As the middle market falls out, game retail collapses

[In his latest Behind the Numbers column, Gamasutra analyst Matt Matthews illustrates a "sustained contraction across a period of several months" at U.S. and UK retail. What have been the driving factors?] In my last column, I tried to give a broad picture of how the overall U.S. video game retail market across all segments was contracting extremely quickly, and then focused on hardware specifically. Today I want to discuss the software scene, which has been undergoing some very interesting changes in the past couple of years. Before I get to the reasons behind the decline, let's get a sense of scope for the changes in retail software sales. So far in 2012, console and handheld software has generated $1.67 billion in revenue, according to official NPD Group data. That's down from $2.42 billion in 2011 for the same period, a decline of $750 million or 31%. The peak for this period of the year was $2.9 billion for the first four months of 2008, so the industry is down 42% from its best showing. The results for units are similar, down 30% from 63 million units of software in 2011 to 44 million this year. From the peak of 73 million units of software in January-April 2008, the market has fallen 39%. It's helpful to put this into a visual form so you can see just how much is being lost. Here are the monthly retail sales for console and handheld software in the U.S. for 2011 and 2012, showing just the change in a single year's time. So it's clearly not a single month's sales that are down, but rather a sustained contraction across a period of several months. I'd also make the point that this phenomenon isn't restricted to the United States. The data in the UK are just as dire, both in terms of revenue (in British pounds) and units. The picture for that market looks like this. (The figures above, unlike the U.S. figures, include PC software revenue. Adding the PC data to the U.S. figures would in fact make them look worse.) Which systems are contributing to the falling revenues in the U.S.? Most of the $750 million decline came from Nintendo's Wii, which I estimate is down $300 million in revenue, year-over-year. Nintendo's handhelds probably lost another $150 million in revenue compared to last year. Most of the rest is from the two HD consoles, the Xbox 360 and PS3, which collectively contributed about $260 million. Splitting it slightly differently, console software is down 29% while handheld software is down 39%. So there's plenty of weakness to go around, and we don't really need to pick on any particular system or segment. Let's look, then, at what might be driving the market down. One obvious culprit is the slim release slate for software this year. As Cowen and Company's Doug Creutz put it in a pithy headline to his notes on the latest retail results from the NPD Group: "It Turns Out That Collapsing Release Slates = Lower Industry Sales." He goes on to say that over the past few years publishers have "aggressively slash[ed]" their title output, and points to only nine title releases in April 2012, far below the 28 titles in April 2011. I asked NPD Group's Liam Callahan about the number of SKUs being released so far this year compared to last year, and he told me that the company had seen "a 25% decrease in the number of new SKUs released in year-to-date April 2012, compared to year-to-date April 2011". Creutz adds to this that a "lack of depth" to the release slate is particularly driving the decline. That is "smaller titles may not individually contribute significant sales" but "in aggregate they do have a meaningful impact." So the middle of the market has fallen out, and that's consistent with the flight of the casual gamer that is a common theme among market watchers. The Non-starter As Wedbush Securities analyst Michael Pachter said to me in a recent email, "casual gamers are never buying consoles again." If true, that would signal a sea change in the balance of power in the video game industry. No longer would companies like Microsoft and Sony and Nintendo hold the reins of power. I prodded him on this point, asking if console makers could turn consoles into platforms for the kind of bite-sized and socially-networked entertainment that currently drives the mobile, tablet, and web-based markets. After all, each console now has a user-friendly interface: Microsoft has Kinect, Sony has Move, and Nintendo has the Wii remote and the Wii U tablet. "It doesn't matter," he told me, since "the hardware purchase decision is a non-starter." Is there another way? Mike Olson and Andrew Connor of Piper Jaffray take the stance that the HD consoles need price cuts as soon as possible and that "it would be a wise strategy for Microsoft and Sony to invest in the service offering" accompanying those consoles. In particular, they point to the Amazon model, where consumers with different interests (video, reading, shopping) are all drawn to the single Amazon Prime service. So, for example, offering a broader variety of video-on-demand providers and add-on services could help make the HD consoles more attractive to the casual consumers, increasing the audience for everything that the console has to offer, including games. Let me be clear that even with price cuts and new services, none of this is going to revive the software situation at retail. Those graphs at the top of this article, the ones showing the dire year-over-year declines, are the same pictures we're going to be seeing for retail software, likely for years. While he and I have had our disagreements, I think I can agree with Pachter that the casual gamers are gone for good -- at least from the traditional business model. The industry giants are still largely focused on packaged game software for dedicated game hardware, and that simply does not make sense in the face of ubiquitous mobile devices and web-based free-to-play entertainment. In my next column, I want to take a closer look at that digital segment of the market. Despite the growth we're seeing there -- in the form of quarterly and fiscal year reports from publishers -- I think there are still some major concerns. The latest NPD Group comments on content sales outside of retail, which includes that digital segment, suggested to me that there might actually be contraction going on there too.