[MoMoBangalore] Gaming Brief: New Report: Chasing After the Elite Consumer

Wed May 2 11:29:58 IST 2007

Chasing After the Elite Consumer

April 30, 2007

The video game hardware market can be a tricky beast.  Video games are
true mass market technology and it can be hard to comprehend just how
pervasive console system hardware has become in society.  However, the
big three hardware manufacturers are not resting on the historical
industry model.  Microsoft, Nintendo and Sony are all radically trying
to expand their markets in different directions.  It is still way too
early in the lifecycle of the new console systems to make definitive
conclusions.  Nevertheless, it is worth looking at some of the problems
that could arise from the path each of the players has taken.

Some of the actions of the video game hardware manufacturers might be
chalked up to a case of Apple envy.  Of course, Apple Computer has
definitely created a buzz with its line of iPod music players that come
in a wide range of styles and features.  However, when you compare iPod
sales with game console sales the numbers are compelling.  This month,
Apple announced iPod sales had passed the 100 million unit mark since
its launch in 2001.  This number is impressive, but in a similar time
period Sony shipped over 100 million PlayStation 2 systems and Nintendo
shipped over 100 million portable game systems.  Furthermore, the iPod
has been launched in over 10 models with a price range from under $100
to as much as $500.  The basic iPod is already on its fifth generation
and there are several versions of iPod nanos, minis and shuffles.
Storage on an iPod can range from less than 1 GB to as much as 80 GB.

Compare the iPod to the Sony PlayStation 2.  The PS2 has come in two,
arguably three, basic form factors with almost no range in price or core
functionality.  With the PS2, Sony kept things simple and cheap.
Consumers are still snapping up the system over seven years after it
first launched in Japan in March 2000.   Meanwhile, it is hard to
imagine anyone that is still using a first generation iPod.  Considering
that before the PS2, the first PlayStation also sold over 100 million
units, Sony seems to have a pretty good business model going.

Sony would probably like to argue they invented the business model for
the video game console market.  Actually Sony just followed and
perfected the model used by Atari and Nintendo.  Meanwhile, both Atari
and Nintendo changed their successful business model and found
themselves marginalized in the console business.

The Atari 2600, released in 1977, was the first true mass market console
game system.  The convoluted story of Atari and its multiple business
missteps has been told in many places.  To make a long story short, the
Atari 2600 was basically a cheap (about $200) toy with hundreds of
really bad games.  Atari tried unsuccessfully to merge successor video
game systems with personal computers and quickly became a historical
footnote.  It took Nintendo to come along and pick-up where the Atari
2600 left off.

With the NES and, to a lesser extent the SNES, Nintendo dominated the
game hardware market.  However, Nintendo noticed that of the hundreds of
games released for its system, the high quality ones from Nintendo and a
handful of third party manufacturers like Square, Enix, Capcom and
Konami, outsold other titles by an order of magnitude.  Thus, for the
Nintendo 64 launch in 1996, Nintendo changed its model to only focus on
core high quality expensive games from a handful of developers they
called the "Dream Team."  Top Nintendo 64 titles did soar to the top of
the best seller list and significantly outsold the top PlayStation
titles.  But beyond the top titles there wasn't much to the Nintendo 64.
In terms of hardware units the PlayStation outsold the N64 by three to
one.  With the GameCube, Nintendo found themselves further marginalized
and the PlayStation 2 outsold the GameCube by over five to one.

The success of the PlayStation systems shows that video game hardware
does best when it creates a core ecosystem for a wide variety of
products from many different developers.  It is extremely rare for an
individual video game title to sell over 10 million units.  To reach 100
million consumers it is essential to have a huge range of products for
multiple consumer tastes.  Mario, Pokemon and Zelda are arguably the
three leading video game franchises of all-time and they are all owned
by Nintendo.  However, it seems those franchises are only enough to move
about 20 million hardware units.  

With the launch of the Wii, Nintendo is definitely expanding the appeal
beyond its core franchises.  However, the biggest ace for Nintendo may
be lack of competition in the mass market price range.  The launch of
the Xbox 360 Elite means Microsoft is now chasing Sony after the
high-end market. The strategy of both Sony and Microsoft seems very
similar to the one Atari and Nintendo unsuccessfully tried.

The Xbox 360 Elite is a $479 system that adds a larger hard drive and an
HDMI port and cable.  It now sits on the shelf with the core $300 SKU
and the $400 SKU (which is the one people are actually buying).  The
goal of the Elite is to target consumers that want to download and play
high definition video.  However, there should be concern that what the
Elite may end up accomplishing is confusing and alienating those
consumers just looking for a solid game system.  

The video game business model depends on building a huge user base in a
relatively short time period.  Therefore, from a macro perspective the
core question with a product like the Xbox 360 Elite is not what it adds
for the high-end consumer, but what does it mean for those cheap skates
that are only willing to spend $400.  This brings us to the first
problem we have with the system: the name.

For years, DFC Intelligence has discussed the challenges of going with
multiple hardware configurations in the video game hardware market.  One
of the biggest issues is consumer confusion.  We have argued that for a
successful multi-SKU approach to work there needs to be a pretty wide
difference in both price and functionality.  Furthermore, it must be
made clear to the consumer that the difference in functionality will not
make a difference when it comes to actual video game play.

With the word "elite" Microsoft is implying that their existing users
and all potential future Xbox 360 buyers that if they only spend $400
they are not elite.  At the same time Microsoft announced the Elite,
Sony was announcing that they were eliminating the low-end $500
PlayStation 3 SKU.  Sony claimed that demand for the $600 PS3 SKU was
over 10-to-1 that for the $500 SKU.  This illustrates a basic rule about
the video game consumer: when you are talking big bucks consumers do
comparison shopping.

When video game systems are priced in the $200 range and lower a small
price change can really move product and consumers tend to be very price
sensitive.  However, in the $300 and up range consumers tend to be a
little more careful with their purchase.  Consumers don't want to spend
$400 on a piece of hardware and be told they are not "elite" and only
getting second best.  At that range the tendency is to want to spend the
money on the best or else wait until you can afford the best.

The Xbox 360 Elite seems like Microsoft's attempt to chase Sony for the
high-end video-centric consumer.  However, this is a power race that
Microsoft simply can't win.  The Elite targets a very niche, possibly
imaginary, consumer that wants a bleeding edge high-definition system
but wants to cut corners when it comes to video playback by using a
comparatively low-tech video game hardware system.  Of course, the Elite
doesn't include an HD-DVD player or even built-in Internet Wi-Fi, so,
for high-definition video, the PlayStation 3 is both more powerful and
more cost effective.  The Elite kind of migrates the Xbox 360 towards a
high-definition video recorder/player much the same way Atari tried to
migrate its video game system into a PC over twenty years ago.

But the issue of what the Elite lacks is not the primary concern.  It is
fine to try and satisfy the high-end consumer, but if doing so alienates
your mass market base it can spell doom. Sony has more flexibility to go
with a high-end strategy because they are still satisfying their core
PlayStation 2 consumer base.  With hot new products like God of War II,
Sony Computer Entertainment is showing existing consumers they don't
need to rush to upgrade to the PS3 (or competing system).  Compare this
with Microsoft that basically slammed the door on the original Xbox and
is now basically telling initial Xbox 360 purchasers they need to buy a
whole new system if they truly want to do high-definition.

The biggest problem with the Xbox 360 Elite is probably the issue of
HDMI output.  Consumers can understand what a bigger hard drive means
and can also feel comfortable knowing that they can always upgrade their
hard drive.  However, it is a safe bet that the vast majority of
consumers aren't quite sure what an HDMI port means.  You can be sure
that the sales clerks in your average retail store will probably be
telling a lot of different stories.  One can envision the following
scenario: 

Consumer: "why does this one cost $80 more than this one."  

Sales Clerk: "the Elite has a bigger hard drive and HDMI."

Consumer: "what is HDMI."

Sales Clerk: "oh HDMI is just for if you want to do high definition."

Of course, this ignores the fact that a year ago Microsoft was arguing
that you don't need HDMI to do high definition and for the vast majority
of consumers regular component cables will in fact work just fine.
However, in the average consumer mind they don't know that.  All they
know is that one day they may want a high definition system and if they
are spending this kind of money they better go with the high-end system.
Or maybe, they should just go home and play with their PlayStation 2
while they research the issue some more and let the market shakeout.
Sony had originally planned to not have HDMI on its lower end SKU, but
because of this exact issue of potential consumer confusion, added HDMI
to both PS3 SKUs shortly before launch.  Of course, finally they just
scrapped the lower end SKU completely. 

It is surprising that Microsoft didn't learn from Sony's PS3 struggles
in 2006.  It is even more surprising that Microsoft feels a need to
chase Sony when it seems the one they should really be chasing is
Nintendo.  For fiscal 2007 Nintendo announced that revenue was up 90% to
over $8 billion.  Initial sales of the Wii were extremely strong and it
is now the system with the momentum.  The Xbox 360 could win a hardware
power contest with the Wii, but probably not at nearly double the price.

The lesson Nintendo learned from the N64/GameCube era was that by
focusing mainly on the hard-core user you are eventually left with just
the hard-core user.  Microsoft has talked a great deal about creating
development tools that will make it easy for developers to create
products for Microsoft platforms (which also include PCs and
increasingly handhelds).  However, the best way to get developers to
create content for a platform is to get the platform in the hands of a
whole lot of consumers.  If the box moves off store shelves you can bet
game developers will find a way to create product to sell to consumers.

In the end, Nintendo and Sony are the ones that probably benefit the
most from the Xbox 360 Elite.  Among new game systems, the Wii now
clearly stands alone in a mass market consumer price range.  However,
for the millions of power video game users the Wii is clearly not a
complete long-term solution.  For many consumers the Wii is a cool
little second system to have and the real long term choice will come
down to Xbox 360 or PlayStation 3.  Sony now has a little breathing
space and they can compete on a more even head-on comparison between the
360 and PS3.  The huge PlayStation 2 user base now becomes a much bigger
ace up Sony's sleeve.  For the Xbox 360 Halo 3 is looking more and more
like make or break title for Microsoft's entire game business

Arya P Bhattacharya - Communication & Hi-Tech
perot systems
Plot3, Sector-125, Noida
arya.bhattacharya at ps.net arya.bhattacharya at ps.net> 
Phone      : +91-120-2432750-79 || Xtn-3751
Fax          : +91-120-2430545
Mobile     : +919818175535 || +919911233001

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