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It stuck me recently that GameStop might be falling victim to The Innovator's Dilemma. This book, published in 1997, a model of why a company that is at the top of its industry can fail to maintain their dominant position in the face of disruptive innovation.
If you haven't read the book, I highly recommend it. This summary does a good job of explaining the premise of the book, so if you haven't read it, go read the summary and come back. The rest of this post attempts to apply the model outlined in the book to the situation GameStop (and other niche game retailers) face with respect to digital download.
The argument that digital distribution is a disruptive technology is an easy one to make. It disintermediates retailers, distributors, and manufacturers, by letting publishers and developers by through a single layer of middlemen (in the form of Steam, Impulse, or Direct2Drive) or even directly to their customers.
Digital distribution also removes the sharp shelf-space restrictions that keep a game's shelf-life artifically low and allow game sales to enjoy a long tail. Numbers are hard to find, but digital distribution has also been accelerating in the past few years.
Part of the Innovator's Dilemma model predicts that established players will be able to enjoy significant revenue growth by retreating from low-margin and low-volume markets as those fall to the invading technology. GameStop's last two quarters are the best they have ever been.
However, one part of GameStop's business has been in serious decline over the past several years, and that is PC games. That is partly due to an overall decline in PC games in general, but it is also to the fact that PC games can't be repurchased and sold as used like heavily DRMed console games can. This resale of games accounted for 23% of the company's revenue last year, and that number is increasing. According to the Wall Street Journal, used game sales account for 42% of GameStop's gross profits.
I suspect that the other major reason for GameStop's withdrawal from PC games is that digital downloads have made their strongest inroads on the PC. Steam is selling tons of AAA games, and casual and indie games are sold primarily online at this point.
The company is not mounting much of a defense in the market where its competition is strongest. They will likely lose the console market the same way, since I would be shocked if the next generation of consoles (Xbox 720, Playstation 4, and Nintendo Puu) didn't include large hard drives and the ability to download full sized titles as easily as on a PC.
GameStop is making the choices they are because that is what is demanded of them by their customers and investors. As a multi-billion dollar public company the tiny digital sales available five years ago would have just been a distraction from meeting their growth goals. That allowed Valve and others to get experience and partnerships that give them a huge head start in the the digital distribution space.
Just in the past 18 months Steam has picked up titles from EA, THQ, and Sony Online Entertainment. These major publishers join Activision and Take-Two that joined the service a few years ago. In fact, GameStop was reportedly so upset at how much THQ was favoring Steam that they temporarily refused to offer pre-orders of Dawn of War II. (Or at least that was the rumor.) All the while, the biggest complaint that most of GameStop's customers have is that it doesn't give them enough for a used game. By and large their customers are quite happy with the company.
Broadband penetration in the US has increased from 4.4% to 50% in the past 9 years. At this point the extensive selection available for download is primed to combine with the relatively new viability of large downloads and drive GameStop completely out of the PC game business.
I believe the same thing is likely to happen for console games within the first two years of the next generation of consoles. Within ten years the dedicated video game store will have gone the way of the travel agent, cable driven earthmover, and walled garden internet service provider.
Or at least that's now it seems to me as a retail outsider and recent convert of The Innovator's Dilemma. What do you think?
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Another major problem is ISPs. Think about how angry ISPs get about P2P traffic clogging up their networks (supposedly). Now the average MP3 album is between 60 and 100 MB depending on bit rate. If the ISPs get angry and throttle traffic (at least they do here in Canada) over 100 MB albums, how do you think they'll respond to people constantly downloading games that are several gigabytes, or even a couple dozen gigabytes, in size? My ISP caps me at 60GB upload/download a month, and I already come close to hitting that a lot of months without downloading next-gen games.
I do think digital distribution is the direction that Sony and Microsoft are moving in (though likely not Nintendo, for a variety of reasons), but I think there are some serious issues to work out before it becomes a really widespread method of selling console games, so I think game publishers and retailers alike probably have a good 5 years or so to figure out how to respond before they're made potentially irrelevant.
But I know a lot of people that hate digital distribution: First, the most obvious issue, digital distributed goods are digital... Some people hate that, I know a guy that is willing to pay much more for a game if it has a box (a good box, not a shitty DVD case), a color manual, and a disc that has sufficient quality to endure several years. The reason? Reading manuals on screen still hurt the eyes of some people, a disc like I said tend to survive more than our HDs sometimes, and boxes are just nice, you can put them on a shelf and show your friends how your non-pirated games kick-ass and how they look poor and cheap by having noone of that...
Second: Security issues, even if they do not exist. A lot of people do not trust paying digitally in any way, for various reasons, this is a clear issue with digital distribution, specially when sometimes a provider do some fishy things (WiiWare only ask for the credit card number, and only ONCE, I know people that has complaints that someone went to their Wii and gone on a spending rampage without knowing that it was already beind automatically debted from the card of the Wii owner...)
Third: Broadband in some places is still a rarity, specially in places that does not matter with everyone having broadband but the ISP does not having a connection itself that can withstand that... A example is that here in Brazil once a broadband provider went offline for one entire day (taking down 1/3 of the national internet with it I calculate... Not only in users, but also sites that used its infrastructure, also the police was not happy with that, since that ISP was the provider of their connection between police stations and the central database).
Fourth: Connections is still slow for people far away from countries where companies usually host their downloads, Brazil is in the south hemisphere, Quakelive for example has permanent lag, because of the physical distance between here and its servers, downloads also rarely exceed 10% of my connection speed (I have a 8 Mbit, and believe me, to us this is a hell of a kickass connection that costs A LOT of money... Also few people has that here, and we too have a downlaod limit, her 20Gbyte month), because the servers are far away, and this results in lag, and as we know downloads are not "streaming", they work with TCP packets, that need response, meaning that each packet take 200ms to go and return.
Fifth: Price... In several countries, internet (even dial-up) costs hell a lot... My parents for example live in a place with poor infrastructure and are forced to use dial-up, and even dial-up it is 60 USD month AT LEAST (if you use it only midnights up to 6:00 it is 60 USD, if you DARE to use it in other time of the day the phone bill skyrockets), and as I said in other paragraph I pay A LOT for my 8MBit, and that is download, poor people that want upload conections to host something (thus increasing the problem of four...), I once wanted to host a MMO, a upload connection of 1Mbit is 600 USD month...
But that this does not mean that Digital Distribution will never work, only mean that stores will exist for a LOOOOOOOOOONG time...
Whether it takes five years (or, as I think is the case at least in NA and likely Europe, less) or not, Gamestop may already be in trouble. What automatically comes to your mind when you think of direct downloads on a PC? It's got to be Steam. Direct2Drive? Prices being equal, in terms of support, ease of use and community, Steam likely is on top. Even if Gamestop invests heavily to try to make up the difference, Steam already has a heck of a lead, and an established brand. I'm not saying it won't happen, but Gamestop sitting on their hands thus far has put them seriously behind. They've bet their business model on the used games market, and up to this point it's worked. Five years from now, it'll be interesting to see. Of course, this is just talking about the PC market. Should full titles for the console start becoming direct downloads... what is the likelihood of Gamestop, or any other brick and mortar, capturing that market? There's a high probability they'd keep distribution in their hands, like you currently see for PSN, XBLA and WiiWare. Best Buy and Walmart can jump up and down and gnash their teeth as much as they want.
If enough of the market goes direct download, it won't really matter. Brick and mortars can either accept a diminished role in games retail, or go on some crazy boycott, with Walmart probably the only ones lunatic enough to try it. And with collective action problems being what they are, it wouldn't work. But notice how I say retail would be diminished. At least for the time being, it doesn't look like retail will, even with the rise of direct download, disappear completely. Some people will, for technical or locational reasons, need access to hard copies of games (at least until infrastructure improves further). And some folks, particularly the "buying for others" market, will still be most comfortable using a brick and mortar retailer. Gamestop won't cease to exist, it'll just have to be a smaller, leaner animal.
Case in point: I'm going to school in Charlottesville, VA (Population roughly 50,000; though in a college town that's anyone's guess). We have a Walmart, a Target, a BestBuy, and five Gamestops. Five. Will the Gamestop flag still fly in Charlottesville five, or ten years from now? Sure. But there sure as heck won't be five. Direct download is where things are trending. For many core gamers, at least on the PC, it already has. I'm finally going to purchase Empire: Total War today. As I look out my window at the gray skies and flecks of drizzle pattering on my window in what I know to be sub-50 degree weather, I'm pretty happy I won't have to load up and drive over to Gamestop.