In Depth: The State Of GameStop -- Game Sales

[GameStop doesn't reveal the dollar values and unit volumes for its used software business -- but in the second part of this exclusive analysis, Matt Matthews estimates the size of its new and used software sales. In the first part, Matthews revealed that the retailer's profit margin on new games is close to 50 percent.] Developers and publishers eye the used videogame segment of GameStop's business with suspicion. They believe they lose revenue when a consumer opts for a used game over a new copy -- but the first-sale doctrine effectively blocks them from claiming any part of the resale revenue. GameStop has steadfastly maintained that used game trade-in credits more often go toward new software and actually bolster new game sales. The retailer doesn't disclose either units or dollars of used software sales. Instead, it lumps that revenue together under a more general used product heading, along with used hardware and used accessories. Below we estimate GameStop's used game sales, in units and dollars, and compare with the figures for new software. We also look at some new signs that the company recognizes the challenges publishers are posing for GameStop's used game business. Times Change, Prices Change In each annual report, GameStop reports the average prices for new and used software sold in its stores. For example, in the past year the average price for all new software sold in GameStop's stores was $41. That figure is presumably for all GameStop stores across the globe during the 12-month period ending on 31 January 2009. However, it is worth noting that the average in the United States during calendar 2008 was $40.82, according to the NPD Group (via Michael Pachter, analyst for Wedbush Morgan Securities). The two figures are not always so close. The average in the U.S. during calendar 2007 was $37.29, whereas the average for GameStop's fiscal year ending 2 February 2008 was a much higher $42. During the past eight fiscal years the average price of new software sold by GameStop has ranged from $34 up to $42. By comparison used software commands a much lower price on average, between $13 and $18 in the past eight years. The chart above reveals an interesting trough in prices during 2005 and 2006. There are several events that may help explain the fall and rise of prices around that period. Going through 2005, original Microsoft Xbox and the Nintendo GameCube were in decline. The Xbox 360 had just begun life in November 2005, and the Sony PlayStation 3 and Nintendo Wii were launched only at the end of 2006. At the same time, GameStop's final stock of software for the original PlayStation was reduced in price and liquidated. The clearance of this lower-priced stock may have depressed average sale prices. Prices may have risen in 2006 with the advent of the $60 price for Xbox 360 and PlayStation 3 software. Perhaps as important, Guitar Hero (and later, Rock Band) saw tremendous sales of expensive software/instrument bundles during the next two years, increasing the average price of software overall. Since 2008, Wii Fit has also sold well enough at a high price that it may have affected the ASP as well. Software Dollars and Units GameStop very clearly labels new software dollar sales in its filings, but lumps used software together with used hardware and accessories under the heading “used video game products”. For that reason, we there isn't actually a direct indication of how much GameStop makes on used software. To estimate used software sales, we will assume that 80% of the revenue in the used product category comes from used software sales. Looking at just new product sales, software generally takes up 66% of the revenue. Given that GameStop's business appears strongly driven by used software with less emphasis on used hardware, we feel that the 80% estimate is reasonable. Under the above assumption, the new and used software revenue figures are shown below. New and Used Software Dollar Sales This comparison of new software revenue and used software revenue makes clear just how much of GameStop's business comes from new software sales. Because GameStop's tremendous revenue growth depends so heavily on the growth of its new software sales, it needs to keep the publishers on its side even as the publishers grouse about GameStop's used software sales. Dividing total new software revenue by the average price of new software yields the total new software units. The same can be done with our used software revenue estimate to get total used software units, but dividing by the average price of used software. The results of these computations are shown below, estimates of new and used software unit sales at GameStop for the past seven fiscal years. Compared to the graph for revenue, the roles of new and used are now reversed. Except for the fiscal year ending 1 February 2003, the number of used software units has always been higher than the number of new software units. Since that time, used software unit sales pulled far ahead in the years ending in 2005, 2006, and 2007. In the years ending in 2008 and 2009, new software unit sales have been at parity with used software unit sales. We can suggest one explanation for this trend in new and used software sales. The fiscal years ending in 2003 and 2004 were the first two full years during which the Xbox, PlayStation 2, and GameCube were all available. In those year new and used software unit sales were very close. Likewise, the fiscal years ending in 2008 and 2009 were the first two full years during which the Xbox 360, PlayStation 3, and Wii were all available. Again, new and used software sales were very close in those years. However used software unit sales were far ahead of new software unit sales for the intervening years. During the early years of a hardware generation there are fewer new software releases and, consequently, fewer used software titles available. During the middle of a generation – say for the fiscal years ending in 2005, 2006, and 2007 – the used software market is flush with stock and prices on used software likewise drop, increasing used software unit sales dramatically. (In fact used software prices did drop further than new during that same period.) Ours is but one possible explanation for the data in the graph above. Surely there are others, and this is one point on which a discussion by many parties might be quite helpful. GameStop's Concerns Publishers have not merely voiced their concerns about GameStop's used game business – they've already taken actions to limit used game sales. In its 10-K filings with the SEC, GameStop has identified risks to its business and some new and subtle changes in language reflect what publishers have done and how GameStop might be affected. We highlight the following section from GameStop's latest 10-K: The ability to download video games and PC entertainment software and play video games on the Internet could lower our sales. While it is currently only possible to download a limited amount of video game content to the next generation video game systems, at some point in the future, this technology may become more prevalent. If advances in technology continue to expand our customers’ ability to access video games, PC entertainment software and incremental content for their games through these and other sources, our customers may no longer choose to purchase video games or PC entertainment software in our stores. As a result, sales and earnings could decline. Restrictions on our ability to take trade-ins of and sell used video game products could negatively affect our financial condition and results of operations. Our financial results depend on our ability to take trade-ins of, and sell, used video game products within our stores. Actions by manufacturers or publishers of video game products or governmental authorities to limit our ability to take trade-ins or sell used video game products could have a negative impact on our sales and earnings. Three key areas of concern can be seen in the text above: Online game distribution – GameStop recognizes that the downloadable games market could cut into its retail sales, in particular into used game sales. In previous filings, these comments on downloadable games referred specifically to PC software and games for older game systems (e.g. Wii virtual console, original PlayStation games on the PlayStation Network). However, this new language refers more broadly to "video games" without those qualifiers. With more software each week on Xbox Live Arcade, WiiWare, and the PlayStation Network, GameStop clearly sees a threat to its business. Downloadable Content – To our knowledge, GameStop has not previously referred to "incremental content" – more commonly known as downloadable content or DLC – as a threat to its business. However, it is prudent to acknowledge the threat that DLC represents to a retailer like GameStop. The current theory is that downloadable content (e.g. Rock Band songs, map packs for games like Halo 3) will entice consumers to hold on to their games instead of trading them in. In a sense, DLC would convince consumers to limit the supply of used software that GameStop wants to keep its stores well-stocked. Government Regulation – This is also a change from the language in previous 10-K filings. While we are not aware of any legislation in the United States that could credibly limit GameStop's ability to sell used games, we presume that GameStop's global business might be subject to new laws introduced in other territories. Tomorrow, in our final discussion of GameStop's financial data, we'll look at regional data and make an estimate of GameStop's share of the U.S. videogame market.