This article originally appeared on The Escapist in December 2005. Fifteen years out, its predictions have held true: Game distribution has gone digital, and stores like Gamestop are reduced to the equivalent of used record stores.
The used game
business works like this: A gamer shows up at Gamestop with a few games he’s
tired of and wants to trade in. Gamestop offers him a lowball price – well
lower than what he’d get if he sold his games on eBay, just high enough to keep
him in the store – and since he’s already there and wants the cash, he accepts
it. More than likely, since he’s a gamer in a game store with cash in hand, he
spends the cash on something else, maybe something secondhand that he can pick
up for $20. Meanwhile, Gamestop marks up and sells the used games it just
bought for three times what it paid for them.
Gamestop
executives describe this as a “margin growth” business – because they make a
much higher profit margin on the sale of every used game than they do on the
comparable sale of a new game. And in the highly competitive retail trade,
margins matter. How much?
“Used games
are keeping the entire ship afloat,” a vice-president of marketing for
Electronics Boutique tells me. “EB and Gamestop make basically no money from
new product.”
No money from
new product? But everybody knows the retailers are the real profiteers of the
interactive entertainment industry, brutally extracting marketing development
funds and ruthlessly returning product in the name of the all-mighty dollar.
Right?
The Savagery of Sellthrough
Throughout
most of the entertainment and media industry, when publishers want to make sure
first-run entertainment sells in droves to the public, they charge what’s called
“sellthrough prices” – and for virtually every form of media, including books,
movies, and music, that price is between $15 and $25. You can get the brand-new
Feast for Crows hardcover for $16.80,
the Star Wars: Revenge of the Sith
DVD for $17.98, and Madonna’s Confessions
on a Dance Floor for $18.98.
But you have
to pay $49.99 for Perfect Dark Zero, or
any other new release video game. In comparison to its closest substitutes from
other industries, video gaming isn’t priced to sell through.
And yet
selling through is the one thing a video game must do. Video games suffer from the shortest shelf life of any
media. You can walk into a record store and buy CDs from the 60s, 70s, 80s, and
today. You can visit Barnes & Noble and pick up books written in the middle
ages. You can buy movies made in the black and white era. But you would be hard
pressed to find a Gamestop selling more than a handful of games older than a
couple years, and the vast majority of shelf space will be for titles releases
in the last six months.
Facing this
short shelf life, game publishers have strategically adopted a tiered pricing
model. The start the games off at the highest price point they can – right now
that’s $49.99 – and they extract as much money as possible from the avid,
got-to-have-it-now consumer. They then drop the price to hit the next tier of
consumers and keep moving units.
The tiered
pricing model works well for the publishers, and if they can convince enough
consumers to buy at the $49.99, it works really
well. Think Halo 2. It’s great for big box retailers like Wal-Mart, too.
Wal-Mart only takes a title that is a proven seller, and any title that doesn’t
sell gets dropped instantly. Wal-Mart doesn’t care if it has the biggest
inventory of games, or covers every genre of game. It just sells the big hits.
For specialty retailers
like Gamestop, the tiered pricing model sucks. Gamestop can’t compete on price
with the likes of Wal-Mart so to differentiate itself Gamestop has to take
risks on unproven new product, and keep a wider inventory of older product. But
unlike music and book sellers like B&N, Gamestop has no evergreen products
that it can reliably keep on the shelves. So its inventory management is a
constant struggle, with price points continuously adjusted, and product constantly
moved around the store depending on its age. Gamestop ultimately suffers
because its shelf space is devoted to games that are, by definition, less
popular and lower priced than what Wal-Mart stocks.
So, imagine
you’re running Gamestop. Imagine you owe $36 wholesale for $50 games, leaving
around $14 profit. And imagine you owe $12 wholesale for $20 games, leaving
around $6 profit per sale. Obviously you’d like to sell more $50 games than $20
games, and so you’re going to organize your storefront to push the hot new
product as much as possible. But to differentiate your business, you have to keep that broad catalogue of
older, cheaper games around – otherwise you’re not offering anything different
than Wal-Mart or Best Buy.
Now imagine
that with used games, you only pay $3 for your $20 games. Suddenly you make more money from a $20 game then you do
from that $50 copy of Perfect Dark Zero. This
is the solution to all your problems. You can offer a wider inventory, stock
older games, and even still profit! Set the prices right and you can even
manage to do trade-in and resale of brand new games for really big profits.
Got that?
Good. Now you understand why Gamestop is transforming itself, right before your
eyes, from a specialty boutique into a secondhand store.
Biting the Hand
It’s a transformation fraught with peril. In adopting used
games as the solution to the inexorable logic of the new game retail business,
Gamestop is alienating its customers, infuriating its suppliers, and arming its
competitors.
Let’s start with customer. As a specialty retailer, Gamestop
has long catered to the enthusiast. The enthusiasts’ desires are simple. He
wants to be able to buy new games for a reasonable price. If the games are
good, he wants to keep them. If the games are worth playing but not worth
keeping, he wants to be able to trade them in. And if the games are bad, he
wants to be able to return them and get new ones.
Unfortunately, today’s retail marketplace offers no way to
return bad games and limited value on trade-ins. Barnes & Noble will give
you store credit for opened music and DVDs if you have a receipt, but Gamestop
will just offer to buy an opened game from you for a few bucks – even though
they’re going to turn around and sell it for $30…
When used game sales were a minor aspect of the Gamestop
business, it was easy for regular customers to overlook the trade-in to sale
price ratios; no big deal. But as every consumer purchase is presented as a
potential money-saving used game purchase, those consumers have a constant
reminder of exactly how much a used game is going for – and, by comparison, how
little the consumer gets on trade-in.
Hardcore gamers are nothing if not web-savvy, and eBay is
out there as a viable alternative to trading in. Exposés on the economics of
trade-ins have already begun to erect the virtual equivalent of “Keep Out”
signs on Gamestop. As consumers become more informed, Gamestop will either have
to increase its trade-in values, or watch its inventory supplies of desirable
used games plummet.
An even more pressing problem comes from Gamestop’s
suppliers, the video game publishers. The relationship between game publisher
and game retailer ranges from Détente to Cold War, with continuous low
intensity conflict over “price protection,” “marketing development funds,” and
“return rate.” Used game sales threaten to make the Cold War heat up – because
publishers see no revenues at all from the sale of used games.
Is it really worth fighting over? It’s interesting to note
that both Activision and Electronic Arts are reporting
that fourth-quarter revenues will fall well below expectations due to
unexpectedly low sales. Meanwhile, Gamestop has announced
“strong margin contributions supporting forecasted
earnings” because “used video game sales growth continues to solidly
meet our goals.”
And so the war drums have started beating. In an interview
with Computer and Video Games, Mark Rein of Epic Games was blunt:
“If you walk into EB in the US,
they try and sell you a second hand version of a game before a new one. I think that's bad. It would be fine if they
share that revenue with us. They can also be marketing partners with us as
well. We can have an official refurbished games policy. That's the problem.
Those resold games use server resources, tech support. The majority of guys
calling up saying "I don't have my serial number", I'm sure a lot of
those are resold. It costs us money. Those customers think they paid for it,
and they're entitled to support. The reality is we didn't get paid. They didn't
pay us.”
Of course, Gamestop doesn’t have to.
“It is 100% legal to re-sell video games. The publishers
have no leg to stand on,” explains Jason Schultz, staff attorney at the
Electronic Frontier Foundation. Because of the First Sale doctrine, publishers
have no legal right to get paid for used games, anymore than book publishers
get paid from secondhand bookstores, or music companies from used record sales.
This won’t stop them from finding another way to strike back at Gamestop,
however.
Even as the publishers make war-plans, Best Buy and
Blockbuster have joined the fray. Most Blockbuster stores now not only rent
video games, they buy and sell used games, too, usually offering significantly
better trade-in values and charging less. Blockbuster is largely ignored in
discussion of game retail, but it needs to find a new business as TV on demand
catches on, and looks willing to fight hard for games revenues.
Best Buy is still testing a pilot program for used games,
but industry insiders seem to expect it to go forward. As a big box retailer,
Best Buy isn’t suffering from the tiered pricing model the way Gamestop is, and
it can accept lower margins on used games. And if Best Buy succeeds with used
games, Target, Wal-Mart, and the rest might follow.
What does it all mean?
The New Model
Gamestop’s margins in the used game business are almost
certain to erode, as consumers seek alternatives, whether peer-to-peer like
eBay, or from competitors such as Blockbuster and Best Buy.
At the same time, the uneasy alliance of retailer and
publisher that has long dominated the interactive entertainment industry will
crumble. This, in turn, will open the way for publishers to aggressively
embrace digital distribution. Up until now, the publisher’s fear of channel
conflict with retail has obstructed their adoption digital distribution. By
“striking the first blow,” retailers open themselves up to a digital
distribution counterstrike.
These two forces – used game sales and digital distribution
– will have strange and conflicting impacts on consumers. A flourishing used
game market will drive prices lower. The higher the price of new games, the
more likely the consumer is to buy it used for less. But the more the used game market flourishes,
the more publishers will race to adapt digital distribution. With digital
distribution, publishers can prevent re-sale and used game trade, both legally
and technologically.
“You are already seeing with XBOx Live and Valve and these
ties online, they are trying to use the online hook as a way to enforce their
business model. You’re going to see more of a trend towards that,” says the
EFF’s Schultz. ““It’s part of an overall battle that’s going on in all the
content industries.”
Here’s what’s likely to emerge as the new business model:
Publishers will release new titles exclusively in digital format at a premium
price. Big box retailers will carry the
most popular titles in physical form at a sellthrough price point. There’ll be
little margin left in used game sales, but it’ll survive with pricing similar
to your local Blockbuster’s secondhand DVDs.
And as for Gamestop? If you want to know what’s in store,
head over to your local college and find the students’ favorite used record
store. There’s not a 100% profit margin in sight.