Caulfield Brian, Forbes.com 04/02/09 18:00:05 GMT

BURLINGAME, Calif - First, the music stores died. Then the video stores. Now a cloud is shadowing the outskirts of the gaming industry. The Web is lurking. There's no telling exactly how this will play out, but there will be blood.

The most ominous sign isn't the debut of a new online gaming service, OnLive, which promises to dispense with the need for consoles or game discs entirely (see "Will OnLive Kill The Game Console?"). Or even that Apple, fresh from displacing the local music store with iTunes, is pumping games directly to iPhone and iPod touch users via its App Store. No, the biggest sign of a change is Nintendo's DSi.

With more than 50 million Wiis consoles sold and 100 million variations of the Nintendo DS out there, Nintendo defines the gaming mainstream. And the Kyoto, Japan-based gaming giant is pushing hard into Web space with its latest gaming gizmo, the DSi. Set to go on sale in the U.S. April 5, the dinky clamshell-shaped gaming gizmo looks a lot like its predecessor. The biggest difference? A built-in wi-fi connection that will allow users to download games directly from Nintendo.

The move could solve one of Nintendo's biggest headaches, said Masato Kuwahara, project leader for Nintendo's DSi hardware group at the Game Developer's Conference in San Francisco in March. After a big debut week, sales of a new game quickly fall to average just 3% of their first week's total. Sales of online games, however, tail off more slowly. That's in part because the game store is always open and always accessible, but also because there's no market for used game cartridges.

Nintendo is now headed in the same direction as the rest of the industry: toward digital distribution of games, and perhaps even toward an industry where many games are hosted on servers rather than only on gaming consoles, handheld gadgets and PCs.

That "future" will arrive in the Winter of 2009 if Palo Alto, Calif.-based OnLive gets its way. The online gaming service, built by entrepreneur Steve Perlman, promises to place games on powerful servers, streaming them to card-deck-sized consoles and low-end PCs. The only question: "Will it be responsive enough? To a game player, that's all that matters," says Ralph Koster, co-founder and president of Metaplace, a service that will allow users to build their own online virtual worlds.

If Perlman can make the lag time between a gamer's command and the screen action imperceptible, he'll solve a host of problems that have plagued the gaming industry. It's tougher to pirate a game, for starters, if there's no physical disk to play it on. Setting up matches with friends also becomes far easier. Gamers wouldn't have to spend more than $2,000 on hardware just to run a demanding title like "Crysis." And Perlman is promising gaming publishers a fatter cut of the revenues, cutting out middlemen like Amazon.com and videogame retailers.

"As Internet console gaming grows in popularity, packaged goods sales and used game sales are expected to suffer," Wedbush Morgan analyst Michael Pachter wrote in a note to investors titled "The Beginning Of The End." "We do not see an immediate threat to the GameStop business model, but believe that this service could ultimately cause GameStop sales to decline in the future."

Even if hosting games on servers fails to take off, however, digital distribution of videogames is moving to the mainstream. Since Apple launched the App Store eight months ago, iPhone and iPod touch users have downloaded more than 800 million applications. Roughly one-fourth are games, and competitors, like those building phones based on Google's Android, are scrambling to catch up.

Qualcomm-based start-up Zeebo, meanwhile, plans to take that model to the game console (see "Why Zeebo Game Console Makes Sense"). The San Diego company is building its console around Qualcomm's mobile communications processors. Because games are distributed wirelessly, there's less opportunity for piracy. Better still, because software developers have already built plenty of games for mobile phones using Qualcomm's technology, Zeebo will be able to tap into a deep developer community.

Will it work? It's hard to tell. The only thing for certain, at this point, is that videogame stores' days are numbered.

Looks like this is the up and coming new disruptive technology for the gaming industry. You guys think that it will succeed? What do you think are the strategies for other gaming industry big players, like Sony?