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Do the PlayStation 4 and the Rise of Streaming Games Sound the Death Knell for GameStop?

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The specialty electronics retailer has to evolve its business rapidly to adapt to the changing market.

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When Sony (NYSE:SNE) introduced its much-anticipated PlayStation 4 gaming console in February, it did not unveil the actual piece of gaming hardware, leaving fans in the dark as to how the console's look had evolved.

But that decision -- to keep the PS4 hardware under wraps and focus on the gaming experience -- highlights the trend toward digitization in gaming. For the first time ever, all PS4 games will be available for digital download. No doubt we can expect the same for upcoming next-generation consoles from Microsoft (NASDAQ:MSFT) and Nintendo (PINK:NTDOY).

Many pundits believe that digital games could sound the death knell for brick-and-mortar gaming retailers like GameStop (NYSE:GME), which are heavily dependent on selling new and used video games. (In its most recent fiscal quarter, used games sales represented a significant 48% of GameStop's gross profits.) The challenges facing GameStop are somewhat more complex, however.

"Digital games obviously kill the used games market," Joey Davidson, gaming editor at tech news website Techno Buffalo, tells Minyanville. "Once these games are offered up on the digital networks, GameStop is never going to touch them because Sony will take them out of its hands entirely. The model will be: Buy once and done. You'll never be able to resell used games."

Though Davidson acknowledges that the digitization of videogame distribution will hurt GameStop, he believes that the market for new and used physical games will continue to be viable for the foreseeable future, pointing out that "30% of all consoles from the last generation never connected to the Internet. We're talking about a third of the market that doesn't even use the online capabilities."

Additionally, Davidson adds that gamers might still prefer to own a physical product. "If I have a physical game, it's mine and I own it forever. If, down the line, Sony goes under, I won't be able to play those digital-only games anymore. If I lose my console, I can't download them again. Physically owning a game means owning it for good," he opines.

For Davidson, the worry for GameStop is not so much the increasing popularity of digital games but the way that GameStop, like other specialty electronics retailers such as RadioShack (NYSE:RSH) and Best Buy (NYSE:BBY), is taking a thrashing from online retailers such as Amazon (NASDAQ:AMZN) in what has been termed the Amazon "showrooming" effect.

"I wouldn't be surprised if a large reason for GameStop's problems is how good the game marketplace is on Amazon," says Davidson. "At any given time, you can look on Amazon and find games for cheaper there."

To counter the threat from Amazon and the digitization of gaming distribution, GameStop has diversified its business beyond videogames. It now sells used Apple (NASDAQ:AAPL) and Android (NASDAQ:GOOG) smartphones and tablets, in addition to its games portfolio.

The company has also made attempts to adapt to the changing marketplace. GameStop now sells accompanying downloadable content (DLC) in stores when customers purchase a game. It has also introduced GameStop Impulse, a digital-distribution retailer and Kongregate.com, a Web gaming platform; and it is set to launch another cloud-streaming game service. In the last quarter, the specialty videogame retailer saw digital revenue jump 40% year-on-year to $77 million, indicating that its digital strategy might be paying off.

Speaking to Forbes about the PS4, GameStop president Tony Bartel was confident that his company would be able to handle the gaming evolution.

"We are excited about digital content distribution and have had great success selling it at retail. We expected, and are ready for, next-gen consoles to have a significant amount of digital content options and we'll continue to drive sales of this content through all of our channels whenever possible," said Bartel.

(See also: Three Ways Retailers Are Fighting Back Against Amazon and the 'Showrooming' Effect.)

Twitter: @sterlingwong
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No positions in stocks mentioned.
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