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Do We Really Need Another Platform Transition? October 14, 2004 Before we go into the heart of the holiday selling season, now is a good time to ignore the present and look beyond the current generation of game systems. DFC Intelligence is in the business of making forecasts for future product sales. However, we have always been hesitant about making bold assertions about such mercurial matters as price cuts or product launches. Predictions like “we think Microsoft will drop the price of the Xbox to $99 in (blank month), 2004” are almost always doomed to be wrong. To hedge our bets we release our forecasts in multiple scenarios to account for different release dates, price points, consumer acceptance and other variables. One scenario that we see as a possibility is that Microsoft may release a new system in late 2005, at least a year before Sony or Nintendo. Considering that late 2005 is now only a year away, it is very important to study the implications of such a move. Of course, we must stress that we do not know if Microsoft will launch a system in 2005. There has been no official announcement and everything is speculation based on unconfirmed rumors. The interactive entertainment industry has a history of false rumors being taken as a confirmed fact. That being said, it is important to study the impact of a 2005 game system launch. There is some talk that Microsoft would make a big mistake by launching a game system in 2005 and thus bringing a premature end to the current game cycle. The problem with this kind of talk is that it tends to ignore reality and the basic fact that Microsoft is most likely to do what is in its own best interests. Many of the people arguing that it would be a mistake for Microsoft to launch Xbox 2 in 2005 are publishers, developers and their investors. These are people that are currently making a great deal of money from the huge PlayStation 2 installed base and have a vested interest in keeping that gravy train going as long as possible. Platform transitions tend to be stomach churning times. Publishers need to decide how to balance development dollars between expensive new systems with a low installed base and existing systems which consumers may be abandoning in droves. Furthermore, consumers spending money on new hardware have less money to spend on software. Many companies fail through poor management of platform transitions. The problem is platform transitions are inevitable and whether one starts in 2005, 2006, or 2007, the same challenges will be present. More importantly, from Microsoft’s perspective, there seems to be very little to lose and much to gain by trying to bring an early end to Sony’s current market dominance. The Xbox has done well, but Microsoft’s Home and Entertainment division (whose main product is the Xbox) lost $1.2 billion in fiscal 2004. Continuing the status quo is simply not in Microsoft’s interest. The main arguments against a 2005 launch for the Xbox 2 are 1) developers will not have time to create quality titles for the system; 2) an early release means the Xbox 2 technology is likely to be a year or more behind the technology in competing systems and 3) consumers simply are not ready for a new system. The validity of all these arguments is questionable. It is likely that if the Xbox 2 launches in 2005 it will be with limited software support. Most publishers realize that investing millions into a platform with a limited installed base does not make sense. Furthermore, development cycles are such that it takes a long time for developers to get up to speed on a new system. However, Microsoft does not necessarily need massive software support. A high profile title from Rare and/or Bungie, some sports titles and maybe one or two high profile titles from a closely supported friendly third-publisher is likely all it will take to get the ball rolling. The Nintendo 64 came roaring out of the gate in 1996 with only 3 software titles. The PlayStation 2 was sold out for its first few months on the market despite the fact that the initial software lineup was extremely weak (although there was no shortage of the number of software titles). Competing systems are likely to face the same problems of limited software in their first year. Meanwhile, developers will have time to improve the quality of Xbox 2 titles. By the time the Xbox and GameCube came out in late 2001, the PlayStation 2 was seeing its first true breakout products with the GT games (Gran Turismo 3 and Grand Theft Auto III). It gave Sony an insurmountable lead in the marketplace. Going back a generation, Microsoft can look to Sony’s efforts with the original PlayStation which came out in 1995, one year before the Nintendo 64. As mentioned, the Nintendo 64 had a huge launch and quickly erased Sony’s lead, largely based on Super Mario 64. However, PlayStation developers started delivering second generation titles like Resident Evil and Tomb Raider and after the initial sales burst Sony was able to regain the lead for good. There have been some systems that launched early and failed to last in the marketplace. Two of the more notable ones were the 3DO system and the Sega Dreamcast. The 3DO launched two years before the original PlayStation and the Dreamcast launched a year before the PS2. In both cases it has been argued that consumers simply were not ready for the new systems. However, this overlooks some more basic problems. 3DO launched at a $700 price point with both tepid marketing and software support. On the other hand, the Dreamcast was actually relatively successful, in its first year it outperformed the original PlayStation. The main problem was that Sega (and 3DO) did not have the financial muscle to compete with Sony and Nintendo. Obviously, this is not a problem facing Microsoft. The market has proven that there is a core base of consumers that will rush out to buy the first new system on the marketplace. However, it is also known that this base of consumers is not enough to support a system for the long term. Thus, the most valid concern is that Microsoft will launch a system that will eventually be technologically leapfrogged by Sony and/or Nintendo. This was clearly what happened with 3DO and the Dreamcast. On the other hand, the PS2 did just fine as the “technologically inferior” system. With the next generation of systems the main problem is likely to be developers finding the economic justification to spend the money to take full advantage of the potential of a system’s capabilities. Unless Microsoft makes some major miscalculations it is hard to see how the Xbox 2 could fall significantly behind the technological curve in a year or two. The main reason Microsoft would not launch a system in 2005 is that it is simply not ready. It is easy to see the strategic reasons why Microsoft wants a new system out first. If Microsoft launches a system in 2005 it will put extreme pressure on Sony and Nintendo, both of whom will have their hands full with a battle for the portable market. Sony has been the dominant player for two generations when they have gotten a system out a year before Nintendo. At the very least, Microsoft can not allow Sony to get another lead. However, saying something may be a good move for Microsoft does not mean an early start on a platform shift will be good for publishers and the development community. Platform proliferation, rising development costs and declining software prices are facts of life in the interactive entertainment. Unfortunately, coping with reality is not an option, it is a necessity. As the old adage goes, “those that can’t stand the heat…” On the positive side, the reluctance to rush to a new generation may be a sign of industry maturity. In the past, the industry (and more importantly its investors) has shown a tendency to ignore established niches and instead focus on sexy, new, but entirely unproven potential niches, whether they be a new game system, online games, wireless games, etc. Even when these segments take off as expected the market is generally overcrowded with would be players. Meanwhile, companies like THQ and Majesco quietly build solid businesses with unsexy “B” grade products for portable and older game systems. The newly announced “console system”, the Atari Flashback is nothing more then a retooled, hardwired Atari 7800 from twenty years ago. This is not technologically innovative, but it is definitely an innovative way to make use of a potentially valuable back catalog. It is likely that smart developers and publishers will increasingly learn to seek out money making niches within the game industry. The interactive entertainment business is going to a multi-platform, multi-market business. It is no longer enough to build a sustainable business by following the high-end consumer from PSX to PS2 to PS3. Companies need multiple strategies to deal with developing expensive cutting edge new brands for new game systems, milking as much money as possible from reliable, established systems and brands, while at the same time looking to new and emerging markets. Development costs are going nowhere but up and to be successful companies must take risky bets on unproven platforms. However, risk can be ameliorated by a multiple platform, diversified lifecycle approach to publishing. Publishers also need to be realistic about market dynamics. We have heard some talk that higher development cost may be alleviated by raising retail prices. Unfortunately, Economics 101 teaches that prices are probably going nowhere but down. Sure a handful of titles backed by brand names like Halo or Grand Theft Auto could come out at $60 and see no significant decrease in sales. However, you can probably count on one’s hands the number of titles that fall in this category. Even a venerable brand like Madden Football is subject to price competition. Madden is a great game, but it thrives primarily because of brand name and consumer familiarity. When Sega releases an excellent football game at $20, brand loyalty is going to be severely tested. As for the ridiculous argument that consumers will see a title at $20 and think there must be something wrong with it…we won’t go there other then to say consumers aren’t that dumb. Madden may still be the leader, but the pressure is clearly on. Dealing with pricing pressure is key for the remaining lifespan of the current game systems. Beyond the inevitable software price declines, a big question to be answered is will there be a strong phase out strategy for current systems? In other words, will Microsoft push existing discounted Xbox sales to build brand share with bargain hunting consumers? Sony did this with PSOne and Sony’s promise of a ten year lifespan may be a major reason why the PS2 continues to do well. If Microsoft can keep the existing Xbox installed base fairly active and allow publishers to leverage development tools across both the Xbox and Xbox 2 it could help ease the risk of high cost projects. It is on this issue that publishers and developers should be putting pressure on Microsoft to act in a way that will be in the mutual interest of all relevant parties.
Scenario 2, from the DFC Intelligence report Worldwide Market Forecasts for the Video Game and Interactive Entertainment Industry, September 2004 version. As part of our ongoing research efforts DFC Intelligence is delivering free monthly briefs on hot topics in the interactive entertainment and video game industry. You (or a colleague of yours) have signed up to receive these briefs. 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/PAL, U.S., rest of world)) through 2009. 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 new 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 600+ page report profiles major companies in the interactive entertainment industry. Each individual company report is about 15-40 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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