Walmart's Move Into Used-Games Business May Be Good for Investors, but Not Gamers

By Josh Wolonick  MAR 19, 2014 1:50 PM

After EA and Microsoft failed to curtail the sale of used video games last year, Walmart's move could be a huge boost for the trade-in business.

 


On March 26, Walmart (NYSE:WMT) will enter the lucrative and high-margin business of buying and selling used games. In doing so, America's largest retailer will instantly become a major competitor for video game retailer GameStop (NYSE:GME), which currently leads the used-games market. Walmart will also have the added competitive edge of being able to offer store credit to customers who trade in their used games, meaning that consumers can exchange their old games for clothing, groceries, dog food, or any other items sold in one of Walmart's 3,100-plus stores in the US.

High-profile game makers have long tried to curtail the used-games business, which can hurt sales of new games. Last year, Electronic Arts (NASDAQ:EA) one of the largest video game developers, proposed a program that would require players of used games to pay an extra fee to the company. Due to a negative reaction from consumers, EA nixed the plan. Likewise, Microsoft (NASDASQ:MSFT) attempted to introduce a feature wherein developers could control whether their titles for the Xbox One could be played by a second or third owner. However, a widespread outcry from fans, and the fact that Sony's (NYSE:SNE) PlayStation 4 included no such feature and would therefore have more appeal to consumers, caused Microsoft to drop that functionality.

GameStop likely celebrated the EA and Xbox One retractions: According to the company's financial reports, used games accounted for $2.4 billion, or 27%, of its total sales in the fiscal year ending February 2, 2013. Moreover, sales of used games represented 44% of GameStop's gross profits that year since used-game sales have a higher profit margin than new-game sales. In the nine-week holiday period ending on January 4, 2014, used games accounted for $530 million in revenue for GameStop. As Pacific Crest Securities analyst Evan Wilson told the New York Times, "It's extremely rare if retailers can find a category that has such high gross-profit margins."

What if Used Games Were to Disappear?

With next-generation video game titles expected to boast increasingly impressive gameplay and graphics, the cost of development for big releases is increasing. Back in the early 2000s, most new games cost $50. Now, $60 is more typical. With rising prices for consumers, the used-games segment will likely continue to grow, especially now that Walmart is making its entrance into the space. But what if Microsoft and EA had gotten their way? What if used games were phased out?

In December of 2012, New York University Stern School of Business professor Masakazu Ishihara and University of Toronto Rotman School of Management professor Andrew Ching published a study asking that exact question. The study, "Dynamic Demand for New and Used Durable Goods Without Physical Depreciation: The Case of Japanese Video Games," found that if used games were to be eliminated from the market, the profit to game publishers would drop by 10% per game. However, if publishers were to adjust prices to optimal levels, they would see per-game profit increase by 19% over current levels.

As Ishihara said in an email to Wired, "We find that the optimal price would be on average about 33% lower than the current price level, if the used-game market were eliminated. So roughly speaking, in the US, game prices should go down to about $40." As he further explained, "The reduction in price is partly driven by the fact that if the used-game market were eliminated, gamers would no longer be able to sell their games and get back some money (so they need to be compensated)."

Used Games, Here to Stay

In a sense, by going into the used-games segment in a big way, Walmart is helping to keep the cost of new games high -- that is, if the aforementioned study paints an accurate picture. Either way, challenges lie ahead for the retailer.

In 2009, Walmart introduced a used-games kiosk in select stores, allowing customers to exchange games for credit on their credit or debit cards. Due to issues with potential fraud and low uptake, the program was short-lived.

This time around, however, Walmart is teaming up with a third party, CExchange, to help build a smooth and profitable used-games business. One of the biggest challenges facing used-games retailers is how best to determine the fair value of a used game. In the video game market, with new games being bought and sold by millions of gamers at once, the fair value of a game can change pretty quickly, especially when stores become inundated with too many copies of the same game. CExchange will help Walmart make sure that this problem doesn't affect the company's ability to provide a fair value to the consumer.

Walmart has said that it will begin buying back used games next week, but it will not begin selling used games until later this year. In the meantime, consumers can use store credit from the trade-in to buy anything they want from Walmart, Sam's Club, or their websites.

With EA's and Microsoft's failures last year to curtail the selling of used games. Walmart's grand entrance into the space means that used games are here to stay.

Follow me on Twitter: @JoshWolonick and @Minyanville
No positions in stocks mentioned.