How GameStop Is Trying to Survive the Xbox One

A GameStop store in Pasadena, Calif. on March 27 Photograph by Mario Anzuoni/Corbis

GameStop, which runs a network of 6,600 retail stores selling new and used video games, is expecting to cash in later this year when gamers can begin upgrading to Microsoft’s Xbox One and the Sony Playstation 4. This is driving GameStop’s optimism, even though Thursday’s earnings report revealed a drop in revenue and same-store sales over the last quarter.

Investors had also been looking on the bright side, sending shares from less than $16 last July to almost $40 earlier this week. But that changed when Microsoft presented its new Xbox on Tuesday, largely because many believe the new consoles could also pose a threat to a major part of GameStop’s business—used video games.

Used video game products made up 27 percent of the company’s revenue in the last fiscal year but 44 percent of its gross profit, largely because the margins are more than double those on new video game products. With even console game systems moving toward online game sales, though, GameStop and other retailers may find themselves cut out of that valuable secondary market.

In a company blog post, Microsoft said it’s “designing Xbox One to enable customers to trade in and resell games.” This didn’t quell speculation that Microsoft is planning to charge additional fees to play used or rented games. (The company hasn’t responded to a request for clarification.)

Gamemaker Electronic Arts sparked customer outrage earlier this year with its new version of SimCity, which required users’ computers to connect to the company’s servers even in single-player mode. Public outcry also compelled EA to cancel its Online Pass program, which required people to purchase licenses to access certain features of games.

Still, companies that have long sold physical objects, from books to music to software, are moving toward the sale of less permanent digital-service licenses instead. Licensing the use of digital goods instead of buying physical ones means the end of resale markets for those items. And despite the natural hue and cry, a 2012 survey by market researcher NPD Group showed that 35 percent of video game buyers said they’d rather download a game than buy a physical copy, even if the download wasn’t discounted. Only 25 percent of respondents said that the year before.

GameStop has been taking steps to adapt its business model online, glomming a digital operation onto its brick-and-mortar business. It regularly sells download codes needed to open certain features of physical games it sells, and it runs a brisk business in PC downloads. It’s also working on publishing its own games for smartphones and tablets as it shutters some physical stores. Chief Executive Paul Raines describes it as a “hybrid” retailer, blurring the lines between physical and digital retail and driving an economy that is based on its own currency—trade credits.

According to the company, it issues $1 billion in such credits each year, in exchange for purchasing used products from customers. It has been expanding the kinds of products it trades to include a broad array of smartphones and tablets; if you call a GameStop to find out how late it is open these days, a clerk will immediately remind you that the store wants to buy any old iPhones or BlackBerrys you may have. The revenue from its trade in mobile products still makes up a modest part of its overall revenue but grew almost 300 percent over the past year. Seventy percent of trade credit is immediately spent on new games, the company says.

If Sony and Microsoft do make people pay fees to make used games work on their new consoles, GameStop is well-positioned to nab a cut of that revenue, says Raines. ”We’re a different company than we were on the last console launch,” he said on a call with investors. “There are no other retailers on the planet that are prepared for this kind of opportunity.”

And with a new generation of consoles coming out, many of GameStop’s customers are holding a good amount of potential trade credit in the form of PS3s and Xbox 360s. There’s one obvious place to spend the money they get in return.

Before it's here, it's on the Bloomberg Terminal.