The business of making and selling video games is changing. In the last five years, the games industry has gradually moved away from established business practices and towards alternative platforms and delivery channels, from digital distribution and free-to-play to self-publishing and crowd-funding. This shift, once believed to pose a threat to the industry's future, has paved the way for new ideas and technologies to take hold, establishing independent revenue streams and opening up the existing market to a wave of new creators and consumers.
But as the global gaming industry grows and adapts to these changes, more and more long-standing business practices have come face-to-face with extinction. The future of physical game media and traditional brick-and-mortar gaming retailers has been the topic of wide debate in the industry for a long time now, pushing both publishers and retailers to come up with a viable solution. While some have argued that progress is impossible without risk and loss, others maintain that the industry should strive to find a way for both old and new business models to work side by side.
So, who is correct? Will physical game media and game retailers survive? And if so, how?
Slowing physical sales
The global games market hit its peak in 2008, riding a post-Wii launch wave of prosperity, marked by the arrival of the casual consumer, an influx of new software, increased audience size, and the growing popularity of rhythm games in the West. But while global gaming industry revenues are forecasted to grow in the next three years (rising from approximately US$56 billion in 2010 to an estimated US$82 billion in 2015, according to PricewaterhouseCoopers), the amount of money made from physical software, hardware, and accessories at the retail level has been in steady decline year-on-year across the US, UK, Japan, and Australian markets.
The most recent figures from consumer market research group NPD for the North American video game market are dire. The first half of 2012 saw a double-digit percentage decline every month, with June hardware sales down by 45 percent and software sales down by 29 percent. In August, NPD released its quarterly update for the US games market: the figures showed that while digital revenue in the games market increased by 17 percent year-on-year, reaching US$1.47 billion, the packaged retail goods business managed just over US$1 billion. But while NPD acknowledged the rise of the digital sector, the company's analysts said that this increase is not yet enough to offset the decline in physical game sales.
So what's going wrong?
"In this unprecedented eighth year of the console cycle, we believe there are few new intellectual properties to reinvigorate interest in the games sector," Wedbush Securities analyst Michael Pachter wrote in July this year.
"Consumers have been offered a never-ending series of sequels, and have been offered fewer choices each year for the last several years, with the result being waning interest in new software purchases and an unprecedented three years of software sales declines. The poster children for limiting consumer choice are Activision, Electronic Arts and THQ, with each company offering 50 percent as many titles as they offered several years ago, with only one new intellectual property launched among the three companies over the last year."
With physical game sales slowing, the industry has turned its attention to the rising digital market. According to a Q1 2012 NPD report, digital format content sales in the US (which includes full games, DLC, subscriptions, mobile games, and social network games) increased by 10 percent, compared to the same period last year, generating US$1.38 billion in revenue, compared to the US$1.5 billion from new physical video and PC game software. Similar statistics have been reported in Europe: digital format sales in the UK, France, and Germany generated US$959 million in revenue in the first quarter of 2012.
While the worldwide increase in digital distribution and revenue has increased the debate surrounding the future of physical game sales, how has this shift measurably impacted game retailers?
Case study: The collapse of GAME
With physical game sales slowing, the industry has turned its attention to the rising digital market.In March this year, UK video game retailer GAME Group--which runs both GAME and Gamestation stores in the UK and mainland Europe--went into administration after requesting its stock be removed from the London Stock Exchange. Prior to the administration period, a number of publishers, including Electronic Arts, Microsoft, Activision, and Capcom had stopped supplying GAME with their latest products, fearing the company was no longer profitable. A week later, GAME Group was purchased by OpCapita, who subsequently took control of 333 stores across the GAME and Gamestation brands, but not before the business was forced to shut down 277 stores and lay off in excess of 2,100 staff members.
Perhaps the biggest blow to GAME's international business preceding its collapse came with the news that the publisher would not be stocking EA's Mass Effect 3. At the time, GAME was forced to open up about its relationships with publishers, a rare move for a retailer to make. In a memo to staff, GAME explained that it had asked game publishers to work with them through their difficult financial situation.
"We asked them to trade with us using manageable credit terms, and for them to continue to do that whilst we work through the strategic review and refinancing of our business," Devine said in the memo. "We gave the industry commitments--we committed to integrity and openness in our dealings, and working with everyone equally."
Devine then revealed that GAME had made the decision not to stock EA's March releases, including Mass Effect 3, due to the publisher not agreeing to GAME's "credit terms" during its period of need.
"As a specialist retailer dedicated to games and gaming, it is never easy to make a decision not to stock a title, particularly one with such a strong fan base. But it is imperative that we treat every supplier evenly, that we stick to our commitments, and that we don't sign up to payment terms that will hamper us further in the future," Devine said.
But while EA's decision to not allow one of the UK's biggest game retailers to stock one of the biggest titles of 2012 may have contributed to GAME's initial troubles, the bulk of GAME's troubles had started a lot earlier.
According to a source within GAME Group who wishes to remain anonymous, the retailer's biggest mistake, both in Australia and in the UK, was to expand too quickly while underestimating the operating costs of running a day-to-day business.
"The company underwent a hurried international expansion without considering the long-term effects of such a costly business decision," the source told GameSpot.
While GAME Group found a saviour in the UK, the Australian branch of the business was not so lucky. The business went into administration in May 2012, putting into motion plans to shut down all of its Australian stores and laying off more than 280 employees in the first round of staff cuts.
Looking at the Australian market, our source estimated an average GAME store pre-collapse turned in yearly sales of somewhere between A$1.5 million and A$2 million. While most businesses must produce at least a 5-15 percent profit each year to stay healthy, the source said that GAME Australia was having trouble reaching this target due to high rent, employee expenses, and an increasingly unprofitable local market.
"GAME entered Australia and expanded very quickly, choosing to open 70 to 80 stores in two years, a number which meant they couldn't easily negotiate the terms of their rental agreements and couldn't afford to be selective," he said. "As both rents and payroll numbers are fixed, GAME lost out when the local market started to fall: the business had to contend with market revenue shrinking by 20 percent in the last two years. They simply weren't selling enough games to cover all their operational costs and still turn a profit."
Our source said that a typical Australian GAME store deducted roughly 12 percent in daily operating costs to rent and 8 percent to payroll, in addition to further costs to cover things like utilities, production, warehouse costs, marketing costs, and taxes. This translated to roughly A$5 to A$6 in pure profit for the store from each game sold, numbers that weren't high enough to keep the business operational.
"What happened to GAME is a sign that the global video game retail market is struggling. With more and more consumers shopping online, and more and more publishers adopting digital distribution measures, retailers everywhere are under pressure to find new ways to survive."
The physical future
Some larger game retailers have already begun to display signs of understanding, doubling their efforts to adapt in the face of a rapidly disappearing physical game market.
US game retailer GameStop's push to establish a mobile and digital business in the North American market has been rewarded with a 23 percent year-on-year growth for the sector in the first quarter of 2012, a figure that, while not enough to make up for a shrinking packaged goods market, gives the retailer a fighting chance.
…some key players in the video game publishing world have been less confident about game retailers' ability to survive.According to GameStop's latest financial report, the retailer expects its store sales to fall 11 percent to 5 percent in the current fiscal quarter, with full-year revenue expected to range from down 5 percent to flat. But while GameStop's digital and mobile sector still makes up the smallest part of the retailer's overall business (15.2 percent of total sales for the period ending April 28, 2012), GameStop seems to have recognized the importance of investing in digital: in July this year, GameStop CEO Paul Raines revealed the retailer is looking for new ways to grow its digital revenue by exploring options for digital second-hand sales.
Though retailers like GameStop and industry analysts like EEDAR's Jesse Divnich remain measured in their observations of the rise of digital distribution and its impact on the future of brick-and-mortar video game retail (Divnich told GameSpot that, while digital distribution remains a continued and growing threat to physical retail, he believes there will always be room for one mass-market specialized game retailer), some key players in the video game publishing world have been less confident about game retailers' ability to survive.
In August this year, EA Games executive vice president Patrick Soderlund acknowledged that though the majority of revenue in the industry still comes from packaged goods, the future will see distribution via brick-and-mortar retail outlets lose viability "sooner than people think". Specifically, in less than ten years time, according to Soderlund.
Clearly stating that his comments were personal and not those of EA as a whole, Soderlund said that he believes the new generation of gamers may not have the same enthusiasm for collecting physical games as previous generations.
EA, whose digital business reached US$1.2 billion in its most recent fiscal year, remains convinced that the lion's share of its revenue will soon stem from digital products. Earlier this year, EA COO Peter Moore stated that though the publisher will never abandon physical media while there is still consumer demand for it, its digital revenues could be just two to three years away from surpassing its boxed gaming business.
The rise of digital has also kept other game publishers in high spirits. In March this year, Ubisoft posted its full-year financial results showing a return to profitability thanks to a doubling of its digital and online sales, a 111 percent jump year-on-year.
Earlier this year, Codemasters cofounder David Darling took things a step further by saying the next-generation of consoles must embrace a digital-only future or face extinction. Darling pointed to digital distribution as a model that gives publishers access to a "worldwide marketplace", while side-stepping the often-expensive processes involved with the distribution of boxed games.
"Sony and Microsoft cannot let the retailers dictate game prices going forwards if they want to break free from the current over-priced model," Darling said. "If hardware manufacturers do not manage this transition soon, they will be overtaken and left behind by companies who are embracing digital distribution wholly and completely. Companies like Apple and Google are not tied to brick-and-mortar retailers with shackles, and are not being held back by them."
EA, whose digital business reached US$1.2 billion in its most recent fiscal year, remains convinced that the lion's share of its revenue will soon stem from digital products.But those in the industry who have worked closely with game retailers believe things aren't as simple as waving goodbye to physical retail and saying hello to digital. Firstly, there's the idea that people enjoy owning tangible products: it's easier to attach oneself (and one's memories, for that matter) to something that can be seen and touched. Secondly, there's the realisation that a digital marketplace will never be able to replicate the experience of dealing with other human beings, something that physical retailers so easily do. This latter point may not be of concern to the experienced, core consumer who may prefer to do everything digitally, but it remains an important part of the point-of-purchase experience for the mainstream consumer.
"I think people underestimate just how important physical game retailers are to the promotion of games as a whole in the mainstream consumer market," an industry source who wishes to remain anonymous told GameSpot.
"Retailers do a lot to push and promote gaming to this growing audience. While the digital market is still quickly growing, it's also still maturing, and is not yet as effective at selling games as physical retailers are."
The humble brick-and-mortar game store may be of some use yet.