Could digital sales also be contracting?

In my last two columns this week, I've detailed some of the specifics behind the declining retail video game market in the United States, focusing on the lagging hardware segment and the collapse in casual gamer engagement on traditional game systems. Now I want to get to the picture for the market outside of retail, specifically the digital content market. The NPD Group has been refining its methods for capturing data about the sales for video game content being sold outside the new, packaged retail market. For over two years they have been periodically publishing their estimates for this consumer spending, and I believe are now including it in their U.S. Games Market Dynamics report. The next report, about the first calendar quarter of 2012, is due out next month. In terms of public data, the NPD Group only reports two types of numbers. The first is the total for new, packaged video game content – the physical discs and cartridges and cards on which games are sold. The second type is, quite simply, everything else. That includes “used games, full game and add-on content downloads, social network games, mobile games, rentals and subscriptions.” For the sake of brevity, I'll refer to this second category as ex-retail. If you read that description of ex-retail carefully, you'll notice that the data includes money spent on non-physical game content and two specific types of physical content, rentals and used game sales. That makes this a little more tricky, since we don't have just the digital part. Now, let me outline the numbers we have. According to my records, the information released by the NPD Group shows that the ex-retail sales in the first quarter of 2010 were approximately $1.68 billion. In the first quarter of 2011, that figure rose to approximately $1.85 billion, an increase of 10%. The final figures for the first quarter of this year aren't out yet, but the preliminary estimates that have been released for individual months are $350-$400 million in January and $550-$600 million in February. (For the sake of completeness, the figure for April was about $350 million again.) The only figure missing is for March, but the data we have already is troubling. According to these figures, total ex-retail spending was $0.9 - $1.0 billion for the first two months of 2012. Therefore March would have to come in around $850 million to $950 million in order for this segment of the market to remain flat year-over-year. On a weekly spending basis, consumers would have had to increase their spending by over 35% just in the month of March, just to keep 2012 even with 2011. If the spending rate in February were to continue through March (i.e. if we scale the 4-week total for February up to a 5-week total for March) then under the most generous assumptions ex-retail sales for the first quarter of 2012 would come in around $1.75 billion, a 5% decline from the 2011 figure. I've visualized that possibility below. That's the best reasonable case, I believe. If sales in March were more like January or April – both of which had averages of about $90 million per week – then the industry could end up with a mere $1.45 billion in ex-retail spending in the first quarter of that year. That's not just a 20% decline from last year, but even comes in below 2010's figure. Since there are two physical product parts to the ex-retail data, could they be driving the decline? It's possible, but I think it's unlikely. Rental sales are, I believe, a relatively small part of the ex-retail figures. If someone knows of solid data to the contrary, I'd love to hear it. As for used game sales, GameStop just reported that used product sales were down only 1% in the February – April period this year compared to the same period last year. I believe GameStop controls 80-90% of the used game market in the U.S., so I don't think that is the source of the apparent decline in ex-retail sales. Another possibility is that the old figures I have are out of date, and the NPD Group has revised but not restated those results publicly. Even the new retail sales data that the NPD Group reports contains minor revisions from time to time, so it would not surprise me to see revisions in their ex-retail data. And, it is clearly the case that capturing ex-retail consumer spending habits is more difficult. Regardless, I want to at least raise the possibility that there is some contraction in the digital market. Certainly, we're seeing generally increasing digital revenue in the quarterly reports from the big software publishers, but the trend need not always be up and it certainly won't continue forever. For example, consider Electronic Arts and Activision Blizzard, the two biggest third-party publishers in the industry. In the first calendar quarter of 2012, Electronic Arts reported non-GAAP digital revenue of $425 million, up 58% from the same period a year earlier. However, in the first quarter of 2012, Activision Blizzard had non-GAAP digital revenue of only $298 million, down 34% from the first quarter of 2011. I've put these results into a figure below to make the comparison more direct. One can easily understand why Activision Blizzard is taking in less revenue right now than it was a year ago, because much of that revenue was actually recorded in late 2011 when consumers were buying Call of Duty Elite subscriptions. That is, instead of spending money on map packs in 2012, many consumers opted to pay for Call of Duty Elite subscriptions when they bought the game at the end of 2011. So that means that the digital revenue at the end of 2011 was higher, right? No. In fact Activision recorded less digital revenue during the quarter in which it launched Call of Duty: Modern Warfare 3 and the Call of Duty Elite service than it did during the quarter a year earlier when it launched Call of Duty: Black Ops. This isn't to say that digital won't continue to be an area of growth in the coming years; in fact, it surely will be the fastest growing segment of the market. And I have no doubt that Activision Blizzard's digital plans will lead to generally higher digital revenue for the company. But it would be a mistake to assume that everyone's digital revenue is always going up, and it could very well be that the entire market for all video game content contracted in the first quarter of 2012. We'll know more in June when the NPD Group reports its official first quarter figures for the full market, and I'll be sure to revisit this issue at that time. (It is my understanding that the non-GAAP digital revenues reported by the publishers are the actual money they take in during that period for those goods and services. The publishers also report GAAP revenue, which takes into account revenue deferral over periods of time during which the company assumes that the consumer is realizing the value of the product sold. So, for example, a DLC pack sold to a consumer could take in $15 at the time of sale but the company may defer some of that revenue and realize it over a longer period, say 3-6 months after purchase. The non-GAAP revenues are therefore the data most comparable to what I believe the NPD Group is measuring.)