12 September 2009

Could Sony and Microsoft's 'Cold War' Business Model Drive Them Out of the Console Business?

It's no secret that Nintendo's 'blue ocean' strategy has been working wonders for the Wii, maintaining consistently high hardware sales at a profit from month to month. While Nintendo frolics carefree in the open sea, Sony and Microsoft have been locked in a war of attrition, amassing arms for control of the same bloodied waters. According to DFC Intelligence analyst David Cole, this 'cold war' of sorts is not sustainable for either party. Let's take a look at some of Cole's main points, and see what it means for the videogame industry at large:

"The bottom line numbers for Sony and Microsoft’s game business are not pretty. From fiscal 2007 to fiscal 2009, Sony’s game division showed an operating loss of well over $3 billion. Meanwhile, during the period from 2004 to 2009, Microsoft’s Entertainment & Devices Division has lost over $4 billion. Much of this loss can be attributed to the cost associated with launching a new console system that is sold at a loss. The reality is Sony and Microsoft really need their hardware systems to have a true 10-year lifecycle so that initial costs can be amortized."

It makes one wonder why these two companies have fought tooth and nail to keep their fingers in the gaming pie. Both companies have been operating at a loss for quite some time, and both have large, more profitable stakes in other industries. The Sony brand is the most trusted when it comes to consumer electronics and home entertainment, and Microsoft has their operating system on virtually every single computer on the planet.

It also suggests that the PS3's (and to a lesser extent, the Xbox 360's) much-touted ten year life-cycle is borne out of necessity rather than any indication of the platform's long-term viability. Both companies leave their statements open to interpretation, though, and when they say "ten year life-cycle", I'm sure many of us believe they really mean, "support existing hardware for ten years, but release new hardware in the meantime." What David Cole is proposing is a true ten year life-cycle - one without the distraction of next-generation hardware until after ten years - and that's the difference.

"Both Microsoft and Sony have a long-term vision that their game boxes will eventually provide a whole host of entertainment services. The problem with that vision is both companies are still caught up in the arms race of the video game console business. It is extremely expensive to launch a new game system every few years and build an installed base from scratch. But game consumers have been trained to constantly demand a new game system and that is what drives much of the market."

If this is what we're expecting, what chance do they have of delivering?

"For Sony and Microsoft, it simply makes little business sense to launch a new game system. They need their current systems to last as long as possible so that they can actually make some money. What makes business sense for Sony and Microsoft is to focus on getting costs down, offering new (and profitable) services to their existing systems and looking to build renewed consumer excitement via new form factors and incremental additions like Project Natal for the Xbox 360."

This is why Microsoft and Sony will likely release another console before the ten years are up. They're damned if they do, damned if they don't. If they release new consoles before ten years are up, they threaten to prematurely kill their current hardware sales before they've even become profitable. If they don't, consumer demand and the excitement for future tech that drives their business model could wane, and the industry as a whole could take a dive:

"The game industry cycle has been driven in large part by new console launches. New game systems have consistently spurred consumer spending to new record heights, right at a time when the established systems are starting to decline. DFC has run best and worst case scenarios for the current generation game systems and in all scenarios, they show a decline in sales over the next several years. Furthermore, with these systems, a growing portion of consumer spending will continue to shift to catalog product, used games and rentals."

Can Microsoft afford to put a spaceship in every home?

"In short, without a major new console system to pump up consumer enthusiasm the game industry faces an inevitable decline."

So even though neither Sony or Microsoft can afford to launch a new console anytime soon, they may have to break their 'ten year rule' just to stimulate sales. It's clear that both Micosoft and Sony are attempting to address this with console 're-launches', in hopes that Project Natal and the PSEye Wand can fuel another five years of sustainable sales, but how realistic is that? And will it drive their price tags back up?

Can Natal push the Xbox 360 over the ten-year finish line?

I suppose in many ways the Wii was a re-launch of the Gamecube with motion controls, but all that really means is that Nintendo pre-empted the potential destructiveness of the console arms race that Sony and Microsoft remain locked in, and bowed out when the time was right.

"For Nintendo, the business model for launching a new console system every five years could still work because they focused on keeping overall hardware costs low by not pushing the technology barrier. Does this mean Nintendo may be the first to launch a new system by 2012? That would be a first for a company with a market-leading platform. Then again, doing so could also really put competitive pressure on Microsoft and Sony."

Could Nintendo feasibly force Sony and Microsoft into a corner by releasing early? Or could they force them out of the business entirely? Just how much money is Sony and Microsoft willing to lose before they say, "enough is enough" and pull out altogether? It's an interesting thought, and one that I can't say I've entertained up to this point.

What do you think about all this? Will Sony or Microsoft break their 'ten-year rule'? Can they afford to? Or will their console 're-launches' be successful enough to keep them afloat?

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