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

GameStop's suppliers Sony, Microsoft, and Nintendo are pushing digital game purchases.

Jan 19, 2014 at 12:00PM

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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Fool contributor Sam Mattera owns put options on GameStop. The Motley Fool recommends Apple, Google, Netflix, and Take-Two Interactive and owns shares of Apple, GameStop, Google, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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