From the latest confusion of news announcements around Sega it kinda, sorta, maybe looks like Sega is officially halting Dreamcast production to focus on coming a more traditional software publisher. Of course, many commentators are using this news to take potshots at Sega with comments like "they never stood a chance," "I told you so," or "they were crazy to try and compete in this market in the first place." In reality it is a little more complex than that. Being a video game hardware manufacturer is a high risk/high reward business. Success brings great reward, but can be very elusive. On the other hand, trying to be a successful top-tier software publisher can be just as challenging.

Sega knew they had an opportunity this past holiday season. The Dreamcast had the best new games, a solid mass market price and was the only new system available. Our visits to Electronic Boutiques stores, a bell weather of the video game elite, confirmed Sega’s strengths. The people in the know were raving about the Dreamcast games and that would seem like a strong sign of future potential. In our latest visit, customers and store employees continue raving about the Dreamcast even as the current announcements unfold. According to one store manager, "Dreamcast buyers have been incredibly happy, while my customers that got a PlayStation 2 have been some of the most disappointed customers I have ever seen."

Unfortunately for Sega, even with the buzz among hard-core gamers, mass market consumers did not bite this past Christmas. According to research from the NPD Group, U.S. Dreamcast software revenue in the fourth quarter 2000 was up a tepid 12% over fourth quarter 1999. That is pitiful for a new hardware system that is supposed to be growing rapidly. When great games like Jet Grind Radio and Skies of Arcadia have negligible sales you know the handwriting is on the wall.

The weak performance of the Dreamcast this holiday season shows the fickle nature of the video game audience. In the mid-1990s, Sega spent tens of millions of dollars saturating the media with ads for products that were often inferior. With the Dreamcast, Sega found they had a solid product, but the company just did not have the capital to do a full-scale marketing blitz. Of course, Sega’s past mistakes may have used up much of the company’s goodwill. Nevertheless, Sega’s history goes to show that in today’s market it takes great product PLUS superior marketing PLUS enormous capital resources.

History may not record the Dreamcast as a market success, but you cannot blame Sega for trying. Even with a 20% hardware market share, the Dreamcast could have been a huge earnings driver for Sega. Who knows what the Dreamcast would have done if such strong anticipation over the Microsoft X-Box had not been built over the past few months. As a software publisher, Sega will be forced to throw themselves on the mercy of other hardware manufacturers. The question now becomes, can Sega capitalize on its powerful entertainment assets or will the company become another mid-level software publisher dependent on the whims of hardware manufacturers.

Even if they exit the hardware business, Sega will remain a huge powerhouse in the video game market. In terms of publishing proficiency, Sega is right up there with Nintendo as the leading software publisher in the world. Nintendo may only publish for Nintendo systems but they are still, by far, the top software revenue generator. Nintendo published software generally accounts for 15-20% of video game software revenue in the U.S. Sega is, arguably, an even stronger software publisher, but over the past few years Sega’s software revenue has been severely hampered because Sega has not had a hardware platform. Once Sega begins to release games for other systems, the company has the opportunity to generate revenue from their incredibly proficient software divisions.

The question around Sega’s future is will Sega publish for all platforms (including support for loyal Dreamcast owners) or will they work exclusively with one hardware manufacturer or will the company be dismantled and sold off into parts. Of course, there were hotly denied rumors a short while back of a Sega/Nintendo merger. Even if true, such a merger would be difficult to finalize. Nevertheless, you can be sure that Sega is exploring options with not only Nintendo, but Sony and Microsoft as well. It is likely to come down to whom can offer the highest bid.

And a deal with Sega may be very expensive indeed. A combination of Sega/Nintendo or Sega/Sony or Sega/Microsoft would change the landscape of the video game industry. All companies involved know this and that is why Sega will continue to have enormous leverage in the game industry. But whether Sega can capitalize on that leverage remains to be seen. A mega-merger may prove impossible to pull-off. An attempted buyout of Sega by Nintendo, Sony or Microsoft is likely to start a bidding war that could eventually mean Sega’s buyout price is too rich for anyone to actually go through and finalize a merger. On the other hand, if Sega starts publishing for all platforms at once they become just another software publisher.

In short, Sega still has incredible potential value, the difficult challenge, as it always has been, is how to best maximize that value. If the company plays its hand right, a bright future for Sega may still be in the cards. Stay tuned this could be one of the most interesting stories over the next year.

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