DFC Intelligence  

The Fight for Number One in Video Games

July 18, 2006

For the past ten years Sony Computer Entertainment (SCE) has been the king of the video game market.  The first PlayStation (PSOne) and PlayStation 2 (PS2) platforms were THE platforms on which the leading third party publishers made the majority of their revenues.  For third party publishers other game platforms had become of secondary consideration to the Sony driven gravy train.  Even in 2006, the PS2 continues to sell the most units at retail.

DFC Intelligence has always said that as the dominant market leader, SCE was largely in control of its own fate.  Microsoft and Nintendo had to hope Sony fumbled or significantly changed its strategy so that they could get an opportunity to capture some of that PS2 audience.  Now it is clear Sony is handing its competitors a golden opportunity. 

DFC Intelligence has just released a 600 page report with our latest forecast for the interactive entertainment industry.  In this report we predict several different scenarios for the individual game systems.  We emphasize that there is a great deal of uncertainty because much will depend on how individual players execute their strategies over the next several years.  However, two things are clear: 1) the high price of the PlayStation 3 is going to slow overall industry growth, especially for software and 2) if Sony does not change its current strategy for the PS3 the system will probably end up in third place in installed base.  Microsoft and Nintendo have been handed that golden opportunity and both companies have a chance to make their systems the market leader.  However, it looks like under any scenario the video game market is going to be severely fragmented, with several incompatible platforms having strong market share and even the possibility of a platform doing well in one region and struggling in another.

As we have mentioned in past briefs, the big concern with Sony is not only the PlayStation 3 launch price, but the signs that Sony has gotten itself into a business model that is not conducive to the mass market video game audience.  There has been a lot of talk about positioning the PS3 as not just a video game system, or even entertainment system, but instead as a computer system.

In fact, SCE chief executive Ken Kutaragi told Japanese computer magazine PC Watch in June 2006 that the PS3 is a computer, not a game console.  Kutaragi was quoted as saying “we don't say it's a game console, the PS3 is clearly a computer unlike PlayStations so far.”  In other words, Kutaragi no longer sees the PlayStation brand centered on a specific hardware configuration that has a life of five to seven years, during which time that hardware is steadily reduced in price as production becomes more efficient. Kutaragi views the PS3 as a computer platform that evolves with new features and capabilities on a constant basis.  Kutaragi was further quoted as saying “Since PS3 is a computer there are no 'models' but configurations.  We'll want to upgrade the hard drive size very soon. If new standards appear on the PC, we will want to support them. We may want the Blu-ray drive to write. In the PC business, if you fix the spec for two years you'll be caught by competitors. Computers should be changing, right? It's inevitable that 60GB hard drive will become too small, and memory may become too small as well.”

The problem with that computer strategy is that it means prices do not come down.  By fixing its hardware standard for several years, video game console systems have been able to significantly lower prices over time by not having to upgrade to the latest technology.  Kutaragi has also talked about what he sees in common between the PS3 and current Apple Computer philosophy and products.  There is clearly a little envy behind such quotes from Kutaragi like: “If Mr. Jobs adds an Apple logo to the PS3, I think users will say it can be sold at $2,000. However it's not possible for the PlayStation brand. That is the difference in the computer world between the PlayStation brand and the Apple brand.”

We would point out that another major difference between Apple and the PlayStation brand is that the PlayStation 2 had a share of over 60% of the video game console market, while Apple’s computer market share has hovered in the 2-3% range.  We believe that under Kutargai’s techno-elite PlayStation 3 strategy, the PlayStation 3 could end up with a market share more resembling Apple products as opposed to the dominant PlayStation 2 market share.

In other words, we think that for the PlayStation 3 to maintain Sony’s number one market share position, Sony will have to shift the current stated strategy of SCE.  It should be remembered that SCE is only one part of the much larger Sony Corporation entity.  Ten years ago SCE was a non-factor for Sony overall, but the video game business has now become very important.  Over the past five years, SCE’s video game business has averaged about $7.4 billion in annual revenue and brought in average annual operating income of around $500 million.  Can Sony afford to lose this video game business in order to go after the smaller base of elite consumers?

Right now the PlayStation 3 could be considered a relatively inexpensive part of a household looking to go to a high definition system.  Consider this mid-level high-definition home theater budget:

High-definition television: $2,500
Stereo Receiver: $600
Speakers: $1,200
Cables: $400
Installation and Calibration: $1,000
Movie/CD/Game Player: $600

Under this budget, a PlayStation 3 is a fairly small line item in what is a $6,000+ take out a home equity line of credit project.  Kutaragi is right, for this consumer the PS3 is a bargain.  However, we must ask how big that consumer base is and if these are the type of consumers shopping for bargains.  Furthermore, when we are talking about Sony’s video game base we are looking at a worldwide business.  Consumers in markets like Europe lag behind the U.S. when it comes to spending thousands on a new home entertainment system

Take for an example, Valencia, the third largest city in Spain.  Walk into an El Corte Ingles (Spain’s flagship retailer) or FNAC (a leading media entertainment retailer) in Valencia and you will see about 67% of video game shelf space given over to Sony products, with another 25% reserved for Nintendo’s portable game systems.  Valencia even has entire Sony Stores devoted to Sony products.  The PlayStation 2 practically defines mass market video games in Spain (and much of Europe) with its casual party franchises like Singstar and Buzz.  In other words, Sony has been absolutely dominant in Spain and most of Europe.  All that is now at risk with Sony’s PlayStation 3 strategy.  Sony’s new approach seems to be to position its products as luxury items, epitomized by a recent ad in a French high fashion magazine which features a PSP dripping with diamonds.

At 600 euro, the PS3 would be more than 35% of the monthly household income of a family in Valencia. Combined with the 2000 euro for an HDTV that could take advantage of Blu-Ray and four games, the total cost could top 15% of a family yearly income. On a per person basis, that would be almost 40% of an adult Valencian’s average income.  Consumers in much of Europe (and North America as well) simply aren’t ready for that type of expenditure and success for Sony will require that 1) they can keep the PlayStation 2 business alive and slow consumer adoption of new systems and 2) they can make the price more affordable.  However, as the chart below shows, even under the best case scenario the PlayStation 3 has a much lower installed base than the PlayStation 2.  Under the worst case scenario the bottom falls out for Sony’s market share.


DFC Intelligence estimates under the best case scenario for the Sony PlayStation 3

So while Sony struggles with positioning issues Microsoft and Nintendo are free to try and build a solid base of actual video game players.  The good news is that for both companies, under any scenario, DFC forecasts that the Microsoft Xbox 360 and Nintendo Wii will have a larger installed base than their respective predecessors.  However, we think the company with the biggest opportunity is Nintendo.  With a market leading price and a compelling mass market message the Wii has the opportunity to be the market share leader in all major regions.

The Xbox 360 also has an opportunity to be the overall market share leader, but we think the system will generally be stronger in North America than in Europe or Japan.  In fact, even under the best case scenario for the Xbox 360 we predict the system will finish third in Japan while being the number one system worldwide.

Other potential issues that concern us with the Xbox 360 have been Microsoft’s struggles to break out beyond the hard-core gamer and the significant losses that the company has been forced to take to build  market share.  Microsoft could become bogged down in efforts to reach out to the mass market via casual games, portable games and other areas that could distract from the overall Xbox 360 business.


DFC Intelligence estimates under the best case scenario for the Microsoft Xbox 360

On the other hand Nintendo has almost nowhere to go but up with the Wii.  Since the 8-bit NES from the 1980s, Nintendo console hardware systems have sold less and less.  Now is the time for Nintendo to turn that around.  In the last generation, the casual mass market game audience by and large went with the PlayStation 2.  The GameCube was stuck with the loyal Nintendo diehard base.  Now with the Wii, Nintendo has the chance to keep its loyal base and expand into a much more mass market audience.  By letting Sony and Microsoft split the hard-core teenage/twenty something video game marketplace, the Wii could end up number one in market share for the next generation.


DFC Intelligence estimates under the best case scenario for the Nintendo Wii

Not surprisingly, under all our scenarios, market fragmentation is a big theme.  For the past five years, the PlayStation 2 has been a steady platform that provided a solid worldwide base for software publishers.  Sony’s strategy is utterly dependent on keeping the PlayStation 2 around for as long as possible and hoping mass market consumers hold-off on upgrading.  However slowing the future can be difficult.  For a consumer there are all types of choices for playing games: portable games, online games, old console systems, new console systems and so on.  The console system remains the largest segment of the overall market, but its importance is clearly declining.  Over the next two years we will see which companies can weather the eventual decline by diversifying beyond the PlayStation business.

 

DFC Intelligence’s research services provide detailed strategic analysis of the interactive entertainment industry. 

A sample of  reports on the video game and PC game market include:

The Online Game Market This 800 page report contains a comprehensive analysis of the online gaming market.  Includes current sales trends, market forecast, and in-depth company profiles.

Worldwide Market Forecasts for the Video Game and Interactive Entertainment Industry Complete five-year forecasts for all individual console and portable game platforms by region (Asia, Europe, North America, rest of world)) through 2011.  Also included are PC game forecasts and historical sales figures.  The report has several scenarios for future market growth including an analysis and forecasts for new systems from Sony, Microsoft and Nintendo, as well as portable game systems.

The Business of Computer and Video Games This report includes an historical analysis, overview of individual hardware system, top-selling games, game genres, consumer demographics, business models, retailer profiles, marketing elements and case studies, industry trends.

Market Leaders in the Video Game and Interactive Entertainment Industry This 750+ page report profiles major companies in the interactive entertainment industry. Each individual company report is about 25-50 pages and has an historical background, financial overview, product analysis and a frank assessment of the outlook for that company. 

Overview of the Video Game and Interactive Entertainment Industry This report is designed to provide an overview of some of the key trends in the video game and interactive entertainment.  The focus is on highlights from the forecasts and analysis of trends, game genres and business issues found in DFC reports.

The Game Market in China This 350 page report contains a complete look at the rapidly growing Chinese game market, including forecasts to 2010, government regulations, market entry strategies, business models, distribution options, game genres and numerous company profiles and case studies.

 

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