Wal-Mart (NYSE:WMT) has decided it wants to own the used video game industry. That could be very bad news for GameStop (NYSE:GME) as it struggles with declining sales for traditional games despite the release of a new generation of gaming consoles.
What is Wal-Mart doing?
Starting March 26, Wal-Mart customers will be able to trade in their video games for immediate store credit both in Wal-Mart locations and Sam's Club stores, as well as on the company's website. The traded-in games will then be refurbished and made available for purchase in what a Wal-Mart press release called "like-new condition at a great low price."
"Gaming continues to be an important business for us and we're actively taking aim at the $2 billion pre-owned video game opportunity," said Duncan Mac Naughton, chief merchandising and marketing officer for Wal-Mart U.S. "When we disrupt markets and compete, our customer wins. They'll save money on video games and have the flexibility to spend it however they want."
Why is Wal-Mart moving into used games?
"For Wal-Mart, like most major retailers, it's about about driving more customers into the store and boosting revenue," Bruce Horovitz wrote for USA Today . "Retailers like Wal-Mart and McDonald's that more widely appeal to lower-income customers have faced a tough time battling back from the economic downturn. These customers face bleaker employment prospects and many don't have extra money to spend."
Offering credit for used games is not only a way to get these customers into stores, it also lets Wal-Mart shake the last few dollars from their pockets.
How healthy is GameStop?
While GameStop has had a tough go of it in recent years, its results for the third quarter of 2013 were surprisingly solid. The company has not reported on its full-year 2013 results yet.
Total global sales for the third quarter of 2013 were $2.11 billion compared to $1.77 billion in the prior year quarter, an increase of 18.8%, the company reported. Consolidated comparable store sales rose 20.5%, well above the forecasted range. GameStop's net earnings for the third quarter were $68.6 million, a 45.3% increase compared to adjusted net income of $47.2 million in the prior year quarter.
"Our strong third quarter sales results give us great momentum as we enter the new console cycle," CEO Paul Raines said in the earnings release.
Holiday sales were strong too as the company reported total global sales for the period were $3.15 billion, a 9.3% increase compared to the 2012 holiday sales period.
"Comparable store sales were driven by new video game console sales as demonstrated by the 99.8% increase in new hardware sales," the company said in a press release.
Will Wal-Mart's move hurt GameStop?
No company wants to see a giant like Wal-Mart move into its territory and announce that the company expects to force prices down. New game prices are generally consistent across all retailers, but the used market can vary greatly. Wal-Mart can hurt GameStop in two areas -- what it pays customers for used games and what it charges for refurbished games.
Gross margins on resale of pre-owned games "are expected to range from 46% to 49% for the fourth quarter and the fiscal year," GameStop reported. That leaves a lot of room for Wal-Mart to to pay more for games and/or lower prices and still make money while squeezing GameStop.
How important is the used market to GameStop?
GameStop earned $2.4 billion of its roughly $9 billion in total revenue in 2012 from the used market, according to the company's most recent annual report; 70% of trades were applied to the purchase of new product. Over 12 million games were refurbished by the company, along with over 1 million hardware units.
The company also forecast in its 2012 annual report that market for used games would stay strong.
Based on reports published by the NPD Group, we believe that, as of December 2012, the installed base of video game hardware systems in the United States, based on original sales, totaled over 294 million units of handheld and console video game systems and grew by 19 million units in 2012. According to IDG, the installed base of hardware systems as of December 2012 in Europe was approximately 187 million units and grew by 14 million units in 2012. Hardware manufacturers and third-party software publishers have produced a wide variety of software titles for each of these hardware platforms. Based on internal company estimates, we believe that the installed base of video game software units in the United States currently exceeds 2.3 billion units.
Gamestop also cited how it intended to continue to grow its used games sales and stated how important they were for the company.
Pre-owned video game products generate significantly higher gross margins than new video game products. Our strategy consists of increasing consumer awareness of the benefits of trading in and buying pre-owned video game products at our stores through increased marketing activities and the use of both broad and targeted marketing to our PowerUp Rewards and international loyalty program members.
Target, Amazon.com, and Best Buy also compete in the used video game space.
Wal-Mart's move is bad for GameStop
It's hard to picture a worse scenario for GameStop. Wal-Mart is entering the used video game market not primarily to increase revenue but to increase traffic in its stores. A company that large getting involved may grow the overall used game market but Wal-Mart will gain share, some of which will come from GameStop.
This should drive prices paid for used games up and the cost of those games at resale down. That may be bad for GameStop but it's very good news for gaming consumers.
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Daniel Kline has no position in any stocks mentioned. He buys used games at Gamestop. The Motley Fool owns shares of GameStop. 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.