GameStop stock plummets on Amazon's entry into used games

You know that recession thing we've been going through? It hasn't been hurting GameStop. The nation's largest specialty video games retailer recently announced sales in 2008 were up a whopping 24% and profits rose 33%.

So why did its stock fall 14% today? Because somebody is about to kill the geese that lays GameStop's golden egg. Or rather, squeeze its margins.

Much of GameStop's profit growth comes from used games.Consumers like them because they're cheaper. GameStop loves them because the profit margin on buying a used game from some kid and then re-selling it is much higher than buying a new game from Microsoft or Activision and then selling it at a set $60 or $50. How much higher? Used game sales represent 44% of the company's gross profits, but only about 22% of its total revenue, according to Credit Suisse analyst Gary Balter.

Amazon.com's move today to start buying used video games is a major blow to GameStop's profit machine. Not because of the sales competition. There are already lots of used games for sale on Amazon.com through third parties. And it's not even clear yet whether the mega-etailer plans to sell the games itself on its site or wholesale them to others.

The problem is on the buying end. Amazon.com is offering higher prices to consumers than GameStop, or GameCrazy. As CNET News helpfully compiled, the difference ranges from $1.50 for "Mario Kart DS" ($16.50 vs $15) all the way to $2.75 for "Fallout 3" ($25.50 vs $22.75) and "LittleBigPlanet" ($29 vs $26.25).

That means one of two problems for GameStop: Either it will buy, and thus sell, fewer used games because more of us with games we want to get rid of will use Amazon. Or it will have to raise its purchase price for used games in order to compete, thus squeezing its profits.

It may not have to raise prices all the way to match Amazon, since consumers still there is a significant convenience factor to going to your nearby story. But it'll have to raise them some if it wants to stay competitive.

That's a win for consumers, a loss for GameStop, and further evidence for video game publishers that they have to come up with new features, like social play and downloadable content, that can keep the burgeoning used games market from destroying their business model.

Update: Analyst Ben Schachter of UBS thinks the market is overreacting, arguing that online trade-ins are very different from in-store. "Online game sales currently comprise less than 2% of GME’s [GameStop's stock ticker] total business (via the gamestop.com website)  and we estimate well-less than 10% of industry game sales," he wrote in a research note today. "We believe the 'instant gratification' of the trade-in process at physical stores remains a key advantage for GME, and we note that GME once offered online/mail-in trade-ins but stopped after issues w/product quality/shipping expenses. The bottom line is that [Amazon] is a formidable competitor, but we don’t see any meaningful near-term risk, and online used just isn’t a particularly big market."