Sony in Jeopardy

David Cole (of DFC Intelligence) has published an analysis of the Playstation 3. It’s well-written, so I thought I’d share parts of it with you:

We emphasize that there is a great deal of uncertainty because much will depend on how individual players execute their strategies over the next several years. However, two things are clear: 1) the high price of the PlayStation 3 is going to slow overall industry growth, especially for software and 2) if Sony does not change its current strategy for the PS3 the system will probably end up in third place in installed base. Microsoft and Nintendo have been handed that golden opportunity and both companies have a chance to make their systems the market leader. However, it looks like under any scenario the video game market is going to be severely fragmented, with several incompatible platforms having strong market share and even the possibility of a platform doing well in one region and struggling in another.

Not good for game developers and publishers, though I believe that expansion of the market (triggered in part by the novelty of the Wii, online services, and growth of portable gaming) will more than offset fragmentation troubles over time.

Kutaragi views the PS3 as a computer platform that evolves with new features and capabilities on a constant basis. Kutaragi was further quoted as saying “Since PS3 is a computer there are no ‘models’ but configurations. We’ll want to upgrade the hard drive size very soon. If new standards appear on the PC, we will want to support them. We may want the Blu-ray drive to write. In the PC business, if you fix the spec for two years you’ll be caught by competitors. Computers should be changing, right? It’s inevitable that 60GB hard drive will become too small, and memory may become too small as well.”

The problem with that computer strategy is that it means prices do not come down. By fixing its hardware standard for several years, video game console systems have been able to significantly lower prices over time by not having to upgrade to the latest technology.

The most important thing that the video game console ever accomplished was to make high-end gaming more affordable and accessible to the masses. Consoles also made life simpler by eliminating the problems with too many platform configurations, which simplified the development process and spared consumers the frustration of searching for games that were compatible with their specific configuration. Sony’s actions seem particularly misguided in light of this.

Kutaragi has also talked about what he sees in common between the PS3 and current Apple Computer philosophy and products. There is clearly a little envy behind such quotes from Kutaragi like: “If Mr. Jobs adds an Apple logo to the PS3, I think users will say it can be sold at $2,000.”

We would point out that another major difference between Apple and the PlayStation brand is that the PlayStation 2 had a share of over 60% of the video game console market, while Apple’s computer market share has hovered in the 2-3% range. We believe that under Kutargai’s techno-elite PlayStation 3 strategy, the PlayStation 3 could end up with a market share more resembling Apple products as opposed to the dominant PlayStation 2 market share.

Couldn’t have put it better myself.

Over the past five years, SCE’s video game business has averaged about $7.4 billion in annual revenue and brought in average annual operating income of around $500 million. Can Sony afford to lose this video game business in order to go after the smaller base of elite consumers?

The answer is “no.” Microsoft has the cash flow to lose console wars and keep on trucking. It will never lie down and never give up precisely because Bill Gates desperately wants to prevent something like the Playstation 3 from becoming “the PC of the living room.” Sony, on the other hand, derives a massive percentage of its yearly profit from the Playstation. It cannot afford to lose.

Take for an example, Valencia, the third largest city in Spain. Walk into an El Corte Ingles (Spain’s flagship retailer) or FNAC (a leading media entertainment retailer) in Valencia and you will see about 67% of video game shelf space given over to Sony products, with another 25% reserved for Nintendo’s portable game systems…

At 600 euro, the PS3 would be more than 35% of the monthly household income of a family in Valencia. Combined with the 2000 euro for an HDTV that could take advantage of Blu-Ray and four games, the total cost could top 15% of a family yearly income. On a per person basis, that would be almost 40% of an adult Valencian’s average income.

Of course, you obviously don’t have to buy an HDTV to enjoy a PS3, but given that Sony has less exclusive content this go-around, and given that Microsoft’s online service (Live) will almost certainly be more polished and interesting than anything Sony launches with, some consumers may not see much point in owning a PS3 without an HDTV…

So while Sony struggles with positioning issues Microsoft and Nintendo are free to try and build a solid base of actual video game players. The good news is that for both companies, under any scenario, DFC forecasts that the Microsoft Xbox 360 and Nintendo Wii will have a larger installed base than their respective predecessors. However, we think the company with the biggest opportunity is Nintendo. With a market leading price and a compelling mass market message the Wii has the opportunity to be the market share leader in all major regions.

As I (and many others) have said before, most consumers aren’t willing to buy three consoles (especially when they’ve become so pricey!) It’s too easy to imagine how people will look to Microsoft for their high-end, hardcore gaming needs, and Nintendo for their quirky and/or more casual needs.

Not surprisingly, under all our scenarios, market fragmentation is a big theme… For a consumer there are all types of choices for playing games: portable games, online games, old console systems, new console systems and so on. The console system remains the largest segment of the overall market, but its importance is clearly declining. Over the next two years we will see which companies can weather the eventual decline by diversifying beyond the PlayStation business.

A worthwhile point. For the first time ever, portable gaming is breaking into the mainstream. That is creating yet another draw on consumers’ wallets. A few hundred bucks here, and few hundred bucks there… is there room left for a $600 PS3 purchase? Perhaps the Playstation brand really is strong enough to make the difference. But brand hasn’t saved console makers (like Atari, Nintendo, and Sega) in the past, so I’m skeptical. I have been since E3.

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