GameStop At A Crossroads

The game industry is entering a digital future. To maintain a place in it, retail chain GameStop has scaled the used game buy-back model that first made it a success--now it's buying used companies, too.

Odds are, when you think of GameStop, you picture yourself trading in a handful of old titles to buy a new release or one of the retailers "pre-owned" games. You imagine yourself in that physical store. Now GameStop is relying that reputation as a gamers' hub in a rapidly evolving era of gaming.

In 2004, when it spun off of Barnes & Noble, GameStop had already opened up a world of play by buying old titles in exchange for credit. The used business is still huge for the retailer--it reported $1.2 Billion in trade-in credit last year. It even owns a 200,000 square-foot facility in Dallas, Texas, that refurbished 17 million discs and 1 million consoles in 2011. Ninety percent of trade-ins come from members in GameStop's loyalty program, PowerUp Rewards, which allows the company to track consumer trends. In 2011, the 17 million PowerUp members accounted for 59% of the retailer's total sales.

But the market for used physical games could be changing soon. Nintendo announced that this year physical games for it's handheld Nintendo 3DS and for the upcoming Wii U console will also come as digital versions. Sony had already gone this way with most of its games for its new PS Vita handheld. And rumors abound that the next consoles from Sony and Microsoft, likely coming in 2013, will have additional measures to counter used games in the form of linking purchases to a player account, ala iPhone apps. 

So GameStop is scalling its breakthrough strategy--buying gently used products--and preparing for a new era of digital gaming by buying gently used companies, too. The GameStop of the future could look something like CostCo. and Netflix, rolled into one.

"We have over 17 million gaming whales," ravenous consumers of game products, GameStop president Tony Bartel says, "And these whales love to spend money on physical games. They love to spend money on digital gaming. We call it a hybrid gamer and what we're seeing is a transition from what used to be a physical business to a hybrid state." With its deep connection to gamers, GameStop says it's well-positioned for this shift. "We know exactly what people have in their library--over 250 million games have been logged into their library, these 17 million customers. So we know a lot about what their playing habits are. We now know what they are purchasing and what their purchase habits are and we are going back now and saying, 'Hey, if you like that, you are going to like this.' " They project business from PowerUp members to grow from 59% of all sales to 75% by 2014.

The GameStop of today can be traced back to a long line of mergers with other game retailers, both in the U.S. (Funcoland and Electronics Boutique) and abroad (Micromania and Gamesman). It still operates some stores under the name EB Games. In 2010 GameStop acquired Kongregate, an online site for browser-based games--50,000 games in total. The casual market that plays these games are in the millions of players and GameStop hopes to find success in the same way that casual powerhouse Zynga has (290 million unique members). "Kongegrate revenue doubled last year, and that's the second year in a row that we've seen revenue doubled, since we've owned them," said Bartel. 

"We know you love to game--we love to game. That's all we do. We don't sell diapers. We don't sell washing machines. We sell games."

Last year they acquired Impulse, a digital download site for PC games, with 1,500 titles, that lets GameStop tap into that market--the 40 million members of Valve's service, Steam, and the 9 million members in EA's Origin service. And GameStop also acquired Spawn Labs, a streaming service for PC games that's currently in beta, but intended to compete with services such as Gaikai and OnLive.

With the public now downloading games on Apple devices and Android devices, the retailer now buys and sells refurbished phones and tablets. They also sell their own Android game controller. They project this mobile business to account for $150 to $200 million is sales for 2012 and to triple by 2014. They couldn't ignore that digital market. "We are saying, 'Hey, we know you love gaming, and you love gaming in all ways,'" Bartel says.

Not everyone believes GameStop should go whole-hog into the digital gaming market. "I think Spawn is complementary, letting people try stuff on the website. But I think of Impulse--there is no reason to think of GameStop as a distributor for digital downloads," says Michael Pachter, Managing Director of Equity Research at investment firm Wedbush Securities. "I think we are going to have packaged products for a long time."

With signs pointing to an increased focus on digital in the industry, GameStop is hedging its bets with the expansion in to their recent digital business. But it isn't abandoning the traditional retail model. The video game industry generates $17 Billion in sales in the U.S. for 2011, according to intelligence agency NPD Group. And GameStop is the biggest force behind those numbers, with 25-30% of sales in the U.S., according to Bartel. The company has 6,700 stores worldwide, with 67% (4,500) in the United States. The Texas-based retailer had global sales of $9.55 billion for it's Fiscal Year 2011, which ended Jan. 28 2012. "We bring the rich benefits of gaming to gamers any time, any where, and on any device," said Bartel. "We know you love to game--we love to game. That's all we do. We don't sell diapers. We don't sell washing machines. We sell games."

But GameStop is going to be there as digital is embraced by the industry's players and the actual gamers. The company has also invested deeply in digital media to support the game industry and their own Power Up members. Why sell video game magazines to deliver news and reviews to your customers when you can create your own? The digital version of the company's Game Informer magazine is the top-rated digital paid magazine in the U.S., according to Bartel. It is the fourth largest magazine in the U.S. according to the Audit Bureau of Circulations with over 7.5 million subscribers.

So far, GameStop's multi-prong digital strategy is working. Its digital business grew 57% in 2011, from $289 million to $453 million. They expect it to grow 50% per year, to reach $1.5 billion in 2014. They project PC downloads to triple in 2012. And the company projects that sales by PowerUp Rewards members will grow from 59% to 75% by 2014.

Most expect GameStop to continue to thrive as a company with a hybrid strategy supporting physical and digital products for hybrid gamers in a rapidly changing gaming culture. "They Dominate," analyst Pachter says, "because they have a good relationship with their customer and they retain that customer, I think they are going to be around for a long time."

[Homepage image: Flickr user Rick Harrison; top image: Flickr user Wright Way Photography]

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