Is video game retail dying? Three theories behind January's sales downer

When I started writing this column back in the middle of 2007, the U.S. retail video game industry was on a roll. The Nintendo Wii and PlayStation 3 were still in their first year on the market, Guitar Hero II had only recently made the jump from the PlayStation 2 to the Xbox 360, and there were over 20 months of industry growth ahead. I recall being skeptical that the growth could continue at that torrid pace, but there was simply so much good news to talk about that negativity got crowded out. Sure, the PS3 was struggling and some core software titles weren't performing as well on the Wii as one might have hoped, but it appeared that time and planning could fix these problems. Last month, January 2012, was the 28th month of decline since the U.S. retail video game industry peaked 35 months ago, in March 2009. That's the context I want to set for a conversation about last month's retail sales estimates, as released by the NPD Group last Thursday. Those figures showed a 34 percent year-over-year decline from January 2011's retail video game sales. I'll remind you that those figures were themselves a decline of 3.9 percent from January 2010. And the January 2010 data reflected a drop of 11.8 percent from 2009, the best January on record in the U.S. In all, over $590 million of industry revenue - or 44 percent - simply evaporated from January in the space of three years. There are other measures we can look at, but they all tell the same tale. Software unit sales in January are down from over 17 million in 2009 to right around 10 million units in 2012. Average software prices are down about $4 per unit sold. Hardware sales are also way down, although by exactly how much is still unclear. So what really happened last month? Let's consider three theories - just theories, mind you - and I'll stake out my own personal position at the end. Theory 1: January Was a Fluke This is the comforting theory, the one in which we assure ourselves that reality isn't quite as terrifying as our nightmares might have us believe. And there are some measures by which January truly was a fluke, irrespective of what consumers chose to do. The most obvious of these is the near absence of new retail titles released in January. According to his notes released to investors on Monday of last week, not one of the publishers that analyst Michael Pachter covers for Wedbush Securities released a new game last month. That includes Activision Blizzard, Electronic Arts, Majesco, Nintendo, Take-Two Interactive, THQ, and Ubisoft. Obviously, this excludes all Japanese publishers except Nintendo, and two major Japanese games were released on January 31 (Final Fantasy XIII-2 from Square-Enix and SoulCalibur V from Namco Bandai), but both of those fell outside the four-week January period for the NPD Group's estimates. Surely there were some releases from someone, right? Not really. According to Liam Callahan, an analyst for the NPD Group, the January 2012 retail release slate was so barren that only eight new video game SKUs were released, compared with 35 the year before. That includes PC releases, he added, which means that consoles and handhelds got 7 or fewer. (It might make an amusing scavenger hunt to seek out just what those 8 games were. A quick search of Amazon turned up National Geographic Challenge and Gran Turismo 5 XL Edition for the PS3, both released in January, but nothing for the Xbox 360 nor Wii.) So with January devoid of any new releases, and the holiday sales frenzy obviously already waning in December (remember, it also had disappointing sales), it isn't any big surprise that sales were so horrid. This is, after all just one month of really bad sales, right? That brings me to a second theory. Theory 2: This Is The New Normal January wasn't just one bad month. It was a truly awful month in a string of generally bad ones. At some point we're going to have to look around and realize that those heady days of 2008 and 2009 simply aren't coming back. And this isn't a new idea. Over 18 months ago Michael Pachter made waves with his observation that investors might "remain spooked by the May [2010] results, as [those results] are beginning to reinforce the notion that the video game industry is in a state of persistent secular decline". Since then, the evidence of a decline has only grown. I think the table below makes this point by looking back over the last five years of sales and picking out the strongest and weakest software sales for each month of the year. Take a look. Look at the five-year lows and then the years associated with them. Six of the lowest totals since the launch of the Nintendo Wii and PlayStation 3 came in the last 12 months. One of those, August 2011, has the lowest recorded software sales in all of the data I've seen for the U.S. market and that runs back into 2004, to the birth of the original Nintendo DS and a year before the launch of the Xbox 360. So what's behind the falling sales? For one, the new hardware market simply isn't as robust as it was during 2007, 2008, and 2009. Even with a huge installed base of older hardware (20 million PSPs, 20 million PS3s, 33 million Xbox 360s, 39 million Wiis, and 51 million Nintendo DS systems) consumers have restrained the purchase of software for the platforms they do have. A few years ago, the Wii was selling faster than Nintendo could supply the market. Software like Mario Kart Wii, New Super Mario Bros. Wii, Wii Play, and Wii Fit figured high in the sales charts month after month. I said at the time, and I still believe, that Wii software sales were very closely tied with new Wii hardware sales. That is, Wii consumers bought most of their software within a very small window close to when they bought a console. Now that platform is dying, very quickly I might add, and those software sales are disappearing. Here, let's put that in picture form. In 2007 the total for Wii software was about $1.5 billion and it jumped to over $3 billion in the following 12 months, serving a base of 17.5 million systems. For comparison, on a base more than twice that size (nearing 40 million), Wii software sales were in the $1.7 - $1.9 billion range during the last year. The problem isn't just the Wii, of course. Music games, in their plastic instrument incarnation, were a big part of the growth of the industry during the 2007 - 2009 period. We still have music games, but today they are mostly called Just Dance and sold by Ubisoft without the plastic accoutrements. Whereas Guitar Hero might have averaged $80 or $90 per game sold because of instrument bundling, the music games of today rely mostly on Wii controllers, Kinect (bundled with many systems), or Move (much weaker sales overall, I believe). Accordingly, they bring in less revenue. (I wish I could speak to the units side of music games, but regrettably this is one area where I have no data to comment.) Those new control systems, Microsoft's Kinect and Sony's Move, also helped pump up the accessories segment for a short period. In 2010, as those accessories launched, that segment hit nearly $3 billion for the year, up from $2.6 billion a year during the peak of the plastic guitar and balance board crazes. Last year, sales fell back down to $2.6 billion a year and will likely drop below $2.4 billion for this year. So maybe the market is slowly settling into a new "normal" level of sales, from which growth can begin again in a year or so. That is, this is a generational lull right before the Wii U comes along and the next Xbox platform is announced, and then the next PlayStation console. This has all happened before. Just look at the total market revenues for the last 15 years. See those lulls in 1999 - 2000 and then again in 2003 - 2004? In both cases, a generational shift occurred and the industry went on to bigger and better things. Or, there is another theory about the current decline. One in which this is really the end of the world as we know it. Theory 3: We're All Gonna Die! Maybe, this theory goes, consumers are fleeing the traditional retail video game market entirely, and the whole video game industrial-complex will come crashing down as brick-and-mortar revenue sources shrivel up and disappear. Consider all the extra-retail, non-traditional gaming markets, the parts of our gaming lives that takes part on smartphones, on tablets, and online. According to a study by the Pew Research Center's Internet & American Life Project, tablet ownership among American adults nearly doubled, going from 10 to 19 percent, between mid-December of 2011 and early January 2012. That's not retail tracking data, of course, but it does indicate a dramatic shift in adult choices for technology and entertainment. Those adults - and any children they might have - now have access to virtual storefronts which offer free, free-to-play, or very inexpensive games. When they let their consoles gather dust for a month or more, they're that much less likely to come back and start buying new $60 games again. Or $40 games. Heck, $20 games might be a stretch. On top of that, these consumers will now weigh their gaming hardware options more carefully. I suspect they will be less likely to buy a new dedicated console, at least at current prices. According to NPD Group data provided to me, the Xbox 360 is still averaging $299 per system at retail and the PlayStation 3 about $272. The Wii, which isn't selling well, is averaging $147, while the Nintendo DS and 3DS together are averaging about $166. We're in the beginning of the seventh year for the Xbox 360 and its average price is still at $300. Granted, it is still the top console in sales right now, but it just saw its January sales plunge by 29 percent compared to last year. At this point in its long life, the PlayStation 2 was averaging $150 per system, or half the price of the Xbox 360, even with inflation since 2007 taken into account. While Microsoft and Sony have been playing chicken with their pricing, quietly cutting their costs and milking each $50 or $100 drop for all it is worth, the mass market may just pass them by and move on to a new generation of gaming devices. I wouldn't consider it a sure bet anymore than a price cut to either console would generate a prolonged and strong uptick in sales. On top of that, would new consoles solve the problem? Without a dramatic shift in the standard technology curve for new consoles, I don't see new systems as really addressing the problem of new consumer expectations. The PlayStation Vita, for example, is a $250 handheld launching into a market where a $170 Nintendo handheld with glasses-free 3D effects and two major Mario games can't break 200,000 systems in a month. The Wii U will end up being underpowered by today's standards, but the touchscreen controller will likely still keep its price high. And then there is the digital revenue issue on the current crop of consoles. For years, money has been escaping from retail and directly into publisher and platform-holder pockets. Not only are Microsoft, Sony, and Nintendo hosting virtual storefronts of their own, where they and third parties sell software directly to consumers, but Activision Blizzard is now offering annual Call of Duty Elite memberships that take an extra $50 per subscriber out of the market. According to their latest briefings, they've collected a cool $75 million on these subscriptions since November. With the periodic introduction of DLC, you can expect that they will extract more money from consumers either directly for the packs or from incrementally added subscriptions. And those, in turn, will take more money and time that could have been spent on new retail purchases. Everything listed above is driving, and will drive, scary retail revenue headlines for the foreseeable future. And, unfortunately, the industry has collectively decided that all those other measures of success - digitally distributed game sales, incremental DLC revenue, and subscription sales - should generally be hidden from view. Why are companies so reticent to share anything concrete that would show the strength of sales on digital platforms? Why are we awash in top 10 lists for Xbox Live and PlayStation Network, but left to guess about the actual figures behind the charts? The answer, I believe, is that the digital revenues coming in are not even close to replacing what is traditionally earned at retail. Margins are high, I believe, on games sold through these stores but the unit sales are so low that they simply can't live up to the expectations traditionally set by retail sales. So, until this disruptive market comes into its own, the publishers and platform holders are protecting it. When it can finally stand on its own, they will happily trumpet its success. The risk is that until that time, dreadful retail sales will dominate the news and increase the chance that investors and consumers will see the traditional industry as one that is dying. Where We Go From Here So where did I end up in my thinking? I'm squarely between theories 2 and 3. I don't think January was purely a fluke. Yes, only eight new retail SKUs is ridiculous, but there have been too many low months in the past year to ignore the trend. In February sales will still be down, although perhaps not to historically low levels. Big releases like Final Fantasy XIII-2 and SoulCalibur V will give software sales a bump, and the PlayStation Vita launch should nudge up hardware sales. But the malaise will linger and still be with us in the long stretch through the middle of the year, when sales are already traditionally low. While I personally would like to own a PlayStation Vita, I can't justify its cost to consumers who aren't even buying the less-expensive systems already on the market with robust libraries of games. The Wii U is still 7 - 9 months away, and consumers may choose to hold off on purchases as Nintendo begins to publicize the system in earnest after E3 in June. That is, we're in a lull at the end of a console cycle, and we should expect the market to stay its current size or somewhat smaller, but it doesn't seem clear at this point that a new generation of systems can push higher than what the market has already seen. Perhaps I'm wrong. Maybe the PS Vita will come out of the gate running and never look back. A retooled 3DS could see a summer renaissance much like the Nintendo DS Lite did in 2006. Perhaps the Wii U will be sold out for three years straight and all of this will seem like a bad dream. Perhaps. I'm not betting on it.