Tuesday, October 14, 2008

Used Games (part two)

Last week, in a discussion of the used game market, I linked to a New York Times article that referenced Internet Exchanges for Used Books: An Empirical Analysis of Product Cannibalization and Welfare Impact (written by Michael Smith, Anindya Ghose, and Rahul Telang). Yesterday, I was finally able to read the full study, and it raised some additional topics that I wanted to touch on today.

It's always difficult to compare different markets when talking about used goods sales. As an example, the study finds that the "cannibalization" rate for used book sales at Amazon is 16% (the percentage of used book sales that replace new book sales). However, the cannibalization rate is 24% for used CD sales, and an astounding 86% for used DVD sales.

I think it's possible that the difference in the cannibalization rate between CD and DVD sales may be misleading due to a limited sample size, but if the DVD rate is even 40%, it's huge.

Also, the study finds that the CD and DVD market are much more sensitive to the price of used goods:
...we note that the new sales of CDs, and particularly DVDs, are substantially more sensitive to changes in used good prices than are books: a 1% decrease in the price of used goods results in a 0.157% and 0.514% decrease in the sales of new CDs and DVDs respectively (compared to a 0.089% decrease in the sales of books).

So in the absence of corresponding data for the used games market, can we make any educated guesses?

First off, a caveat (thanks Scott Hills). The used market (Amazon) in the study is different than the Gamestop model, because Amazon doesn't stock any used book inventory--they're a transaction facilitator. This shouldn't affect consumer behavior, but at the other end, it certainly affects the behavior of the content provider, because this is (seemingly) a zero-risk business for Amazon.

Moving on. Certainly, it's fair to argue that digital goods (including games) will have a higher cannibalization rate than books, because their condition doesn't degrade over time.

Well, except they do. Sort of.

Think about it. The console replacement cycle means that every 4-5 years, there will be a new generation with 2X or more horsepower than the previous generation. Games look much, much better, because developers have more power to use. So while a digital copy doesn't physically degrade, when consoles get replaced, its desirability does, in effect, degrade to some degree.

Does that affect consumer behavior? I think it does, to a point, but no one has studied it yet.

Music isn't like that. Once CD's were introduced, they really haven't substantially changed in the last two decades, and the "high definition" audio formats have failed miserably in terms of gaining critical mass. I have CD's from 1988 and they sound as good or better than CD's I can buy today.

Watching movies, though, has changed substantially in the last twenty years, from VHS to DVD to Blu-Ray. And I think the improvement in picture quality each generation, while not as dramatic as generational change in consoles, has still been significant. Plus, inside the DVD generation, there was the introduction of progressive scan DVD players, which was nearly a generational leap by itself.

So while the rate of change (and improvement) still doesn't match consoles, DVD's to be the closest basis for comparison to the gaming market. And if so, then used game sales have an extraordinarily high degree of cannibalization of new game sales.

As an aside, I find it very puzzling that the cannibalization rate for used CD sales is so much lower than used DVD sales, because I would expect it to be reversed, for the reasons I've just discussed--in particular, that a CD in 1987 sounds as good as one today, while there are substantial differences in quality in the media used for movies. I'd like to someone study the habits of CD buyers versus DVD buyers to explain that difference, but today is not the day to explore that topic.

Now let's look at how manufacturers and publishers could respond.

How would console manufacturers mitigate the used market? I believe they would introduce a console that would get accepted by the mass market as quickly as possible (because of a reasonable price point), and would include innovations that would make previous generation games look "unfun" in comparison.

Fun degradation of the previous generation, in other words.

Oh, wait, we have that already--it's called the Wii.

Low price point, $10 lower cost of new games, innovative play experience. Why would anyone want a used Gamecube game at this point?

At the other end of the spectrum, there's the PS3. Overengineered, massively overpriced at launch (from a consumer standpoint), and more expensive games. It's the perfect recipe to keep the PS2 used game market thriving for years.

Not only that, but I think a robust used game market (for the previous gen) probably has its own cannibalization effect on new console purchases.

In other words, if you can't distinguish yourself, and quickly, the used game market will affect you in every direction--new game purchases, new console purchases, and consumer interest in general.

Let's move on to publishers. In a world where the used game market is not only thriving, but the business foundation for an eight billion dollar company (Gamestop), then how do developers and publishers respond?

Well, they've already responded in one way: they raised prices. New games for the PS3 and 360, at least, generally cost $59.95 instead of the $49.95 standard of the previous generation.

Yes, I know: development costs are higher, allegedly. Theoretically, that's certainly true, but do game companies plan development costs based on theoretical maximums, or on how much they can afford to spend developing the game to make a profit based on their sales projections?

I would argue that it's the latter--for anyone who wants to remain solvent, that is.

Publishers are in a Catch-22 situation here. They want to reduce used game sales, but they also want to sell more new games, and the more new games they sell, the bigger the used market will get. And while they may talk about transitioning to a download-only model, that's still 5-10 years away, at least, and it's going to make consoles more expensive (because if Best Buy can't sell new games and has zero margins on the consoles, they're not going to waste the shelf space). Plus, there's a reasonable chance that when the legal dust has settled, consumers will have the right to resell what they've downloaded.

Wouldn't that be a bitch for publishers? Gamestop wouldn't even have to stock inventory--they'd just resell licensing keys. I only imagine the fury that would ensue.

Why, exactly, am I giving up my rights to resell what I've purchased if I download it instead of buying it on disc? I don't think there's a good answer to that, really (there are plenty of bullshit answers, but no good ones), so I don't think the gaming industry should count winning that battle as guaranteed.

So what else can publishers do? Well, they can lock lots of content on the disc, and only unlock it once. The second purchaser is out of luck.

I don't like this approach--at all--but it clearly seems to be where we're headed. EA is already doing that with their sports games. The "Live 365" feature in NBA 09 (daily downloads that adjust ratings based on real-world game performance) is free, but if you buy a used copy, it's going to cost you $10 (it was originally reported as $20, but this was apparently in error).

Oh, and it's not just their sports games, because the "free 20 song download" coming for Rock Band 2 is only usable once per disc. The "AC/DC Live" tracks (coming soon to a Wal-Mart near you) includes a one-use code that will let you transfer the tracks into Rock Band/RB2.

EA isn't the only one, either. Micrososoft is including a one-use code with Gears of War 2 that will allow you to donwload five extra multi-player maps.


Really, I don't think either side is sympathetic here. Gamestop is a carrion-feeder, certainly, because of the ridiculously low prices they give people for trade-ins, but publishers won't accept returned games, and at least they're giving us something. Publishers have every right to be pissed off at Gamestop, but since they've completely shut off the return of games for refunds (even crap games that ship in alpha status), it's not like they come off as the victim here.

Actually, WE come off as the victim here.

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