading on both consoles.

    - 2) For the large majority of "serious" gamers who need instant reactions on multiplayer games, they already have a good enough internet connection.

    - 3) PC gaming has already gone digital-only, and has the same file sizes.

    - 4) Internet speeds are only going to get better as more and more consumers are exposed to fiber networks.

    Even if 5% of the consumer base goes digital, it will deliver a substantial blow to GME's bottom line.

  • Report this Comment On January 20, 2014, at 3:28 AM, TheMightyPikachu wrote:

    Why GameStop Is Doomed, Part 3: Fool contributor Sam Mattera owns put options on GameStop.

    The article is extremely one-sided. The current situation isn't rosy for GameStop, but it's hardly time to throw up hands and start shouting "Doom!" - *based on this article, anyways*.

    The Earth's atmosphere is about 21% oxygen. Oxygen burns. Therefore, if I'm going to smoke a cigarette, the earth's atmosphere will catch on fire and civilization as we know it will come to an end as firestorms sweep the globe. "Doom!"

    @Mattenth -"Digital doesn't need to "take over" for GameStop to be in serious trouble. If 20% of the market switches to digital, that's a 20% (or more) decline in GameStop's profits."

    I realize you probably were writing in haste, Mattenth, but come on! If your supermarket gets 20% less chicken in its weekly shipment, is 20% of the population of your town going to die off? Think, man, think!

  • Report this Comment On January 20, 2014, at 9:26 AM, JonROrcutt wrote:

    While I agree GME is in trouble, I don't believe digital downloads will be the death of them. I will simply give my perspective as a sports gamer with my son. We always regret when we buy games as downloads. 1) They take up storage space, and 2) and even more importantly, is we always want the latest version of whatever new game that is released. Downloading new rosters is great but the accurate roster downloads stop when the season is over.

    We like having the hard disc so we can take it Gamestop and receive a little cash back to apply towards the latest release. Every time we download a game we quickly regret it when the new version comes out and we have to buy it without being able to turn the older version in for the new game.

    This is just a non-financial perspective into why many gamers prefer buying the actual game in disc form.

  • Report this Comment On January 20, 2014, at 11:34 AM, nevadajess wrote:

    Here is some food for thought, my wife and myself like to relax at home and play games on a side by side basis which is becoming harder and harder to do with most of the new games being online one player games. To me it seems like the game industry is pushing for a life where there is no one on one or group activity. Yes I am from the older set (40 to 50 age group) and when I was growing up you went out and played with others, now kids just sit at home. Sorry got side tracked, we purchase older games from video stores because they are two or more player games and don't have to be online to play. I have watched my children play games online with others and the fowl mouth language that was overheard from some of these young kids is just horrid. If I was caught saying half the things I heard there would of been a bar of soap or whipping in store. The online play to me is just another way that that kids get away with controlled chaos, and everyone wonders why the kids are so uncontrolled and unruly. I like the quality time that I have with my wife when we play together on a side by side basis, I have even got my youngest daughter into this also by playing side by side games with her. Here I go again on a sideline sorry.Why cant they make more two or more player games that are not totally lame to keep the family values going at home as a family not an individual secluded in there rooms. My rant is over thank you for your time.

  • Report this Comment On January 20, 2014, at 12:36 PM, Slate99 wrote:

    @jonROrcutt

    It is easy enough for the publishers and console manufacturers to offer the same deal you get from GameStop and enter the "used" market. Every sale GameStop does is a full loss to the original publisher. Using their digital stores they can take back your license, credit your account and offer them up on a marketplace as used to others interested in buying. Now instead of a full loss they get everything.

    Any lost used sales at GameStop are a non-issue for them as they see no gain from used sales and by offering a trade in mechanism I doubt that initial sales would be that seriously impacted.

  • Report this Comment On January 20, 2014, at 8:05 PM, PAJohnDoe wrote:

    Does anyone else that has problems with trade-in values just do E-Bay instead? I've been a very successful e-Bay seller for over a decade, and while I usually deal more in other items, I've done pretty well when dabbling in video games, far better than trading in your used games. I know most traders are of the "I want it now now NOW" variety, but if you have even the slightest bit of patience, re-selling your stuff yourself will usually work out better and you can have the extra funds for when the next big game comes out. I know like I sound like an ad for E-Bay, but if you complain about what GameStop is going to give you, knowing it's their job to turn around and make at least double that, and then you take what they're offering anyway, you have only yourself to blame for taking advantage of you and continuing to lowball everyone else while they're at it.

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