Game over

Once as ubiquitous in the American strip mall landscape as Blockbuster, video game retailers will soon follow the now defunct rental store. Two new consoles and dozens of best selling game releases amid a year where Americans have few better options than sitting at home to play video games created what many hoped would be a perfect storm for unprecedented video game retail sales. It was not enough to save video game retailers. The video game industry, now the most profitable form of entertainment worldwide, is systematically removing itself from the world of real estate.

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Last year people spent $145 billion worldwide on video games. That’s a staggering number considering the box office earned just $42.5 billion and the music industry just $20.2B, according to Newzoo. Those numbers will be even more stark when tabulated for 2020. The pandemic has shut down movie theaters and concert venues, limiting revenue potential for both industries. Video games on the other hand have never been more popular. Early monthly estimates show sales are up 20 to 40 percent year-over-year. There’s plenty of money to be made in the video game industry. Just not in real estate. Microsoft, Nintendo, Sony, Twitch, Activision and Epic Games are posting record numbers. The increase has come on the back of content like games, but hardware sales are also soaring, a sure sign that more people are getting into gaming for the first time. Put simply, more people are becoming gamers and gamers are buying even more games, speeding up the growth of an industry that has already been the fastest growing form of entertainment for years.

All of that means soaring profits from video game companies and crumbs for retailers. GameStop, the largest special purpose video game retailer, reported another quarter of disappointing results, posting a net loss for the Q3 2020, a year when experts expect more money to be spent on games than ever before. The launch of the new PlayStation 5 and Xbox Series One/X saw GameStop’s same-store sales numbers rise in November but neither console is likely to be enough to alter the company’s trajectory. Sales are still far too low and boosts in same-store revenue come only after years of decline. Most gamers can tell you these days GameStop is selling everything but video games. The retailer has shifted its focus to collectibles, apparel and other trinkets related to gaming but the few games they actually sell are all mostly kept behind the counter. The pandemic was a double-edged sword. On one side, demand for games and consoles has never been greater. On the other, fear of the virus has hampered in-store retail.

One of GameStop’s largest investors, Ryan Cohen, who owns roughly 10 percent of the company, has called for additional store closures. In a letter, he urged the company’s leadership to adopt “practical steps to cut its excessive real estate costs.” Cohen suggests the best path forward is to sell hundreds of stores and allow leases to expire on others, transitioning into an e-commerce driven business. He explicitly mentions the fact GameStop has lost hundreds of millions of dollars while the global gaming market has expanded by tens of billions, going so far as to say the companies’ failure to seize even a small portion of the sector’s monumental growth adds “insult to injury for GameStop’s stockholders.”

Questionable management decisions likely played a key part in GameStop’s demise, but video game retailers’ biggest problem started before the pandemic and will be around long after; physical gaming media is a dying technology. Like record stores, video game retailers are becoming functionally obsolete. Gaming can trace its roots to the arcade, where wooden cabinets stacked end-to-end created experiential retail before any real estate writer was savvy enough to pen the phrase. The first commercially available console, the Magnavox Odyssey released in 1972, changed everything by allowing gamers to bring their favorite arcade games home with them. Game developers were no longer counting quarters. They started counting millions.

Gerald Lawson, a designer for a company called Fairchild, further revolutionized the industry by inventing game cartridges. By separating the game from the console, developers could sell and players could play an endless number of games on the same console, creating a lucrative new revenue stream on top of console sales. Gaming wasn’t just selling an experience anymore, it was selling physical products to gamers at stores. In a few short decades, chains like GAME, Babbage’s, Gamecrazy, Rhino Games and Egghead rose and fell. Now GameStop is the last major video game retailer standing, absorbing or killing off its competitors. Sooner rather than later, it will be game over for GameStop too.

Digital downloads and competition from the world’s largest corporations has left video game retailers reeling. Digital revenue made up nearly 63 percent of last year’s historic revenue, according to S&P Global. Online marketplaces that allow gamers to purchase and download the game via internet connection are quickly becoming the industry standard and that’s no accident. Microsoft and Sony, behind the Xbox and PlayStation, respectively, operate their own digital storefronts over Xbox Live and the Playstation Network, where the console manufacturer takes a cut of the game sale, not the retailer. Leveraging their digital storefronts, two of the most recent Xbox and PlayStation iterations don’t have a way to even play physical media, they can only play digital downloads. Over the years game developers have sharpened their knives to expertly cut out the middleman, selling directly to consumers through an increasing array of in-game purchases. Savvy game developers Like Valve and Epic Games have launched their own marketplaces, establishing themselves as the middleman for games from other studios to sell into their larger fan bases. Emboldened, Epic is taking on the world’s largest corporation, Apple, in a bid to end Apple’s App Store status as a middleman between gamers and the mobile version of Epic Game’s record breaking hit Fortnite. A decision on the pending litigation between the two tech giants will create shockwaves for the entire gaming industry.

Whatever of the sector is left after digital downloads is being gobbled up by big box retailers using gaming sales as a way to buoy their own chances of survival. On earnings calls throughout 2020, executives at Walmart, Target, Best Buy and other big box retailers specifically mentioned increased demand for video games as reason sales growth is at record levels. They’re all chasing Amazon, which for three years now, has been the largest electronics retailer in America.

Even big box retailers buying wholesale likely won’t last long in the gaming space. The margins don’t make sense anymore. In the 1980s a retailer could buy the latest Nintendo game for $25 to turn around and sell it for $50. Today, games are mostly sold wholesale at $49 and retailed at $60. For a good release, in which a big box retailer got the best wholesale price, they’re still only profiting roughly $5-$7 per unit.

Problem is, most releases these days aren’t good releases. The frequent pace of releases means many developers and retailers must price-drop. To make money, retailers must correctly estimate their sales to make the biggest wholesale purchase they can for the best price and then hope the game stays popular long enough to move the units at the original price point in hopes they make enough money to cover rising real estate and labor costs of retail. The thin margins on new games is offset by up-selling on other items, like extra controllers. In big box stores, there’s far more up-sale potential. Some stores like Walmart and Target may even be willing to take a loss on new games just to get the customer in the store, where they’ll hopefully purchase at least a few other household or personal items with higher margins. Margins are better on consoles but a business built on relying on console sales isn’t sustainable considering how infrequently a new console is released.

The deck is stacked against retailers. Game developers have intentionally stacked it. If the thin margins weren’t tough enough, publishers are continually pushing for more leverage in distribution deals with retailers. Exclusivity is only for the game studios themselves, everyone else is forced to compete over whatever scraps are left over. In-store demos used to drive traffic for game retailers, but again, developers have taken that away too, now releasing Alpha, Beta and demo versions of their games online for free. Selling a game early can forever you lose the privilege of selling games from a major studio, even levying financial penalties in some cases. By not allowing any differentiator between retailers beyond what the developers themselves create, game developers have eviscerated any chance for them to develop brand loyalty with their customers. The increasing complexity and exposure related to major game distribution deals is driving off all but the biggest players. Beyond GameStop, the few remaining special purpose video game retailers have abandoned new games and consoles altogether, now operating as little more than nostalgic scrap traders, selling used vintage games and consoles the developers have long since abandoned.

Independent game stores will soon be no more common than record stores. The days of lining up outside your local strip mall for the latest midnight release are done. Digital sales and big box retailers have made competition too difficult. After being launched to new heights by retailers in the 80s, 90s and 2000s, the gaming industry has now positioned itself against retailers, designing games, marketplaces and payment methods that bypass the humble retail middleman.

“I don’t think this industry, in retail, is left in 10 years,” Jason Brassard, owner of Trade N Games in Fenton, Mo, told Polygon. “… No, not in the least bit. I mean, there will be some collectibles, but paying two employees who work full time and paying a few thousand in rent, nah. No way. Not a chance.”

It’s tempting to think of video games, movies and music as victims of the same phenomenon of digitalization. Middlemen, whether they be retailers, cinemas or record studios, are going broke left and right, knee-capped by a new form of direct-to-consumer technology like streaming and digital downloads. That doesn’t tell the whole story. Global revenue from music has been falling for years. The film industry is faring better, but not by much, only registering small increases in revenue despite rapidly rising studio spending on global releases. It’s not surprising then that real estate that relies on those industries is struggling. Video gaming on the other hand is a veritable gold mine growing by double digits every year. The difference is the gaming industries’ boom was designed to blow right by brick-and-mortar retailers and go directly to the consumer through their console. [Propmodo]