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GameStop Faces Pain from Best Buy, Downloading

Listening to GameStop is like hearing an investment bank's CEO in March 2008 telling stockholders not to worry, that all is well and in control. Of course, little would have been well and nothing was in control. GameStop management is whistling past the graveyard. Just as a report comes out of how company management has decided that downloading simply isn't in the near-term cards for gamers, along comes Best Buy and its plan to really enter the used game business, which represents the big margin boost for GameStop.

On the content downloading front, GameStop doesn't seen an "addressable market" for game downloading until 2014. At that point, the company thinks that about 25 percent of the population will have access to the necessary technology.

So what happens when digital distribution does start to directly affect GameStop? "Management... feels that digital growth and brick and mortar growth can co-exist," said [Sterne Agee analyst Arvind Bhatia]. "Through their brick and mortar locations, the company can help facilitate and capitalize off digital. Overall, management did not seem at all concerned about the near-term threat but instead is looking at ways to potentially profit from digital."
Frankly, this seems like burying your head in the sand. How does it take until 2014 for 25 percent of the population to have the "technology required to download full games"? According to the Organization for Economic Cooperation and Development, US broadband penetration is already around 27 percent. That's one of the more pessimistic estimates you can find. Strategy Analytics pegs it at 60 percent.

The difference may be a matter of methodology and semantics. Do you count physical area covered, or population? But even the lower estimate suggests that GameStop is five years behind reality. In my rural area, we only got DSL in the fall of 2008, with a top speed of about 1.5 megabits per second, and my son still manages to download Xbox game content as well as entire movies. Sony certainly has downloading built into the PS3. If this is possible where we are, it's possible virtually anywhere you can find any connection that is faster than dial-up. As Ben Kuchera at Ars Technica points out, "All you need to download games is a roomy hard drive and a broadband connection, and neither of these things are rare among the game-playing public."

GameStop certainly wouldn't want to hear about downloadable games because the concept plays havoc with the company's business model. It relies on buying used games from customers and then selling them at a relatively small discount under new copies, so it makes far more margin on used games than on new. But then, GameStop has largely had that market, which works best on impulse and physical presence, to itself. That's about to end. Best Buy CMO Barry Judge announced via blog yesterday that the company is entering the used game business:

This week, several of our Dallas and Austin stores will test a kiosk-based model that allows customers to insert their used games into a kiosk that will scan it for functionality, and immediately issue a voucher that is instantly redeemable for a Best Buy gift card. It's a pretty slick system and one of the few trade-in programs to provide instant gratification; you get the gift card on the spot and can redeem it on anything in the store â€" not just another game. We'll also be testing the sale of used games in those stores, and some of the kiosks will even rent games and movies.
GameStop does have an advantage in the number of stores it has: 6,207 compared to Best Buy's 1,023. (Note that Best Buy actually has a much greater number of stores, but many are devoted to cell phone and car audio products.) However, Best Buy is over five times the size of GameStop in revenue and has roughly three times the net earnings. That gives the big box retailer the economic freedom to price used titles significantly under GameStop, forcing the latter to either compete and lose margin or to try maintaining prices and lose volume. In either case, it could be a game over for GameStop.
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