Is GameStop in Trouble?

Find out why the world's largest retailer of video games is reducing its store count by 2%.

Apr 1, 2014 at 2:48PM

GameStop (NYSE:GME) recently forecasted full-year earnings below market expectations, as it faces fierce competition from big retailers such as Best Buy and Wal-Mart (NYSE:WMT). The company also disclosed during the most recent earnings call that it plans to open 300 to 400 retail locations that will have a focus outside of games. At the same time, the company plans to reduce its video game store count by 2%.

With more than 6,000 stores all over the world, GameStop is the world's largest retailer of video games. Since its foundation as a small software retailer in Dallas in 1984, the company has experienced massive growth, because of the huge popularity of video games and the company's ability to build a strong brand within the gamer community. However, recent events show that GameStop may depart gradually from its traditional business of selling video games to improve the top line. Can GameStop recover, or will this chain store become the next RadioShack

Gamestop

Source: GameStop Market Model 03/28/13.

Heavy exposure to console manufacturers
As the world's largest video game retailer, GameStop is heavily exposed to the performance of console manufacturers, such as Sony, Nintendo, and Microsoft.  Unfortunately, in early January Nintendo admitted that poor sales of its flagship console, the Wii U, were hampering its business. And Microsoft's Xbox One had a difficult start, with sales of Sony's PlayStation 4 outpacing Microsoft's flagship console.

That being said, because Microsoft and Sony released new versions of their flagship consoles in the most recent quarter, GameStop was able to increase revenue to $3.68 billion from $3.56 billion. However, net profit fell significantly to $1.89 per share in the fourth quarter, from $2.15 per share a year earlier.

The lucrative business of selling used video games
The cause for the decrease in profitability may be related to sales of used video games, which is probably the company's most profitable business.

Selling used video games is a very lucrative business. It is also a huge market, as there are nearly a billion games in American homes. Aware of this, big retailers have started to offer their own second-hand game market. In March, the world's largest retailer, Wal-Mart, announced its own video game trade-in program. The retailer will let consumers trade in their old video games for gift cards that can be used to shop for items in its stores.

The new strategy
It's hard for a niche retailer such as GameStop to compete against giant retailers like Wal-Mart or Amazon.com, as they enjoy various scale advantages. Wal-Mart operates more than 4,000 stores in the U.S. alone and is likely going to become a big competitor once the retailer starts exchanging old video games for gift cards. To survive, GameStop needs diversification. Otherwise, the company could face a similar situation to other niche chains, like RadioShack, which recently announced that it will close more than 1,000 stores after reporting a huge quarterly loss.

The company's current strategy appears to be based on gradually closing video game stores, and at the same time opening stores that sell other products. It already has more than 200 stores focused on selling phones.

From now on
The company could also benefit from focusing on selling complementary goods that have promising demand, such as wearable computing devices. It could also rent retail space to manufacturers that are willing to set up exhibition rooms.

To differentiate itself from online retailers, Best Buy has used the "store within a store" concept successfully, by partnering with Samsung to create the Samsung Experience Shop, a place inside Best Buy stores where customers can try Samsung's latest mobile devices.

Final Foolish takeaway
As the world's largest video game retailer, GameStop is heavily exposed to the performance of console manufacturers, which face several challenges ahead, like the increasing adoption of mobile devices as gaming platforms. The company also faces fierce competition from big retailers, such as Wal-Mart. To improve sales in such a difficult environment and avoid becoming the next RadioShack, the company is trying to diversify its business, by going beyond games and opening new stores that focus on other products, such as phones. Finally, it should be noted that the company has a strong brand within the gamer community. This is probably GameStop's most valuable asset and will help the company with the transition.

It's not just video games turning your TV into big business
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Victoria Zhang has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, Google, and Netflix and owns shares of Amazon.com, 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.

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