Can a big “O” squash a little fly?

Internet clearinghouse Overstock.com Inc. is launching online video game rentals, presenting a new challenge for GameFly Inc., the L.A.-based market leader.

Salt Lake City-based Overstock, GameFly and others are hoping to vacuum up a bigger share of the $700 million game rental market, with a subscription model similar to that of DVD phenomenon Netflix Inc. For a monthly fee, gamers can rent one or two games at a time, keep them as long as they want, mail them back when they’re finished using the postage-paid return envelope, and wait for delivery of the next game on their list.

But it’s still a fledgling market, and companies like GameFly have to convince users that it’s worth it to pay $15 or $21 per month when they can go to their local video store and rent a game for about $6.

Blockbuster Inc. currently enjoys the lion’s share of the video game rental market it took in almost $500 million in game rentals last year, about 11 percent of company revenues.

The couple hundred million left over belongs to the online rental market, where GameFly and several smaller companies are vying for gamers’ attention.

Backed by Sequoia Capital, privately held GameFly does not reveal revenues, spending, or subscriber numbers. But it has about 4,000 game titles in its library. “We carry virtually every game released in the U.S. every year,” said Chief Executive David Hodess. “Almost all gamers rent games that’s a fact that everyone in the industry is aware of.”

And with next-generation video games priced in the $60-range, the idea of renting before buying becomes more attractive.

“If you’re buying a car, you’re certainly going to want to drive it first,” said Ryan Masterson, national sales director for game publisher THQ Inc. Most video rental outlets have added a sales portion to their business, because many customers find they enjoy renting a game so much they want to keep it. “It’s like a free demo for us,” Masterson explained. “If they never rented it, we would have never gotten any of that customer’s business at all.”

GameFly offers used titles for purchase at a 20 percent to 30 percent discount and they’ll send the original packaging.

Few statistics are available on the rent-to-buy market, but the NPD Group tracks consumer behavior and video game retail sales. “There’s a certain comfort zone with video game consumers when it comes to how much they’re willing to pay,” said David Riley, video game spokesman with NPD Group. Last generation video games cost between $40 and $50 per game, but with the launch of the Xbox 360 and the upcoming PlayStation 3, last-generation titles have been slashed to the $20 to $30 range. These consumers will migrate to the new systems, and “at $60 per software title, the sticker shock can be intimidating,” Riley said. “That’s where video game rental companies can ‘help’ the consumer.”

But it won’t necessarily help the rental companies.

Tricky terrain


Netflix enjoys a revenue-sharing agreement with movie studios, so it buys DVDs at a cut rate about $12 per disc. Video game publishers, on the other hand, have no such agreements with online rental outfits. GameFly is forced to buy games from distributors at a wholesale price, or about $40 for a game that retails for $50. Next-generation titles that retail for $60 will only be more expensive. Concerned about the viability of the market, Netflix has famously stayed away from the video game business.

“I’m even less optimistic now about online (game) rental than I was before,” said Michael Pachter, analyst with Wedbush Morgan Securities. “Yes, the higher game price is more conducive to rental, but the problem is the rental outfits have to buy the games.”

Another problem is longevity. Unlike movies, which can still have a rental life a year or two after release, video games die. There’s no reason to play “Madden NFL 2004” once “Madden NFL ’05” is on store shelves.

Game publishers do forge sales agreements with some video rental outlets, though it’s not as sweet a deal as the movie business.

“We work very closely with Hollywood Video and Blockbuster,” Masterson said. “They’re both top-20 accounts of ours, and are pretty significant to our business.” The two video stores made up almost 5 percent of THQ’s total sales of $757 million last year.

“We have not had those discussions yet with GameFly, but I’d love to model the business very similarly,” he said, adding that he has already received calls from Overstock.com, though he has not had a formal conversation with the company.

For its part, GameFly intends to forge ahead with its business model. “We have no big plans to phase anything out completely,” Hodess said. “We pretty much need to stay close to what’s successful.”

GameFly spent almost $3 million last year in advertising according to TNS Media Intelligence, hitting its target market on MTV, gaming magazines and online. Overstock.com spent $17 million in media advertising in one quarter last year.

But pessimists say all the advertising in the world won’t make up for a dicey business model. “Higher costs for raw materials are actually worse for the online rental model for games,” Pachter said. “It’s going to pretty much seal the fate of these guys.”