Game Console Industry

The game console industry is unpredictable, as the market leader changes as frequently as new games being released. Currently, the most prominent console manufacturers in the industry are Sony (PlayStation), Microsoft (Xbox), and Nintendo (Wii). While Sony and Microsoft focus on powerful machines and games targeted at older teens and young adults, Nintendo’s family friendly, less graphically polished consoles target an entirely different market, and is not applicable to the Sony/Microsoft battle. The adoption of consoles depends heavily on one factor: the content available.A console manufacturer needs to have third-party developer support in order to have a steady stream of quality video games being released throughout the year. Although brand loyalty, technical capabilities and price certainly plays a part on the purchase decision of an individual, consumers tend to buy the console that offers the games that the consumers enjoy the most. Sony and Microsoft both publish a cata logue of a unique line up of video games made in-house as well as receive royalties from third-party video game developers such as Electronic Arts and Activision (ATVI).Microsoft and Sony both use a loss leader strategy, pricing their consoles lower than the production cost; thus, increasing the market for higher margin sales of related software, licensing fees, accessories, and downloadable content. As such, both firms sacrifice console profit to attract customers to adopt their ecosystem. This pricing strategy for game consoles, coupled with each console’s respective launch dates, has immense effect on setting the competitiveness of the companies for years to come.Historically, higher initial pricing methods bottlenecked initial uptake on consoles, and is often followed by price cuts to encourage greater adoption. During the launch of Xbox 360 and PS3, the price disparity and subsequent price drops hugely altered consumer purchasing decisions. The lower initial price point for Xbox 360 resulted in a quick grab for market share, but Sony followed with price cuts; thus, resulting in a price war – one that was won by Sony in total number of sales, but also the most amount of losses.To most consumers, these consoles are mutually exclusive and purchase decision is mostly based on value for money. Timing of the launch is also crucial as many gamers aim to be first adopters for new consoles. Relationship with Gaming Suppliers and Consumers The winner’s curse exists due to the biased optimism of bidders and the unknown value of the object being bid on. This is especially true in the heated rivalry between Xbox One and PlayStation 4. The bid that these two giants are trying to win is the hearts of the console gaming community.However, both companies are unable to actually quantify how much the console gaming industry is worth as bidding takes place during the production phase, prior to sales. Generally video game players can be segmented into PC gamers, Console Gamers, or Casual Gamers. The PC gamers are currently being served by Gaming PC's, with the latest technology and the widest variety of customization regarding multimedia; this is essentially the enthusiasts market.The Casual Gamers are generally younger gamers who have less of a focus on the depth and graphical intensity of games. This demographic is currently being satisfied by Nintendo's Wii & DS or a normal home PC. Both the PS4 and the Xbox One can be categorized as serving the console gamers, for these gamers often demand high quality machines, certain elements of media integration, and high degree of innovation from new generation consoles. However, above all else, the quality of games and price of systems are the primary order winners for console gamers.The quality of games is generally determined based on the two factors of aesthetic and gameplay. The aesthetics of a game depends largely on the processing capabilities of the system while the gameplay comes f rom the creative minds of the game developers. Thus, for Sony and Microsoft to accurately predict the relative demand for their consoles, they need to evaluate the strength of both these key success factors. In the eighth generation of consoles, Xbox One and PlayStation 4 have very similar processing power and graphics rendering capabilities.The similarity of the two devices mean that the order winner for a console gamer will not be based on the internal capabilities, rendering demand predictions using aesthetics of a game irrelevant. With regards to game play, this falls squarely on the shoulders of game developers and publishers. Both Sony and Microsoft have their in-house gaming development arm under subsidiaries. Microsoft's game developer, 343 industries are responsible for the blockbuster hit â€Å"Halo 4†, which has  already sold 4 million copies to date.On the Sony side their in-house developers, Naughty Dog has created the â€Å"Uncharted† franchise and has sold 5 million copies with its second instalment alone. From an exclusive content perspective, both companies all have clear winners and it is very difficult to predict which exclusive content will outsell the other. Aside from exclusive titles, there are also independent game developers such as Activision-Blizzard and Square Enix.These independent game developers are capable of influencing player behaviour by releasing exclusive content on specific systems. For example, Microsoft's partnership with Activision on Call of Duty Modern Warfare 3 (COD MW3), ensures that specific content only gets released over the Xbox platform, thus incentivizing players to choose Xbox during the game’s release in November 2011. Microsoft's success with Call of Duty does not however spell doom for Sony, as Sony's partnership with developers like Square Enix’s Final Fantasy franchise creates enormous success as well.In the end, not only are most games playable across the two different plat forms, but even for the exclusive contents the two firms are essentially ensuring competitive exclusives are available on their respective consoles. Adding to this uncertainty is the fact that games are very much like animated blockbuster movies, while having a talented cast of game developers certainly lowers the risk of creating an unpopular game, it is not guaranteed to always be a hit. A perfect example of this is the game â€Å"Haze†, supported by Sony's PS3 and developed by the All-Star developer Free Radical Design.Prior to its release it was deemed to be the Halo (one of Xbox's most successful franchises) killer. However, once the game hit the shelves it was met with lukewarm reception and only 500K in sales, which resulted in the closure of Free Radical and a huge write-off for Sony. At the time of production for Xbox One and PS4, many games for the consoles have yet to be developed; therefore, making it almost impossible to foresee which franchise will continue to d o well and which will fail.One key order winner for console gamers is the quality of games, yet on this specific metric Microsoft and Sony are practically non-differentiable and it is nearly impossible to predict which console will fare better than the other. Subsequently, because of this ambiguity, it contributes to the notion that in this common value auction, the players do not know the actual market value of the item they are bidding on, and will likely overpay due to the uncertainty. The launch of PS4 and Xbox One As the launch of PS4 and Xbox One is extremely recent, there has been little market data to show who is winning out the competition.Because these consoles are the eighth generation of gaming platforms, observing current actions in comparison to past events can grant us a view into their individual competitive advantages and assess their strategy. The pricing strategy for Xbox One is to offer the console at a much higher premium. At $499USD, the Xbox is $100 more than the PS4, which is largely attributed to the Kinect 2 motion-sensing technology as part of the package. It is yet too early to tell how consumers will react to this huge price discrepancy, as the value added for the bundled technology creates an interesting value proposition.This pricing strategy is also noticeably opposite of what Microsoft has done in the past. In the previous generation of consoles, Microsoft sold each Xbox 360 at a loss of $126, while Sony saw $130 loss per PS3. Microsoft claims to be, at minimum, breaking even per unit of Xbox One to cover variable costs. While this discourages a price war like what has taken place in the pass through Sony and Microsoft’s use of loss leader strategy through their pricing, it is yet to be seen if consumers will be able to swallow the $100 difference. In contrast, Sony is selling the PS4 at an average loss of $60 per console, at a price of $399 per unit.Even with the addition of PS Eye, a similar accessory to the Kinect 2 t he $100 premium of Xbox One is still higher the PS4 cost with PS Eye. We can see that Sony chose to continue to pursue a loss-leading strategy, potentially overestimating the revenue that can be reaped from future sales. Sony is still operating with the optimistic idea that by incurring a high initial loss, they will be able to reap higher benefits in the future, continuing their vicious cycle of the Winner’s curse. Microsoft’s marketing expenditure for the Xbox One launch is expected to exceed $120 million USD.Assuming that Microsoft is breaking even per each console sold, that means it needs to sell at least 200K consoles just to see a return on marketing investment. Noting the fact that Xbox One’s controller itself cost over $100MM USD to develop, a small snippet of full R&D costs, the timeframe at which Xbox makes a positive net present value remains to be seen. Xbox 360 sold just over 79MM units over its time-span; with shifting consumer focus away from con soles to PC gaming, it is hard to predict just how profitable or unprofitable the One will be for Microsoft.The situation is just as devastating for Sony; with a unit contribution loss of $60, it would take a lot of cross-product sales to achieve a return on investment. Sony is just as heavily invested in terms of development and marketing costs compared to Microsoft. Even with the uncertainty of consumer adoption and market share capture rate, the two firms are going head-to-head in hopes of securing a return on their investment through capturing more of the pie. Beyond competing on price and marketing, Sony and Microsoft are competing for first adopters through launch dates.Historically, Sony entered the gaming console market first with the original PlayStation while Microsoft waited a whole generation before entering. PS2 dominated the sixth generation of gaming consoles while the original Xbox only gained about 1/8th of the pie. By launching 13 months ahead in in Europe, Microso ft effectively out competed Sony and was able to gain almost half of the market share. This neck to neck competition means the launch of the eighth generation of consoles will determine who truly wins out in the console world, as clearly both firms are much more concerned about getting their consoles into people’s homes at any cost.Interestingly, Microsoft decided to launch in the Eurozone ahead of Sony while the situation is reversed for the North American market. The two firms are essentially trying to steal shares from each other’s respective strongholds. There are many competitive strategies at play for this battle, but regardless of these actions, both firms are losing money. Microsoft has been making a net loss with the gaming division in the past decade, largely attributable to the winner’s curse and also price wars. There has been signals that Microsoft wants to shift away from this competition that has resulted in such heavy losses on both sides.With a pricing that supposedly creates a unit contribution of zero, Microsoft is no longer suffering from the Winner’s curse to win out the bid of each individual consumer’s wallet. Although it has yet to be seen whether this will be effective as consumers are price sensitive in this industry, Microsoft is also trying to change its value proposition and appeal more to the mass market. Microsoft’s marketing launch strategy focuses largely on pushing the entertainment hub aspect of the product, as opposed to solely the gaming aspect.Many of Microsoft’s marketing ads have been focused on the multimedia content and screen sharing technology of the console. This aims to shift Xbox’s value proposition away from Playstation’s game centric focus, and attempt to communicate to consumers the value for money. In contrast, Sony continues to align their image to fit the hard-core gaming segment alongside the pursuit of the loss-leading strategy. This image is n ot only reflected in marketing techniques, but also the technical specifications of the consoles.Even with the lower price of the PS4, Sony chose to integrate a more powerful console, in hopes that the ‘hardcore’ gamers will buy more games. The heavy initial spending on R&D and marketing is in essence a bid for greater market share. Contrary to the winner’s curse, in this competition between Sony and Microsoft there is no ‘winner’ as increased spending has not translated to greater profits. The pricing and technological attributes of the product is also a bid for each consumer’s purchasing dollar in which the winner makes either a loss or no profit for the console sold.These individual transactions amalgamate to result in the desire to gain a larger share of the pie through greater console sales which leads to heavy losses on both sides. Winner’s Curse Winner’s curse occurs in a common value auction due to incomplete information. In the case of Sony and Microsoft, the adoption rate of their respective consoles is the objective of the auction. Since the value of each customer is worth roughly the same to both Microsoft and Sony, they have equal incentives to win the bid and they are differentiated only by their individual valuations.Prior to the launch of the Xbox One and PlayStation 4, Microsoft and Sony independently evaluates the value of the market which historically has been inaccurate. At the end, the player that wins the auction and sells the most amount of consoles will often be the one that incurs the largest losses. This is perfectly exemplified in the seventh generation consoles of Xbox 360 and PlayStation 3, where PlayStation won the bid and outsold Xbox, but in doing so, it cost Sony's console gaming division $5B relative to Microsoft's loss of $3B. These corporations can justify such large losses as they have cash cows in other divisions.The fact that these losses are justifiable is due to both firms’ competitive orientation; if one pulls out of the market, the other would dominate and be profitable. This has been seen in Olympic broadcast rights bidding where stations are willing to lose just so competition won’t gain. The reason for such over-bidding comes down to optimism. Since the value of consumer adoption is nearly impossible to estimate, Sony and Microsoft are essentially guessing what their potential monetary success would. From this uncertainty, the ‘winner’ is simply the one that made the bigger and more optimistic mistake.In the last generation Sony won the auction by making aggressive price cuts following the launch of their console as well as investing heavily into marketing and development expenditures. This spending exceeds the actual value generated from sales of the console and games; thus, resulted in a large deficit of $5 billion dollars. Both firms have been extremely stubborn in their strategies, going head to head to ensur e the other firm does not win. As discussed previously, there has been signs that both firms are acknowledging this winner’s curse scenario, resulting in both aiming to focus on different segments of the consumer market.As this industry is relatively young and consumer interests are fickle and unpredictable, there has been uncertainty in the value of the market. The loss-leading strategy was extremely effective and profitable for Sony during the sixth generation of consoles, prompting Microsoft to enter into the industry. As such, now it is impossible for one to pull out as both realize the market potential when there are no direct competitors. Another strategy for Microsoft or Sony to adopt is to occupy another space and focus their appeal to specific consumers.Nintendo’s Wii was able to be extremely profitable and outsell both Xbox 360 and PS3 as it appealed to a wider demographic, stressing the value proposition of social gaming. The Xbox One is aiming to occupy a d ifferent space by becoming a multimedia hub rather than just a gaming console. However, the success of this is yet to be determined. Analysts suggest that the Xbox should be priced lower in order to compete against the PS4 and PS Eye bundle. However, looking back at this price war and continued winner’s curse, it may be a better strategy for Xbox to maintain its price position.Sony at this moment is more on the defensive where they are not able to raise their price without suffering backlash from consumers. As well, it may be prudent for Sony to wait and see Xbox’s transition away from hard-core gaming to see if they regain adoption rates from this demographic. The winner’s curse has plagued this segment of the gaming industry severely in the past decade with Xbox and PlayStation. As Microsoft tries to redefine its appeal and shift to a more middle segment of the market, this winner’s curse will start to be alleviated.This can only be realized if consumer s accept Xbox’s new position, otherwise the negative spiral continues. Ideally, a consumer will be educated in the differences between the two and purchase based on pragmatic reasons as opposed to perceived value. Xbox pricing their product at cost is a strong indication there is desired change to avoid the winner’s curse. Similarly Sony is losing less per unit of PS4 as well. With less incremental loss per unit, the firms will hopefully generate a profit in the long-run for their gaming divisions.