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stage of its development. Between 1995 and 2006 the industry had been dominated
by Sony, whose PlayStation had accounted for well over half of world console sales
during the previolls two product generations. However, in the new generation of
video game consoles-the seventh since the industry's origins at the beginning of the
1970s-an entirely new situation had emerged. What was once believed to be a
winner-take-all market was now a three-way battle between Sony, Microsoft and
Nintendo with unusually small differences between them in market share.!
In terms of unit sales, Nintendo's Wii was the outright winner in all three of the
world's major markets (see Table 12.1). However, in revenue terms, market shares
were almost equal, reflecting the fact that the PS3 ($399 in the U.S.) was considerably
more expensive than either the Xbox 360 ($199 in the U.S.) or the Wii ($149 in the
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CASE 12
. TABLE 12.1 Cumulative sales of leading models of video game console in major
markets to March 31, 2009
Console
Nintendo Wii (million)
Microsoft Xbox 360 (million)
Sony PlayStation 3 (million)
Japan
U.S.
Europe
8.1
1.0
3.0
20
14
15
9
9
U.S.). The emergence of Nintendo as the new market leader after several years of
lagging as a weak third to Sony and Microsoft was a major reversal of fortune. Many
observers had written off Nintendo as a serious contender-it seemed to lack the
financial or technological muscle to compete against Sony or Microsoft.
As Sony and Microsoft's product development teams prepared for the next
generation of competition-both companies were rumored to be planning the
launch of new consoles in 2012-the unexpected success of Nintendo's Wii had
created considerable confusion for their video game strategies.
The Nintendo Wii had challenged several deeply entrenched assumptions about
the video game industry. The evolutionary trajectory of the video game console had
been perceived to be towards greater multifunctionality. One of the reasons that
Sony and Microsoft had placed so much emphasis On their video game businesses
and devoted so many resources to them was because they viewed the video game
console as a general-purpose home entertainment device and a mechanism for
linking with the internet. As a result, both Sony and Microsoft viewed video game
consoles not just as important products in their own right but as critical components
of their strategies for building strength within the fast-moving market for home
entertainment. For example, Sony had used the PS3 as its standard bearer in its
standards battle with Toshiba over technical standards for high-definition video
disks. Wii had severely dented this logic-it was a dedicated gaming machine with
few of the general entertainment features of PS3 or Xbox 360.
Wii's Success also pointed to a major shift in the market for video gaming. The
conventional wisdom of the industry had been that the video games market was
concentrated among males aged between 11 and 30 and in order to access this
demographic group the console makers needed to court "hardcore garners" when
developing and launching new models. The way to attract these sophisticated,
intensive Consumers was through hardware with immense processing power and
brilliant graphics and games that combined cinematic-quality and graphic realism
with strong characters and complex storylines. Yet, Wii's main market was among
casual garners. Compared to PS3 and Xbox 360 it was seriously underpowered in
terms of both processing speed and graphics. The appeal of its games was the speed
with which they could be learned rather than their sophistication.
In developing their video game strategies and their next-generation consoles, a
critical issue for Sony and Microsoft was whether Wii was an outlier. If it was, the two
companies could continue with the strategic logic that had guided their efforts since the
beginning of the twenty-first century. If it was not, then Sony and Microsoft had better
imitate the key elements of the Wii strategy. The stakes were high. In recent years the
world market for video game hardware and software was about $25 billion. The fact
CASE 12
FIGURE 12.1 Worldwide unit sales of video game consoles by product generation
50,--------------------------------------------------,
256 bit
32-64 bit
(e.g. PlaySlation)
w30+-------------------------------~~--------------~--_1:
~20+-----------------~~~~~~--~----~~--~--~::
that every new generation of consoles had surpassed the sales of its predecessor (see
Figure 12.1), reinforced both firms' interest in capturing market leadership in the future.
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CASE 12
million copies worldwide). By 1988, Nintendo had an 800/0 market share of the $2.3
billion U.S. video games industry.
Nintendo's market dominance and huge profits rested upon its careful
management of the relationship between hardware and software. Nintendo kept
tight control of the supply of games, managing their quality and their releases. Its
dominant market share in consoles allowed it to dictate stringent terms to game
developers. Developers were required to follow strict rules for the creation and
release of games for the NES console. Cartridges incorporated a "security chip" that
ensured that only cartridges produced by Nintendo from licensed developers could
run on the NES. Nintendo undertook all manufacturing of cartridges, charging
games developers a 20% royalty and a manufacturing fee of $14 per cartridge (the
manufacturing cost was $7). The minimum order-1 0 000 cartridges for the
Japanese market and 50000 for the U.S. market-had to be paid in advance. Any
game developed for the NES could not be released on a competing system for two
years.
Between 1984 and 1992, Nintendo's sales rose from $286 million to $4417
million. By 1990, one-third of U.S. and Japanese households owned an NES and in
both countries its share of the home video console market exceeded 90%.
Nintendo's return on equity over the period was 23.1%, while its stock market value
exceeded that of both Sony and Nissan during most of 1990-1.
the gamer community. Sega ill-coordinated its Saturn system-few game titles,
- - - - - - - - - - - - - - - - - - - - - - - - - - - CASE 12
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CASE 12
viewed as children's toys, games consoles were emerging as the primary tool for
electronic entertainment, with the ability to offer movies, music and many of the
communications functions currently performed by PCs.
The Xbox was a technology breakthrough: "Arguably the most powerful games
console ever made, developed after consultation with more than 5000 garners and
games creators, it has a staggering array of features: an internal hard disk with a
733MHz processor, 64MB of memory, a DVD player, Dolby Digital 5.1 Surround
Sound and an Ethernet port that makes it the only game console that's internet-ready
and broadband-enabled. "2 Yet, with successive generations of consoles,
technological capabilities were becoming less and less a distinguishing factor and the
critical differentiator-software-was a problem for Microsoft. Xbox was launched
with 19 games available, compared with 200 for PS2.
Despite a successful u.S. launch with 1.5 million sold in the six-week Christmas
shopping period, Japan- proved to be a difficult market for Xbox-not only were
launch sales disappointing but Xbox's reputation was damaged by complaints that
it caused scratching of CDs and DVDs. Microsoft's ability to establish itself in a
strong second place to Sony rested on three factors: Microsoft's formidable
reputation in IT, its launch of blockbuster games Halo and Halo2, and Xbox's
online capabilities. In November 2002, Microsoft launched its Xbox Live online
gaming service with interactive gaming and direct downloading of new games. A
few days after the launch of Xbox, Nintendo joined the fray with its GameCube
console.
The major casualties of the intense competition between Sony and Microsoft were
Sega and Nintendo. Despite massive price cutting, Dreamcast sales went into sharp
decline even before Microsoft's entry. At the end of 2000, Sega announced its
withdrawal from video games hardware to focus on software. Meanwhile Nintendo
was trailing both Sony and Microsoft in sales. By December 2006, Sony had sold
around 111 million PS2s, compared to 24 million Xboxes, 21 million GameCubes
and over 10 million Dreamcasts.
entertainment and Microsoft's strong online presence. Through Xbox Live, users
could purchase and download video games, in-game extras such as weapons and
costumes, and movies and TV shows-including high-definition TV shows.
SonyPS3
Meanwhile, Sony's launch of its PS3 was dogged with multiple delays. Most of the
problems related to the technological ambitiousness of the hardware. PS3's
revolutionary multicore cell processor, developed jointly with IBM and Toshiba,
proved difficult and expensive to manufacture-it was estimated that each cell
processor cost Sony $230 per unit. Even more problematic was the delayed Blu-ray
DVD drive, the initial production of which was believed to cost about $350 per unit.
Merrill Lynch estimated that the total cost of the components for the PS3 could
amount to $900 per unit. 3
The Blu-ray drive was a central element of Sony's strategy. It was engaged in a
fierce standards battle with Toshiba over the technical format of the next generation
of high definition DVDs. PS3 was to be a key product in gaining market acceptance
of Blu-ray.
Software was another problem for PS3. The complexity and power of the
hardware extended the potential and the cost of games written for PS3. Software
development costs were estimated at four or five times those of PS2. To
encourage developers to write for PS3, Sony was obliged to cut its royalties. At
its initial launch, Sony had 15 titles available for PS3, although few made full use
of PS3 's technical capabilities. The most popular of the new games was
Resistance: Fall of Man.
PS3's launch in Japan on November 11, 2006 and in North America on
November 17 was marred by lack of product. Following both launches, PS3s were
selling on online auction sites in Japan and the U.S. at a substantial premium to their
retail list prices. The European and Australian launches were set for March 23, 2007.
One of the results of product shortage was continuing strength of Sony's PS2.
During the critical month of December 2006, Americans bought 1.4 million PS2s,
outselling PS3 (491 000 units), Xbox 360 (1.1 million units) and Nintendo Wii
(604000 units).
Nintendo Wii
One of the biggest surprises of the new round of competition was the strong initial
showing of Nintendo's Wii. Technologically, the Nintendo Wii lacked the advanced
features of either the Xbox 360 or PS3; its primary innovative feature was its remote
wand-like controller that was sensitive to a range of hand movements. As a result,
Nintendo claimed that its Wii was more intuitive than other consoles and could be
learned more easily. This linked with a marketing strategy that aimed to recruit new
games players and targeted a very broad demographic-including older consumers.
Wii was launched in North America on November 19, 2006, on December 2 in
Japan and December 8 in Europe. The launch was accompanied by 16 new games
for Wii-of which several were new versions of existing franchises (for example,
Legend of Zelda: Twilight Princess). Nintendo also mounted its biggest ever
advertising campaign.
Table 12.2 compares the rival seventh generation consoles. Table 12.3 shows unit
sales of leading video game consoles across the different product generations.
685
686
TABLE 12.2
Console
Hardware
Connectivity
DVD
Games
Sony PS3
Cell Broadband
Engine 550 MHz
RSK GPU
HDTV-capable
20 GB version:
Integrated Blu-Ray
player. Backwards
compatible with
DVD
50 titles available
at end of 2006
DVD player.
Additional HD-DVD
drive available
for $199
No cu rrent DVD
playback. Plans to
launch integrated
DVD version in Japan
in 2007
c. 30 titles at time
$250
of launch. Backwards
compatible with
GameCube
Microsoft
Xbox360
IBM Xenon,
Power-PC CPU
500MHzATI
custom GPU
HDTV-capable
Bluetooth 2.0, an
ethernet port and
four USB docks.
60 G8 version:
Compact flash, SD
and memory stick
duo, WiFi.
Option to purchase
WiFi adapter.
Core version:
Three USB docks,
ethernet port
20GB version:
Nintendo
Wii
IBM Broadway
Power-PC CPU
GPU developed
with ATI EDTV
video output
TABLE 12.3
Second
generation
Nintendo
Sega
Sony
Microsoft
Others
Wireless controllers
Bluetooth, two USB
docks, SD slot,
internet via IEEE
802.11 or a Wii
LAN adaptor
Atari 2600,
Fairfield
Channel F,
Magnavox
Odyssey
by
20GB version:
$499
60GB version:
$599
Core version:
$299
20 GB version:
$399
platform (millions)
Seventh
generation
(to endMarch 2009)
Third
generation
Fourth
generation
Fifth
generation
Sixth
generation
NES: 60
Master
System: 13
Super NES: 49
MegaDrive'
Genesis: 29
N64: 32.9
Saturn: 9.3
PS3: 26.7
Xbox 360: 30.2
'"
16
14
12
10
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4
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Hardware
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688
was "in" and "hot." The adult market comprises numerous niches, each with an
interest in a different type of game. Adults like titles that fit in with their lifestyle and
interests. Sports-based games were very popular among adult males. However, in
terms of intensity of game playing, teenage boys remained clear leaders: U.S. males
between the ages of 12 and 17 with a video game console in their home devoted an
average of 14 hours a week to game playing. Females in the same age bracket played
an average of 4 hours a week. The popularity of Nintendo's Wii had contributed
substantially to the growth of video gaming among adults and females.
The growth of video games playing had opened up an entirely new source of
revenue for video games publishers: advertising. Product placement within video
games generated advertising revenues of $56 million in 2005 in the U.S. alone. Both
Microsoft and Google acquired advertising agencies specializing in video game
advertisement placement.
/
Software
Each video game console supplier ("platform provider") licensed' third-party
software companies to develop and distribute games for its system. Two types of
company were involved in video games software: video games; publishers, which
were responsible for financing, manufacturing, marketing and distributing video
games, and video game developers, which developed the software. Video game
publishing was increasingly dominated by a few large companies-the most
prominent being Electronic Atts (see Table 12.4). Typically, the software publisher
submitted a proposal or a prototype to the console maker for evaluation and
approval. The licensing agreement between the software company and the hardware
provider gave the console maker the right to approve game content and control over
release timing, and provided for a royalty payment from the software company.
Game developers were paid a royalty, typically between 5% and 150/0, based on the
publishers' revenues from the game.
Escalating game development costs were a result of the demand for multifeatured,
3-0, cinematic-quality games made possible by increasingly powerful consoles.
Atari's Pac-Man released in 1982 was created by a single developer and cost about
$100000. Halo 2 released for the Xbox in 2004 involved 190 developers and cost
$40 million. By late 2006, Halo 2 had sold 8 million copies at $50 each. For the new
generation of consoles, most games cost more than $12 million to develop. In terms
of both costs and revenue patterns, video games closely resembled movies, with
Electronic Arts
Konami
Take-Two Interactive
Activision
Others
19.8
9.8
9.9
8.8
52.7
- - - - - - - - - - - - - - - - - - - - - - - - - - CASE 12
TABLE 12.5 Top-selling console games in the U.S., 2008 (by units sold)
Publisher
Release
date
Units sold
Title/platform
(0005)
Av. retail
price ($)
Nintendo
Nintendo
Nintendo
Nintendo
Rockstar Games
Dec. '06
Apr. '08
May. '08
Mar. '08
Apr. '08
Activision
Nov. '08
Nov. '08
5280
5000
4530
4170
3290
2750
2310
1890
1870
1650
50
50
90
50
40
60
40
40
30
40
Microsoft
Rockstar Games
Electronic Arts
Nintendo
Apr. '08
Aug. '08
Nov. '05
similar success rates-a mere few became money-spinning blockbusters. Table 12.5
shows the top selling titles of 2008. Like movies too, creating a brand franchise
through a succession of sequels had become a key competitive strategy. Rising
development costs were a key factor causing consolidation among publishers.
As the power of the publishers had grown and the costs of development had risen,
so exclusivity ties had disappeared from most licensing contracts-most leading
games titles were cross-platform. For example, several titles that were once PS3
exclusives have been released simultaneously on Xbox 360. These include Grand
Theft Auto N, Final Fantasy XIII, Virtual Fighter, and Devil May Cry. Wii has several
exclusive titles, most of which were developed by Nintendo.
The development of video games required a blend of technology and creative
talent. The development process included game development and design,
proto typing, programming, art, computer graphic design, animation, sound
engineering, technical writing, editorial review and quality assurance. It took 18 to
36 months to complete a new title based on a new platform. To "port" an existing
title to a different platform took up to 9 months. Many games were based on
characters and themes that were either owned by the game developer or licensed
from third parties. The licensing fees paid by software publishers for exclusive rights
to the intellectual property of media companies and sports organizations grew
substantially between 1998 and 2002. Securing the license to produce a game based
on a hit movie (for example, Harry Potter) could cost several million dollars. In the
sports market, licenses paid to sports leagues (NFL, NHL, MLB, NBA, FIFA)
typically involved an upfront payment,.plus a royalty of 5% to 150/0 of the wholesale
price for each unit sold.
Not only did software sales exceed hardware sales-software was responsible for
virtually all of the industry's profit. The console makers followed a "razors and
blades" business model: the consoles were sold at a loss; profits were recouped on
software sales-both games developed internally and royalties received from thirdparty games publishers. The result was strongly cyclical earnings for the platform
providers: the launch of a new console would result in massive cash outflows; only
with a substantial installed base would the platform provider begin to recoup the
investment made.
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CASE 12
n~allliradllrt'rs
Nintendo
Total sales
Operating income
Net income
Op. incomt;'Av.
total assets (%)
Return on avo
equity (%)
(Yen, billions)
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
534
172
84
10.6
573
156
86
9.9
531
145
56
6.1
463
85
97
9.7
554
119
106
9.5
504
100
67
8.9
514
110
33
10.5
515
113
87
9.7
509
91
98
7.9
966
226
174
19.5
1672
487
257
27.0
14.0
12.9
7.7
12.2
12.0
7.4
3.7
9.6
10.4
16.8
11.0
Sony
Sales of which:
Games
(Yen, billions)
1998
1999
2000
2001
2002
2003
2004
2005 2006
2007
2008
6761
700
6804
760
6687
631
7315
661
7578
1004
7474
936
7496
754
7160
703
1016
974
1284
1219
7475
918
CASE 12
(Yen, billions)
Sony
Operating income
of which:
Games
Net income (loss)
Op, income/Av,
total assets (%)
Return on avo
equity (%)
2001
2002
2003
2004
2005
2006
2007
2008
141
225
135
185
99
114
191
71
374
137
179
5.5
77
122
3,7
(51)
17
3,1
84
15
1.7
113
116
2,2
68
89
1.1
43
164
1,2
9
124
1.9
(232)
126
0,6
(124)
369
2,9
9,8
6,1
0,1
0,1
4,8
3,6
6.3
4,1
3,94
(3,08)
1998
1999
526
348
117
222
6.7
13,2
2000
($, millions)
Microsoft
2000
Sales of which:
Home & entertainment
Operating income
of which:
Home and entertainment
Net income
Op, income/Av,
total assets (%)
Return on avo
equity (%)
n.a.
2001
22956 25296
n.a.
n,a.
11006 11720
2003
2004
2005
2006
2007
2008
28365 32187
2748
2453
11910 13217
36835
2731
9034
39788
3110
14561
44282
4292
16472
51122
6069
18524
60420
8140
22492
2002
n.a.
n.a.
9421
24.4
7346
21,2
(847)
7829
18,8
(924)
9993
17,9
(1011)
8168
10,3
(451)
12254
17,6
(1283)
12599
23,6
426
14065
29.3
(1969)
17681
30,9
26,9
16,6
15,7
17,6
11.7
19,9
28.6
16.45
42.47
not available.
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