Already contending with soft sales and rising costs, video-game publishers have one more thing to worry about: The used-game market. That was one of the implications of GameStop's ( GME)
earnings report earlier this week and of recent game sales data. Though new-game sales have been weak in recent months, GameStop, the leading video-game retailer, reported strong demand for used games and expects that strength to continue -- at least in this quarter. Whether sales of used games cut into those of new games is an open question, say analysts. But the strength of used-game sales is an indicator that in the near term, consumers are becoming more cautious about spending money on games. With Microsoft ( MSFT) having recently launched its new Xbox 360 game console and with other new game machines on the horizon, many consumers are likely saving up money to buy the new machines, they say. "Consumers are going to be a little tighter with their wallets, says David Cole, an analyst with industry research firm DFC Intelligence. "That's a big challenge for software publishers overall." Hard numbers for used-game sales are difficult to come by, because none of the major industry research firms track them. GameStop itself has only recently begun divulging information about its used business. But if GameStop's numbers are any indication, the used business is a significant part of the industry -- and it's growing rapidly. Sales of used products -- which include both hardware and software -- amounted to $511.8 million last fiscal year for GameStop, or about 28% of the company's sales. That was up sharply from two years earlier, when such sales totaled $296.4 million, or just 22% of the company's overall revenue. Electronics Boutique, which recently merged with GameStop and also released its used sales results in recent months, saw similar growth over that period.
Sales of used products grew from $212.5 million, or 16% of revenue, in fiscal 2003 to $419.9 million, or 21% of revenue in fiscal 2005, which ended in January. Through the first nine months of this year, GameStop has sold $458.8 million worth of used products, representing about 32% of total revenue, up from $355.2 million, or 31% of revenue in the same period last year. For retailers, the attraction of the used business is high profit margins. In the third quarter, for instance, GameStop saw a gross margin of 45% on sales of used products, compared with about 25% on new software sales and just 11% on new hardware. And though the company's sales of new software outpaced that of used products, GameStop saw more gross profit dollars from the used business. Those kinds of numbers are drawing new entrants into the space. Best Buy ( BBY), according to published reports, has started testing the market for used games in some of its stores. The growing demand for used games comes amid a cyclical transition in the video-game industry. Microsoft's new Xbox 360 game console is only the first of three next-generation game machines expected to debut in the next year. Such transitions have typically been tough for video-game software publishers because they often result in
slumping or stagnant sales -- and increased costs. The rising costs have to do with development expenses for next-generation games. Analysts expect such costs to rise to as much as two times for games played on current-generation consoles. Meanwhile, analysts often chalk up poor sales to a number of factors, including the link between game and hardware sales and an installed base of console owners. That it can take up to a year or two before a particular console reaches a mass audience puts a limit on sales of games for the device.
Another factor that can lead to price cuts or poor unit sales is the increase in consumers' attention on next-generation systems. Publishers, in response, could have a hard time drumming up interest in games for previous-generation devices. But the rise of the used games business could be one more factor weighing on new-game sales. Why spend $50 or $40 on a game for an aging console, when the same game can be gotten for half as much, just days or weeks after the release? The problem for the publishers is that while retailers benefit from consumers choosing used games, they don't. Publishers, as widely believed, don't get a piece of the action after the game's initial sale. "It's a bit of a sore spot for publishers, because obviously, they'd like to see every unit sold be a new unit," says Anita Frazier, an analyst with industry research firm NPD Group. Some analysts think the threat to publishers posed by used games varies depending on the quality and perceived value of the games. Despite the rise of the used market last year, Microsoft and Take-Two Interactive ( TTWO) still sold millions of copies last year of Halo 2 and Grand Theft Auto: San Andreas, respectively. For titles such as those, people will continue to spend top dollar. Assuming that such games live up to their hype, few owners are likely to part with them, which helps to limit the supply of used games -- and keeps the price of them high enough to pose little threat to new-game sales. "If you continue to put out good games ... maybe you don't have as big a problem with the
used market," says James Lin, an industry analyst with the Simba Group. Still, analysts aren't entirely convinced that the used-game market poses a big threat to the publishers. In many cases, the market for used games appears to be different than that for new ones, says Michael Pachter, an analyst with Wedbush Morgan Securities.
Used-game buyers seem to be from kids who have no money of their own or people from lower-income families, he says. If that's the case, such sales are in addition to, not instead of, sales of new games, he adds. "My gut tells me this doesn't cannibalize new sales," he says. And used sales could actually boost new-game sales in the long run, says Cole. Such sales can introduce younger or poorer customers to game franchises for which they'll pay full fare when they are older and more affluent, he says. "If you get people in there playing games, it's a good thing," he adds. The publishers are certainly hoping so.