USED GAMES A BOON AND A BANE FOR INDUSTRY

The rap on video games is that they're pricey and getting pricier. But if that's what you suspect, you haven't shopped around lately. The typical $49.99 MSRP for a hot, first-rate title is only for gamers who insist on a pristine copy of, for example, "Peter Jackson's King Kong: The Official Game Of The Movie."

Other, less-fussy gamers can go to their neighborhood GameStop, plunk down $27.99 for a so-called "preowned copy," and go home knowing they saved 44% on what is essentially the very same game -- perhaps without a manual or box -- but guaranteed to work nonetheless.

No, that's not because "Kong" is a moldy-oldie that's outlived its shelf-life. Its publisher Ubisoft released the top-rated title just 12 weeks ago, on Nov. 21, and Ubisoft and retailers are still selling it in Xbox, PlayStation 2, and GameCube console formats for its original $49.99. That's just the way the used-video-game biz works, much to the chagrin of the companies that make the games who seem to be increasingly critical of how their new-games business is being affected by the used-games business.

Here's the used-game business model: A gamer who bought "Kong" new at retail, who finishes it or just decides he doesn't want to keep it, can sell it back to GameStop and receive $9.60 in cash or $12 credit towards another game. GameStop marks that up 133% and resells it for $27.99 which, according to Michael Pachter, contributes to the company's $800 million to $1 billion in annual U.S. sales on used games alone. Pachter is a research analyst covering the videogame sector at LA-based Wedbush Morgan Securities.

"GameStop and Electronics Boutique [which merged with GameStop last April] essentially own about 80% of the second-hand game market," says Pachter, with about 3,200 stores in the U.S. combined. Their competition comes mainly from Movie Gallery's Hollywood Video and Game Crazy stores and Blockbuster's Game Rush stores. And Best Buy is currently testing the used-games business in about 50 stores.

A spokesperson at Grapevine, TX-based GameStop would not return calls for this story.

Meanwhile, what Pachter is hearing from publishers is that each second-hand game sale cancels out one possible new-game sale, which is cutting into the game makers' profits.

“Publishers were originally looking at the second-hand market as a second swipe at the apple,” observes Hal Halpin, president of the Interactive Entertainment Merchants Association (IEMA), the trade association that represents 75% of retailers that sell video games, including Wal-Mart, Toys R Us, Circuit City , Target, and Blockbuster. “They were hoping that used games would drive new sales, or that there might be a revenue-share option, such as with DVD rentals.”

But apparently they feel it hasn't turned out that way.

“I think publishers are making noise because they'd like to get a piece of that almost $1-billion that GameStop is making … and that's all there is to it,” says Pachter. “Or they'd like to somehow regulate the price of used games, to be able to say to GameStop ‘we'll sell you copies of, say, the brand-new “Halo,” but you've got to promise us that you won't sell the used copies for less than 80% of the new price.' If the retailers were to do that, if the used copies of a $50 game would go for, say, $40, most gamers would pay the extra $10 for the new version. That's how the used market would be regulated, but I don't think that's going to happen.”

While the used-game business has been an ongoing concern of publishers, the problem for them has been exacerbated by the current sales slump and the fact that the industry is in a platform transition from current-generation to next-generation consoles.

“Publishers have always been leery of this model and how it doesn't help promote sales of new games,” explains Wim Stocks, executive VP at Atari. “But my vehemence is more pronounced now because, in a platform transition, gamers will always find the most economical way to buy or play the current games -- either by renting them or buying them used -- before switching over to the next-gen games. And that just seizes up the marketplace for current-generation products.”

While gamers may be anxious to commit to newer consoles, he adds, that has proven very difficult given the fact that Microsoft's Xbox 360 is in such short supply.

Stocks' preference would be to have some sort of agreement with retailers that used games could only be sold, say, three or six months after the launch of a product.

“But, if you talk to anybody in the used business, they'll tell you that they don't make enough margin on sales of new releases and that, in the large, expensive environments in which these guys operate -- in the mall-based stores -- that a three- or six-month delay becomes a problem for them,” Stocks says. “While some of that may be posturing, I'm sure some of it is real and we as an industry have to address this segment of business in a way that's amicable for both the retailers and the publishers.”

Despite calls to some of the other large game publishers -- including Electronic Arts, Ubisoft, THQ, Activision, Sony, Vivendi Universal, LucasArts, and Capcom -- none were willing to comment for this story.

Not everyone agrees that the second-hand-games business is hurting new game sales.

“I appreciate their perspective,” says the IEMA's Halpin, “but have a hard time seeing the sales erosion that the publishers' claim. I've had these kinds of discussions before with publishers and I suggested to them they should look at rental and used as avenues to expand their potential base. Imagine if rental had never come along; it would have been phenomenally detrimental to the growth of the business. Any publisher today will tell you that Blockbuster and Movie Gallery are both Top 10 customers for them. We work in a hits-driven business and games that don't sell well in the first 60 days have a financial impact on the entire sector. The used and rental markets expand that window and permit secondary opportunities.”

Indeed, the existence of the used market increases the number of new purchase transactions, argues Pachter, because only people who bought new games have games to trade in.

“And when they trade in their games and get a GameStop credit, what do they do with those credits?” he asks. “They buy games, of course. Sometimes they buy new games. If, instead, they buy used games, so what? In creating more demand for used games, it keeps the price of used games up, which means there is less cannibalization of new-game sales. It's all a very delicate balance. And I think the market will tend to keep things in equilibrium.”

At Atari, Stocks says he agrees that if a consumer buys a new game with credits for selling an old one, it does “help keep the churn in the marketplace. But publishers are spending most of their marketing dollars at the time of the launch of a product and most TV campaigns run a week to six weeks past launch. Yet, in that timeframe, somebody can buy a cheaper, used version of the game and that is certainly not helping the publisher who has made a massive investment not only in the game but also in the marketing of the game,” he notes. “So, yes, the used sale can generate a new sale later on, but that's not when the money is really needed.”

Industry observers see the used-game business continuing to flourish for several reasons. First, gamers are being conditioned to trade in their used video games more quickly; unlike a movie that they might want to watch over and over again, once they've beaten a game, they're done with it … and they know they can exchange it for something new and more challenging.

More importantly, predicts Pachter, there will be a supply spike in used Xbox games when the current-generation console is discontinued.

“Sure the next-gen Xbox 360 is supposed to be backwards-compatible with the Xbox -- meaning that you should be able to play the older games on the new console -- but, in most cases, you need to go online to download a patch to make the older games work, and most gamers aren't going to want to do that,” he contends.

While Microsoft hasn't said when it will stop manufacturing the Xbox console, Pachter notes that the company stopped taking delivery of the nVidia graphic chipsets on Aug. 1, 2005 . “From that day forward,” he explains, “Microsoft has only been able to make Xboxes with the nVidia chipsets it has in inventory. By my calculations, they only had 2 million chipsets in August and the company has built one million Xboxes since then. Then means that they can't manufacture Xboxes much longer, not without the graphic chipsets. ”

One wrinkle that could have a devastating effect on the used-game business is an encryption patent that Sony owns, according to Pachter. If Sony were to incorporate it into its not-yet-released PlayStation 3 (PS3) next-generation console, he reports, new games loaded into a PS3 would automatically be registered with that particular machine. Any attempt to play the game on another PS3 wouldn't work.

“I believe that Sony came up with that technology to thwart piracy,” Pachter says, “but if they were to use it, it would also thwart second-hand sales since nobody would buy a game that can't be played elsewhere.” Pachter doubts whether Sony will implement the technology “mainly because it would be very unpopular with gamers who like to take their games over to their friend's house and play them with others. However, you never know.”

Since publishers have little leverage over the used-game retailers who, according to Pachter, own at least 20% of the games market, the sector is likely to continue to do well.

“Honestly, publishers can gripe about the used and rental markets ‘til the cows home, but the reality is that the First Sale Doctrine permits the legal re-sale of this product,” notes the IEMA's Halpin, “so it's a moot debate. If we, as an industry, are truly worried about the commoditization of our products and the erosion of wholesale and retail price points, there are far better uses of our time to that end. We need do nothing more than come together and discuss the matters face-to-face and agree upon resolutions that are both practical and legal.”

Atari's Stocks agrees but says it's not that easy: “Speaking only for Atari, I can tell you that we've tried to have a dialogue with the used-game retailers as recently as last year. We believe there's a discussion we can have with them about how publishers can share in the proceeds that come from a secondary sale. Obviously, that would make us feel very differently about the business. But, at this point, those kinds of talks have been met with a lot of pushback and it's just not something the retailers seem willing to consider. What can I say? The balloons have been floated.”