There is plenty of discussion these days about whether leading video game retailer GameStop (NYSE:GME) is doomed to follow a Blockbuster-like path to irrelevance and/or whether would-be rivals like Netflix (Nasdaq:NFLX) and Coinstar (Nasdaq:CSTR) can get into its kitchen. Unfortunately for GameStop bulls, there are some real reasons for concern. (For other companies that are threatened by strong competition and a changing market, check out Companies Playing Catch-Up With The Competition.)
Investopedia Markets: Explore the best one-stop source for financial news, quotes, and insights.

Digital Isn't Everything
A recent article on TheStreet.com tried to point toward growing digital sales as a sign that GameStop is adapting with the times and capable of staying competitive. To be fair, online revenue is growing nicely - up 69% in the recently-announced second quarter - while overall revenue dropped 3%. Unfortunately, there's more to the GameStop story than that.

GameStop thrives in large part due to its very lucrative used game business. Used games account for roughly one-third of company sales, but more than half of company gross profit. Needless to say, digital downloads do not lend themselves to customer resales and high-margin used sales for GameStop.

But wait, you say, isn't digital content much higher margin? GameStop does not provide enough information in its financial statements to strip out the gross profitability of digital sales. Nevertheless, investors can look at other digital retailers to get a sense of what GameStop may expect. Netflix sports a sub-40% gross margin, as does Amazon (Nasdaq:AMZN), and Sega Sammy's efforts to drive more digital download has not shown any real economic benefits for the company either. (For more on margins, see A Look At Corporate Profit Margins.)

... But It's Cheaper To Compete?
Maybe GameStop cannot reap the same gross margin on digital revenue as on used games, but surely the operating profits have to be better, right? Perhaps. It is certainly true that digital delivery does not demand the sort of occupancy costs that a retail store network requires. But has GameStop talked seriously of shutting down large numbers of stores?

Let's just say that GameStop does pull back significantly on its retail operations - ceding the in-store fight to big box retailers like Best Buy (NYSE:BBY) or Wal-Mart (NYSE:WMT). What then of the company's relationships with the likes of Microsoft (Nasdaq:MSFT) and Sony (NYSE:SNE)? If GameStop is no longer going to be useful to these console makers as a hardware distribution point, it would certainly stand to reason that they will move to marginalize GameStop as a game vendor - Xbox and PlayStation owners can already buy direct (and digital) from Microsoft and Sony with their boxes, and further marginalizing GameStop may not be so hard.

Oh, and don't forget that GameStop isn't exactly the only company looking to sell digital game content. Activision Blizzard (Nasdaq:ATVI) and Electronic Arts (Nasdaq:ERTS) are likewise looking to increase their digital businesses and they have the advantage of brand working for them.

The Bottom Line - Maybe Not Doomed, But Certainly Threatened
The online giant that is Amazon has arguably already had a big role in killing two competing retail concepts (Borders and Circuit City), and it certainly seems that there are some risks of irrelevancy to the GameStop model. That said, GameStop has at least one thing going for it - those used games are still popular (sales up 12% this past quarter) and still very lucrative.

What's more, GameStop does have some opportunity to use online distribution to its benefit. There could well be a place for GameStop to engage independent developers and become the favored distributor for them in both the offline and online world - something akin perhaps to the eBay Store or Amazon Associate concepts.

For now, though, investors would likely to do well to be cautious with this name. Few companies manage to transition and transform their business models without major disruptions and GameStop needs to prove that a digital delivery model can replace in growth and margins what it will likely cannibalize from used game sales. (To gain a better understanding of business models, check out Getting To Know Business Models.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!