Gadgets Galore

June 29, 2010

We all knew that the 2010 E3 was going to be about 3D and motion control. In this regard we definitely were not disappointed. Our heads were spinning with all the new accessories designed to enhance the game experience. Now the big issue is figuring out whether consumers will bite. Overall, we must say we remain a little skeptical about some of the approaches.

DFC Intelligence just released its latest forecast of the worldwide video game, PC game and online game markets through 2015 where we forecasted a gradual slowdown in sales for the Nintendo Wii and Microsoft Xbox 360, with a pickup in sales for the Sony PlayStation 3 in 2010 and 2011. Our forecasts vary significantly by country with the Xbox 360 stronger in the U.S. and U.K., while the PlayStation 3 is stronger in continental Europe and Japan. However, we continue to believe that the Wii will have the highest overall sales, even as the system faces a year-over-year sales decline.

This year’s E3 presentations did nothing to change DFC’s overall perspective. The strongest showing, ironically, was Nintendo. The Wii software lineup was solid with a focus on core Nintendo franchises. However, the biggest surprise was how impressive the portable 3DS looked. DFC has been cautious in forecasting sales for new portable systems, because of the competition faced with smart phones and other portable devices. While we are still cautious, we think the 3DS looks like it may be unique enough to stand out from the pack.

In terms of the overall vision for 3D in gaming, DFC remains skeptical. The reliance on glasses in all but the 3DS is something we see as a possible impediment to widespread consumer adoption. We still think 3D may remain more of a gimmick than something consumers want to do on a regular basis. Nevertheless, it could work as a selling point for a system like the PlayStation. Consumers may not actually use any of the 3D features, but just the fact that they are there could encourage them to buy a PlayStation 3 over a competing system. In other words, 3D could be a great showroom feature. It is definitely a selling point for someone purchasing a 3D TV, but even if a consumer does not yet plan to buy a 3D TV they may want the PlayStation 3 “just in case.” As for actual day-to-day practical use, we don’t see it yet.

In our view, much of what Sony is doing is trying to say their system has something for everybody. Of course, the big risk is consumer confusion. We have to admit we are still coming to grips with all the different gadgets available for the PlayStation 3 and what games require what devices. Explaining that to consumers will be a major challenge for Sony and it will be interesting to see their approach this fall.

Nevertheless, a key point worth noting is that having a lot of accessories for a system has worked in the past. For Sony, the PlayStation 2 became the best-selling system ever because of its diverse product line. In Europe, the Eyetoy camera and Singstar microphone were extremely popular add-ons that helped drive hardware sales. Those gadgets had much less of an impact in North America. Meanwhile, the Wii has all kinds of add-ons: the Nunchuk, the Zapper, the MotionPlus, the Wii Fit Balance Board, and the Wii Wheel being some of the official ones from Nintendo. It is clear that far from confusing consumers, these accessories have helped the system appeal to a larger audience.

Which brings us to Microsoft. The Xbox 360 clearly needs to diversify beyond the core first-person shooter audience. At E3 it was clear that Kinect is not designed for the hard-core game consumer. Microsoft is putting almost all its eggs into the Kinect as a way to appeal to the “casual” consumer and expand its user base. Of course, Microsoft has been trying to do this for some time and in that regards the Kinect can be seen as the latest in a long line of products intended to make Microsoft a mass market entertainment company. Unfortunately, based on what we have seen, DFC continues to feel that Microsoft is going to struggle to expand beyond its core audience.

The Kinect technology is cool, but in practical terms we feel it is somewhat limited. There are questions about how the technology captures non-lateral movement, and there is the lack of complex control options. However, that’s not a deal breaker for Kinect, as Microsoft is targeting a casual audience with family friendly titles.

With Kinect, Microsoft is trying to follow after what has worked for other companies. The Kinect clearly goes after what Nintendo has done with the Wii and more specifically the Wii Fit Balance Board. However, it also emulates what Konami has done with Dance, Dance Revolution, so it is arguably an enhancement over the Wii Fit. So at the end of the day, is the Kinect going to be the latest in expensive workout gadgets designed to attract a fitness audience to the Xbox 360? It not only appeals to mom for her workouts, but with the Kinectimals product, Microsoft is taking on Webkinz. While mom works out the kids can use the Xbox 360 to play with stuffed animals. In other words, all these products have proven to be big consumer hits, so if they are all on Xbox 360 every family in America is going to want an Xbox 360. Or at least that seems to be the theory.

There are numerous problems with this approach, but the biggest problem is Microsoft, at its core, is simply not an entertainment company. Almost every time Microsoft has tried to emulate successful entertainment products they have failed. Of course, the biggest exceptions have been some of their work in PC gaming prior to the Xbox and then the Xbox platform itself. However, in both these cases the appeal was to a fairly high-end niche of dedicated gamers. With MSN and casual games Microsoft was able to attract a fairly large and diverse audience, but these products were free. We don’t know the price of the Kinect, but it is definitely not free. An Xbox 360 with a Kinect is likely to cost as much as an annual membership at the local YMCA.

The true mass market that has driven hardware sales for systems like the DS, PS2 and Wii to the 100 million plus mark (eventually in the case of the Wii) has eluded Microsoft’s grasp. Clearly it is not from lack of trying. With the Zune, Microsoft made a major effort to challenge Apple’s iPod dominance. Closer to home, Microsoft has always tried to go after the Nintendo audience. In 2002, Microsoft acquired the leading U.K. development house Rare. Prior to the acquisition, Rare had been a leading developer of major hit exclusive titles for Nintendo platforms. The thinking was that Rare would attract Nintendo fans to Microsoft’s platform. It didn’t happen.

In its business software, Microsoft has been successful in analyzing what works for users of other products and incrementally incorporating those features into Microsoft products. The problem is developing hit entertainment products simply does not follow that model. Take for example the Viva Piñata product, developed by Rare and released in November 2006 to compete with the release of the Wii and PlayStation 3. Viva Piñata followed along the lines of Nintendo’s wildly successful Pokemon franchise, with a little Animal Crossing thrown in. Like Pokemon, Viva Piñata had its own television series designed to drive kids to the game and vice versa. Microsoft even worked with 4Kids Entertainment to produce the show. 4Kids was the producer behind Pokemon. Viva Piñata was a well reviewed title, but has gone down as an obscure footnote in the game industry. It clearly did nothing to establish the Xbox 360 with the core Nintendo audience.

Kinect is definitely an interesting product. We think it is more compelling than Microsoft’s Xbox Music Mixer product released in late 2003 (for those that don’t remember, Music Mixer was a music application with a microphone designed to turn the Xbox into a karaoke machine). At the end of the day, we see Kinect has having some appeal to a well-heeled fitness audience. In terms of changing the overall video game hardware platform market share we see it having a negligible impact. The Xbox 360 has some good years left, but the platform is clearly on the downside of its lifecycle.

The longer term issue facing the console manufacturers is that the business model of launching a new hardware system every five years simply no longer works. It is expensive to develop powerful new hardware, especially when the practice has been to sell it below cost. Those costs are harder to justify when the prevailing consumer trend has been to less-involved gaming experiences that do not require high-end graphics.

Profits need to be made by delivering products and services. The challenge in today’s market is it takes years for hardware manufacturers to sell the products and services needed to make up for the losses of doing the research and development, marketing and competitive pricing needed to build the installed base of a console system. Products like Kinect and PlayStation Move are an attempt to get around this dilemma. Unfortunately, we think they are at best a temporary attempt to tackle a much larger strategic issue.

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