Why Wal-Mart's Plan to Enter the Used Video Game Business Is a Serious Blow to GameStop

When the largest retailer in the world targets a company's core business in its crosshairs, there's reason for that company to be concerned. That's exactly what Wal-Mart (NYSE: WMT  ) plans to do in the area of used video games. Wal-Mart will soon allow consumers to trade in their used video games in exchange for store credit, which clearly represents a shot across the bow for the other major video game retailers. And other video game retailers have good reason to worry.

Wal-Mart hunts a cash cow
For years, the $2 billion market for used video games was dominated by GameStop (NYSE: GME  ) , and to a much lesser extent, electronics retailer Best Buy (NYSE: BBY  ) . GameStop has long capitalized on video game trade-ins, which have become a major part of its overall business thanks to the huge margins involved. GameStop's pre-owned sales now account for 26% of its revenue and 42% of its gross profits. Not surprisingly, Wal-Mart has taken notice of those fat margins, and wants a piece of the pie.

Wal-Mart believes it can offer a unique value proposition to consumers, as opposed to GameStop or BestBuy. It will give store credit to gamers, who can use that credit at any of its Wal-Mart and Sam's Club stores. And, because Wal-Mart states it's the second-biggest seller of video game software and hardware in the United States, gamers are already comfortable going there.

Not surprisingly, shares of GameStop fell as much as 5% on the day of the announcement, in which the broader market rallied. Clearly, investors are worried that Wal-Mart may kill GameStop's golden goose. Previously, GameStop took pride in the fact that its trade-in program gave it a unique advantage over other merchandise retailers, but all that looks in serious doubt now.

Add in the fact that physical video games, in general, are facing increasing competition from online and mobile devices, and you can clearly see the beginnings of a distinct bear case against GameStop.

The plan makes sense for Wal-Mart, which clearly needs to shake things up. Wal-Mart is stuck in a period of sluggish growth, and is looking for new avenues to move the needle. Wal-Mart's same-store sales, which measure sales growth at stores open at least one year, have declined for four quarters in a row.

For a ship the size of Wal-Mart, a company that does more than $450 billion in annual sales, finding new paths to growth is no easy task. But an entry into the video game trade-in business could represent a new revenue stream, and a way to get more shoppers in the door more frequently.

Can GameStop withstand Wal-Mart's assault?
In the aftermath of Wal-Mart's announcement, a few sell-side research analysts came to GameStop's defense, citing the fact that this isn't the first time a competitor has tried to steal share in the video game trade-in market. Indeed, other brick-and-mortar retailers have tried to enter the used video game business. Of course, it's worth noting that none of those were Wal-Mart.

Wal-Mart is the largest retailer in the world; if it wants to pursue a business, chances are it can do so effectively. Plus, Wal-Mart's distinct advantage is that it will offer gift cards that can be used at its stores to buy anything from food to toothpaste. Gamers who trade in at GameStop have to use the cash to buy other video game software or hardware; gift cards at Wal-Mart can be used to buy just about anything. The mounting competitive pressures on GameStop from online games and mobile device gaming are only heating up. Wal-Mart entering the trade-in business will only make things harder for GameStop going forward.

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