The last time I wrote about GameStop, we had just heard the first details about Microsoft's plans for the Xbox One and it looked like the used game business would be under assault. Since then Microsoft has reversed course, to an extent, and GameStop's business model will survive largely intact for at least the beginning of this generation.
As Michael Hogan, an executive vice president with the company said in last week's investor conference call, “there was some concern that console manufacturers might attempt to limit consumers' ability to share, trade or resell games” and that their customers were telling them that such a system “would seriously limit purchase interest in the new consoles.” Once Sony announced that its PlayStation 4 disc restrictions would be the same as the PlayStation 3 disc restrictions, and Microsoft essentially followed suit, the situation has “clearly resolved in favor of the consumer” or, put another way, in favor of GameStop's relationship with its consumers.
However, as I have stressed before, GameStop is not sitting idly by while the market shifts further and further to digital distribution. All that is necessary for digital to succeed is for consumers to buy nothing from a physical store. It requires no further action by publishers or console manufacturers.
Since GameStop began its transition to digital back in 2010, the company has grown its total annualized digital revenue rate from $289 million per year to $710 million per year, or a compound annualized growth rate (CAGR) of 43 percent over the last 2.5 years. That is impressive -- but the company used to have a goal of hitting $1.5 billion digital revenue per year by January 2015, and that goal would have required a CAGR of 50 percent for four years.
If it maintains the current 43 percent rate, it will reach $1.2 billion per year by January 2015, far short of its goal – but still impressive. However, its growth rate has slowed in the past few quarters, so even that more modest target may be harder to hit. I don't think it's any mistake that GameStop hasn't mentioned the $1.5 billion per year target in over a year now, but that doesn't mean they aren't still looking to reach it.
If you've been following GameStop's digital numbers, the growth in PC isn't a surprise. But I do think it's a little counterintuitive, given how little floor space the company has traditionally given to PC games. Where is the growth coming from?
In a word: Steam.
As Tony Bartel, GameStop's president said last week, “Steam Wallet sales continued their strong trajectory, tripling globally during the quarter as we have now completed our global rollout of this service. Even in the U.S., Steam Wallet revenues nearly doubled over last year's second quarter.”
I'm amused that a service like Steam, broadly perceived as an alternative to retail, is helping to boost sales at GameStop, one of the largest and most vilified retail video game stores.
Big change coming
GameStop is not sitting idly by waiting for the end. They know that big change is coming. “By 2015, console digital will be nearing $4 billion”, said GameStop's Hogan last week, but added their own special twist: “much of [that console digital product] will be sold in stores.” So, how is GameStop's transition to digital going? Let's look at the numbers. Below I've graphed estimates of GameStop's total digital annualized revenues. That is, each point represents the total digital revenue for the four quarters ending with the date below that point. So adjacent data points include a three-quarter overlap in data – and in this way, we can see how the annualized revenue changes on a quarterly basis.
The Steam factor
The new wave of consoles will be even more digital-driven than the previous generation, and if GameStop is right that consumers will buy much of that digital content in retail stores, then GameStop is positioned well to ride that wave. It is still possible, I believe, for them to get well over their digital revenue over the $1 billion per year mark within the next 1.5 years as the new generation comes online. Just to throw out some numbers based on Hogan's comment above, suppose that console digital is $4 billion in 2015 and that roughly one third of that money passes through retail first. Then GameStop is looking at the potential of grabbing a slice of $1.6 billion in digital revenue. They'll hit $500 million in console digital just in the current fiscal year, so there is plenty of room to grow. But that's just console digital, and for GameStop that's only part of the picture. As the figure below shows, GameStop's PC digital business is about half the size of console digital, and it is growing even faster.