Both GameStop Corp. (NYSE:GME) and Pandora Media Inc (NYSE:P) appear to be facing immense challenges. GameStop Corp. (NYSE:GME)’s product, video games, is rapidly becoming digital-only, while Pandora Media Inc (NYSE:P) is facing an onslaught of competitors that offer a far better service than itself.
GameStop is today’s Tower Records
Tower Records was the dominant music retailer for most of the second half of the 20th century. It declared bankruptcy in 2006 after its product — music — went wholly digital.
The same phenomenon is currently taking place with GameStop Corp. (NYSE:GME), the world’s largest retailer of video games. Since 2005, more and more games have been available via direct, digital download.
Not like books
But I should make one point here. The phenomenon taking place in video games is different from the one afflicting the book market. While digital books are infinitely more convenient, there are still plenty of people that prefer to read a traditional, paper book.
In fact, a 2012 study revealed that more than 2/3rds of Americans still prefer paper instead of digital.
Perhaps this is why Barnes & Noble, Inc. (NYSE:BKS)’s founder, Leonard Riggio, has offered to acquire the bookstore portion of the business. While some ambitious money managers may have projected the complete eradication of the physical book business (replaced fully by digital) onto Barnes & Noble, Inc. (NYSE:BKS), Riggio may be smart enough to understand that there will be market for physical books for quite some time.
New consoles, more digital
But unlike books, physical copies of video games are little different than their digital counterparts. In fact, video gamers may only prefer physical copies of their games for one reason: they can be sold at a later date.
Yet, that’s slowly changing. Microsoft Corporation (NASDAQ:MSFT)’s next console, the Xbox One, will still allow users to purchase retail copies of their games, but these copies must be activated and periodically verified online.
The details surrounding Xbox One’s used games policy remain murky, but if Microsoft Corporation (NASDAQ:MSFT) goes ahead with its plan to allow users to trade activation codes online, there will be no more incentive for a user to purchase a retail copy in place of a digital one.
For its part, Sony Corporation (ADR) (NYSE:SNE) has been experimenting with going wholly digital for years. The company released a version of its handheld PSP (called the PSP Go) in 2009 that was not capable of playing physical games, only digital files.
Further, Sony Corporation (ADR) (NYSE:SNE) has embraced the future of cloud gaming, purchasing Gaikai last year for about $400 million. With cloud gaming, users don’t even own a digital file, let alone a physical version of the game — it exists wholly on Sony Corporation (ADR) (NYSE:SNE)’s servers.
The third player in the console trio, Nintendo, has not moved as enthusiastically towards a digital future, but its recent console, the Wii U, has thus far sold poorly, lessening Nintendo’s overall relevancy. Still, Nintendo does offer digital downloads of many of its games.
Like music a decade ago, video games appear destined to go fully digital, perhaps within just the next few years. When that happens, it’s hard to imagine GameStop Corp. (NYSE:GME)’s core business surviving.
Pandora is one deal away from having its business rendered completely obsolete
Pandora Media Inc (NYSE:P) hasn’t been a public company for very long, but it wouldn’t surprise me if it wasn’t one for much longer.
Shares rallied 8% during Thursday’s after-hours trading session, primarily because the company reported a revenue figure that beat expectations. Yet, the Internet streaming giant continues to lose money, posting a loss per share of $0.16.
But questions of profitability and loss aren’t the company’s issue. Rather, Pandora Media Inc (NYSE:P) is challenged by a far more severe problem: the rise of competitors that offer a service far superior to its own.
Pandora continues to insist that these competitors pose little threat to its business, that they’re “fundamentally” attacking different markets. The company’s CEO, Joe Kennedy, explained this on a recent Bloomberg appearance:
“[Google Inc (NASDAQ:GOOG)’s new music service] is fundamentally different from Pandora Media Inc (NYSE:P). Pandora is really all about radio, our goal is to redefine radio…Google Inc (NASDAQ:GOOG)’s is fundamentally a paid service. It’s fundamentally about on-demand access to music.”
Kennedy is, of course, completely right in his assessment of Google Inc (NASDAQ:GOOG) music. To get access, users must pay a monthly fee. What’s more, mobile access is limited to those with Android devices.
But a subscriber to Google Inc (NASDAQ:GOOG) (or any of the other music services) isn’t likely to use Pandora Media Inc (NYSE:P). While Google Inc (NASDAQ:GOOG)’s music service does offer on-demand functionality, it also has radio capabilities — as do the other subscription services like Spotify and Rhapsody.
Pandora Media Inc (NYSE:P) has been widely successful on mobile devices, posting steady revenue growth that has far exceeded its desktop growth rates. Why is this?
To some extent, this is common sense. People want to listen to music away from their desktop — in their car, at the gym, or on a walk.
But a larger factor is that, excluding services of dubious legal quality, none of Pandora’s competitors are free on mobile. Although Spotify offers free radio functionality, its on-demand service requires a subscription to be used on mobile devices.
But Spotify is diligently working to change that. The company is pushing to get an ad-supported mobile version out there, and if it ever does, Pandora Media Inc (NYSE:P) will find itself facing a competitor that is virtually superior in every way — a combination of online radio and on-demand.
If Spotify was able to offer its service for free, a service that featured roughly 20 times more music than Pandora and the ability to play music on-demand as well as radio functionality, it’s hard to see why anyone would opt to use Pandora Media Inc (NYSE:P) in place of Spotify.
Trading broken businesses
I’m not advocating investors short either of these stocks directly. Because I’m not the only person smart enough to realize the immense challenges both companies face; short interest in the stocks is over 20%.
Consequently, someone short these stocks could be in for a world of hurt — periodic short squeezes coupled with a potentially high borrow could make the trade unprofitable, even if both businesses ultimately do deteriorate.
But at the same time, I just can’t see why anyone would plan on holding these stocks, assuming they aren’t playing the long side for a potential short squeeze. The long-term future for both companies appears fairly grim.
The article 2 Companies With Deeply Flawed Business Models originally appeared on Fool.com.
Salvatore “Sam” is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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