While PC gaming distribution went digital long ago, the major game consoles still support physical game discs. Selling those discs is video game retailer GameStop's (GME -6.49%) core business. Selling used discs is GameStop's cash cow. GameStop as a business only makes sense if the status quo remains intact.

Microsoft (MSFT 0.92%) may have other ideas. The software and gaming giant is reportedly planning to launch a new version of its Xbox One game console without a disc drive within the next couple of months. The Xbox One S All-Digital Edition, as it's reportedly called, represents a nightmare scenario for GameStop.

A scared man.

Image source: Getty Images.

The end of used games

There's no such thing as a used PC game anymore. PC games are bought on digital platforms like Steam, and that's the end of the story.

Used console games are still a thing -- and for GameStop, a lucrative one at that. Margins are low for new software and hardware, but the company makes a killing buying and selling used games. In the third quarter, GameStop's pre-owned and value video game segment enjoyed a gross margin of 43.1%. That's nearly twice the profitability of new video game software, and four times the profitability of new video game hardware.

About 25% of the company's total gross profit in the third quarter came from pre-owned products. With GameStop selling off its Spring Mobile business, which sells mobile devices through more than 1,000 stores, used games will account for an even greater proportion of GameStop's profits going forward. That's a gigantic problem.

Even without a disc-less game console on the market, GameStop's used game business has been struggling. Sales have been falling since the start of 2016, and gross profit has been in decline even longer. Things got even worse over the holidays, with the company reporting a 16.4% year-over-year drop in pre-owned sales in the nine-week period ending Jan. 5.

If Microsoft does launch a disc-less Xbox in the next few months, the decay of GameStop's pre-owned games business could accelerate. And even the new game software business could take a hit. A disc-less console coupled with a subscription service, like Xbox Game Pass or Microsoft's rumored game streaming service, would hasten the shift toward digital.

Check out the latest earnings call transcripts for GameStop and Microsoft.

GameStop doesn't have much of a strategy

After announcing the sale of its Spring Mobile business, GameStop said that it planned to increase its focus on the video game industry. But its core video game business has no future. That's not much of a strategy.

Instead of having a real strategy, GameStop is aggressively buying back its own stock. The company announced a new $300 million share repurchase authorization earlier this month, enough to retire about a quarter of its outstanding stock. Shares of GameStop may look cheap based on earnings, but they're not worth much if the core business vanishes over the next few years. The company is almost guaranteed to be overpaying.

Console games are going digital, and there's nothing GameStop can do to stop it. The used games business will continue to disintegrate, putting pressure on GameStop's bottom line. GameStop is already dying, but Microsoft's disc-less Xbox represents a twist of the knife.