Why the Great Video Game Recession Is Actually a Migration

Given the place that video games have occupied in mainstream consumer culture,
its hard to believe that there isnt greater opportunity to make a buck on them.
Consider Activision Blizzard (NASDAQ: ATVI ). The companys Call of Duty
franchise has transformed the entertainment industry over the past four years.
Perennial entries in the series2009s Modern Warfare 2 , 2010s Black Ops , and
2011s Modern Warfare 3 have sold in excess of 60 million copies. New Call of
Duty games are used to sell products from Pepsi (NYSE: PEP ) to Chrysler Jeeps.
Thats to say nothing of the companys World of Warcraft online game, which
commands a base of 10 million subscribers, many paying a monthly fee of $14.99.
Yet shares in ATVI have foundered around $12 for years now. Heres the truth
about the videogame business: millions play the games, millions pay for them,
but sales simply arent growing in the exciting ways they were just a few short
years ago. The industrys holiday sales paint a particularly troubling portrait.
According to the NPD Group, video game console sales shrank 28% year-on-year, to
$1.3 billion in December, with Sony (NYSE: SNE ), Microsoft (NASDAQ: MSFT ) and
Nintendo (PINK: NTDOY ) all seeing declines in total Playstation 3, Xbox 360,
and Wii sales, respectively. Game publishers like ATVI, Time Warner s (NYSE: TWX
) Warner Bros. Interactive, Take-Two (NASDAQ: TTWO ), and especially Electronic
Arts (NASDAQ: ERTS ) dominated game sales charts, but there wasnt as much
game-sales revenue to go around. It totaled just over $2 billion for the month,
down 14% year-on-year. November sales were strong enough to mitigate some of
that losscombined, retail game sales were down just 3% from 2010 across November
and Decemberbut overall, video games arent making what they used to at retail.
Total U.S. sales across gaming machines, games, and accessories in 2008 came to
$22 billion. This declined to just over $20 billion in 2009, and again in 2010,
to $18.6 billion. Retail sales sank to $17 billion for 2011. Where has all that
money gone? Will it come back? Maybe. These numbers are bad but not as dire as
they first look. As the Entertainment Software Association (a lobbyist group
representing the games industry) reports, consumers actually spent $25 billion
on videogames in 2010. The discrepancy between that number and NPDs recorded
number comes from the sale of digital goods and services online. The NPD didnt
begin tracking digital sales until earlier this year, and even then its
reporting of $17 billion in total sales for 2011 reflects retail only. The
virtual goods market—digital items purchased in social games like Zynga s
(NASDAQ: ZNGA ) FarmVille —is expected to total $2.2 billion across 2011,
while mobile games sold through digital services like Apple s (NASDAQ: AAPL )
App Store are expected to bring $5 billion in revenue for the year. The digital
market is recouping retail losses. Analysts with ABI Research expect mobile game
revenue to total $16 billion by 2016. The question now is whether retail revenue
will continue to retract or rebound when Microsoft, Sony, and Nintendo introduce
new machines to the market over the next few years. Nintendo already plans to
release the Wiis successor, the Wii U, later this year and many industry
followers expect Sony and Microsoft to introduce new devices for release in
2013. Those consoles may not be enough, though. Its important to remember that
when U.S. video game retail sales peaked in 2008, the industry was seeing
unprecedented demand for expensive accessory-based games, particularly ATVIs
Guitar Hero series. Instead of paying $60 for a game, consumers were spending
upwards of $200 for plastic instrument-based music games. In 2009, Guitar Hero 3
was the first individual game to break $1 billion in sales, predominantly
because of its high price tag. The market for these games has completely
disappeared, however, forcing both ATVI and Viacom (NASDAQ: VIA ) to cancel
their mutual franchises in the category. The contraction in retail sales since
then is a result of changing consumer tastes as much as a shift to digital
venues. The short version for investors: Keep a close eye on the video game
industry because it is going through a profound transformation. Once exciting
cult stocks like ERTS and ATVI may not ever recover, but new players will emerge
to take advantage of the shift. ZNGA has disappointed since making its IPO, but
others in that sector wont. For now, be wary. The sky isnt falling, just moving.
As of this writing, Anthony John Agnello did not own a position in any of the
stocks named here. Follow him on Twitter at