Why GameStop Was (Almost) in the Toilet

It has nothing to do with the iPhone, Android, or Zynga. For the past several years, GameStop GME has been a star. With rising sales and revenue (even in the face of a withering economy), the company seemed to be impervious. It was, in many ways, the do-no-wrong retailer. Times have changed. After GameStop announced a decline in Q2 profit, the stock took a serious beating, losing around 10%. Shares recovered in the late afternoon, prompting Tony Bartel, GameStop's president, to tell Reuters that the “optimism about the second half of the year is now beginning to make it onto the marketplace. That word is starting to get out and you're seeing a recovery taking place.” Bartel may be right – from an investor's standpoint, at least. But the company was very close to a total meltdown. And that potential meltdown did not have anything to do with GameStop's strategy (which is solid), its industry (which is still very strong), or its digital-only competition. Bye-Bye Supply Unlike Best Buy BBY, which attempts to cash in on any industry available (it pushed hard with games, which didn't work out too well; now it's pushing hard with tablets and smartphones), GameStop's entire industry is locked into one item. To fully understand the retailer's dilemma, try and imagine what the world would be like if there was a chain of grocery stores that specialized in and only sold dairy products. This store – we'll call it DairyStop – allows customers to return spoiled milk, eggs and cheese for a small amount of credit, which can be used to purchase new items. DairyStop also sells a greater variety of milk and cheese than most supermarket locations. Since Americans love dairy products, a store like this could easily flourish. In this fantasy world, what do you think would happen if all of our dairy farmers began to produce fewer eggs, fewer cartons of milk, and fewer packages of cheese? What if the eggs, milk and cheese that were produced did not taste very good? How do you think consumers would respond to this development – by embracing what few dairy products were available? Or would we slowly learn to eat other things and move on from dairy? Remember: DairyStop only sells dairy items, so it suffers the most in this scenario. Supermarkets, meanwhile, sell fruits, vegetables, meat, and crates full of pre-package junk. Thus, humans still have something to eat. This is the problem GameStop is facing. Its dairy products (video games) are drying up. Game publishers aren't releasing as many as they used to, and the ones that do get released tend to disappoint. It has created a world in which consumers – even diehard game players – are forced to look elsewhere for quality entertainment. Consequently, consumers are visiting GameStop less than they did a couple of years ago, and that's having a huge impact on the company's bottom line. Food for Thought Not all of GameStop's problems can be blamed on the publishers. One thing that a lot of people don't realize is that the first and second quarters were not historically a big time for gaming. Only in recent years has that changed, and while it would have been great for this cycle to last forever, there was no way that was ever going to happen. Eventually, things were going to slow down again. Some publishers would inevitably get greedy. Some would get sloppy. And some just wouldn't be able to keep up with the challenge of releasing so many games. That's another thing that people tend to forget – that game development is one of the most challenging professions in the world. While I am wholeheartedly against product delays (and years of pre-release hype), I am in favor of realistic time tables. Realistically, it will take a development team 24 to 36 months to produce a masterpiece. Some games require more time. Developers know this. Publishers know this. Consumers know this as well. But whenever the stars align and a bunch of great games are released at once, the resulting sales figures (which are typically high) gain a ton of media attention. After things taper off, we start to hear the “gaming is dying!” stories again. What Can GameStop Do? In the fictional scenario above, our dairy-only market was left with very few options. It could, in theory, use its spare capital to buy up a few farms and begin to produce its own dairy products. But DairyStop does not have any experience in this area. Just because the company has mastered the art of selling these items does not mean it can produce them. The same is true for GameStop. It could go out and buy a struggling publisher, whip it into shape, and produce a few great games. But would there be any point? The amount of money that would be needed to pull this off (not only in the acquisition but in hiring talent, producing a quality game, and marketing it to consumers) could greatly exceed the benefits. That, of course, assumes GameStop was successful in this endeavor. With no prior experience in this realm, it could be a total disaster. Unfortunately, there isn't much else that GameStop can do right now. It could use some of the power it holds over the game industry to politely encourage it to perform more productively. But by doing so GameStop could end up alienating the suppliers (game publishers) it needs most to sustain its own business. Follow me @LouisBedigian