Originally posted on sciy.org by Ron Anastasia on Wed 18 Oct 2006 01:23 PM PDT  

INSIGHT

By David Cole

OCTOBER 17, 2006

PlayStation 3's Tough Transition Game

Sony's new video game console offers pricey, cutting-edge tech. But serious rivals await, from Nintendo and Microsoft—and other platforms

Way back around the start of the decade, Sony Computer Entertainment released a product that promised to revolutionize home entertainment. The PlayStation 2 was a game machine that could play DVD movies and would eventually be able to offer online gaming, as well as home shopping, the ability to deliver products via digital distribution, and many other applications. The PS2 went on to become a dominant game platform, even as it proved unsuccessful as a diverse home-entertainment platform.

In 2006, the PlayStation 2 passed the first PlayStation as the best-selling console game system of all time with more than 106 million units shipped worldwide. This is more than four times what the Microsoft Xbox and Nintendo GameCube were able to ship. Simultaneously, DVD became firmly established as the home-movie format of choice and going online became a mainstream activity.

However, the takeoff of DVDs, the Internet, and the PlayStation 2 occurred independently of each other. DVD players were used for movies, computers for Internet access, and the PS2 simply did what game machines do best: played games. All the extra features were relative non-factors for the PlayStation 2. To put it bluntly, the PS2 was a cheap piece of plastic for playing games.

So why did the PS2 succeed? What mattered to consumers was that it provided incredible entertainment value for the entire family. While Nintendo focused on its big-name, kid-friendly franchises and the Xbox resonated with the PC-centric acne crowd that love their games violent and bloody, the PS2 had something for everyone. Sports, action, racing, kids' products, karaoke, the EyeToy camera, and, yes, virtual bloodshed—all could be found on the PS2. This was the game system for the masses, which, in its prime years, sold in the very consumer-friendly $200 price range.

PLATFORM TUSSLE.  However, the video game industry can be especially turbulent because every five years or so consumers start looking to upgrade to new systems based on the latest technology. Everyone must start from scratch, and that includes Sony (SNE). Sony's upcoming PlayStation 3, scheduled to ship in North America and Japan in November, is designed to deliver on many of the promises made for the PS2.

The PlayStation 3 is a different beast from its predecessors. This is a system sturdy enough to be the centerpiece of a home entertainment system. It is not a plastic toy. The focus this time is on power pure and simple. The goal is to push cutting-edge technology that, while expensive and difficult to develop for today, will be around for years to come.

The challenge Sony faces is that the competition is not sitting still. The goal for Sony is to keep the PlayStation 2 base happy and content for the next several years as they gradually migrate to the PlayStation 3. Microsoft (MSFT) and Nintendo (NTDOY) would like to speed up that migration pattern, not to the PS3 but to the Xbox 360 and the Nintendo Wii. Sony's goal is to slow that upgrade cycle, but that can be difficult when you have well-heeled competitors looking to push their own platforms. In November, 2005, Microsoft launched the Xbox 360, which clearly put the pressure on Sony to go to market with the PlayStation 3. Even Nintendo is getting a jump this time, promising to ship 4 million units of the Wii in 2006, vs. only around 2 million units anticipated for the PS3.

ENERGIZING ITS BASE—EVENTUALLY.  The other key challenge facing Sony is that its powerful new system is not cheap. This holiday season a new PS3 will cost almost as much as a Wii and an Xbox 360 combined. Clearly, Sony needs a way to explain the price difference. The problem is, most consumers are likely to evaluate the PS3 as they did the PS2: as a game machine, not as a powerful multifunction device. As a Blu-ray player, the PS3 is inexpensive, but early adopters in this market are probably not bargain hunters.

Furthermore, the number of technology-elite consumers pales in comparison to the tens of millions of consumers that buy video game systems and could care less about the latest in expensive high-definition video display. These mass-market consumers are exactly the demographic that Sony lucratively tapped with the PS2. It is unclear whether these consumers will follow Sony upmarket, especially considering the stiff competition.

The key to selling game consoles is good games. The Xbox 360 has built a solid library of software in its first year. With the Wii, Nintendo has almost nowhere to go but up and the system may have potential to appeal to not only the loyal Nintendo base, but also to a more casual adult audience. Meanwhile, developers are just now learning the complexities of writing code to the PS3's Cell processor and its eight SPE processors.

The good news is that once developers learn how to take advantage of the PlayStation 3's unique development capabilities, the games could look superior to those for competing systems. The bad news is, it could be some time before standout PS3 games appear on a regular basis. In the meantime, Microsoft and Nintendo have a golden opportunity to build solid installed-bases for their systems.

The biggest ace Sony has up its sleeve is the large PlayStation 2-installed base that may not be in too big a hurry to buy a new system. The battle for the video game hardware market will not be decided this holiday season, or even in 2007. This is a war that will be fought over the next several years and will depend on the efforts of not only Sony, Microsoft, and Nintendo, but of hundreds of third-party manufacturers. Given the hit-oriented video game market, it is a war that could be significantly affected by a handful of games that have not even begun development.

DEVELOPERS' RACKET.  In other words, there should be no rush to declare winners and losers. However, one thing that seems clear is that Sony's dominant video game market share is destined to decline. For the past 10 years, video game developers have thrived on Sony's PlayStation platforms. It has been possible for companies to make a great living solely off the PS One-/PS2-installed base. Even if the PS3 is the best-selling system, it appears Microsoft and Nintendo will increase market share.

On top of that, the video game console business faces increasing competition from other platforms. There are emerging mobile and online game markets that increasingly operate outside the realm of the console business. In 2004, console software accounted for nearly 50% of worldwide interactive entertainment revenue. By 2011, DFC Intelligence forecasts only about a third of revenue will come from video game-console software revenue.

In this platform transition, software developers and publishers face enormous challenges, but also have a great opportunity to stand out from the pack. It no longer is just about having the biggest intellectual property (IP) to pump out on the PS2 and from there possibly generate some secondary revenue on other platforms. The leading companies will need the tools and technologies to leverage their IP across multiple platforms. A high-end PlayStation 3 title is not only likely to be expensive to develop; it will probably not be easy to port to other platforms.

Popular licensed IP familiar to consumers will still be a big draw for the game-buying public. However, this alone will clearly not be enough. More than ever, success in the video game industry is about having a complete package of technology, content, marketing, and distribution savvy. This is truly a time when winners are separated from losers, the big can stumble, and the unknowns can become major players. In 2007, the game will just be starting.

David Cole is the founder and president of DFC Intelligence, a strategic research firm focused on interactive entertainment. Since 1995, DFC has published numerous reports tracking the emergence of the worldwide video game and online game markets. Cole and other DFC analysts are frequent speakers at industry conferences around the world.

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