E3 2004: The Start of the Portable Market Battle
May 19, 2004
Whew! Another E3 under our belt. Hard to believe this year was number 10. Every year we always reach to find an overriding theme to encapsulate the three days of throbbing chaos. Last year we went with online games. For E3 2004 our focus was clearly on portable games. We don’t mean to ignore the 5,000 some other products shown at E3, but we feel we had a pretty good idea of the upcoming best-sellers before we went into the show. No surprises in names like Doom III, Grand Theft Auto: San Andreas, Half-Life 2, Halo 2, Metal Gear Solid 3, and The Sims 2. Meanwhile, new console systems are still well more then a year away. The real interesting short-term battle in the interactive entertainment market is Sony and Nintendo locking heads in the portable space.
E3 2004 marked the unveiling of the Sony PSP and the Nintendo DS. We must say that we are very impressed with both products. DFC Intelligence recently released some conservative forecast for the portable market based on our preliminary assumptions. We estimated the worldwide portable market to increase from $3.9 billion in 2003 to over $7 billion by 2007. Over the next month we will be working to revise those forecasts based on what we saw at E3. We definitely expect those forecasts to go up. However, we will also say that there are still many unknowns that make forecasting this market difficult. This month, instead of doing a detailed analysis of the individual portable systems, we thought we would take a look at some of the major overriding issues in the portable market.
Pricing: Our biggest disappointment was that no announcements were made about hardware pricing. This is not surprising given that we have two competitors jockeying for position and it looks like pricing could be the key deciding factor of success. Because Sony is not launching the PSP in North America and Europe until spring 2005 (it launches in Japan late 2004), it makes sense for them to wait and see how Nintendo prices the DS.
The concern with pricing is very real considering that hardware price points of over $150 are unproven in the portable market. Thus history provides no guide to potential consumer demand. In the console market, consumers of recent years have been willing to pay much higher prices. The PlayStation 2 blew away all previous pricing/demand models. We will now find out whether this trend follows over into the portable market.
The Network Effect: One reason hardware pricing is probably more important in the portable market then in the console market is what we like to call “the network effect.” The network effect is where consumers tend to buy the same system their friends own. This occurs in the console market, but it is even more pronounced in the portable market. With wireless networking capabilities, consumers will want to own the same system their friends own so that can play multiplayer games. In addition, the portable market is somewhat unique because there are a significant number of households that own multiple versions of the same system. In other words, it has not been uncommon for all the siblings to get their own Game Boy Advance. This is where a significant hardware price difference could give one system a major market advantage.
The other thing to note about the network effect is the existing consumer base each company brings to the table. Nintendo has a large base of established portable game consumers. The fact that the DS is backwardly compatible is a major deal. Simply by getting its existing owners to upgrade, Nintendo has a major market. On the other hand, Sony has a huge base of customers loyal to the PlayStation brand. Many of these consumers do not own a portable system. Sony’s opportunity is creating a new market of portable consumers. The major questions are: 1) can the Nintendo DS appeal to a market beyond just existing GBA owners? and 2) can the PSP penetrate the existing portable market or is its growth dependent on creating a new audience?
Storage Media: The two new portable systems use very different software storage media. The Sony PSP has its own proprietary optical disc-based media, called UMD. The Nintendo DS will utilize a propriety flash memory similar to the Compact Flash and Sony Memory Stick storage cards popular in digital cameras (for saving game data PSP also has Memory Stick input). This technology was developed by Matrix Semiconductors (Nintendo made a $15 million investment in Matrix in February 2003), a company that specializes in building high-density, low cost chips. Essentially the DS software will come on an advanced version of the cartridge-based media found in the current Game Boy Advance.
We have always said that, all else being equal, cartridge-based media is better than disc-based media. Not only is cartridge-based media faster, it is more durable. Durability is especially important in the portable market where systems tend to get thrown around a great deal. It remains to be seen how a disc-based system with many moving parts will handle the abuse of traveling in backpacks etc.
However, all is not equal between cartridge-based media and disc-based media. The trump card for disc-based media has always been cost. A UMD disc can handle 1.8 GB of data. The new Nintendo DS cartridges will be able to handle up to 1 Gb of data. In the confusing world of bytes and bits, it is important to note the difference between the big B and the little b. A byte is worth 8 times more than a bit. Thus the Nintendo DS cartridge can hold up to 125 MB of data, or about 14 times less than that of the PSP.
The obvious difference between the two storage media is that PSP software will be able to contain video. From our analysis perspective the more important difference is our next big issue, software economics. Exactly how much the Nintendo DS storage media will cost is a major issue. A 125 MB Memory Stick or Compact Flash card for a digital camera currently costs around $25 to $40 at retail. Obviously that pricing is untenable for the game market. The markup on memory cards is currently high, but exactly what the manufacturing cost for DS will be is a major question.
Software Economics: Perhaps our biggest unanswered question on the portable market is exactly how much opportunity will there be for third-party software publishers. The economics of the portable market have always made it hard for companies other then Nintendo to make money. High cost of goods combined with lower software prices and lower software sales have made for a difficult business.
With a lower cost of goods, we expect that plenty of software publishers will migrate towards the PSP. Whether they do the same with the Nintendo DS will probably depend in large part on the answer to the media cost question. However, even with a lower cost of goods there still may not be a major profit opportunity for third-party publishers in the portable market. Even with its poor economic model, there has always been an abundance of software for the Game Boy Advance. As publishers sense any potential profit opportunity the floodgates tend to open and the market quickly becomes deluged with product. The end result is even more downward pressure on software prices and lower average unit sales per title. Only time will tell if the new portable systems will truly improve portable software profit margins.
Retail Shelf Space: As we have reported over the past year, retail shelf space for interactive entertainment has been expanding. The launch of the new portable systems is likely to be the start of what we forecast will be a three-year trend: fighting for retail shelf-space. The new portable systems will soon be followed by new console systems, all of which, for the short-term, will co-exist with the existing game systems. Inventory management is going to become a key issue. New shelf space will likely come at the expense of existing products and it will be interesting to observe how different retailers handle this issue.
Cell Phone Gaming: We have always said that the ability of cell phones to play games currently provides very little competition for the established players in the interactive entertainment industry. Going forward we still see these as parallel, non-competitive markets. However, cell phone gaming is a potential opportunity in that it is likely to introduce a new audience to portable gaming. The PC online gaming world has seen an explosion of users for quick casual games and products like Neopets. This audience has a large portion of females and represents a significant number of users that do not traditionally play video games. The casual PC online game audience is likely to be a prime market for cell phone gaming. Our major question is can Sony and Nintendo find a way for their systems to reach that audience or will this continue to be primarily about marketing to existing video game users.
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:
DFC Dossier The DFC Dossier is published ten times a year and provides subscribers with regular updates and analysis of the latest market trends.
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.
The Market for Portable Video Games This 185 contains complete five-year forecasts by platform, a look at portable game software, portable game online trends, and business models and revenue expectations for game publishers.
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 2012. 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.