Can Cheap Video Games Save GameStop?

GameStop (NYSE: GME  ) has an interesting problem on its hands: It's selling too much brand-new -- and expensive -- stuff. After an almost two-year siesta, video-game fans are back to spending with a vengeance. In fact, people are buying new consoles released by Microsoft and Sony at such a fast pace that it's sucking the air out of the rest of the market.

The problem
To see this phenomenon in action, look no further than GameStop's latest business results. Powered by record launches for the Xbox One and PlayStation 4, hardware sales spiked higher by 100% over the holidays last year. That's great news for GameStop, especially since it managed to increase its market share to a record high.

However, that success came with a big drawback. Sales of new software titles for prior-generation consoles plummeted by 22% over the same period, suggesting that gamers were depleting their budgets on the $400 and $500 consoles, leaving little room for other purchases. And this shift in spending has resulted in a major reordering of GameStop's sales mix: Software sales tanked to 33% of revenue last quarter, as compared with 45% in the same period of 2012. 

GameStop's sales breakdown last quarter. Source: Company financial filings.

The problem for GameStop is that consoles are much less profitable than every other product that it offers. The company logged an 11% profit margin on console device sales last quarter, which was less than half the margin it got from new software sales and just one quarter of the profitability it registered in its lucrative used video-game division.

That profit swing goes a long way toward explaining why GameStop missed its latest earnings forecast despite clocking a strong revenue boost. Sure, comparable-store sales rose by an impressive 8% last quarter, but earnings fell by 14% thanks to the unfavorable product mix.

The answer
A good portion of this issue will actually solve itself over time as the next-gen consoles mature, and as more titles come out for the devices. A deeper used and new video-game market will develop soon enough for the Xbox One and PS4, and GameStop can then expect to return to its usual, more profitable sales mix. But the company also aims to help that process along by making a push into the market for cheaper video games.

The category for games priced at $20 and below, as opposed to $60 for big-name blockbusters, was worth $400 million in sales last year. That's an enticing category, considering GameStop's total video game revenue in 2013 was $3.8 billion. However, to protect its massive profit margins on pre-owned games, the retailer has left that market mostly to competitors. While GameStop dominates used and new video game retailing overall, its market share is much lower in the value category. 

Foolish bottom line
Entering that market should give the company a healthy sales boost, on the order of a few percentage points of revenue. Still, investors should expect a trade off in slightly lower profitability going forward.

By GameStop's estimates, its pre-owned game margins will be pulled down by the addition of value offerings, falling to roughly 45%, as compared with the 48% it has enjoyed until now. That's still a very profitable business model. And its likely a worthwhile trade if it grows the overall sales pie and gives the company the opportunity to sell more games in addition to those popular console devices. 

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  • Report this Comment On April 07, 2014, at 3:53 AM, Interventizio wrote:

    "Sales of new software titles for prior-generation consoles plummeted by 22% over the same period, suggesting that gamers were depleting their budgets on the $400 and $500 consoles, leaving little room for other purchases." Can it be instead that with these new super-powered game consoles, titles for the last-generation consoles stink? After all, what do you pay 400-500$ for if you don't have any game? Right now, gamers are simply playing those few new-generation games that are available, and are progressively abandoning last-generation consoles and that's it.

  • Report this Comment On April 07, 2014, at 5:42 AM, Nomadder wrote:

    "The category for games priced at $20 and below, as opposed to $60 for big-name blockbusters..."

    Could you expand on this category?

    As far as I'm aware, the vast majority of new console games sell for 50-60. Forget about "blockbuster status", that's 95% of new console games.

    Anything selling for $20 or below just means it's old, used, not selling well, or all of the above. Unless we're talking handheld games, and I'm pretty sure Gamestop has those covered as well as they can.

    I suppose box releases of digital titles are another exception, but a rather small one, and again, not really something that Gamestop leaves out of it's stores when available. Other than that it's not really a "market" so much as a price-point. I mean, what have they been leaving to competitors?

    If I'm off-base, then by all means, let me know what other $20 games we're talking about here (that Gamestop has supposedly been turning up their nose at thus far).

  • Report this Comment On April 07, 2014, at 8:47 AM, TMFSigma wrote:

    @interventizo - That's part of it, sure. I think the industry was surprised by just how quickly gamers are fleeing the prior-generation consoles, especially given that there aren't that many next-gen specific games out yet.

    @nomadder - I think we're talking mostly older properties and stuff from smaller publishers. Scanning the walmart website, for example, I saw CoD Black Ops, an Angry Birds game, and Plants v. Zombies for around that $20 mark. These aren't used, and they're for consoles.

    -Demitrios

    @TMFSigma

  • Report this Comment On April 07, 2014, at 7:02 PM, Nomadder wrote:

    So, like I said, older games and box copies of digital titles?

    Again, I don't see how this constitutes Gamestop "(leaving) that market mostly to competitors."

    Gamestop sells these games. In the snapshot of the moment, they might be listed for more...but if they are selling for that much, then Gamestop will be both making more money than competitors and, according to your stats, leaving a market up to a competitor.

    If you're holding to your thesis, then what must Gamestop do? Lower the price on an old CoD game by $10? Make sure to go find more new copies of Angry Birds (when they make much more off of selling used copies)? s for PvZ, well, that one is even listed on Gamestop's site, new. For $19.99.

    And remember, in the case of Angry Birds, just because they do not sell new copies on their website does not mean they do not carry them in-store.

    There is no "market". It's just a price that a lot of different things fit into. You are misreading the data.

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