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I am an avid videogamer, and have a strong affection for Valve and its products. The corporation is responsible for cult-classic titles such as Portal, Half Life, Counter Strike, Team Fortress 2, and Dota 2.

It may surprise you to hear that my favorite product of theirs is not a game. My favorite Valve product is called Steam, and it gives gamers extraordinarily cheap access to PC games. Steam's ridiculous deals can reach higher than 75% off! Their bargains, and the advantages of PC gaming, have completely turned me and millions of others away from going to stores to buy games. After all, why spend half an hour and money on gas just to buy a game at 2-4 times the price?

The consumer pays for an unlimited download license when using Steam. This is particularly useful for older games where hard copies may be impossible or prohibitively expensive to obtain. Unlike with hard copies, the gamer does not have to worry about losing a disc. Steam remembers what they have bought and the customer may download the game as many times as they like.

What does this mean for me?

Fortunately for those of you invested in developers, such as Activision Blizzard (NASDAQ:ATVI), Electronic Arts, Inc. (NASDAQ:EA) Take-Two Interactive Software, Inc. (NASDAQ:TTWO), Sega (OTCPK:SGAMY), and similar companies, Steam gives you little to worry about. In fact, Steam is a boon. Steam allows your company to reach more players and achieve otherwise unattainable sales volume.

Steam does this by putting games that are several years old, and have stopped selling as a result of their age, on sale at a steep discount. Developers agree to this because margins simply do not matter with digitally downloaded games. The development cost is a flat amount. Every sale over this set amount is pure profit.

Developers figured this out years ago, and this is a significant reason as to why video game developers have managed to weather the recent recession. The sheer volume of sales that Steam can deliver completely outweighs the relatively negligible cost to the company.

Steam is able to offer massive discounts to both gamers and publishers by distributing the software from their servers to individual PCs. Because Steam does not require publishers to pay to manufacture discs and boxes and instruction manuals, and then ship these to retailers, publishers can allow steam to cut these great deals. All Valve has to do is pay for their server farm, which their cut of the sales more than covers.

Valve Corporation is a private company, and does not issue shares, which is probably why you haven't heard of them if you are not a gamer. It's a shame for us investors, as the company is quite profitable.

However, this does not mean we can simply ignore the company. Their impact on GameStop (NYSE:GME) is significant, and it will become even more pronounced over the next few years.

Let's begin by comparing prices:

Dark Souls: Prepare to Die edition

Game Stop - $39.99

What I paid on Steam during their holiday sale - $19.99

Tropico 4 (No Expansions)

Game Stop - $19.99

Tropico 4 and all expansions

Steam Sale - $10

Call of Duty 4

Gamestop - $29.99

Steam sale - $14.99

I could go on to list hundreds of other games with similar price gaps. Gamers value their money as much as anyone else. More and more shift to PC gaming, as I did, specifically because Steam offers such great deals, all of which can be accessed from the comfort of one's own home. These sales aren't rare one-time events, either. Steam has a daily sale, a midweek madness sale, and a weekend sale, for a total of 9 sales a week. Then there are the huge seasonal sales, which over the course of a couple weeks, puts almost every game in Steam's inventory on sale. Most games are on sale multiple times a year.

No need for alarm... yet

While this information may be alarming, I do have some good news for those of you who are long GameStop. As mentioned earlier, Steam is a PC program. Steam does not sell games that are exclusively for consoles (Xbox, PS3, WiiU). Console gamers do still make up the majority of gamers. Although precise statistics are difficult to obtain, we can get a decent idea through sales. Call of Duty 4's console version outsold the PC version roughly 10 to 1.

This is an extreme example, however. Each game varies in their console to PC sales ratio, and any gamer will tell you that any game from the CoD series is the perfect example of a "console game." As the author in the linked article notes, a more reasonable ratio of console to PC sales for CoD4 is 5 to 1, as digital PC sales (Steam) are not measured. Most other games have lower console to PC sales ratios.

At any rate, console gamers still have to do it the old-fashioned way, by going to the store and physically purchasing a copy. I'll be generous and say this is 80% of gamers (but not even 50% of total game sales). Owing to this, GameStop isn't quite as threatened by Steam as I make them out to be. As I mentioned at the beginning of the article (and will further address later), this 80% majority is dwindling rapidly.

Unfortunately, GameStop has not pivoted to cater to the PC gamer in the way Steam and other competitors have. This leaves GameStop in the position of "console game merchant." As the shift to PC gaming becomes more obvious, so too will GameStop's weakness in the gaming sector.

I have to give credit where credit is due. GameStop has done a decent job at retaining current consumers by offering trade-ins, a rewards program, and midnight release promotions. However, the dollar is king, and GameStop lacks control over one key aspect as a "console game merchant": the price of consoles.

The fading cost advantage of consoles

Console gamers like to tout the fact that a high-end PC gaming rig costs about triple what a console does, which completely offsets any price savings on PC software. They have a point. There is a growing problem with their point, though, and it's one other than the "red ring of death" debacle.

Sony (NYSE:SNE) is still losing money on their Playstation venture. Microsoft's (NASDAQ:MSFT) Xbox division has lost over $3 billion. The total losses between the two companies is roughly $8 billion. The logic behind accepting these losses was that the companies would eventually make up the difference in game sales and licensing fees. Unfortunately, time has shown these companies that this model does not work. Thanks in large part to the used-game market GameStop so effectively capitalized on, the next generation of these consoles could see price levels much closer to that of a PC.

A console offers less than half the utility of a PC. If the two become comparable in price, gamers will begin to wonder if the cost is worthwhile, particularly when a litany of games are available on the PC that are not available on any console.

The rest of the world plays on the PC

Cost arguments aside, "Performance and Enthusiast" PC gamers, defined as people who spend over $1000 on PC gaming equipment, are growing rapidly. China is the biggest component of this growth, and there was not a single country that showed a decrease in "Performance and Enthusiast" PC gamers. On top of that, there are over a billion PC gamers worldwide.

I wanted to compare the growth of the PC in China to console growth, but I couldn't find statistics on console use in China. It turned out there was a reason for that. The console market is non-existent in China. Sony and Microsoft simply do not sell consoles there. There are some hacked bootleg consoles, but these are much harder to get in China than a perfectly legal PC. This represents a catastrophic miss for Microsoft, Sony, and GameStop. The result of this failure is billions of yuan being pumped into PC gaming, making it a nigh-unstoppable growth machine, and I doubt Sony and Microsoft's gaming divisions will recover from this mistake.

PC gaming has growing competitive advantages

Hits including the Elder Scrolls series, Portal, Minecraft, and the World of Warcraft, to name but a few games, all have something in common: they were designed for the PC. Yes, some were eventually ported to consoles to increase sales, but that's not the point here.

Increasingly, developers develop games for the PC not only because it's where the real money is, but also because it is so much easier to do. The PC and Steam also allow independent studios to enter the gaming market with much lower costs.

The result is a leveled playing field for independent developers, resulting in the PC's dominance in attracting new creative talent. Even if money is no object to console gamers, quality still matters to these consumers, and the PC is where the quality games are being found more often.

Publishers also get about 4x the marginal revenue from Steam sales as opposed to retail, which is causing them to strongly promote PC gaming. If they can turn the current ~80% of console gamers toward the PC and Steam instead, their profits will skyrocket. It behooves publishers to take this course of action.

Competitive gaming is free advertising for the PC

The largest competitive gaming events are for the PC, thanks to the massive popularity of World of Warcraft and League of Legends. Would-be professional video game players invest countless dollars and hours into their shot at the big time, while hundreds of thousands of fans watch these players duke it out.

While hardcore gamers like this are a minority, casual gamers do take the hardcore players' opinions seriously. These professionals spend 8 or more hours playing every single day, and are an independent source. Gamers trust these players more than a CEO who is biased toward his own company. Since the professional gamers are mostly PC players, the console loses out on important publicity.

GameStop cannot win in the PC game market

It is apparent that the odds are stacked against the future of the console. As GameStop is indeed a "console merchant", this puts them in jeopardy. Frankly, it is too late for the company to shift their focus to PC game sales.

As I mentioned before, Steam crushes GameStop in terms of overhead costs, convenience, and pricing. There is no realistic way for GameStop to close this gap short of copying Valve's model, which will prove to be prohibitively expensive for GME. If the PC continues to gain market share at the pace it has for the last few years, there will be only one realistic option for GME. GameStop will be forced to scale down their operations, and that's the best case scenario.

If you remember what happened to Borders books back in 2011 due to Amazon's (NASDAQ:AMZN) pricing and convenience advantage, you may see a parallel here. Steam's service is similar to Amazon's, for video games instead of books. The difference is that Valve generates profit, and will be able to sustain their operations ad infinitum as a result. It would not be an exaggeration to expect a similar result for GameStop.

What about mobile gaming?

It has its niche, and is growing in popularity. Like the PC, it has a low barrier for entry for independent studios. These simple games also appeal to the masses. However, these games are not a threat to the PC or the console.

When a console or PC gamer sits down to play, the idea is to do so for several hours after work or school, and the experience is meant to be immersive. Mobile games are much simpler, and are more for killing time while waiting for your name to be called at the doctor's office, or in line at the deli. Certainly, this could change in the future.

But for now, and for the foreseeable future, mobile games and PC/Console games exist in separate universes, on separate platforms, with separate target audiences. Both Steam and GameStop have little concern for this market, and rightfully so. Devices like the N-Gage and the PSP were failures because these markets are indeed separate.

What to do

If you are interested in shorting GME, waiting until after the release of the new PS4 and "Xbox 720" (official name not yet released) is probably a good idea. Once GameStop enjoys the burst of sales from the release of these consoles, the environment will be much more favorable for a short position on GME.

If you have no position in GME, stay away. There are many safer and more profitable investments that you can make. There is some upside potential from the upcoming release of next-gen consoles, but in my mind it is not enough to warrant keeping money in GME, especially for the risk-averse investor. I suggest to anyone who is long to consider selling. Your capital will be put to better use elsewhere. I, for one, will be following my own advice and stay clear of any position in GME.

I am but one console gamer turned PC gamer. As my generation ages, more will follow in my footsteps. The gaming console's days are numbered, and so too are GameStop's.

Source: Valve, Steam, And The Threat To Your GameStop Investment