GameStop CEO Paul Raines Talks Retail Transformation by John Gaudiosi @FortuneMagazine April 14, 2016, 4:05 PM EDT E-mail Tweet Facebook Linkedin Share icons GameStop gme has built a $1 billion digital business, and its collectibles business has grown from $75 million in 2014 to an estimated $500 million business in 2016 with a $1 billion forecast for 2019. But the overall video game industry saw a 15% slump in physical retail sales in 2015, and the console games business has been flat since 2012. GameStop has tried to combat this trend through diversification and expansion across four key businesses, including physical game products, mobile and digital gaming, collectibles, and technology brands. The company has even entered the traditional publishing business with Insomniac Games’ upcoming independent game, Song of the Deep, which will also be supported with a children’s book series. Most recently, GameStop met with its investors today in Dallas, TX to discuss the company’s transformation strategy. In 2015, GameStop saw 25% of its operating earnings come from non-physical gaming. That number is forecast to reach 50% of its operating earnings by 2019. GameStop has also added an $850 million business outside its brick-and-mortar stores through technology brands such as Spring Mobile AT&T Wireless (900 stores), Simply Mac (76 stores), and Spring Mobile Cricket Wireless (70 stores). That business is projected to deliver approximately $1.6 billion in revenues by 2019. Over the last two years, the average profit contribution of core GameStop branded stores increased 23% from $143,000 in 2013 to $176,000 in 2015. GameStop’s video game business grew 14% in 2015, and gained four share points, accounting for $524 million in revenues in the U.S. alone. Over 60% of GameStop purchases involve both the web (especially via mobile devices) and in-store transactions. The company has grown its PowerUp Rewards user base to 46 million people since 2010 and can target everything from games to electronics to this very active consumer base. With virtual reality itself now a reality as Facebook’s Oculus Rift and the HTC Vive are available now, Sony PlayStation VR coming in October, a new Nintendo NX on the horizon, and rumblings of both a PlayStation 4K and new Xbox One in the works, 2016 will infuse new hardware into the ecosystem. HTC is already demonstrating Vive in GameStop stores across the country. As the video game business moves away from physical purchases and more towards digital sales, GameStop CEO Paul Raines explains the company’s diversification strategy for its 7,076 global retail locations as well as the online business in this exclusive interview. Fortune: Many of the headlines around traditional console video games these days are negative. How healthy is the game industry? Raines: Last year, we had a record net income year, record profitability, and record gross margin. From a global perspective, we had a real good year all around the world. I would say our strongest units were probably Canada, and our weaker units…we sold Spain, and we’re consolidating and trying to get some cost reduction going in Europe. We expect to see an $8 billion business this year in the traditional games business. And our guidance is for a 3% to 5% operating earnings growth from 2016 to 2019 regardless of what happens in the physical games business. How is GameStop diversifying to stay relevant in the changing video game landscape? If you look at our results last year, we may be at an all-time high on profit contribution from our core GameStop branded stores. People want to say we’re going the way of the physical gaming dinosaurs and all that. The truth is we’re overtaking with market share gains through omni-channel sales—over 60% of customer purchases involve both the web and stores—and new businesses like digital and collectibles, a lot of the loss of physical gaming. At the same time, we’ve branched out into this technology brands business with Spring Mobile AT&T—which is approaching 1,000 stores—Spring Mobile Cricket Wireless, and Simply Mac. Those units have contributed a significant amount of revenue this year, and we’re forecasting for 2019 they’ll be a $1.6 billion business. What impact has AT&T’s DirecTV acquisition had on your business? One of the reasons we signed an exclusivity deal with AT&T was because they showed us the pipeline of what was coming. We knew they had landlines, a very aggressive and well-positioned wireless network, and we knew that they were entering the digital home networking space with Digital Life. And they shared with us they were looking hard at a DirecTV acquisition and some other services for the connected car and so forth. We’re in discussions now about some other announcements that we’ll make around other content that we can push out through DirecTV. It’s a pretty exciting when you think about all of the different things they could do with that platform because they can sell you that platform for your home, but it could also be on your phone, on your laptop, on all kinds of wireless devices. It’s a very interesting connectivity play for us. Would Kongregate be a potential gaming platform for DirecTV? We’ve discussed that. There are a lot of things we could do with DirecTV and with their media platforms. If you look at AT&T’s capital budget, they spend $18 billion a year on their network alone just to keep it maintained and growing and aggressive. In addition to that, they have a pretty healthy CapEx budget for acquisitions and joint ventures, and they’re very aggressive in the media space right now. We like that because basically they need us to be an excellent distribution addition to their corporate stores, and that’s what we’re doing. What’s the rollout plan for ThinkGeek as a retail chain? We have three stores in the U.S., but don’t forget we have over 30 overseas. Australia is the primary place, and those are branded Zing Pop Culture simply because we didn’t own ThinkGeek at the time. We have some aggressive plans in the United States. We’ve announced plans for 25 stores in the U.S., plus another 32 overseas. What have you learned about the collectibles business? When we first got into this we thought that the collectibles business was a pretty simple business. What we’ve learned is that the geek community is a whole lifestyle community. So not only do they like the Batman statues, they like Star Wars Darth Vader waffle irons and the Star Trek pizza cutter. We’ve got a lot of merchandise. There’s a lot of geek culture out there, and we found that it’s a highly fragmented $13 billion market in the U.S. There are not a lot of big players in it, and we’ve been able to roll into that pretty well. The ThinkGeek acquisition has been a very positive one for us because it let us pick up a website that had pretty significant traffic and over $140 million worth of sales. We’ve been able to remove a lot of their cost and their supply chain and the things that didn’t really have a big enough size to command better performance from their partners, but we also were able to leverage the wholesale business into our store. Our ThinkGeek stores also sell Funko Pop Vinyls, Pokémon cards, you name it; we carry it in there. ThinkGeek has been able to give us a pretty interesting platform. For example, we sell Walmart and Target wholesale ThinkGeek products. It’s a great way to leverage their design capabilities with our distribution capabilities and grow our wholesale business while we’re at it. Are you setting things up so if we do hit a point in the future where consoles don’t exist GME is running self-sufficiently? I don’t think there’s a doomsday on physical product. There will always be a physical business for us. I don’t think that will ever go away, contrary to what a lot of skeptics and everybody else thinks. We’ve always said that consoles are cyclical. It sounds very important because the traditional history of GameStop was to ride high in the console cycle and then hunker down and try to get through the slow period. Our board doesn’t want us to do that anymore. We’ve built a diversified portfolio so that as consoles cycle in and out, we do pretty well either way. We are trying to build a business that goes beyond just gaming. We’ve heard rumors about a PlayStation 4K console and a new Xbox One iteration launching this year. What impact would that have on GameStop? The traditional GameStop model during the emerging console cycle was to sell a lot of hardware, and the software and the pre-owned sales would lag behind. So you have a high top line and a lower margin. Then as the console cycle gets longer in the tooth, you sell more pre-owned and software. You get richer margin rates, but your top line is less. We’ve disrupted that now because we’re into the early days of the console cycle, and really our margin rates have expanded instead of contracting. That’s because the console plays less of a roll in our overall business today. When you add in our digital business, technology brands business, and our collectibles business, we’ve been able to expand our gross margin rate almost 600 basis points in five years. Of course, new consoles are always going to be good for GameStop. We probably had 35% to 40% market share on the consoles that just launched in the U.S., and most countries that we operate in. Given the diversity strategy does that impact the name of the GameStop stores? People have asked us, “Why don’t you change the name of the company,” and I don’t really want to do that. We’ve got debates going on internally all the time. GameStop is the right name for the company today, but in the future, it might change and transform. If we called it GME, maybe that means: Games, Mobile, and Entertainment. That could be a big category for us to be in, but nothing really to announce on that.