THE GAMES MAKERS PLAY

ANNE SHERBER

LOS ANGELES -- As the industry prepares for the Electronic Entertainment Expo (E3) here next week, May 11 to 13, retailers will soon witness media convergence in new game platforms.

As a result, some food retailers see traditional retail distribution threatened with the emergence of the newest of gaming hardware decked out, in varying degrees, with Internet, computer and DVD capabilities. Yet others say opportunity is ahead.

The industry continues to set sales records. Last year more than 215 million computer and video games were sold, a 19% increase over 1998 sales, according to data compiled by the NPD Group, Port Washington, N.Y. It was the fourth consecutive year for double-digit growth for the industry, and an increase of more than 100% since 1996.

Douglas Lowenstein, president of the Interactive Digital Software Association, Washington, D.C., and producer of the E3 show, noted that on a dollar basis, entertainment software sales topped $6.1 billion in 1999, an increase of 11% for the $5.5 billion in sales the previous year. Specifically, video game sales grew to $4.2 billion, up 13.5% from 1998, and PC games sales increased 15.5% from $1.8 billion in 1998 to $1.9 billion last year.

The huge growth in this segment of the entertainment industry has been generally good news for food retailers because the retail price of the most popular games begins at $29.99 and can climb to $69.99. Consumers are inclined to rent software either as a prelude to or instead of a purchase. Although game publishers are increasingly targeting adult gamers, the key demographic is still much younger, which makes supermarkets a convenient retail outlet.

"Video game rentals have always been very good for the type of consumer that we serve in supermarkets. It seems to be the right thing for a supermarket shopper," said Robert Feinstein, president of Marbles Entertainment and Supermarket Video Inc., both based here. Marbles has video rental departments in Albertson's and under SVI serves some 500 grocery stores on a shared revenue basis.

Additionally, unlike the demand for prerecorded movies, which, between revenue sharing and short pay-per-view windows, tends to decline dramatically after the first three weeks of release, video games have been virtually evergreen, with some groceries reporting that the games continue to rent briskly even a year after their initial release.

Bill Bryant, vice president sales, grocery and drug, for La Vergne, Tenn.-based Ingram Entertainment, notes that because of the product's long legs, many of the supermarkets that his company services realize between 9% and 15% of their rental revenue from video games.

But all that may be about to change.

The first sign of a shift in gaming software distribution came in early April when Sega of America, San Francisco, announced that it would give away its $199 Dreamcast consoles to consumers who sign up for two years of unlimited on-line access at $21.95 per month. In September, Sega, which has sold about two million consoles since its introduction, will launch SegaNet, an Internet service that will provide games directly to consumers over the Internet.

Gamers who sign on will receive the console and a keyboard. Those consumers who have already purchased consoles will receive a keyboard and a $200 rebate. SegaNet is an indication of where the company expects its emphasis to be, going forward, said industry observers. Sega is convinced its target audience -- 12- to 24-year-old males -- wants to play games over the Internet. About a dozen major games are expected at the launch. Food retailers are responding cautiously to this news, said industry executives. According to Bryant, most of Ingram's customers have significant Dreamcast inventory in their rental libraries with no immediate plans to reduce their purchases or sell off current titles.

The Sega Dreamcast console is the only console that currently comes with a modem preinstalled. But that may well change when Sony Computer Entertainment America, Foster City, Calif., debuts its eagerly anticipated Playstation 2, scheduled for the fall. "The Playstation 2 will probably be the largest launch of any consumer electronics product ever." predicts Josh Marson, video game buyer for the Woodland, Calif.-based Valley Media. "They'll easily reach a million units within a couple of weeks after launch." It appears that Sony is taking steps to ensure that Marson's prediction comes true. Media sources reported last month that an unnamed Sony employee confirmed that the new console, which has already appeared on the cover of Newsweek, will ship with a modem and a hard drive. Sony's console, which sold close to one million units in two days when it was introduced in Japan, is already equipped with a DVD drive that will also play audio CDs.

The machine also boasts backward compatibility -- old games will play on the new hardware -- a feature of particular importance to supermarkets with significant investments in inventory. "The backwards compatibility is an extremely important issue for retailers," noted Bill Liesenfeld, nonfoods buyer for Houston, TX-based Sak 'N' Sav, which carries Playstation and Nintendo titles for rental.

By adding a hard drive and a modem, Sony would not only be taking direct aim at Sega but would also be making a preemptive strike against software giant Microsoft Corp., Redmond, Wash., which recently announced that it will release its own gaming hardware. If consumers can be convinced to use set-top gaming consoles as DVD players, one benefit of the new tricked-out boxes could be increased DVD rentals. The same customers who take home games may want to rent movies on disk. "We're recommending that if a supermarket with a rental department is not currently carrying DVD for rental, that they enter that category before the new gaming hardware is introduced," said Bryant.

The Microsoft product, called the X-box, is expected in the fall of 2001, and will be a hybrid game-console-cum-PC, featuring a Pentium III processor and an eight gigabyte hard drive. The company is said to be currently courting game developers. "The games are what matter to our customers," said Ryndie Liess, video manager of Country Mart in Hollister, Mo., which currently carries software for Nintendo and Playstation consoles. Liess estimates that her video rental department derives about 5% of its revenue from game rentals.

The final wild card in the game wars will be Redmond-Wash.-based Nintendo of American's next generation machine, the Dolphin, which is not expected at retail until January, 2001. Nintendo, currently with the biggest market share, is also the biggest target. But the company has a few aces up its sleeve, not the least of which is that it is the video game licensee for Pokemon. The franchise is so strong that even though the Playstation 2's arrival is imminent, sales of the current console have been brisk, driven in part by the availability of Pokemon Stadium, which allows set-top players to connect to the wide range of Pokemon games available for the Game Boy.

But even with Game Boy's enormous appeal and market share, supermarkets are reluctant to carry the software either for rental or sale because of software's diminutive size. "Too easy to steal," noted Feinstein.

There are signs that even before the upcoming sea change in video gaming, some supermarkets are abandoning the product. One Utah-based retailer, who asked not to be named, indicated that competition from Hollywood, Blockbuster and other retailers are keeping margins very low. "I'm giving [video games] six months," he said, noting that he is looking at one-hour photo where his games rental area is now.

Although on-line gaming may not have the immediate effect of eroding video game rentals at retail, it seems inevitable that, ultimately, more and more gaming software will be acquired over the Internet, bypassing traditional retail outlets. The speed with which consumers have adopted the DVD format signals a new willingness to abandon old formats for new ones and may foreshadow consumers' readiness for new gaming options, said industry watchers.