Friday, May 12, 2006

PlayStation 3: DOA?

Earlier this week, prior to the start of E3 in Los Angeles, all three of the game console powerhouses—Microsoft, Nintendo and Sony—held press conferences to show off their upcoming products. Sony’s presentation was the most anticipated, and according to reports, most disappointing of the three.

Sony showed off the PlayStation 3…again. And, like previous demonstrations, almost everything they showed were prerecorded, canned demos of games. That was unimpressive, but the real shocker came at the end of the show, when Ken Kutaragi, President and CEO of Sony Computer Entertainment, announced the price. In the U.S., the PlayStation 3 will be sold in two versions: A stripped-down $499 model with a 20GB hard disk, no WiFi, no HDMI (meaning no digital HD capabilities) and no flash memory ports, and a fully-loaded $599 model with a 60GB hard drive, WiFi, HDMI and flash memory ports. Both models have Blu-Ray drives that can also read DVDs and CDs.

After Kutaragi announced the prices, the only sounds you could hear were crickets, with the occasional clunk of a jaw hitting the floor. By comparison, the stripped Xbox 360 sells for $299, and the fully loaded model costs $399. The new Nintendo Wii (snicker about the name among yourselves) wasn’t priced at the show, but the expectation is that it’ll certainly be no more than $299, and possibly as low as $199.

What’s fascinating is that Kutaragi was quoted post-conference as saying that he thinks the price of the PlayStation 3 may be too low. There seems to be a serious disconnect between Sony and reality, and I think that I’ve figured out what it is: Sony sees the PlayStation 3 as a home entertainment center, and the rest of the world sees it as a game console. When a company and its customers think differently about the same product, the customers always win, because they pay the bills.

Sony’s logic seems to go like this: Their first Blu-Ray player, which is now scheduled to ship in June, will sell for $1,000. The PlayStation 3 will sell for 50% to 60% of that price, but will be able to do much, much more. Thus, the PlayStation 3 is a bargain. On the other hand, most consumers will see the PlayStation as a game console that’s as much as 50% more expensive than the top-of-the-line Xbox 360.

Based on the demos that Sony’s given so far, the PlayStation 3’s games don’t seem to look all that much better than the 360’s. Sony’s clearly playing catch-up to Microsoft’s Xbox Live online service, and it threw a 3D motion sensor into its controller at the last minute to counter the buzz surrounding Nintendo’s Wii controller. Given all this, will consumers purchase a game console whose primary competitive differentiation appears to be its Blu-Ray player?

The answer to that question is critical, not only for the success of the PlayStation 3 but for the very survival of Sony. It’s been reported that the cost of the fully-loaded console and controllers is $900. Assuming that Sony manages to sell them to dealers for 30% off list, they gross $420 per machine, for a loss of $480 each. Normally, the statement “We lose money on every one, but we make it up on volume” indicates a serious lack of common sense, but it’s actually true in the video game business. In order to sell enough video games to recoup the loss on consoles that all the manufacturers incur, you have to sell lots of consoles. Somewhere down the road, if you sell enough consoles, your manufacturing costs drop, and you lose less money. The possible outcomes look like this:

  • Don’t sell any consoles, and you lose your R&D, manufacturing and marketing costs.

  • Sell tons of consoles, and the subsequent game sales more than offset the losses from the consoles, leaving a nice profit.

  • Sell some, but not enough, consoles, and you cover neither your sunk costs nor your loss on each console. You also don’t get your manufacturing costs down enough to make money on sales of fewer games.

Sony’s risk is that PlayStation 3 sales could end up in the “Death Valley” of “okay, but not good enough.” Sony’s game operations have kept the company afloat for years, so if the PlayStation 3 isn’t a smash hit, it could take a big chunk of the company down with it. I’ve dumped on Sony a lot since I started this blog, in part because the company should be doing a hell of a lot better than it is. But, with the PlayStation 3 debacle, Sony is challenging GM for the coveted “Best Snatching-Defeat-from-the-Jaws-of-Victory” award.
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