Looking at the Big Three after E3

May 31, 2005

The end of May and another E3 has come and gone.  Of course, this year it was all supposed to be about the new systems.  Before the show even started the video game world was inundated by flashy press conferences talking about the gaming technology of the future.  However, the actual E3 show floor was more about the current business.  Coming out of E3 it is hard to say if we truly learned anything we didn’t already know, or at least strongly suspect, about the next generation of game systems.  If anything, this year’s E3 highlighted the fact that the next generation will not truly kick into high-gear until around 2007.  The nuts and bolts of E3 2005 was about the here and now and that is probably the way it should be.  The primary purpose of the show is to provide retailers and media an overview of products for the upcoming holiday season.  The Xbox 360 aside, holiday 2005 will be all about the current generation.  Nevertheless, DFC Intelligence must concern itself with new game systems.  Next month we will be releasing our latest forecasts for both the current and next generation systems.  This month we thought we would lay down some of the thought process behind our forecasts. 

The first point that must be made is that forecasts are always subject to change.  The interactive entertainment industry is a very dynamic business that can change significantly based on a handful of games or sudden changes in the whims of consumers.  This is why in doing our forecasts we release multiple scenarios.  These scenarios provide a worst case to best case range for each system.  They also highlight the crucial point that any forecast for interactive entertainment must be prepared for uncertainty and flexible enough to handle market change.  As conditions change and new products are announced we will adjust our forecasts as necessary.

In talking with people about the E3 show we found a great diversity of opinion.  The most divisive subject was that of Microsoft and the Xbox 360.  There were some that argued that by getting an entire Christmas season to itself, the 360 would gain an insurmountable lead and Microsoft was likely to be the market share leader of the next generation.  At the other side of the spectrum, there were quite a few that thought the Xbox 360 looked like the Dreamcast part 2 and Sony would make it obsolete with the technologically superior PlayStation 3.

Almost everyone we talked to felt that Sony seemed very confident, as befits a market leader.  Of course, Sony, unlike Microsoft, didn’t have to show much and could just focus on playing the tech spec card.  Sony clearly put Microsoft on the defensive with its arguments that the PlayStation 3 technology would be far superior to the 360.  However, we don’t believe that technology will be much of an advantage for any of the game systems.  The technology argument is one Microsoft can probably counter with relative ease.  Indeed, E3 was not over before Microsoft responded with a detailed technology comparison showing why the PlayStation 3 did not have an advantage.

While we don’t by any means think the Xbox 360 will be the next Dreamcast, we also think that the early launch is overrated.  For one, expensive new game systems like the 360 are not big holiday gifts.  Most consumers that buy a system when it first launches are buying if for themselves and don’t care if it is December or June.  The new game systems will probably not be big holiday gifts until holiday 2007.  The main advantage of launching early is that it gives developers time to build up a library of software that makes a system look good against its competition.  With the game market, system sales will not be about technology or past history, it will be about the games of the future which we have yet to see.  By getting an early start the Xbox 360 will have time to build up that crucial game library that is the entire reason consumers buy the hardware.

There are many that argue that Sony’s PlayStation has such dominant brand strength that Microsoft can at best only hope to put a minor dent in Sony’s market share.  We think this overrates the power of brand loyalty.  Video game consumers are, in mass, very fickle and will shift platforms in a heartbeat if something better comes along.  Consumers (especially those that buy lots of games) are learning that it is not a major investment to buy multiple systems.  The main challenge is not to give consumers a reason to shift to a new system.  This is where Sony has been very successful.  Sony has worked very hard at building a stable consumer base.  The PlayStation platforms have consistently appealed to the largest fan base.  Nintendo and Microsoft may have had some bigger hits, but Sony has been consistent and that makes for repeat consumers.  Sony could still be one major misstep away from losing all that goodwill, but right now we don’t see any evidence of such a misstep occurring in the near future.

In contrast there must be some concern that Microsoft risks losing a great deal of goodwill.  They risk losing that goodwill by not keeping the current Xbox alive.  At E3, Sony had all kinds of goodies for the PlayStation 2.  Sony had new entries for established franchises like Ratchet, Sly, Jak, and SOCOM.  There was strong support for the EyeToy accessory, new products like Shadow of the Colossus, a Neopets title for the younger audience and solid exclusive support from heavy hitters like Square Enix.  In other words, the PlayStation 2 looks like it will be a very exciting system through at least 2006.

With Microsoft it seems to be all about Xbox 360.  It appears that Jade Empire and Forza Motorsport may be the last big Xbox exclusives.  Of course, there is always a lot of talk about backward compatibility.  In our opinion backward compatibility is overrated. Microsoft’s best base of initial consumers for the 360 is current Xbox owners.  For these consumers backward compatibility is probably not a major issue because they already have a system that can play Xbox software.  However, not having new software that can play on the older system may be an issue.  No matter what Microsoft does, most Xbox owners will not be looking to upgrade to a new system until late 2006 or 2007.  If these consumers see Microsoft ignoring the Xbox for the 360 while the PlayStation 2 still gets all kinds of cool new exclusive games that becomes a problem.  Considering that many Xbox owners also own a PS2 it becomes a true head-to-head comparison.  If a consumer suddenly finds themselves playing their PlayStation 2 all the time while their Xbox gathers dust, when the time comes, are they more likely to buy an Xbox 360 or a PlayStation 3?

We think that one reason the GameCube may have struggled this generation is that Nintendo was so quick to kill the Nintendo 64.  Of course, the N64 was clearly a system past its prime, with a challenging software model.  However, it still had a large consumer base that saw the software pipeline suddenly dry up, forcing them to buy a new game system.  There are many consumers that can’t wait to rush out and buy a new game system.  However, there is an even larger base of consumers that do not like to feel forced into upgrading.

This of course brings us to the question of Nintendo.  There are many in the game industry who have entirely written off Nintendo and we simply can’t understand this attitude.  The GameCube was a major disappointment and Nintendo has seen every generation of console system sell less and less.  However, with the Revolution, Nintendo gets to start from scratch and try and correct its missteps.  Furthermore, Nintendo clearly has the ability to build major hit titles, the biggest determinant of a system’s success.  Nintendo is often knocked as being behind the technology curve, but the company has been a technology innovator on things like wireless controllers and of course portable gaming.  An accessory like the card e-Reader was essentially a form of the micro-transaction model so highly touted by Sony and Microsoft.   

Over the next few years, a possible trend that could play into Nintendo’s favor is what we call the emergence of the “Nintendo Dads.”  These are consumers that grew up with Nintendo and are now having children of their own.  In the past generation we saw a growing number of parents (usually dads) actively play the game systems with their children.  We think that this trend really helped Sony and, to a lesser extent, Microsoft.  The PlayStation 2 had products to appeal to the whole family, whereas the GameCube content was specifically targeted towards a younger audience.  More importantly, parents for the current generation of systems were not as familiar with the Nintendo brands. 

As an example look at a 33-year old dad buying a system for both himself and his 6-year old son.  In 2002, this dad would have been born in 1969 which would have made him 18 when the NES took-off around 1987.  Back then, 18 year olds did not play video games in large numbers.  Instead, this dad would most likely have cut his teeth on Atari and Nintendo would not have meant much to him.  Go forward to 2007 and this 33-year old would have been 13 in 1987 and would probably have been very familiar with Nintendo and its characters like Mario and Zelda.  A 33-year old dad in 2007 will be one of the first generation of parents personally familiar with Nintendo products and thus possibly inclined to buy a Nintendo system for his children.  Consumers in their teens and twenties tend to distance themselves from the products of their childhood, but such concerns over “being cool” can start to disappear with age, replaced by nostalgia.  This trend alone could really benefit Nintendo going forward and one of the few things certain about the Revolution is that Nintendo will put a big emphasis on the nostalgia card and its historical software library. 

So where does this leave us with forecasting the individual performance of the next generation game systems?  DFC Intelligence will be releasing detailed forecasts in June.  As mentioned we will be releasing multiple scenarios for the industry, and these scenarios will be constantly revisited over the next several years.  Right now, our best case scenario for each system has the Xbox 360 at 40%, the PlayStation 3 at 50% and the Revolution at 35%.  Obviously these scenarios are mutually exclusive, the best case scenario for the 360 is definitely not the best case scenario for the PS3 or Revolution and vice versa.

The main point we stress with our forecasts is flexibility.  The interactive entertainment market is driven by hit products that simply can not be created by will, even from the largest company with the best business plan.  Nintendo once looked invincible, now many have written them off.  It is surprising how big players can face sudden falls from grace.  Beware of any publisher that puts too much investment into any one system.  Successful publishers will have their eggs spread across many baskets.  DFC Intelligence releases all kinds of numbers designed as roadmap for the future.  Nevertheless, predicting the future is something we always do with the caveat that we could easily be wrong.  Proceed with caution.

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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:

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 2010.  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. 

The Online Game Market This 660 page report contains a comprehensive analysis of the online gaming market.  Includes current sales trends, market forecast, and in-depth company profiles.

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