The Genius Accounting Behind Gamestop’s Power Pass Program

Gamestop is launching a new rental program called PowerPass. Here is the details from Engadget

The program will run you $60 for six months. You can drop in to your local GameStop to get a different game at any time, but you can only have one title out at a time. At the end of the six months, you can choose one game to keep for no extra cost. You’ll need to be a free or paid member of GameStop’s Power-Up Rewards program to sign up for the rental program.

Now, a lot has been said about this new program. Instead, I want to discuss why, from an accounting perspective, this is a genius idea.

If you’ve ever read Robert Kiyosaki’s book Rich Dad, Poor Dad, you’ll know there are two ways you can make money on an asset

Capital Gains – This is where you sell the asset you have for a price higher than you bought it for (I should note Capital Gains are a bit different, but we’ll focus on this definition for this article).

  • Cash Flow – The asset itself generates cash, such as a bond paying interest or an apartment complex paying rents.

 

Now, the way retail makes its money is through buying wholesale and selling to consumers. For instance, a Grocery story may buy Frito Lays Potato Chips for a $2.00 and sell them to you for $2.50, netting $0.50. Gamestop works the same way. They buy games from the publishers for a set price and sell them back to consumers at the suggested retail price. The used games business works the same way only Gamestop buys from you rather than the publisher.

The Problem With The Current Model

Gamestop takes a good deal of risk with this model. According to Bankrate, game prices start falling a few weeks after release. You can get a larger discount if you wait even longer (Bankrate claims about 12 percent based on their example). This doesn’t seem like much, but the margins are already tight. According to the LA Times, retailers make about $15 per title. If the price drops 12 percent, the margin shrinks to about $7. Even if Gamestop makes a profit on the sale, this may not be enough to keep up with payroll. This is why Gamestop has issues with unprofitable stores.

Analyst place Gamestop’s woes on the rise of digital, but I disagree with that notion. Gamestop global sales increased about 3 percent in the second quarter of 2017. The issue may be due to this pump-and-dump push from AAA publishers. Most game sales are made within the first few weeks, and then demand crashes (which results in a push for pre-orders). These games get traded in soon after release. Gamestop needs to sell these copies to new consumers who want it at the lower price. With the current model of games, it becomes harder to sell used game especially if the game was bad or lacked replayability. Gamestop can sell unsold new copies back to publishers, but they can not for used copies. For Gamestop to make money, they need to sell the games for more than they bought them for (this is why Gamestop is notorious for giving you so little for trade-ins).

To a degree, these risk aren’t unique to Gamestop. Retail is dependent on turning over enough goods to turn a profit. Because US accounting uses historical cost, fluctuating prices can greatly impact a store’s profit. Moreover, companies only recognize the cost of inventory when sold or deemed obsolete. It’s why analyst keep an eye on the inventory balance as increases may indicate obsolescence. Right now, Gamestop doesn’t seem to have this problem, but the company is still struggling with the pressure of the current model and unprofitable stores.

Why the Power Pass is Genius

So with the risk of publisher’s early push model, falling prices and talk of the model being “doomed”,  how does Gamestop manage. That’s where this program comes in. The program converts Gamestop’s retail model into a rental one. Better yet, it turns their used game inventory from capital gains cash flow. This is why Gamestop’s new program is genius.

Now, Gamestop sells you a service rather than a product. Their used games aren’t an asset that needs to be turned-over for more than they were bought. These games become part of a larger rental library. No longer does Gamestop need to worry about a glut of inventory littering shelves and backrooms. Now, these larger libraries become part of the service. Sell them or rent them. Either way, Gamestop makes money in the end.

This also allows Gamestop to buy used games for more money. Although used games can be as high as $55, they may sell a title for much less. With the Power Pass program, customers get a used game at the end of the period, essentially buying any title for $60. Since Gamestop is guaranteed $60, the company makes more money off the used game than they would have otherwise. Moreover, Gamestop needs more inventory in order to justify the program to customers (no one wants a rental program with too few games). Since they can get more on each used game, they’ll be able to buy your games for more than they may have otherwise.

And of course, this plan calms analyst’s fear of a “digital only future.” Renting games isn’t possible with a digital model, so the program will help to differentiate Gamestop from Nintendo, Sony and Microsoft’s digital storefronts. Even though I disagree with this notion, I’m sure it makes the investors and analyst happy.

Conclusion

For those paying attention to the company’s financials, note that Gamestop won’t recognize the revenue until the end of the rental period. Per Generally Accepted Accounting Principles, the revenue won’t be recognized until it’s earned. A portion accretes into revenue each month.

Nevertheless, this program is a great way to profit from their used game inventory. The reaction I’ve seen from the program has been very positive, and I am interested in it myself. And from an accounting perspective, it’s a genius move as it alters the company’s revenue model. It’s a great idea all around.

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