We are just six months into the next-gen console cycle, but it's already clear that the launch has been a success. Sales of Microsoft's (NASDAQ:MSFT) Xbox One and Sony's (NYSE:SNE) PlayStation 4 are at more than double the level they managed at the start of the last generation, according to research firm NPD.
Of course, every electronics seller from Wal-Mart to Best Buy to Amazon.com wants a piece of that action. But one retailer is absolutely dominating all the rest: GameStop (NYSE:GME).
The video game retailer announced last week that its hardware sales were up 182% over the last six months as it tightened its grip on the hyper-competitive market for consoles. This is how GameStop manage to pull off that impressive feat.
In stores now
It started with having tons of inventory on hand in the critical first few weeks after launch. At a time when supply wasn't even close to meeting demand, Microsoft and Sony forked over huge numbers of their precious devices to GameStop. That often meant that it was the only place in town that shoppers could buy those consoles over the holidays.
The reason for that hefty allocation is simple: GameStop tends to sell more games with every Xbox One and PS4 that it delivers. At launch the retailer booked an attach rate of 3.3, meaning that people bought on average more than three games to go with each new console. That's a full 60% higher than the attach rate for the rest of the industry, and it explains why GameStop is a key partner for game publishers and hardware makers alike.
The company also benefits from a huge base of loyalty card users. GameStop's PowerUp rewards card boasts 36 million members worldwide and a 25% penetration among U.S. households, including more than 7 million paid members. That's a lot of highly engaged customers for GameStop to canvas for market intelligence and to send promotions to. And it also makes for a massive pool of gamers that are looking to collect rewards points that they can apply toward future purchases.
But GameStop's trade-in business is probably the single biggest reason why it has been dominating the market for Xbox One and PS4 sales. At a price of $400-$500, the next-gen consoles don't come cheap. Buying from GameStop gives customers an easy way to lower that cost by funding at least part of their purchase using stuff that they already own.
And that's exactly what gamers are doing: A full 17% of purchases last quarter were made using trade credits, GameStop said. And that number was as high as 20% for the growing category of digital sales.
Ironically, the success it's had in selling more consoles has actually hurt GameStop's bottom line. Those devices are the lowest margin products that it offers, and so profitability has taken a hit as new consoles grow to a bigger proportion of sales. Over the holidays, for example, hardware sales doubled as a percentage of sales, dragging profitability down with it.
But that's a short-term pain that comes with a long-term payoff. As we get deeper into the console cycle a more vibrant used video game market will eventually push the company back toward its historical levels of software sales. In fact, that's already starting to happen: pre-owned software rebounded to 30% of sales in the first quarter of 2014, up from 20% a quarter back. If that trend continues then GameStop should have no trouble parlaying its impressive hardware success into more exciting wins on the software side.
Profit from this content shift
Video games are just one piece of a massive entertainment industry that's being revolutionized right now. For example, you know cable's going away thanks to the rise of digital delivery. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.
Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com, GameStop, and Microsoft. 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.