University of California Video Game Supremacy Case Study Analysis In November 2006, with the launch of the Sony PlayStation 3 a mere weeks away, Sony Corpo

University of California Video Game Supremacy Case Study Analysis In November 2006, with the launch of the Sony PlayStation 3 a mere weeks away, Sony Corporation’s CEO Sir Howard Stringer reflected on the past 30-year history of the video game industry, while crossing his fingers that the PS3 would have a successful launch in an increasingly cut-throat industry. The goal of this EC is for you to read the case study on Sony’s Battle for Video Game Supremacy and discuss how network externalities and complementary assets affect strategy and competition.The reading has a little big long and I just need two page of each page space 1.5You have a maximum of 2 pages to write your essay (space 1.5, Times New Roman, Font 12). 07-046
Rev: December 8, 2011
Sony’s Battle for Video Game Supremacy
John Sterman, Kahn Jekarl, Cate Reavis
As Sir Howard Stringer, CEO of Sony Corporation, settled in for his flight back to Japan from New
York, a number of pressing issues occupied his mind about Sony’s future. At the forefront, Sony’s
next generation video game console, the PlayStation 3 (PS3), was set to launch worldwide on
November 17, 2006, a mere week away. Despite PlayStation 2’s (PS2) dominance in the last
generation of gaming consoles, Stringer understood that past successes were no guarantee of future
success in the intensely competitive game industry.
Microsoft had launched the first volley in the last console war by releasing the Xbox 360 in the fall of
2005. Within one year, almost 4 million Xbox 360s had been sold worldwide, giving Microsoft a
significant head-start in the race for market dominance. Meanwhile, Nintendo, a competitor thought
to be dead due to the lackluster sales of its previous console, the Nintendo Gamecube, had generated
significant “buzz” around its new entry, the Nintendo Wii (pronounced “we”). Targeting more of a
mainstream audience than Sony and Microsoft, the Wii, scheduled to launch just two days after the
PS3, posed a serious threat to Sony’s market share, particularly due to its $249.99 retail price, half the
price of the PS3.
Stringer also knew that there was much more at stake than winning the console war. The next
generation of the DVD market was at stake as well. In addition to being a gaming console, the PS3
was a Blu-Ray disc player. Blu-Ray was a next-generation optical disc format that held more than
five times as much information as DVDs and allowed high-definition television (HDTV) owners to
watch movies with an unprecedented level of image quality. The PS3 was, in effect, the “Trojanhorse” for the Blu-Ray format.
This case was prepared by Kahn Jekarl, MBA 2007, and Cate Reavis under the supervision of Professor John Sterman.
Professor Sterman is the Jay W. Forrester Professor of Management and Director, MIT System Dynamics Group.
Copyright © 2007, John Sterman. This work is licensed under the Creative Commons Attribution-Noncommercial-No Derivative
Works 3.0 Unported License. To view a copy of this license visit http://creativecommons.org/licenses/by-nc-nd/3.0/ or send a
letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA.
SONY’S BATTLE FOR VIDEO GAME SUPREMACY
John Sterman, Kahn Jekarl, Cate Reavis
Sony found itself in an intense standards war with Toshiba, a well-established Japanese electronics
manufacturer, that, in partnership with Microsoft, had developed its own digital video standard, the
HD-DVD that retailed for $500. The battle lines were being drawn as companies including HBO,
New Line, Intel, and Sanyo aligned themselves with HD-DVD and Fox, Disney, MGM, Lionsgate,
Apple, Dell, Pioneer, Panasonic, Philips, HP, and Sharp sided with Blu-Ray. Warner Brothers and
Paramount were supporting both formats. 1
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While winning the digital video format war could prove to be extremely profitable for Sony, the battle
would be hard-fought. Sony, meanwhile, had had some disappointments in the past in estalishing its
own technology formats. In the mid 1970s, it launched the BetaMax, a home videocassette tape
recording format which was quickly outmarketed by JVC’s VHS format largely due to the fact that
VHS tapes held more taping capacity (two hours) compared to Betamax’s one hour. In 2003, Sony
attempted to establish its own music and movie playing format by introducing the Universal Media
Disc (UMD) for its portable gaming device the PlayStation Portable (PSP). Initial PSP units were
sold with the UMD version of Spider-Man to highlight the flexibility of the device. But UMD never
took hold, in large part due to the lack of UMD titles and the number of other devices that played
UMDs.
Stringer was well aware that replicating the PS2’s success would not be easy. The price of the PS3
would be a significant barrier to widespread penetration. At $599, the PS3 could no longer be
considered a toy and would not likely be an impulse purchase for the majority of consumers.
Although compared to stand-alone Blu-Ray players, which sold for $900-$1,000, the PS3 could be
considered a bargain since it could play games as well including some older generation PlayStation
games.
By all accounts, since entering the video game industry in 1994, Sony’s ability to capture the
attention spans of child and adult gamers had been impressive. However, as technology became more
varied and versatile, so did consumer tastes. Stringer knew it was critical that Sony kept consumer
appetites at one and the same time satiated and begging for more.
0B
The Evolution of Home Video Games
During the 30-year history of video games, the industry had experienced significant changes not only
in who played video games— the average computer and video game player in the United States was
33 years old while the average age of the most frequent video game purchaser was 40 years old— 2
but in how they were conceived, developed, priced, and ultimately sold, all of which had significant
implications for Sony as it prepared for the launch of the PS3 and the competitive response that would
inevitably ensue. (Figure 1 breaks down video game players by age and gender.)
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1
John Wenzel, “The Season’s Main Event: Battle of the Digital Decade,” Denver Post, September 26, 2006.
2
Entertainment Software Association, Essential Facts About the Computer and Video Game Industry 2006
Rev: December 8, 2011
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SONY’S BATTLE FOR VIDEO GAME SUPREMACY
John Sterman, Kahn Jekarl, Cate Reavis
Figure 1
Video Game Players by Age and Gender, 2005
70%
60%
50%
40%
30%
20%
10%
0%
Under 18
18-49
50+
Male
Fem ale
Source: Entertainment Software Association, Essential Facts About the Computer and Video Game Industry 2006.
Microsoft, Nintendo and Sony would all be launching their new generation of video game consoles at
a time when the industry was ripe for a new growth spurt. In 2005, the U.S. video game and PC game
retail industry—including the sales of portable and console hardware, software and accessories and
PC game software—generated nearly $10.5 billion in revenue in 2005, a 6% increase over 2004
(Figure 2). Of this amount, software sales totaled $7 billion (229 million units), a slight drop from
the $7.4 billion generated in 2004. 3
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Video Game Software Sales (in US$ and units)
US$ billions
8.0
6.0
4.0
2.0
0.0
Sales
1996
2.6
Volume 74.1
1997
3.7
1998 1999
4.8
5.5
2000
2001
2002
5.6
6.1
7.0
2003 2004
7.1
7.4
2005
300.0
250.0
200.0
150.0
100.0
50.0
0.0
millions of units
Figure 2
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Sales
Volume
7.0
108.4 153.0 185.2 197.1 211.0 226.4 241.4 250.0 228.5
Source: Entertainment Software Association, Essential Facts About the Computer and Video Game Industry 2006.
3
The NPD Group.
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SONY’S BATTLE FOR VIDEO GAME SUPREMACY
John Sterman, Kahn Jekarl, Cate Reavis
The software sales decline was mostly due to the industry’s transition to the next generation of
gaming hardware. Those consumers interested in purchasing a gaming console were willing to hold
off a year until the next generation had arrived, while those with current generation consoles such as
the Xbox and PS2 were reluctant to purchase new software for a system that would soon be outdated.
Most industry forecasts, however, were very optimistic, with firms such as PricewaterhouseCoopers
estimating that the industry would grow to $46 billion by 2010 (11.4% CAGR). 4
F
F
The industry had traveled leaps and bounds from the days when Atari was providing U.S. households
with the newest and greatest inventions in electronic entertainment.
6B
The Rise and Fall of Atari
In 1966, an engineer at Sanders Associates, a small New Hampshire-based electronics company,
developed Odyssey, the first home video game system. A ball-and-paddle game that could be played
on a TV set, the Odyssey achieved limited commercial success. Its successor Pong, however, did
extremely well in arcades and the home market. Nolan Bushnell, founder of Atari, oversaw the
development of Pong and introduced the home version in 1975. Atari sold 150,000 copies of Pong in
the first year.
Electronics manufacturers quickly saw the benefits of producing a console that could play multiple
games. In 1976, Fairchild, a U.S. electronics company, developed the first console of this kind
naming it the Fairchild Channel F. Atari quickly followed suit with its 2600 VCS (“video computer
system”). In late 1977, Atari released the VCS for $199 with a library of nine titles. Each cartridge
cost $5-$10 to manufacture and retailed for $25-$30.
By 1979, many other electronics and toy companies were entering the home console market including
Mattel, Coleco, RCA, and Philips Electronics. Despite the new entrants, Atari represented two-thirds
of the home console market in the United States. Home versions of hit arcade games such as Space
Invaders and Asteroids grew the game industry into a $3 billion business by 1982. 5
F
By the end of 1983, however, the industry had collapsed. The market had been saturated with
multiple consoles and poor quality software, killing consumer appetite for games altogether. In one
notable example, Atari developed E.T., a game based on Steven Spielberg’s hit movie by the same
name. With only one month to deliver a game in time for the holiday season, the development team
created an extremely poor title. Atari took such an enormous loss on E.T. due to unsold inventory
and a large licensing fee that it ended up dumping five million of copies into a landfill in New
Mexico. 6 In 1983, Atari posted a $536 million loss and the company was sold at a substantial
F
F
4
PricewaterhouseCoopers, Global Entertainment and Media Outlook: 2006-2010
5
Mark Mayfield, “What Your Kids Want,” USA Today, December 2, 1988.
6
Ronald Grover and Cliff Edwards, “Game Wars,” Business Week, February 28, 2005.
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John Sterman, Kahn Jekarl, Cate Reavis
discount in 1984. The video game market was moribund for several years after the collapse until
Nintendo came and took the U.S. market by storm.
7B
The Rise of Nintendo
Kyoto, Japan-based Nintendo began as a playing-card manufacturing company. After diversifying
into various kinds of electronics in the 1970s, Nintendo entered the home video game market in Japan
in 1983 with its Famicom system. In an effort to avoid the quality issues that had plagued other game
consoles, Nintendo focused on producing fewer, but higher quality games. The Famicom could
display 52 colors at a resolution of 256×240 pixels, superior to the competition of the day. Launched
at 24,000Y ($100), the Famicom cost 50% less than the closest competitor.
All games that were produced for the Famicom (known as the Nintendo Entertainment System in the
United States) had to go through Nintendo’s approval process in order to receive the Nintendo “Seal
of Quality.” A security chip was installed into every console to ensure that only Nintendo-approved
games could be played on the system. Manufacturing of the Famicom was subcontracted out to
numerous companies. Wary of giving any one manufacturer too much information about the overall
production process, Nintendo used up to 30 different suppliers and completed final assembly of the
system at its own production facility.
Due to its popularity, Nintendo licensed out the development of games. Nintendo charged licensees
20% of the 6,000Y ($30) wholesale price for every game sold. In addition, licensees had to pay the
manufacturing costs of the system in advance, with a 10,000 unit minimum order. Once Nintendo
entered the U.S. market, in 1985, the minimum order was raised to 30,000 units. Nintendo also added
an exclusivity clause that prevented licensees from producing games on competing consoles for two
years. Companies such as Namco, one of the first licensees, complained that Nintendo’s monopoly
over the market was hurting the industry, but eventually backed down and agreed to Nintendo’s
terms.
Nintendo had a tight grip on retailers as well, requiring them to place orders, take delivery, and pay in
a matter of months, as opposed to the year time-frame they were used to. The company also
exercised strict inventory management, quickly removing games that were not selling well and, at
times, restricting supply to maintain the appearance of scarcity. Atari filed a number of lawsuits
against Nintendo contending the company used monopolistic practices to shut out competitors
including withholding merchandise from retailers that sold competitors’ products or attempted to
discount the price of the system. 7
F
By 1990, with hit titles such as Super Mario Bros. and The Legend of Zelda, Nintendo represented
more than 90% of the U.S. home console market. Approximately 30 million NES units had been
sold, about one for every three American households.
7
“Atari Video System to Battle Nintendo,” Houston Chronicle, November 22, 1989.
Rev: December 8, 2011
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SONY’S BATTLE FOR VIDEO GAME SUPREMACY
John Sterman, Kahn Jekarl, Cate Reavis
Nintendo’s next system, the Super Nintendo launched in September 1991, did not capture the market
like its predecessor. Super Nintendo’s lack of backwards-compatibility prevented Nintendo from
taking full advantage of its existing catalog of games. Meanwhile, Sega, another Japanese home
console manufacturer, had successfully entered the U.S. market two years earlier with the Sega
Genesis console and effectively fought Nintendo to a draw. Strong internal game development at
Sega coupled with relatively favorable terms for software licensees (in comparison to Nintendo)
paved the way for an extremely competitive library of titles for the Sega Genesis.
By the mid-1990s, Sega was the least of Nintendo’s worries as Sony entered the video game market
with a bang.
8B
Sony Enters the Arena
Believing that a three-dimensional (3D) game could provide a more immersive experience than a
traditional two-dimensional (2D) game, the Sony PlayStation, launched in 1994, was designed as a
fully three-dimensional machine. Ken Kutaragi, the lead architect for the PlayStation, believed game
players were eager to navigate 3D environments that were more life-like than 2D, side-scrolling
games such as Super Mario Brothers. Ready for the jump in complexity, gamers rushed to purchase
the PlayStation. Within two years of launch, PlayStation revenues reached $700 million with profits
of $70 million. 8
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Sony opted for the compact-disc format instead of the traditional cartridge format that Nintendo
historically utilized. CDs held up to 20 times more information than a standard cartridge and allowed
game developers to create the more intricate characters and environments required for a 3D
experience. The potential downside of the CD format was the “seek time” needed for information to
be read from the disc, making CDs 50 times slower than a cartridge. 9 Advanced data formatting,
however, minimized disruptions to the game-play experience. CDs were also attractive to Sony and
its licensed developers because their production costs were falling below costs for cartridges. By the
late 1990s, the manufacturing cost for a CD game was about $1.50 per unit compared to $12.00 for a
cartridge game. 10
F
F
F
When it came to the library of games that were available for the PlayStation, Sony took a much
different approach than Nintendo and was less restrictive about the number of games that were
released for the PlayStation. Sony recognized that competing with Nintendo on a game-to-game
basis would be difficult. Nintendo had the very best game developers in the world. Sony believed
that a greater selection of titles for the consumer would be the best chance to topple Nintendo. While
still maintaining a detailed approval process for game developers, Sony succeeded in creating a robust
8
Robert Le Franco, “Take That, Nintendo,” Forbes, June 3, 1996, p. 96.
9
Peter J. Coughlan, “Note on Home Video Game Technology and Industry Structure,” HBS Case No. 700-107, June 13, 2001.
10
Ibid.
Rev: December 8, 2011
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SONY’S BATTLE FOR VIDEO GAME SUPREMACY
John Sterman, Kahn Jekarl, Cate Reavis
library of titles. Retailers such as GameStop and Electronics Boutique soon had entire walls
dedicated to PlayStation titles.
With the PlayStation, Sony succeeded in capturing 60% of the U.S. market by 1999, dwarfing
Nintendo’s 30% share and Sega’s 5%. 11 Kutaragi, now president and CEO of Sony Computer
Entertainment Interactive, was charged with improving on the PlayStation’s success with its
successor, the PlayStation 2 (PS2). With powerful graphics and a loyal following of experienced
game development studios, the PS2, launched in October 2000, was again a resounding success. One
of the main features responsible for the PS2’s success was the additional functionality the console
provided for consumers. The first PlayStation’s ability to play audio CDs was considered a minor
feature as many people already had CD players. But the PS2 had the ability to play DVDs. Launched
in 1996, DVD players had yet to become a mainstream device and at the end of 1999 could be found
in just 11% of U.S. homes. 12 At $299, a price on par with DVD players, the PS2 gave users access to
this new technology at a reasonable price. The PS2 enabled consumers to upgrade their moviewatching experience while getting a cutting-edge video game console.
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By early 2006, Sony’s PS2 dominated the video console market with a 55% market share, followed
by Microsoft’s Xbox with 24%, Nintendo Game Cube with 15%, and the newest entry, Microsoft’s
Xbox 360 with 6%. 13 Meanwhile, eight of the top 10 selling video games in 2005 were for the PS2
(Figure 3).
F
Figure 3
Rank
1
2
3
4
5
6
7
8
9
10
F
Top Selling Video Games, 2005
Title
Madden NFL ‘06
Pokemon Emerald
Gran Turismo 4
Madden NFL ‘06
NCAA Football ‘06
Star Wars: Battlefront 2
MVP Baseball
Star Wars Episode 3: Revenge of the Sith
NBA Live ‘06
Lego Star Wars
Platform
PS2
Nintendo
PS2
Xbox
PS2
PS2
PS2
PS2
PS2
PS2
Publisher
Electronic Arts
GBA
Sony
Electronic Arts
Electronic Arts
Lucasarts
Electronic Arts
Lucasarts
Electronic Arts
Eidos
Source: NPD Group.
11
“Sega’s New Player Fails to Scare Competitors,” The Associated Press, May 14, 1999.
12
“DVD Video to Outstrip VHS,” Inside Multimedia, September 27, 1999.
13
Dean Takahashi, “Dean and Nooch on Gaming,” San Jose Mercury News, January 13, 2006.
Rev: December 8, 2011
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SONY’S BATTLE FOR VIDEO GAME SUPREMACY
John Sterman, Kahn Jekarl, Cate Reavis
1B
Game Development and Publishing
Gaming manufacturers made their money not from the sales of consoles—in fact most consoles were
priced below cost— but rather from software. It was widely believed that Microsoft’s Xbox console,
launched in 2001, was sold at a $100 loss per unit 14 and estimates indicated that each Xbox 360,
launched in 2005, lost close to $130 per unit. 15 A number of industry analysts believed Sony’s PS3,
even at $599 for the premium version, would sell at a loss of $250 per unit. (In 2006, Sony earned
about $8 on each PS2 sold. 16 )
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Acting as gatekeepers for developing and selling games on their respective systems, gaming
manufacturers typically received between $5 and $7 for every unit of software sold for their particular
console. 17 On average, video games sold between 200,000 to 300,000 units; a blockbuster was any
title that sold over 5 million units.
F
F
Over the 30-year history of the video game industry, the role of game developers and publishers had
evolved to the point where companies like Microsoft were paying large sums of money to bring the
talent in-…
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