Why GameStop Corp. Is Doomed, Part 4: New Business Ventures

GameStop is entering new markets, putting it in competition with both Outerwall and Apple.

Jan 26, 2014 at 9:00AM

I've already pointed out the many challenges facing GameStop's (NYSE:GME) core business -- the push toward streaming and digital downloads among established video game players, as well as the rise of alternative consoles that rely exclusively on digital distribution.

But GameStop's management is well aware of these trends. To survive as its core business deteriorates, GameStop is relying on a number of new initiatives that have it competing with firms as diverse as Outerwall (NASDAQ:OUTR) and Apple (NASDAQ:AAPL).

From used video games to used electronics
The most visible of these new programs is its push into used electronics. In addition to video games, GameStop's customers can buy or sell used smartphones, tablets, and MP3 players. GameStop has been slowly expanding the program to more of its stores, and extending the list of products it accepts.

In an era of smartphones and tablets, it's an interesting idea, and it leverages one of GameStop's core competencies: The retailer has been refurbishing and reselling used video-game consoles for years. Still, it's difficult to imagine a national chain surviving on refurbished mobile products, especially given the level of competition in the space.

Apple expanded its own trade-in program late last year, allowing customers to trade in their old iPhones at any Apple store. This is particularly noteworthy, given that much of GameStop's used electronics business consists of Apple products -- it wasn't until last spring, for example, that GameStop was willing to accept used Samsung devices.

Then there's Outerwall, a company similar to GameStop in a number of ways. Like GameStop, Outerwall's Redbox movie-rental business is under pressure from digital distribution, and like GameStop, Outerwall is betting on refurbished electronics to remain viable.

Last July, Outerwall acquired ecoATM for $350 million. ecoATM operates a number of kiosks that allow customers to sell used mobile devices for cash. In December, Outerwall announced that it was discontinuing some of its other kiosk businesses, including its much-heralded Rubi coffee venture, allowing it to focus its efforts on expanding ecoATM.

Of course, Outerwall and Apple aren't the only competition. There are numerous other Web-based services such as Gazelle and Swappa, in addition to the wireless providers themselves.

Selling access to digital storefronts
Then there's GameStop's own digital business: its digital storefront, Impulse, its upcoming streaming service, and the cards and download codes it sells for other companies.

Although video gamers have, on average, become older over time, there's still a large subset of teenage gamers out there, many of whom lack the credit and debit cards necessary to make online purchases. GameStop's management would argue that its retail business fills a necessary niche, both by selling these cards outright, and by allowing gamers to trade in their old physical games in exchange for digital purchases.

GameStop began selling Steam Wallet cards in 2012, announcing its partnership with Valve in a press release. On the company's earnings call last August, GameStop's president bragged about how many of these Steam Wallet cards the company was selling, remarking that sales had tripled in the quarter.

I find it baffling that GameStop's management would emphasize this to shareholders, or even view it as a positive -- roughly speaking, it would be the equivalent of having Borders Books boast about the amount of Kindle gift cards it had been selling before its demise. While moving product may help GameStop in near term, over the long run it's only hastening the company's decline. In facilitating digital purchases, GameStop is undermining its core business model.

Moreover, GameStop's own digital storefront, Impulse, competes directly with Valve's Steam, selling PC games digitally over the Internet. Often, however, buying a game through Impulse requires the use of Steam; for example, purchasing BioShock Infinite from GameStop's website doesn't actually give you access to the game, but rather, a download code that you enter into Steam. Gamers may appreciate the competition, but as Steam's own built-in store charges the same for BioShock Infinite as GameStop's Impulse, it isn't clear why gamers would choose Impulse over Steam.

Lastly, there's GameStop's own radical attempt at breaking into streaming games. GameStop acquired Spawn Labs, a streaming video-game technology company, in 2011. GameStop had initially planned on rolling out the service by the summer of 2013, but that window has come and gone, and Spawn's streaming service is nowhere to be found. GameStop may eventually enter the streaming market, but it's not clear how a relatively small retailer will compete with a multinational electronics giant like Sony.

GameStop Kids
Finally, there was GameStop's attempt to reinvent itself as a toy store. For the 2012 holiday shopping season, GameStop rolled out a few dozen concept stores (called GameStop Kids) that transformed its normal locations into ones specifically focused on children's video games, physical toys, and other video game-related children's merchandise.

It was an interesting idea, but it seems to have failed. GameStop's management didn't mention the initiative in its last earnings call, and though it still lists some locations on its website, the few I contacted informed me that they had converted back to traditional GameStops. In general, the children's toy market appears to be struggling, with specialty retailer Toys R Us recently blaming the poor birth rate for its sluggish sales.

GameStop remains dependent on physical video games
Even if you disagree with my analysis of these initiatives, it's indisputable that they do little to move GameStop's bottom line.

Last quarter, new video-game hardware, software, and used products accounted for 85.5% of the company's net sales, and roughly 80.2% of its profit. GameStop's "other" category, which includes PC software and refurbished electronics, declined as a percentage of sales and profit on a year-over-year basis. Until these initiatives demonstrate real growth, GameStop remains a seller of physical video games.

That means the company is deeply challenged by the shift toward digital distribution, both by the traditional video-game manufacturers who are starting to push it aggressively, and by new competitors that don't even offer a physical option.

GameStop, like the many retailers that came before it, stands to see its core business decimated by the Internet. Although the company is committed to returning cash to shareholders, with so many trends working against it, it is a question of when -- not if -- its core business will no longer be viable.

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Fool contributor Sam Mattera owns puts on GameStop. The Motley Fool recommends Apple and owns shares of Apple and GameStop. 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.

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