Video game publishers are excited over the trend toward downloadable content sales. And there's good reason for all the giddiness: Digital purchases are pushing revenue and profits to record highs for companies like Activision Blizzard (NASDAQ:ATVI) and Electronics Arts (NASDAQ:EA).
In Activision's case, the digital sales channel accounted for a record two-thirds of revenue in the third quarter, up from 25% at the end of last year. That category also posted huge gains by leaping 95% year over year, as compared to the 23% rise from regular retailing channels.
The same shift toward digital is boosting EA's results, too. Last quarter, EA booked a 95% rise in downloadable content sales on gaming consoles, which helped push total digital sales higher by 30%. Profitability spiked up to 66% of sales from the prior year's 62%. EA credited digital sales, particularly a jump in full game purchases, for the surprising profit boost.
Devaluing video games
But there's one major risk embedded in the trend toward downloading video games that could come back to haunt publishers: falling prices.
According to GameStop (NYSE:GME), the average price gamers have been paying to download new AAA titles lately is just $22. That's compared to a full retail price approaching $60 and a price gamers expect to pay for a digital license of closer to $35.
Sure, that ultra low $22 average is being held down by some temporary factors, mainly temporary giveaways and hardware bundles that include digital download tokens. Wal-Mart, for example, is now selling a PS4 console pack that includes a voucher for the downloadable version of either Destiny, Call of Duty: Advanced Warfare, or Madden 15. The effective cost to gamers for these digital titles is far below the retail price.
And then we have all the games that are being given away for free. In fact, by GameStop's count, more than $100 million worth of games have been delivered for no extra charge to console hardware customers in just the past year.
It makes sense that digital games should sell for less than physical copies since there's no good trade-in market for these products. Shoppers can usually get about $20 of residual value for brand-name games once they're done playing, frequently by selling the game right back to GameStop or another retailer. That lowers the effective price for most big titles to around $40. But that's still far from the $20 mark that digital sales are trending toward.
The upside for game publishers is that digital promotions are helping in two important ways. First, they are accelerating the rollout of next-generation game consoles. Sony's PlayStation 4 and Microsoft's Xbox One devices are sitting at 73% above where their installed base was at same time in the prior generation. Digital promotions are also speeding along the adoption of electronic shopping by gamers, which has the potential to lift publishers' profits as delivery costs fall.
What GameStop thinks
But could digital selling eventually push video game values too low to justify the investment? GameStop sure thinks so. Here's how company President Tony Bartel put it recently in a conference call with analysts:
We want to help ensure that our industry does not make the same mistake as other entertainment categories by driving the perceived value of digital goods significantly below that of a physical game.
When the free digital token programs end, we believe that the industry will need to work together to continue to price goods in a way that sustains profitability and encourages the great innovation that this category needs.
Yes, GameStop's motives with this warning involve self preservation. It is the biggest physical retailing presence in the industry, after all, and will lose business as publishers deal more directly with customers. But the risk that it's highlighting is worth watching. The big gap between digital and physical video game prices might be hard for publishers to close once their promotions are over.
Demitrios Kalogeropoulos owns shares of Activision Blizzard, Netflix, and Apple. The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of Activision Blizzard, 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.