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Video Game Rental Service Gets Alpha Mail Rival

Santa Monica’s GameFly has been known as the “Netflix of video games” for years. But the industry leader in game rentals now faces a challenge because Netflix has pressed “start” on its own game rental business.

Last week, Netflix, the industry leader in movie rentals, announced that it will specialize in streaming movies. The Los Gatos company formed a separate division, Qwikster, for mail-order DVD and video game rentals. That could pose a problem for GameFly on market share and price point.

“GameFly is getting slammed,” said Billy Pidgeon, a gaming analyst at M2 Research in New York. “Netflix has certain economies of scale. It will be very hard for GameFly to compete on price.”

Pidgeon and other analysts said GameFly will face pricing pressure from competing with Qwikster, which will use the same home-delivery subscription model as GameFly.

Qwikster will have a wider customer base at launch than GameFly: Netflix has 24 million total subscribers, 14.2 million of which are DVD subscribers, according to one estimate.

GameFly, which reported it had 410,000 subscribers last year, did not respond to requests for comment for this article, citing a quiet period. A company spokeswoman declined to say whether the quiet period was in anticipation of a public offering. The company filed with the Securities Exchange Commission for a $50 million IPO last year, but hasn’t taken any other steps forward.

GameFly released a statement last week in response to the Netflix announcement, saying that competition in video game rentals is nothing new.

“We have continued to grow even as Blockbuster and Redbox increased investment in console games,” the statement said.

Blockbuster and Redbox offered game rental at stores and kiosks, however. Qwikster will be competing directly with GameFly because it will use a similar online subscriber and home-delivery model.

But GameFly could potentially benefit in direct competition with Netflix. In a note to investors earlier this month, Netflix said that its July price increase might drive away 1 million subscribers. Pidgeon said GameFly’s might pick up some of the unhappy defectors.

Analysts expect that customers will receive two bills – one for Netflix and one for Qwikster. Pidgeon said such a system could be a frustrating inconvenience for customers.

“There’s going to be some friction in splitting people who have a Netflix account,” he said. “That is going to buy GameFly some time.”

According to analysts who follow Netflix, the company has been aware that some customers have wanted game rentals added for years.

GameFly, which launched in 2002, charges subscribers from $16 to $37 per month, depending on the number of games rented.

Qwikster has not announced pricing for video games. The Qwikster DVD service will charge customers $8 per month to rent one disc at a time or $12 for two and up from there. There will be additional charges for games.

Pidgeon said GameFly can also distinguish itself from Qwikster by marketing itself as a service catering only to gamers.

Netflix, which has a market capitalization of $6.9 billion, will be able to outspend GameFly on advertising, said Andy Hargreaves, an analyst at Pacific Crest Securities in Portland, Ore. (GameFly is still private, but its market cap would be a fraction of Netflix’s.)

“They have more money than GameFly to invest in the business and to market it aggressively,” he said.

Confidence game

Netflix has not yet indicated how it intends to market the video game business. David Wells, the company’s chief financial officer, speaking at an investor conference in New York last week, said the expansion into video games was intended to instill confidence in the new spinoff company more than an attempt to get market share of game rentals.

“(The video game business) is a small thing,” Wells said. “It’s not expected to generate a ton of profit for us. But it’s more a signal that we’re … not abandoning DVDs for the consumer.”

Pidgeon said the mail-order rental market for video games isn’t expected to grow in coming years, as downloadable games become more prominent.

In May, GameFly acquired Direct2Drive, a digital gaming distribution company, and plans to launch its game download service later this year.

Netflix hasn’t unveiled any plans to distribute games digitally.

“We are the only retailer offering games physically and digitally for both rental and purchase,” last week’s GameFly statement said.

As the competition between GameFly and Qwikster plays out, the clear winners are video game publishers and distributors, such as Agoura Hill’s THQ Inc. and Santa Monica’s Activision Blizzard Inc., which sell their games wholesale to rental services such as GameFly and Qwikster.

“Both THQ and Activision benefit because it’s another distribution partner,” said Edward Williams, an analyst at BMO Capital Markets in New York. “As a means of increasing potential units of sales, it helps.”

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