PRINT THIS STORY:

CHANGE TEXT SIZE:

Video game business spawns new toy wars

By JIM McCARTNEY

When Nintendo 64 pumped life into Super Mario, it also revived a struggling video game retailing industry.

One company that benefited from the boost is Eden Prairie, Minn.-based FuncoLand, the national retailer of new and used video games, which has undergone a dramatic rebound in the past year. As a result, it has attracted new competitors.

Last year, new and used video game hardware and software sales increased nearly 50% to $5.5 billion, and FuncoLand sales enjoyed a similar spurt.

In the fiscal year ended March 1997, the chain saw its sales jump nearly 50% and witnessed an even more impressive leap in profits.

That trend has continued in fiscal 1998. During the first nine months of the current fiscal year, FuncoLand's sales rose 37% to $118 million (about 20% on a same-store basis), and its net income nearly doubled to $5.3 million.

Not bad after losing money in two of the last four years.

"It's been just a terrific year," said Stan Bodine, president and COO of Funco Inc., operator of the FuncoLand chain. "A real key for the industry is that prices are coming down for the hardware and the software, and there's better availability of the product."

Brent Rystrom, an analyst with Minneapolis-based Piper Jaffray who follows Funco, also credits the company's management for its success.

"It was an exciting turnaround," he said.

Enter Grow Biz International, Golden Valley, Minn., which hopes to provide head-to-head national competition. In August, the new and used goods retail franchiser paid $6.58 million for the stores and franchising rights of Video Game Exchange, a 40-store Cleveland-based used video chain.

One factor which prompted Grow Biz to enter the field was Funco's remarkable turnaround. Grow Biz watched the Funco's progress with particular interest, because both companies are located in the Twin Cities area.

"We'd been following the business since Funco was a local company," said Brad Tait, president of the new Grow Biz franchise chain. "We watched Funco, and we just decided the time is right."

Grow Biz officials saw FuncoLand ride an industrywide recovery which was sparked by the introduction of a new generation of video game systems from Sony, Sega and Nintendo, the Big Three among video game makers.

The transition pumped up both ends of FuncoLand's sales: customers bought new games and machines, and traded in their old ones, providing fresh inventory for young or budget-conscious customers. (FuncoLand's sales split 50/50 between new and used products.)

"There's another key reason for growth -- as players age, they continue to play, as 25-year-olds trade in their old machines for the new generation machines," Mr. Bodine said.

Grow Biz has since opened two stores under its new prototype -- called It's About Games -- and is in the process of opening three more. The company plans to open another 20 stores by yearend in its existing markets of Georgia, Kentucky, Maryland, Minnesota, Ohio and Pennsylvania. In addition, the firm expects to sell 40 more stores to franchisees this year, Mr. Tait said. In the long run, he hopes that It's About Games will grow to a chain of between 800 and 1,000 stores.

But the company has a long way to go to catch up to industry leader Funco, which has 250 stores in 19 metropolitan areas and plans to add 50 to 60 more during the coming fiscal year.

"Funco is by far the biggest player in this industry," Mr. Tait acknowledged. "But there's a lot of room and untapped markets."

As a result, after cutting back its expansion over the last few years, Funco again resumed an aggressive growth plan, adding 34 stores during the last three months of 1997, the last dates for which information was available at presstime.

Until recently, Funco's main competitors in the $5.5 billion new and used video game business have been Target, Wal-Mart, Sears, Roebuck and Co., and Best Buy, as well as national chains that specialize in computers and computer software. A few of those retailers are starting to accept trade-ins, although none have yet aggressively pursued the used market, according to Mr. Bodine.

While FuncoLand and It's About Games have stores in neighborhood centers and regional malls, they prefer power centers stocked with national retailers, including some of their competitors.

"We'd love to be in power centers next to a Best Buy, or a Toys 'R' Us, or a multitheater complex -- anything that attracts young teens," Funco's Mr. Tait said.

Although FuncoLand and It's About Games will be direct competitors, some key differences exist between the two. FuncoLand's stores are a little larger on average: about 1,500 square feet for FuncoLand, compared with about 1,200 square feet for It's About Games franchises.

FuncoLand sticks mostly to video games, machines and accessories, while Grow Biz has broadened the It's About Games concept to include other items appealing to its prototypical customer: the 17-year-old male. Among the additional items sold are computer game CDs, comic books, sports and video game trading cards, video game-related posters, animated videos from Japan called "anime," and video game strategy books.

While some new categories have done better than expected, such as card games, trading cards and strategy games, others have disappointed, such as CD-ROM video games, Mr. Tait said.

The financial strength of Grow Biz -- it had earnings of $2.6 million last year on sales of $91.5 million -- makes it an important new player in the industry, said Mr. Rystrom of Piper Jaffray. But he doubts whether the franchising approach will work as well in video games as it has in the other areas Grow Biz has pursued. Grow Biz also operates new and used goods retailers Play it Again Sports, Once Upon A Child, Computer Renaissance, Music Go Round and Disc Go Round.

"To succeed in this industry, you need extreme discipline and a broad base of knowledge," Mr. Rystrom said. "Given that, I'm not sure how well an independent franchisee will do."

Mr. Tait argues Grow Biz's sophisticated point-of-sale system, which reports sales back to headquarters, will help the chain build a huge database on which to track seasonal trends and regional differences.

Still, Mr. Rystrom said, the test for the independents will come when the next down cycle hits.

If Funco's experience is any indication, It's About Games is in for a ride as wild as the adventures of Nintendo's Mario or Sega's Hedgehog. As new hardware improves graphics or "playability," players eagerly anticipate the new machines, according to Mr. Rystrom's scenario. But given the lack of new software titles and high sticker prices (starting at $200) for the new machines, they hold off until software titles come out and hardware prices come down. In the meantime, sales go into freefall as the industry is caught in the transition, he said.

Franchises will be easier to sell during the current up cycle, Mr. Tait believes: hardware prices are coming down and new titles are coming out.

"We've seen a steady stream of new titles this year, while there were only limited releases last year," agreed Mr. Bodine.

Meanwhile, the older machines and titles go out almost as fast as they come in.

"Your four-year-old doesn't need the Nintendo 64 -- you can buy an old Nintendo with a one-year warranty and four games for less than $60," said Darcy Debing, FuncoLand's district manager for its 14 Minnesota stores, including 12 in the Twin Cities.

Grow Biz and Funco officials hope that Sony, a relatively new player in the industry, will help smooth out the cycles through its financial strength and marketing savvy.

Mr. Rystrom, however, thinks that's wishful thinking. Even Sony cannot buck the irresistible forces of the marketplace, he argues.

"I really doubt anything will smooth out these cycles," he said.

But Funco's cost-cutting and attention to detail during the last downturn could help it ride out retail's ups and downs, whether seasonal or the result of industry changes, Mr. Rystrom said.

"They did a great job to not only benefit from the up cycle, but to manage through the down cycle," Mr. Rystrom said.