Sean Spector was sitting in his darkened bedroom at 2 a.m., engrossed in a marathon session on the video game “Halo,” when he caught an entrepreneurial opportunity in his cross hairs: Why not do for gaming what Netflix Inc. had done for movies?
Spector was nearly done saving the galaxy from alien bad guys when he realized that it took only a few days to play through a game that cost him $50.
“The challenge of being a gamer is that you can never afford to play all the games you want to play,” said Spector, who teamed up in 2002 with fellow video game zealot Jung Suh to found GameFly Inc., a Los Angeles-based firm that charges customers a monthly fee to rent video games by mail.
The privately held GameFly has emerged as a leader among at least half a dozen fledgling firms attempting to take the business blueprint laid out by Netflix and apply it to the booming video game business, which racked up $7.3 billion in software sales last year.
Rental companies such as GameFly predict big opportunities over the next year as new game consoles from Microsoft Corp. and Sony Corp. debut. New systems generally generate a flurry of buying, but gamers fear that the cost of next-generation titles may rise above $50, providing a new incentive to rent.
But some industry observers are skeptical of the economic underpinnings of online video game rental firms, which pay far more for games than Netflix pays for movies. They note that the shelf life of most video game titles is much shorter than it is for movies, leaving little value in offering a deep catalog.
“I think GameFly’s just toast,” said Michael Pachter, an analyst with Wedbush Morgan Securities. “I think they’re an idea in search of a business model.... You might want to see ‘Mission Impossible’ ” years after it was released, but “you don’t want to play ‘Madden Football 1995.’ ”
Moreover, the companies continue to be dogged by the prospect that one of the titans of the movie rental business -- Blockbuster Inc. or perhaps even Netflix -- will begin offering video game rentals online.
An executive for Blockbuster, which currently rents video games from its store locations, indicated through a spokeswoman that this year the company would consider adding games to its online subscription offerings, though he cautioned that the company was satisfied with its current approach.
Revenue from video game rentals totaled $498.8 million last year at Blockbuster, accounting for 11.3% of the company’s rental revenue, the spokeswoman said. Industrywide, revenues for in-store video game rentals totaled $699 million last year, according to Rentrak Corp., which does not yet tally figures for online game rentals.
Netflix has no plans to add video games to its repertoire, a spokesman said.
Of all the rental companies, GameFly -- which declined to offer subscriber figures or discuss its financial performance -- may have the best shot of survival because of its deep pockets. It has received financing from Sequoia Capital, the Silicon Valley firm that provided seed money for Google Inc. and Apple Computer Inc., as well as Lehman Bros. Venture Capital.
The money has allowed GameFly to distinguish itself from the competition by advertising on MTV, Comedy Central and other television networks. The company’s subscriptions are also sold at Best Buy Co. stores.
“They’re helping out the whole industry” by drawing attention to online video game rental services, said Daniel Anello, chief executive and founder of GameLender, a rival firm based in San Jose that boasts more than 7,000 video game titles.
GameFly is run by Chief Executive David Hodess, who founded Cooking.com before taking over at GameFly. Founders Spector and Suh serve, respectively, as vice presidents of marketing and content.
GameFly targets men ages 18 to 35 and moms who rent video games for their kids with three service plans. For $21.95 a month, subscribers can keep two games as long as they like. When customers finish with the games, they drop them in postage-paid envelopes provided by GameFly, which then ships fresh titles gleaned from subscribers’ wish lists.
In addition to subscription fees, the company recoups the cost of the games by reselling them to customers at a reduced rate. Customers who rent a game and decide they want to buy it can do so with a click on the GameFly website, and the company then mails them the packaging and the instruction manual.
GameFly stocks more than 3,000 titles at a Los Angeles warehouse that serves as the company’s headquarters and lone distribution center. Netflix, by contrast, has 35 distribution centers.
The cost of acquiring the games continues to present problems for the rental companies. GameFly buys games wholesale from publishers and distributors, Hodess said, paying about $40 for each copy of a popular title.
“Making a profit with the high cost is one of the challenges,” Hodess said. “The games don’t turn around as fast as movies do, so we should have lower postage and material and labor costs.”
By contrast, Netflix has revenue-sharing deals with studios, which have agreed to sell movies to Netflix at a discount in exchange for a share of the rental revenue, a company spokesman said. GameFly and rival GPlay Inc. have not been able to strike similar deals with the top-tier video game manufacturers.
“They don’t want to upset their current cash cow, which is the retail sales,” said Tuyen Vo, a co-founder and vice president of Oakland-based GPlay. Vo said GPlay had 2,900 titles and had serviced more than 30,000 customers since 2002.
Analyst Pachter said one of the fundamental problems with the online video game rental idea was that it was most likely to appeal to the hard-core video game enthusiast. Hard-core gamers burn through video games in a matter of days -- sometimes hours -- and thus will borrow more titles per month for their monthly subscription, he noted, raising the company’s shipping and handling costs.
Similarly, Schelley Olhava, an analyst at research firm IDC, suggested that the monthly subscription model might not appeal to casual gamers because it would take them months to log the few dozen hours needed to play a game to its climax. Indeed, less fanatical gamers typically never finish the games.
“Some gamers might not feel they’re getting their money’s worth if they have the game for a couple of months,” Olhava said. “They can pay the same amount and actually purchase the game.”