GameStop's New Service Could Hurt the Company's Most Important Business

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GameStop (NYSE: GME) is adding another fold to its used video games business, and it's probably not one that investors should be celebrating. On Nov. 19, the company will roll out a program that lets members rent used video games. Subscribers to the PowerPass service will have the opportunity to take a used title from the store, come back and swap it out for a different one, and repeat this process as many times as they like within a six-month period.

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Even better for consumers, they'll even get to keep the last game that they have rented through the service, and it all costs only $60. That sounds like a pretty sweet deal for GameStop customers, but it's one that the company's shareholders are right to be apprehensive about.

PowerPass shows used-game weakness

GameStop's stock has slumped roughly 5% following the announcement of its rental service on Oct. 27 and now trades in the range of five-year lows. It's not hard to see why. On some level, the PowerPass program is an admission that the outlook for its used software business is worse than previously anticipated. Even more troubling, the service could actually further weaken the segment and accelerate its decline.

New and used software sales are GameStop's core profit drivers, and both are under threat as more consumers opt to purchase games through digital downloads. Similar to the way that downloading and streaming reshaped the home entertainment industry and rendered outfits like Blockbuster irrelevant, digital distribution is gradually hollowing out the video game retail business.

From a long-term vantage, this transition appears to be inevitable, and there's not much that GameStop or other retailers can do to stop it. On the other hand, how fast this transition takes place and how the affected businesses operate in the meantime remain crucial questions. GameStop needs its video game business to remain as sturdy as possible while the company shifts to growth segments like collectibles, mobile hardware, and wireless service sales. Any move from the retailer that could speed the decline of its software sales deserves intense scrutiny. 

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There's a real threat that GameStop is devaluing its used game business with programs like PowerPass. Granted, the retailer likely has more insight into inventory trends and other facets that indicate whether its new rental service can be a fruitful development, but there's the dangerous potential for a backfire here.

Last fiscal year, GameStop's pre-owned and value video game products segment accounted for 26% of sales and 46% of gross profit. The PowerPass program could also put a dent in its new-game sales. Used copies generally hit shelves shortly after a game's release, so members of the program won't have to wait long until the biggest new games are available for rental. Combined new and used software sales accounted for 55% of sales and 80% of profits last year, so it's crucial that GameStop has made a smart calculation by getting into the rental business.

What's the upside?

It's possible that the PowerPass program will encourage more traffic at the company's stores. Last quarter saw same-store sales traffic decline 8.9% year over year, and limiting further declines is an important priority.

If subscription members regularly travel to its stores to swap out their rented game, the company will have the opportunity to pitch preorders for upcoming software and hardware and also convert sales in other categories. This could be a boon as the company aims to increase sales of pop-culture collectibles at its stores.

Change isn't always good

Efforts to keep up with the impact of digital sales on its core software businesses should generally be welcomed, but GameStop's new program could actually offer too much value. At the very least, it highlights the retailer's precarious position.

As someone who has been eyeing GameStop as a potential buy based on its hefty dividend yield (now at roughly 8%) and solid performance for its growth businesses, the introduction of the PowerPass rental program makes me less bullish on the company, even after recent sell-offs.

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Keith Noonan has no position in any of the stocks mentioned. The Motley Fool owns shares of GameStop. The Motley Fool has a disclosure policy.