Digital Is Set to Disrupt Another Industry

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Innovation in tech continues to accelerate at a rapid rate. We are seeing a volume of start-up financing and valuations that we haven't seen since the dot-com bubble. However, the difference this go around is that the products and services being created are very "sticky" to consumers' lives. Meaning, we are seeing the likes of "game-changing" tech that is proving to be highly useful for everyday use, from Uber to DropBox.

Yet, the high level of innovation goes beyond the typical start-up; we are seeing a higher emphasis on innovation at large companies, such as Google, which is working on driverless cars. In any case, the market is filled with companies that will be greatly affected by the rise of the digital world.

Newspapers are already feeling the squeeze, as well as printer makers and the U.S. postal service. However, one of the companies that will see the greatest impact will be GameStop . The transition to digital gaming will likely be swift, catching many investors off guard; akin to when drowned out the book industry earlier this decade. Amazon almost single-handedly bankrupted Borders and it has helped cut Barnes & Noble's market value in half over the last decade.

There are a couple of big headwinds that will continue to pressure GameStop. The biggest, of course, is the rise of digital content, while the other is a potential disappearing of the console. It took the gaming industry seven years to release the latest string of gaming consoles. It appears that for every release, the downtime is getting greater and greater. That's because consumers, and gamers, are filling their time with mobile games.

Granted, the latest string of consoles pushes the limits when it comes to gaming, expanding beyond just gaming and taking a bigger role in living room entertainment. Yet, the success of the new consoles will not translate into a one-to-one success ratio for GameStop. That's because the big draw for console owners isn't just games this go around. Many consumers are purchasing the new platforms for household entertainment purposes. There will be more time spent watching movie and streaming-video content than ever before. A big contributor to the this has been a transition away from conventional cable TV and to lower-cost options, such as Netflix.

An end to consoles 
The Microsoft Xbox One and Sony PlayStation 4 could be the last major console releases we ever see. Now, that's a bold prediction but not unprecedented. It's no secret that Xbox doesn't make up a huge part of Microsoft's revenue. There's even been speculation that the tech giant could look to spin off the unit.

The losses for Microsoft's "other" businesses, which include Skype, Xbox, and Windows Phones, is almost $2.5 billion per year. However, its entertainment/devices segment continues to break even thanks to Android royalties; effectively, hiding just how poorly Xbox might be doing.

Beyond that, there's a lot of uncertainty still surrounding the company, including who will be the next CEO. As a result, investors should be on the sidelines. The company is already up 35% year to date.

Meanwhile, even Sony has its own issues. It's currently still in the middle of a battle with activist investor Daniel Loeb, who wants to spin off the entertainment division. During its third-quarter results, Sony saw its gaming segment lose $8 million year over year. Sony also struggled to make a profit off of its PlayStation 3 that was launched some seven years ago. Like Microsoft, Sony has its focus on other products besides gaming. Sony's main business is movies and music. As well, its other key business is smartphones, which is where the majority of its capital is going these days.

The rise of digital delivery should only continue. There is an increasing number of video game developers distributing their games via digital platforms. Both PlayStation and Xbox already allow gamers to download digitally purchased content, right from their couch. Given the need for convenience, digital should continue to gain momentum.  

While the average console gamer is 30 years old, this generation is being outpaced by the younger generation. Gen-X has some 50 million members, while Gen-Y has more than 70 million. Generation Y loosely includes individuals born between the early 80s and early 2000s. The significance of this is that the younger generation will lead the way with the transition away from consoles to portable games.

Foolish bottom line
All in all, the move toward digital is coming, and with it will come the decrease of needed hardware. With more than half of GameStop's revenue coming from the resale of used games, it has a lot of exposure to digital downloads. As gamers transition toward the digital market, and as console gaming gets overtaken by social gaming, GameStop will feel the pressure on the top line.

Remember that when Microsoft made its announcement to prevent the playing of used games on the Xbox One, GameStop had a violent sell-off. Ultimately, a large part of GameStop's revenue could disappear in a very short time period, leading to an even more pronounced and prolonged downward spiral in its stock price. 

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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