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GameStop's digital plan falters Exclusive
GameStop's digital plan falters
November 26, 2012 | By Matt Matthews




Between 2010 and 2011 GameStop announced three acquisitions to stake its claim in the majority-digital future of video games. First it snapped up the web-game company Kongregate at the end of July 2010 and then at the end of March 2011 agreed to purchase Spawn Labs, a streaming technology company, and Impulse Labs, the digital distribution subsidiary of Stardock Systems.

So when GameStop announced during its April 2011 Investor Day event that it intended to reach $1.5 billion in annual digital revenues by January 2015, that kind of goal didn't seem completely unrealistic. After a roaring success through the end of 2011, including a Call of Duty Elite subscription rush, the company saw its annualized digital revenues increasing at a rate of around 55 percent per year.

Anyone with a calculator could do the arithmetic: $450 million per year increasing at a rate of 50 percent per year for three more years gives you just over $1.5 billion. It seemed not only possible but likely that the king of the brick-and-mortar video game industry could be a billion dollar player in the digital future.

Then the digital revenue figures for 2012 started to roll in, and the growth in GameStop's digital segment retreated dramatically. The 60 percent growth rate in the first half of the company's 2011 fiscal year became a mere 25 percent growth rate in the first half of its 2012 (current) fiscal year. That slowdown was one of the main points in my column in August.

With the latest set of results, the news is not much better. The growth is still there, but it's again at a much lower rate than what the company had a year ago. Instead of the 61 percent year-to-date growth in its digital revenues a year ago, the company is seeing more like 28 to 30 percent growth this year.

Now, don't get me wrong, the company's digital figures are still headed in the right direction, but that $1.5 billion annual figure is now out of reach.

Let me put this into a picture that makes my point. To smooth out the seasonal variations, I'll look at a trailing-twelve month total for GameStop's digital receipts, fit to an exponential model, and extrapolated out to the point at which GameStop said it would hit the $1.5 billion annual digital revenue figure.



Under this model, the company will hit approximately $1.3 billion in annual digital revenue during its 2014 fiscal year (ending in January 2015). That's not so bad, and would still give the company well over a billion dollars of high-margin revenue, something that was practically unthinkable just two years ago for a giant retail outfit like GameStop.

But, remember, that takes into account three years of data, including a period when its digital receipts were much growing at a much higher rate. If you look closely at the figure above, you can see that the last three data points are trending below the model curve.

How does the picture change if we take into account just the last two years of data, during which the digital figures grew less quickly? That's the image below:



Under these assumptions, the company will hit only $900 million in digital revenue by the end of its 2014 fiscal year, which puts it well below the $1 billion mark.

The reality of the next two years will likely be somewhere between these extremes. I do think it likely that GameStop will find ways to expand its digital revenues to the $1 billion level, but beyond that now seems unlikely to me.

And, if you take the time to read through the latest call with investors, you'll note that there was no mention of that $1.5 billion target. That's a distinct change from public statements for the past year, and as recently as August of this year, Robert Lloyd, GameStop's chief financial officer and executive vice president, confirmed that “[the digital revenue] target that's out there has not changed”.

What they did tell us to expect is for digital revenue in the current fiscal year to come in around $590 million to $635 million, a downward revision of their previous $675 million target. On the low end, that would be about 30 percent growth for the year, only modestly above the year-to-date growth rate.

But in an interesting twist, GameStop's digital fortunes are still currently tethered to the fortunes of the retail business. (“Just when I thought I was out,” said Don Corleone.) In at least two key ways, the company has tied its digital sales to software commerce at its retail locations.

First, when a GameStop employee sells a game, either used or new, the employee will attempt to bundle that sale with DLC, either in the form of standalone packages or season passes. For games with an online component, employees are trained to inform consumers of online passes, so that they can conduct that transaction with GameStop instead of at home alone. Ideally, the company wants every game sale to also be a DLC sale.

Second, when a consumer trades a game in, employees are informing consumers that that trade credit can now be used to purchase DLC or other digital content, including points and cash value for the online stores accessible through Microsoft, Sony, or Nintendo consoles and handhelds.

The point of these transactions is to keep GameStop within the loop of as many transactions as possible. In theory, the company hopes to establish themselves as the consumer's reliable, local source for video game purchases.

Regardless of the strategy, this side effect is clear: when either of GameStop's software segments lag, the company is in a position to lose part of its digital business too.

And precisely what happened during GameStop's last quarter. That's what led Tony Bartel, president of GameStop, to tell investors that “the decline in the gaming category has negatively impacted our console DLC and POSA cards, resulting in a lower [digital] growth rate than we anticipated.”

Commenters on my columns discussing retail sales often complain that retail isn't the full story and that leaving out digital video game sales makes the picture look more grim than it actually is. I think the lesson I take from GameStop's most recent results is that the two markets, retail and digital, can be intimately connected.

That is, I think some in the video game community feel that money not being spent at retail is likely being spent in the video game economy elsewhere. However GameStop's experience says something a bit more nuanced: fewer consumers are showing up at retail and as a result those consumers won't buy the related digital goods either.

This doesn't completely preclude the case where consumers are going all-digital. Speaking just from personal experience, I haven't bought a new retail console game since Uncharted 3 last winter. Recent games like Borderlands 2 were purchased purely in digital form. GameStop is just another place where I can buy codes for the online stores.

But there are millions of consumers who do a majority of their video game commerce at brick and mortar stores, including GameStop. At latest count, the company's loyalty card program had 21 million members in the U.S. alone.

As the retail activity of those consumers decreases, we should be aware at least that there could be a corresponding decline in digital sales too.


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