Digital Sales Can Make Up For Physical Declines, But Questions Remain

[Digital video game sales in the U.S. can offset declines in physical sales, leading to a "strong upward trend" for 2011, but foggy data hinders the trackability of progress, says Gamasutra analyst Matt Matthews in his regular Behind the Numbers column.] The recent turnaround in software sales at U.S. retail was so significant because for most of the year, those sales figures have shown nothing but year-on-year declines. Now, the physical product industry is on the cusp of holding level from 2010 to 2011, after years of falling sales, according to data released by the retail-tracking firm NPD Group. However, when we consider all spending on games, including digitally-distributed social and mobile games along with sales of used physical games, it seems likely now that total video game spending in the U.S. will see a strong upward trend for 2011. At least, that's what I see coming out of the public numbers that the NPD Group released recently as part of its Total Consumer Spend Estimate (TCSE), a measurement of the video game market that "extends beyond the dominant physical retail sales." On the other hand, it has also become clear that something is unusual about the data publicly released so far about the TCSE, specifically about the fourth quarter of 2010. I'll explain a bit more about what that means below. First, let's look at what we know about the first three quarters of 2011 and how they compared to the first three quarters of 2010. The figures released by the NPD Group so far in 2011 suggest that through the first three quarters of the year, total consumer spending on video game content has decreased by about 3 percent, or $300 million, from the same point in 2010. Of the segments that are described in the public data, only the nebulous Other segment -- which includes all content spending that isn't new retail software -- grew. Collectively, the spending in that segment grew by over 6 percent. Retail console software was down nearly 9 percent, while handheld software was down over 10 percent. Poor old retail PC software was down nearly 39 percent, but the first three quarters of 2011 didn't have a big PC game like Starcraft 2 to goose spending on PC games at retail. Here's what those figures look like as a graph: Some of that growth in the Other segment is undoubtedly growth in non-retail gaming outlets. The amazing growth of smartphone/tablet platforms like Apple's iOS and Google's Android is clearly fueling interest in mobile gaming. The free-to-play (F2P) model has proven quite lucrative for several games. See, for example, how registrations for Sony's DC Universe Online increased dramatically upon its switch to F2P. However, I believe a big chunk of that Other segment is really older retail content churning through the used game channel, mostly at GameStop. While GameStop will certainly argue that that benefits publishers and developers (see, for example, my column from a few weeks ago), it should still be clear that most of that money goes to benefit GameStop's used games-centric business model, not the larger content-production industry. How big of a chunk is the used game market? Just based on what I know about GameStop's business, I'd estimate that used game sales through GameStop in the U.S. accounted for something like $1.1-$1.2 billion of consumer spending on video games during the first three quarters of this year, up about 8 percent over the comparable period last year. So at least 20 percent of the consumer spending outside of new retail content is probably what consumers are spending on used games at GameStop. That doesn't even take into account used games through other outlets, like Best Buy, Amazon, or eBay. And since used game sales appear to be growing at a rate faster than the rest of the Other segment, that means that all those other content areas are actually growing slower than the aggregate 6 percent. We still don't know how each is doing -- for example mobile games could be growing quite quickly while social games are flat or declining -- but accounting for used game sales does sharpen the picture a little. One more thing about the TCSE figures before we look at what to expect for the rest of the year: When we look at retail software in the third quarter, the data shows a terrifying 13 percent drop in software sales dollars. According to the NPD Group's TCSE release, the non-retail segment of the market was flat in the third quarter, compared to last year's figures. That's disappointing, given the 7-10 percent growth shown in previous quarters, but at least it didn't actually contract. How will we end up once all the data is collected on the full year of 2011? With October and November showing real signs of life at retail, I am optimistic that the NPD Group's TCSE could show the content spending at $16.2 billion, an improvement over the figures previously announced for both 2010 and 2009. However, I am particularly dubious about the NPD Group's figures for the fourth quarter of 2010, and I think it will release a revised value for content spending that year that makes the figure for this year come in around flat. To see this, you have to take all the values that the NPD Group has released about its TCSE and parse out what it works out to in each quarter. If you do that, you'll find that its estimates showed that total consumer spending outside of retail during the fourth quarter of 2010 came in around $900 million -- down from $1.6 billion in the third quarter. For comparison, retail spending roughly triples from the third quarter to the fourth. The figure below makes this clear. Either that non-retail number is off or there is an as-yet unexplained trend in the relationship between retail spending and non-retail spending for video game content. Should we believe that while retail spending triples from the third to the fourth quarter of each year, there is a corresponding 50 percent drop in non-retail spending for video games? There is a crude kind of logic to that idea, but I think it's more likely that the NPD Group is still refining its model and estimates and the 4Q 2010 figure that we can back out of the public data has a larger margin of error. That said, I don't envy the NPD Group its job of estimating consumer sales, especially on non-retail game sales. They're doing a job that no one else has done successfully, and one for which hard comparative data is scarce, brutally expensive, or simply unobtainable. Recently, Michael Pachter of Wedbush Securities wrote in a note that he expects another entity to begin reporting "more relevant and meaningful data" about the digital marketplace in the coming year or two. I pinged the notably gregarious analyst about that comment, and his response was evasive. Take that however you wish. Regardless, I would welcome more research and reporting, especially if the relevant big-picture bits are made public to the video game industry and media. Not only would this present some competition in the marketplace for information, the marketplace in which the NPD Group earns its livelihood, but it would put more pressure on content providers and content outlets to take part in regular data reporting.