The video game industry is shifting toward digital distribution. At some future date, physical game discs will simply cease to exist -- gamers will download their purchases directly over the Internet.
Many of them already do, but many more could be about to make the switch to digital. Both Microsoft (MSFT 0.27%) and Sony (SONY 0.28%) are aggressively pushing digital alternatives to physical game sales.
As a retailer dependent wholly on physical video game sales, GameStop (GME -1.81%) is uniquely positioned for failure.
GameStop's last stand
Most of the video game industry is already dependent on digital distribution. If you're going to game on your iPad, for example, you couldn't use a disc even if you wanted to. PC gamers, enthralled with services such as Steam and GOG, have long traded in their discs for digital downloads.
There's only one area of the industry where physical discs remain common: living-room consoles. Most owners of Microsoft's Xbox and Sony's PlayStation still purchase hard copies of their games, and play them directly from their console's disc drives. They can buy a digital version from Microsoft's and Sony's respective online marketplaces, but there isn't much incentive to do so.
While it does save them a trip to the store, the games aren't any less expensive. Moreover, they can't be resold or traded to friends. And gamers with slow Internet connections may find the long download times unbearable.
But all that could be about to change.
Microsoft is going to make gamers an offer they can't refuse
Earlier this week, Microsoft announced that it would begin experimenting with digital game discounts. If you own Microsoft's latest console, the Xbox One, for a limited time this month you'll be able to buy a digital version of Ryse: Son of Rome directly from Microsoft's online marketplace for just $40.
This is such a tremendous blow to GameStop's business model that it's difficult for me to overstate the matter.
Right now, your local GameStop would charge you $60 for a physical, brand-new version of Ryse. If you were willing to buy a used version (and GameStop would prefer you did), you would still have to shell out $55. In other words, while Microsoft is running that deal, gamers have virtually no reason to buy a copy from GameStop.
What's important to note is that Ryse isn't just some old, obscure game -- it is one of the Xbox One's best-looking launch titles, and has been out for less than three months. This is the type of game GameStop is most dependent upon for its business.
To be clear, Microsoft has said this is only a test; a trial balloon to gauge gamers' reactions. But if this were to become a common trend -- a discounted, digital version of a game offered shortly after its release -- GameStop would have a real crisis on its hands. Gamers may prefer to buy physical when the digital game is the same price, but a digital game offered at a 33% discount would be an offer most could not refuse. GameStop would be forced to counter with its own price cuts, or lose out on business entirely.
Sony isn't any better
But that's just Microsoft, and as I've pointed out, the Xbox One isn't even selling well. Sony's PlayStation 4 has outsold Microsoft's console around the globe, and even if Microsoft undercuts GameStop, the company still has a partner in Sony -- right?
Not really. While Sony hasn't offered up any cheap, digital PlayStation 4 launch titles, the Japanese giant is pushing digitial distribution in other ways. Last month, Sony unveiled PlayStation Now, an on-demand video game streaming service that promises to digitally deliver old PlayStation games over the Internet -- no downloading required.
More menacing might be Sony's Instant Game Collection. Each month, subscribers to Sony's PlayStation+ service get a slate of free digital games that they can download and play so long as they remain a member. While this service has been available for years, it's much more a threat to GameStop today than it's ever been in the past.
Sony's last console, the PlayStation 3, offered free online multiplayer. In that era, PlayStation+ was simply an optional service for dedicated gamers. But today, that's no longer the case -- PlayStation 4 owners must purchase a PlayStation+ subscription in order to game online.
Given the popularity of online multiplayer games, the great majority of those owners will subscribe, so more Sony gamers than ever before will have access to the Instant Game Collection. And while that won't, by itself, eviscerate the demand for PlayStation 4 games at GameStop stores, it will have a negative effect.
Countdown to the inevitable
The move toward digital distribution is in full swing. The debate is no longer about the inevitability of the outcome, but about how long it will take. Wedbush's Michael Pachter, a notable GameStop bull, believes the company has at least 10 years left on its core business.
While that's certainly possible, I would be utterly shocked if the company manages to survive another five years, let alone 10. Its two major suppliers, Microsoft and Sony, are moving against it aggressively.