Harmonix's Digital-Only "Dance Central" Is Troubling for GameStop

Harmonix's next title will be available only through Microsoft's digital storefront. GameStop stands to lose.

Jun 11, 2014 at 6:00PM

Harmonix, the creator of popular music- and rhythm-based games such as Guitar Hero and Rock Band, has announced that its next game, Dance Central: Spotlight, will be coming to Microsoft's (NASDAQ:MSFT) Xbox One later this year.

Unfortunately for GameStop (NYSE:GME), Dance Central will not be appearing on its store shelves -- instead, the game will be distributed digitally, requiring buyers to download it directly from Microsoft's online storefront. That's an obvious problem for the retailer, as it continues to depend on the sale of physical game discs.

Harmonix embraces digital distribution
Previous installments in the Dance Central series had received retail releases, even if they were also available digitally; Spotlight will be the first entry in the franchise to be distributed completely over the Internet.

Harmonix isn't the first developer to shun physical retail -- in recent years, the rise of digital distribution has led to a plethora of video games that are only available as a download. But most of these, games like Braid and Super Meat Boy, have been smaller titles developed by indie studios. Dance Central is a major franchise -- although it isn't in the same league as Grand Theft Auto, the original Dance Central sold more than 2.5 million copies.

GameStop is vulnerable to digital-only titles
Admittedly, Dance Central is only one game, but it does serve to highlight what is becoming a troubling trend for GameStop. Some of the largest video game publishers in the world have declared their explicit intentions to move toward a model that is 100% digital -- and for good reason, as the margins on digital games are higher.

A cursory glance at GameStop's financial results indicates how devastating this could be to the company. Although GameStop provides a necessary outlet to move video game hardware and software (for the time being), the company also has somewhat of a parasitic effect on the industry -- the reselling of used games often comes at the expense of new game sales, and video game developers and publishers don't receive a cut.

Instead, GameStop keeps every dollar it makes on used video games, and used software accounts for much of GameStop's earnings. In fiscal year 2013, for example, used video games generated more than 40% of GameStop's profits.

The more game creators follow in Harmonix's footsteps, the more GameStop stands to lose, as digital games cannot be resold.

Microsoft is facilitating the digital revolution
Microsoft, as the owner of the Xbox platform, is doing what it can to encourage gamers to purchase their games digitally. This month's software update to Microsoft's Xbox One operating system included many new features -- chief among them is the ability to utilize external hard drives. This makes it possible to now own a sizable digital game collection, as the Xbox One's 500 GB internal hard drive can fill up quickly.

Microsoft has also pledged to offer digital titles at aggressive discounts, and has begun to give away select Xbox One games to Xbox Live Gold subscribers on a monthly basis.

Can GameStop survive in a digitally driven world?
GameStop, does, technically, sell digital games. When Dance Central: Spotlight is released, you will (more than likely) be able to purchase it from GameStop -- the question is, why would you?

Owners of Microsoft's console can purchase download codes for digital-only games from GameStop. As with an iTunes gift card, these codes are then entered into the Xbox One system to unlock the game. But digital games can also be purchased from within the Xbox One itself, directly from Microsoft's own storefront, cutting GameStop out of the equation entirely. Barring the occasional GameStop-exclusive digital sale, it's hard to imagine many gamers going through the trouble of buying their digital game codes from the retailer. Even if they did, digital game sales are still immensely detrimental given GameStop's dependency on the sale of used game discs. Because Dance Central: Spotlight is a digital-only title, GameStop will never be able to sell a secondhand copy of it.

With console games slowly embracing digital distribution, I believe GameStop's current business model will not be viable at some point in the near future. Although the company insists that it has a role to play in digital distribution, it is difficult to imagine the specialty realtor operating in a world where digital game downloads are common.

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Sam Mattera is short shares of GameStop. The Motley Fool owns shares of 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.

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