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State of the Video Game Console War

It’s been two years since the last time we stepped back and took a look at the console war from both a sales and financial perspective. Since then we have found out that the video game industry might not be “recession proof” but it is certainly “recession resistant” and has held up significantly better than other sectors of the economy.

With all that has happened in the industry over the last two years I thought it would be a good time to update the charts and see who’s in the lead, who has turned it around and who hasn’t.

*Microsoft did not announce exact sales numbers in their last earnings report but instead stated that the 360 has sold “over 40m”

In terms of sales all three companies did a good job moving hardware and have at least doubled their respective install bases since 2008.

  • Sony PlayStation 3 – 22.85 million unit increase from 2008
  • Nintendo Wii –  46.48 million unit increase from 2008
  • Microsoft Xbox 360 – 21 million unit increase from 2008

Looking at each company’s market share shows some weakness with the Xbox 360 which lost 7% of the market from 2008 (1% to the PS3 and 6% to the Wii).

With console sales numbers out of the way let’s take a look at how each company’s operating income has performed over the last two generations of consoles.

Note: See the Reference Material and Notes at the bottom of this article for important information concerning the operating income reported in the charts above.

Sony

The PlayStation 3 is not responsible for all of the operating losses shown above but the system has not been a financial success for Sony’s Networked Products & Services division. Despite slowly closing the sales gap between the PS3 and the Xbox 360 the division has just recorded its fourth year of operating losses and it’s doubtful that the division will reach the breakeven point in the PS3’s fifth year.

Sony’s current plan to salvage the PS3 rests on 3D HDTVs to bring in core gamer support and the PlayStation Move to lure casual Wii owners to the Sony camp. Both strategies are very risky and also unlikely to succeed in their goals.

3D HDTV technology is new, expensive and has yet to garner much consumer interest. Over the next couple of years this situation could change (ironically, the Nintendo 3DS will do more to raise consumer interest in home 3D than anything Sony can do) but until then adoption rates will remain low. This makes it unlikely that consumers will buy PS3 hardware and software for 3D features in the near future.

Additionally, the PlayStation Move will face its own cost issues when the motion controller launches this September. Current PS3 owners will be able to pick it up from anywhere between $50 (if they already own the Eye camera and use a DualShock in lieu of the navigation controller) to $170 [$100 for two Move controllers, $30 navigation controller, and $40 for the Eye]. The cost associated with the Move will certainly turn off the majority of current core PS3 owners but it’s reasonable to expect that some percentage of the current install base will buy it in order to take advantage of the pointer functionality for shooters in particular.

Non-PS3 owners will be able to get the system, one Move controller, the PS Eye and the Sports Champions game for $400.  Add to that one more Move controller and the navigation controller and the total price tag comes up to $480. Considering these are casual gamers who either already own a Wii or could buy one for $200 Sony’s chances of making a dent in Nintendo’s install base is slim at best.

Even if Sony achieves the best case scenario (3D in the home spurs PS3 sales and Move succeeds in pulling casual support from the Wii), the earliest they will be able to get the division back into profitability will be in the PS3’s sixth year. In this scenario that would give Sony five years before their “ten-year plan” is up to try and recover their losses before launching a new console. Taking into account the costs involved with bringing a new system to the market, it is unlikely that the division will ever fully recover its accumulative losses before the end of the PS3s life cycle.  Especially if the time value of money is taken into consideration, which it is not in this analysis.

If Microsoft and/or Nintendo launch a new console at any time within the next five years Sony will find themselves between the proverbial rock and a hard place. Having incurred nothing but massive losses since the PS3’s launch Sony is not in the ideal position to release new hardware alongside the competition, and if they choose to do so it will increase their current losses. Should they decided to stick with the PS3 they run the risk of having their hardware being dismissed as ‘last-gen’ in the eyes of the consumer, even if on a technical level it’s not.

Nintendo

While Sony and Microsoft made the mistake of producing expensive hardware and then selling it at a loss Nintendo put their efforts into a modest console upgrade, motion controls and the ability to sell a lower priced product with a profit margin. Just a quick glance at their earnings since the launch of the Wii shows that this business model has clearly paid off for Nintendo. Even if the DS and Wii had not become the mass market success stories that they did Nintendo would have still operated at a profit much like they did during the GameCube’s life cycle.

Nintendo’s closest competition for the Wii in the near term comes from the PlayStation Move (PS3) and Kinect (Xbox 360). Both devices are attempting to convert the causal audience from the Wii to their respective systems. The actual threat this poses to Nintendo’s market share is very low, mainly due to the costs associated with PS3/Move and Xbox360/Kinect combined with the current recession and high unemployment.

Furthermore, the launch of the 3DS will come sometime within six months of the PlayStation Move’s release this September, possibly in time to directly compete with Kinect this Holiday season. The 3DS along with a strong lineup of core Wii titles announced at E3 should go a long ways towards keeping gamer’s dollars flowing towards Nintendo.

With a commanding market share and strong financial position Nintendo is in the leadership position as to when to launch the next generation of home consoles, however this should not be taken as a sign that a Wii 2 is on the way any time soon.

Despite slowing hardware sales the Wii is still increasing its market lead over its competitors and the system appears to have at least two full fiscal years until sales and operating income drop to a level that would indicate the launch of a new system. Additionally, with the launch of the 3DS sometime before March 31, 2011 it is highly unlikely that Nintendo would cannibalize their own sales by releasing two new video game systems within the same fiscal or calendar year. With this in mind, I expect the launch of a new Nintendo home console between March 2012 and March 2013.

Microsoft

After years of losses with the original Xbox and the first two years of the 360 Microsoft has managed to turn their Entertainment and Devices Division around and become profitable over the last three fiscal years. These recent gains have a long way to go before they cover Microsoft’s entry cost into the video game console business but it’s unlikely that their shareholders will pull the plug now that the company has started to climb out of the hole.

Currently, Microsoft has decided to follow Sony in chasing after some of Nintendo’s casual Wii audience with the release of Kinect later this year. Unlike Sony, who built upon the ideas pioneered by Nintendo’s Wii Remote, Kinect uses no controller for input but instead has users control the games through physical actions or verbal commands. Also in contrast to Sony, Microsoft chose to show off Kinect at E3 with almost nothing that would interest the core gamer and this is going to cause a problem for the company.

The Xbox 360’s install base is considered to be made up mainly of core gamers.  With very little Kinect software shown that would appeal to them there is almost no reason for the majority of the current 360 install base to buy it. This will force Microsoft to rely on new system sales to casual gamers to develop a Kinect install base. New Xbox 360 owners will need to spend either $200 or $300 for a console and then, if early reports are correct, up to $150 for Kinect. That places the Kinect entry price between $350 and $450. Even if Microsoft puts together a 360 Arcade / Kinect bundle for as little as $250 the total price can still shoot up to $300 or $350 with the purchase of an Xbox Live Gold single or family account. For a causal gamer who already owns a Wii there is little reason to spend another $300, at least, to make the switch.  For casual gamers who don’t own a Wii it’s still a hard sell in comparison to Nintendo’s console.

While I don’t expect Kinect to have much impact on 360 sales the system should remain a positive influence on Microsoft’s Entertainment and Devices Division through the rest of the current generation of consoles. When Nintendo looks to be closing in on a release of new console look for Microsoft to follow their lead and release a new Xbox with a modest power increase over the 360. I believe Microsoft has learned their lesson with the 360 and will look to sell their next system at a more consumer friendly price point and a profit at launch.

Short Term Predictions for U.S. Video Game Console Prices

At this point in a normal console cycle the expectation would be that as we move closer to the Holiday 2010 shopping season that Sony, Nintendo and Microsoft would cut the price of their systems to increase sales. I don’t believe this to be the case this year for a number of reasons.

Both Sony and Microsoft will experience costs associated with launching PS Move and Kinect this year. Cutting their console price points in the same fiscal year as the launching of the new controllers will only serve to create an added expense.

Sony and Nintendo have the added pressure of the continued weakening of the US Dollar in comparison to the Japanese Yen. This has the effect of lowering operating income and expanding operating losses for any company operating out of Japan and doing business in America. In fact, Nintendo has already made statements regarding their concern for this situation. This currency exchange pressure will make it unlikely that either company will cut their price points in 2010.

Industry Concerns

The largest ongoing concern for the video game industry is the state of the global economy. Increasing unemployment will further reduce discretionary spending by consumers which will have some degree of negative impact on video game hardware sales. In particular, the poor economy combined with the historically low consumer adoption rates of video game console add-on peripherals could result in lower than expected sales for Kinect and PlayStation Move and increased losses for Microsoft and Sony.

While economic factors will have a negative effect on all three companies Sony and Microsoft’s video game divisions are in the most danger. Where Nintendo has a profitable business model and years of operating income to fall back on, Sony and Microsoft are either still operating at a loss or are seeing very small returns on their investments. During hard economic times companies have shown a tendency to cut out or scale back operations in under-performing divisions. I don’t believe that Sony or Microsoft will pull out of the video game console business, however I do acknowledge that their current situations make it a possibility.

Disclaimer

The author of this article has owned Sony (SNE) and Microsoft (MSFT) stock in the past.  At the time of that this article was published the author has a long position on Nintendo (NTDOY).

Gamer Investments does not suggest or endorse buying any stock in any company and strongly recommends that you conduct your own research before making any investments.

All information, aside from actual sales and operating income data, contained within this editorial is the opinion of the author and is not based on any “insider information”.

Reference Material and Notes

* At the time of publishing of this editorial Microsoft has not announced their Q4 earnings for FY 11.  Therefore FY 11 is missing one quarter of results for Microsoft.

** FY 10 and FY 11 results for Sony and Nintendo are influenced by the weakening of the US dollar in relation to the Japanese Yen.  As a result Nintendo’s FY 10 and FY 11 gains are slightly lower than they would have been if they were calculated in prior years. Sony’s losses in these years would be slightly lower had they been calculated in prior years. See the reference material for specific operating income and calculations.

*** Operating income for Sony and Nintendo was calculated at the historical exchange rate between the Yen and Dollar that occurred at the end of each fiscal year.

**** The operating income listed above is only for the division of each company that handles their video game console business. For Sony this is the Networked Products & Services Division (formally the Game Division), Microsoft’s results are from their Entertainment and Devices Division and Nintendo’s numbers exclude their earnings from “other investments”. Because of this the amounts reported contain operating income from sources other than the home video game consoles.  Sony’s results include sales of  the PSP, VAIO PCs, Walkman, etc.  Microsoft’s EDD includes the Zune, PC games, various hardware products, etc. Nintendo’s earnings include GameBoy, DS and software income. For the full description of operations in each company’s division check their IR website from the links here.

Sources

Gamer Investments editorial – PS2 May Have Won Last Generation’s Sales Battle but it Lost the Console War

Wii Hardware Sales

PS3 Hardware Sales

PS3 Hardware Sales

Xbox 360 Hardware Sales

Sony Earnings Reports

Nintendo Earnings Reports

Microsoft Earnings Reports

PlayStation Move price

Xbox 360 Slim price

Xbox 360 Slim Arcade price

Kinect price rumor

Xbox Live Gold Family Pack price

Historical exchange rates provided by http://www.x-rates.com/

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