By summer 2009 the world video games industry had entered a new and unusual

stage of its development. Between 1995 and 2006 the industry had been dominated
by Sony, whose PlayStation had accounted for well over half of world console sales
during the previolls two product generations. However, in the new generation of
video game consoles-the seventh since the industry's origins at the beginning of the
1970s-an entirely new situation had emerged. What was once believed to be a
winner-take-all market was now a three-way battle between Sony, Microsoft and
Nintendo with unusually small differences between them in market share.!
In terms of unit sales, Nintendo's Wii was the outright winner in all three of the
world's major markets (see Table 12.1). However, in revenue terms, market shares
were almost equal, reflecting the fact that the PS3 ($399 in the U.S.) was considerably
more expensive than either the Xbox 360 ($199 in the U.S.) or the Wii ($149 in the

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. TABLE 12.1 Cumulative sales of leading models of video game console in major
markets to March 31, 2009
Console
Nintendo Wii (million)
Microsoft Xbox 360 (million)
Sony PlayStation 3 (million)

Japan

U.S.

Europe

8.1
1.0
3.0

20
14

15
9
9

Sources: Estimates based on information from http://en.wikipedia.orglwiki/Seventh-generation_video

_game_console; Forrester Research.

U.S.). The emergence of Nintendo as the new market leader after several years of
lagging as a weak third to Sony and Microsoft was a major reversal of fortune. Many
observers had written off Nintendo as a serious contender-it seemed to lack the
financial or technological muscle to compete against Sony or Microsoft.
As Sony and Microsoft's product development teams prepared for the next
generation of competition-both companies were rumored to be planning the
launch of new consoles in 2012-the unexpected success of Nintendo's Wii had
created considerable confusion for their video game strategies.
The Nintendo Wii had challenged several deeply entrenched assumptions about
the video game industry. The evolutionary trajectory of the video game console had
been perceived to be towards greater multifunctionality. One of the reasons that
Sony and Microsoft had placed so much emphasis On their video game businesses
and devoted so many resources to them was because they viewed the video game
console as a general-purpose home entertainment device and a mechanism for
linking with the internet. As a result, both Sony and Microsoft viewed video game
consoles not just as important products in their own right but as critical components

of their strategies for building strength within the fast-moving market for home
entertainment. For example, Sony had used the PS3 as its standard bearer in its
standards battle with Toshiba over technical standards for high-definition video
disks. Wii had severely dented this logic-it was a dedicated gaming machine with
few of the general entertainment features of PS3 or Xbox 360.
Wii's Success also pointed to a major shift in the market for video gaming. The
conventional wisdom of the industry had been that the video games market was
concentrated among males aged between 11 and 30 and in order to access this
demographic group the console makers needed to court "hardcore garners" when

developing and launching new models. The way to attract these sophisticated,
intensive Consumers was through hardware with immense processing power and
brilliant graphics and games that combined cinematic-quality and graphic realism
with strong characters and complex storylines. Yet, Wii's main market was among
casual garners. Compared to PS3 and Xbox 360 it was seriously underpowered in
terms of both processing speed and graphics. The appeal of its games was the speed
with which they could be learned rather than their sophistication.
In developing their video game strategies and their next-generation consoles, a
critical issue for Sony and Microsoft was whether Wii was an outlier. If it was, the two
companies could continue with the strategic logic that had guided their efforts since the
beginning of the twenty-first century. If it was not, then Sony and Microsoft had better
imitate the key elements of the Wii strategy. The stakes were high. In recent years the
world market for video game hardware and software was about $25 billion. The fact

CASE 12

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FIGURE 12.1 Worldwide unit sales of video game consoles by product generation

50,--------------------------------------------------,
256 bit

(e.g. Xbox 360)

40+-----------------------------------------------~~,

32-64 bit

(e.g. PlaySlation)
w30+-------------------------------~~--------------~--_1:

~20+-----------------~~~~~~--~----~~--~--~::

that every new generation of consoles had surpassed the sales of its predecessor (see
Figure 12.1), reinforced both firms' interest in capturing market leadership in the future.

History of the Video Game Industry, 1972-20U7

Atari and First and Second Generation Consoles: 1972-1985
The home video games market emerged during the late 1970s as an extension of
arcade video games. The first generation of home video consoles were dedicated
machines that embodied a single game. One of the first of these was Pong, created
by Nolan Bushnell in 1972. He formed Atari to market this game player. In 1976
Atari was acquired by Warner Communications, Inc.

The second generation of players featured 4-bit processors and interchangeable

cartridges. Bushnell designed the Atari 2600 home video game console, which,
following the release of Space Invaders (1979) and Pac-Man (1981), unleashed a craze
for video games. By 1982 Atari held almost 80 0,1, of the video game market.
Atari was unable to prevent independent software developers from marketing
games for the Atari 2600. During 1982, 20 new suppliers of Atari-compatible
consoles entered the market and 350 new game titles were released in that year.
Declining sales of consoles and oversupply of games caused video game sales to
decline from $3 billion in 1982 to $100 million in 1985, resulting in massive losses
for Warner.

Nintendo and Third Generation Consoles: 1986-1991

In 1983, Nintendo, the leading Japanese supplier of arcade video games, released its
8-bit Famicom home video system. The U.S. launch of Famicom-renamed the
Nintendo Entertainment System (NES)-in fall 1985 was a huge success, selling over
a million units during the first year. Nintendo Entertainment System's sales were
driven by a series of games created by legendary games developer Sigeru Miyamota:
Donkey Kong, Legend of Zelda and Super Mario Brothers (which eventually sold 40

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million copies worldwide). By 1988, Nintendo had an 800/0 market share of the $2.3
billion U.S. video games industry.
Nintendo's market dominance and huge profits rested upon its careful
management of the relationship between hardware and software. Nintendo kept
tight control of the supply of games, managing their quality and their releases. Its
dominant market share in consoles allowed it to dictate stringent terms to game
developers. Developers were required to follow strict rules for the creation and
release of games for the NES console. Cartridges incorporated a "security chip" that
ensured that only cartridges produced by Nintendo from licensed developers could
run on the NES. Nintendo undertook all manufacturing of cartridges, charging
games developers a 20% royalty and a manufacturing fee of $14 per cartridge (the
manufacturing cost was $7). The minimum order-1 0 000 cartridges for the
Japanese market and 50000 for the U.S. market-had to be paid in advance. Any
game developed for the NES could not be released on a competing system for two
years.
Between 1984 and 1992, Nintendo's sales rose from $286 million to $4417
million. By 1990, one-third of U.S. and Japanese households owned an NES and in
both countries its share of the home video console market exceeded 90%.
Nintendo's return on equity over the period was 23.1%, while its stock market value
exceeded that of both Sony and Nissan during most of 1990-1.

Sega and Fourth Generation Consoles: 1992-5

Sega's origins, like Atari and Nintendo, were in arcade games machines. 5ega
launched its 16-bit Genesis home video system in Japan in October 1988 and in the
U.S. in September 1989. Despite graphics and sound that were superior to Nintendo's
8-bit system, sales of Genesis were initially sluggish until the introduction of Sonic the
Hedgehog in June 1991. With strong support from independent games developers,
130 software titles were available for the Genesis by September 1991.
Nintendo launched its 16-bit machine, the Nintendo Super-NES, in September
1991. Its huge installed base, brand awareness, and distribution strength, allowed it
to maintain its leadership in Japan. Howe.ver, in the U.S. and Europe, Sega's bigger
library of 16-bit titles (320, compared with 130 for Nintendo by January 1993)
allowed it to split the market with Nintendo.

Sony PlayStation and Fifth Generation Consoles: 1995-8

The new generation of 32-bit consoles was initiated by Sega with the launch of its
Saturn console in November 1994. A month later Sony introduced its PlayStation
console-the result of a six-year development effort led by Sony's video games guru,
Ken Kutaragi. Both PlayStation and Saturn used CD-ROMs rather than cartridges.
However, PlayStation was launched with an impressive number of new game titlesthe result of courting top games developers, financing game development and
providing comprehensive software development tools. Sony also entered with a
powerful array of resources: a strong brand reputation, global distribution capability
and content from its movie division. Its launch of PlayStation was well-orchestrated
and supported by a massive advertising budget-prelaunch promotion included a
number of cryptic and ambiguolls advertisements that created strong interest within

the gamer community. Sega ill-coordinated its Saturn system-few game titles,

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RIVALRY IN VIDEO GAMES

haphazard distribution and a shortage of manufacturing capacity meant that Sony

was able to overtake Sega's early lead.
Meanwhile, Nintendo attempted to recapture market leadership by leapfrogging
Sony in technology. The N-64 system-launched in Japan in June 1996, in rhe U.S.
in September 1996 and in Europe in the spring of 1997-used a 64-bit processor
and came with several highly popular new games, including Super Mario 64.
Although the N-64 had a big price advantage over PlayStation ($199 compared to
$299) it retained cartridge storage of games. The production of cartridges involved
higher fixed costs and did not allow the flexibility to quickly produce and distribute
additional copies of hit games.
The result was that Sony pursued a different software strategy from Nintendo.
While Nintendo concentrated on a smaller number of big-selling games (the average
N-64 title sold over 400,000 units in 1997), Sony went for a much bigger library of
games (over 300 titles at any point of time) many of which targeted minority
preferences (the average PlayStation game sold 69000 copies). The outcome was
leadership for the PlayStation in all the world's major markets.

The Sixth Generation: Sony versus Microsoft, 1999-2005

The 128-bit generation of video game consoles was inaugurated by Sega's launch of
its Dreamcast console in November 1998. It most innovative feature was the
capacity for internet connectivity which allowed interactive games playing. Despite
a successful initiallaunch-900 000 units were sold in Japan and 1.5 million in the
U.S. during its first three months of their respective launches-Dreamcast failed to
deliver a knockout blow to Sony's market leadership. The advantages of 128-bit over
64-bit technology were marginal and standard internet connections did not support
fast-action interactive play. Sega attracted limited support from independent
developers and failed to find a killer app for its Dreamcast.
On March 4, 2000, Sony launched PlayStation 2 (PS2) in Japan. Although 17
months behind Dreamcast, Sony's periodic leakage of information about PS2 had
supported intense pre-release interest in PS2 and had continually undermined Sega's
efforts to popularize Dreamcast. Kutaragi's brief had been to design a games machine
with performance that exceeded any PC and with graphics processing power ten times
that of the original PlayStation. With cinematic-style graphics, a DVD player and the
potential for internet connectivity, PS2 aspired to be a multifunctional tool for
accessing the internet, offering online games, e-commerce, email, and playing music
and videos. According to Kazuo Hirai, president of Sony U.S.: "PlayStation 2 is not the
future of video games entertainment, it is the future of entertainment, period."

Yet, despite billions of dollars spent on product development, new manufacturing

plants and a massive worldwide advertising campaign, PS2's launch was marred by a
shortage of key components-notably the graphics synthesizer (made by Sony) and the
"Emotion Engine" microprocessor (made by Toshiba)-resulting in a shortage of PS2s
for the critical U.S. Christmas shopping period. There was also a lack of software. The
power and sophistication of PS2, together with its technical quirks, created complex
problems for developers-most PS2 launch titles were revisions of earlier titles.
For all the massive resources that Sony brought to the battleground for the new
generation, success was far from assured-in November 2001 the industry's
competitive landscape was transformed by the entry of Microsoft. The software
giant's entry was seen as symbolizing the potential of video games consoles. Once

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viewed as children's toys, games consoles were emerging as the primary tool for
electronic entertainment, with the ability to offer movies, music and many of the
communications functions currently performed by PCs.
The Xbox was a technology breakthrough: "Arguably the most powerful games
console ever made, developed after consultation with more than 5000 garners and
games creators, it has a staggering array of features: an internal hard disk with a
733MHz processor, 64MB of memory, a DVD player, Dolby Digital 5.1 Surround
Sound and an Ethernet port that makes it the only game console that's internet-ready
and broadband-enabled. "2 Yet, with successive generations of consoles,
technological capabilities were becoming less and less a distinguishing factor and the
critical differentiator-software-was a problem for Microsoft. Xbox was launched
with 19 games available, compared with 200 for PS2.
Despite a successful u.S. launch with 1.5 million sold in the six-week Christmas
shopping period, Japan- proved to be a difficult market for Xbox-not only were
launch sales disappointing but Xbox's reputation was damaged by complaints that
it caused scratching of CDs and DVDs. Microsoft's ability to establish itself in a
strong second place to Sony rested on three factors: Microsoft's formidable
reputation in IT, its launch of blockbuster games Halo and Halo2, and Xbox's
online capabilities. In November 2002, Microsoft launched its Xbox Live online
gaming service with interactive gaming and direct downloading of new games. A
few days after the launch of Xbox, Nintendo joined the fray with its GameCube
console.
The major casualties of the intense competition between Sony and Microsoft were
Sega and Nintendo. Despite massive price cutting, Dreamcast sales went into sharp
decline even before Microsoft's entry. At the end of 2000, Sega announced its
withdrawal from video games hardware to focus on software. Meanwhile Nintendo
was trailing both Sony and Microsoft in sales. By December 2006, Sony had sold
around 111 million PS2s, compared to 24 million Xboxes, 21 million GameCubes
and over 10 million Dreamcasts.

The Seventh Generation: Nintendo Bounces Back

The next round of competition in video game consoles-the seventh generationfeatured the three survivors from the previous round: Sony, Microsoft and
Nintendo. However, both Sony and Microsoft believed that the market was tending
towards a duopoly. Nintendo had neither the financial nor the technological
resources to match those of Sony and Microsoft. Yet, these new round of
competition would feature some major changes in the competitive dynamics of the
video game industry and some surprising reversals of fortune.

Microsoft Xbox 360

The first of the seventh generation video game consoles was Microsoft's Xbox 360
released on November 25, 2005. Xbox 360 was the first major console with a near
simultaneous global launch as opposed to a phased rollout. The Japanese launch
occurred just two weeks after the North American launch. The launch also features
a major shift in the market positioning of Xbox. Compared with the original Xbox,
which emphasized processing power and focused on hardcore garners, Xbox 360's
positioning eschewed technology in favor of versatility, design and coolness. The
Xbox 360 strategy emphasized the hardware's multifunctionality for home

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entertainment and Microsoft's strong online presence. Through Xbox Live, users
could purchase and download video games, in-game extras such as weapons and
costumes, and movies and TV shows-including high-definition TV shows.

SonyPS3
Meanwhile, Sony's launch of its PS3 was dogged with multiple delays. Most of the
problems related to the technological ambitiousness of the hardware. PS3's
revolutionary multicore cell processor, developed jointly with IBM and Toshiba,
proved difficult and expensive to manufacture-it was estimated that each cell
processor cost Sony $230 per unit. Even more problematic was the delayed Blu-ray
DVD drive, the initial production of which was believed to cost about $350 per unit.
Merrill Lynch estimated that the total cost of the components for the PS3 could
amount to $900 per unit. 3
The Blu-ray drive was a central element of Sony's strategy. It was engaged in a
fierce standards battle with Toshiba over the technical format of the next generation
of high definition DVDs. PS3 was to be a key product in gaining market acceptance
of Blu-ray.
Software was another problem for PS3. The complexity and power of the
hardware extended the potential and the cost of games written for PS3. Software
development costs were estimated at four or five times those of PS2. To
encourage developers to write for PS3, Sony was obliged to cut its royalties. At
its initial launch, Sony had 15 titles available for PS3, although few made full use
of PS3 's technical capabilities. The most popular of the new games was
Resistance: Fall of Man.
PS3's launch in Japan on November 11, 2006 and in North America on
November 17 was marred by lack of product. Following both launches, PS3s were
selling on online auction sites in Japan and the U.S. at a substantial premium to their
retail list prices. The European and Australian launches were set for March 23, 2007.
One of the results of product shortage was continuing strength of Sony's PS2.
During the critical month of December 2006, Americans bought 1.4 million PS2s,
outselling PS3 (491 000 units), Xbox 360 (1.1 million units) and Nintendo Wii
(604000 units).

Nintendo Wii
One of the biggest surprises of the new round of competition was the strong initial
showing of Nintendo's Wii. Technologically, the Nintendo Wii lacked the advanced
features of either the Xbox 360 or PS3; its primary innovative feature was its remote
wand-like controller that was sensitive to a range of hand movements. As a result,
Nintendo claimed that its Wii was more intuitive than other consoles and could be
learned more easily. This linked with a marketing strategy that aimed to recruit new
games players and targeted a very broad demographic-including older consumers.
Wii was launched in North America on November 19, 2006, on December 2 in
Japan and December 8 in Europe. The launch was accompanied by 16 new games
for Wii-of which several were new versions of existing franchises (for example,
Legend of Zelda: Twilight Princess). Nintendo also mounted its biggest ever
advertising campaign.
Table 12.2 compares the rival seventh generation consoles. Table 12.3 shows unit
sales of leading video game consoles across the different product generations.

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TABLE 12.2

Comparison of seventh-generation games consoles

Price
(December
2006)

Console

Hardware

Connectivity

DVD

Games

Sony PS3

Cell Broadband
Engine 550 MHz
RSK GPU
HDTV-capable

20 GB version:

Integrated Blu-Ray
player. Backwards
compatible with
DVD

50 titles available
at end of 2006

DVD player.
Additional HD-DVD
drive available
for $199

130 titles at end

of 2006 (of which
65 allow interactive
play through Xbox
Live). Backwards
compatible

No cu rrent DVD
playback. Plans to
launch integrated
DVD version in Japan
in 2007

c. 30 titles at time
$250
of launch. Backwards
compatible with
GameCube

Microsoft
Xbox360

IBM Xenon,
Power-PC CPU
500MHzATI
custom GPU
HDTV-capable

Bluetooth 2.0, an
ethernet port and
four USB docks.
60 G8 version:
Compact flash, SD
and memory stick
duo, WiFi.
Option to purchase
WiFi adapter.

Core version:
Three USB docks,
ethernet port

20GB version:
Nintendo
Wii

IBM Broadway
Power-PC CPU
GPU developed
with ATI EDTV
video output

TABLE 12.3

Worldwide sales of video game consoles

Second
generation

Nintendo
Sega
Sony
Microsoft
Others

Wireless controllers
Bluetooth, two USB
docks, SD slot,
internet via IEEE
802.11 or a Wii
LAN adaptor

Atari 2600,
Fairfield
Channel F,
Magnavox
Odyssey

by

20GB version:
$499

60GB version:
$599

Core version:
$299

20 GB version:
$399

platform (millions)
Seventh
generation
(to endMarch 2009)

Third
generation

Fourth
generation

Fifth
generation

Sixth
generation

NES: 60
Master
System: 13

Super NES: 49
MegaDrive'
Genesis: 29

N64: 32.9
Saturn: 9.3

GameCube: 21.2 Wii: 50.4

Dreamcast: 10.6

Atari 7800: <0.3 NEC TurboGrafx: 11

Source: Various newspaper articles.

PlayStation:100 PS2: 140

Xbox: 24.0
3DO: 1.2

PS3: 26.7
Xbox 360: 30.2

CASE 12 RIVALRY IN VIDEO GAMES

TIl(' Yidpo (;ames Industr,\' in 201m

The Video Games Market
During 2009, the wodd video games industry was experiencing contraction after
consumer expenditures hit a peak in 2007 and 2008. Unit sales for all three leading
consoles were down sharply-partly as a result of market saturation and partly as a
result of global recession. Sales of games had contracted too-refuting the widely
held assumption that video games were recession-proof. In the U.S. the decline in
consumer expenditure was especially severe (see Figure 12.2).
However, most observers believed that the recent slump was cyclical rather than
an indicator of a longer term decline. As a form of entertainment, video game
playing was continuing to grow. In the U.S. over 40% of households owned video
game consoles and annual expenditures on consoles and games exceeded cinema box
office receipts. Although prices on consoles had been cut during 2008 and 2009,
video games consoles had not suffered the same decline in prices that had afflicted
computers.
Central to the long-term expansion of the video games market was a broadening
of the consumer base. Not only was video game playing expanding from Japan,
North America and Western Europe to most of the wodd-its demographic appeal
was broadening. Once the preserve of teenage boys, by 2008, the majority of the age
group 18-44 were video games players and even among the 55-64 age group, 24%
played video games. Female participation had also increased strongly. While
children who grew up playing video games continue to do so as adults, game
preferences changed greatly with age. Adolescents were more concerned with what

FIGURE 12.2 Worldwide consumer expenditure on video game hardware and

software, 1990-2009
20
18

'"

16
14
12
10

/"""--

8
6
4

~
~

........".

I \
I
\
I
/A
...., / \.
J

./

"

~~~~*~~~~*~~~~&~~~~~

~~~~~~~~~~~~~~~~~~~~

1-- Hardware & software

Hardware

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was "in" and "hot." The adult market comprises numerous niches, each with an
interest in a different type of game. Adults like titles that fit in with their lifestyle and
interests. Sports-based games were very popular among adult males. However, in
terms of intensity of game playing, teenage boys remained clear leaders: U.S. males
between the ages of 12 and 17 with a video game console in their home devoted an
average of 14 hours a week to game playing. Females in the same age bracket played
an average of 4 hours a week. The popularity of Nintendo's Wii had contributed
substantially to the growth of video gaming among adults and females.
The growth of video games playing had opened up an entirely new source of
revenue for video games publishers: advertising. Product placement within video
games generated advertising revenues of $56 million in 2005 in the U.S. alone. Both
Microsoft and Google acquired advertising agencies specializing in video game
advertisement placement.
/

Software
Each video game console supplier ("platform provider") licensed' third-party
software companies to develop and distribute games for its system. Two types of
company were involved in video games software: video games; publishers, which
were responsible for financing, manufacturing, marketing and distributing video
games, and video game developers, which developed the software. Video game
publishing was increasingly dominated by a few large companies-the most
prominent being Electronic Atts (see Table 12.4). Typically, the software publisher
submitted a proposal or a prototype to the console maker for evaluation and
approval. The licensing agreement between the software company and the hardware
provider gave the console maker the right to approve game content and control over
release timing, and provided for a royalty payment from the software company.
Game developers were paid a royalty, typically between 5% and 150/0, based on the
publishers' revenues from the game.
Escalating game development costs were a result of the demand for multifeatured,
3-0, cinematic-quality games made possible by increasingly powerful consoles.
Atari's Pac-Man released in 1982 was created by a single developer and cost about
$100000. Halo 2 released for the Xbox in 2004 involved 190 developers and cost
$40 million. By late 2006, Halo 2 had sold 8 million copies at $50 each. For the new
generation of consoles, most games cost more than $12 million to develop. In terms
of both costs and revenue patterns, video games closely resembled movies, with

TABLE 12.4 Share of U.S. video games market by publisher, 2006

Publisher

Electronic Arts
Konami

Take-Two Interactive
Activision

Others

Market share by value (%)

19.8
9.8
9.9
8.8
52.7

Source: From WWN.researchandmarkets.com/reports/354861/video_gamejndustry.htm.

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TABLE 12.5 Top-selling console games in the U.S., 2008 (by units sold)
Publisher

Release
date

Units sold

Title/platform

(0005)

Av. retail
price ($)

Wii Play (Wi i)

Mario Kart Wii (Wii)
Wii Fit (Wii)
Super Smash 8ros. 8rawl (Wii)
Grand Theft Auto IV (Xbox 360)
Cal! of Duty: World at War (Xbox 360)
Gears of War 2 (Xbox 360)
Grand Theft Auto IV (PS3)
Madden NFL 09 (X80x 360)
Mario Kart OS (DS)

Nintendo
Nintendo
Nintendo
Nintendo
Rockstar Games

Dec. '06
Apr. '08
May. '08
Mar. '08
Apr. '08

Activision

Nov. '08
Nov. '08

5280
5000
4530
4170
3290
2750
2310
1890
1870
1650

50
50
90
50
40
60
40
40
30
40

Microsoft
Rockstar Games
Electronic Arts
Nintendo

Apr. '08
Aug. '08
Nov. '05

similar success rates-a mere few became money-spinning blockbusters. Table 12.5
shows the top selling titles of 2008. Like movies too, creating a brand franchise
through a succession of sequels had become a key competitive strategy. Rising
development costs were a key factor causing consolidation among publishers.
As the power of the publishers had grown and the costs of development had risen,
so exclusivity ties had disappeared from most licensing contracts-most leading
games titles were cross-platform. For example, several titles that were once PS3
exclusives have been released simultaneously on Xbox 360. These include Grand
Theft Auto N, Final Fantasy XIII, Virtual Fighter, and Devil May Cry. Wii has several
exclusive titles, most of which were developed by Nintendo.
The development of video games required a blend of technology and creative
talent. The development process included game development and design,
proto typing, programming, art, computer graphic design, animation, sound
engineering, technical writing, editorial review and quality assurance. It took 18 to
36 months to complete a new title based on a new platform. To "port" an existing
title to a different platform took up to 9 months. Many games were based on
characters and themes that were either owned by the game developer or licensed
from third parties. The licensing fees paid by software publishers for exclusive rights
to the intellectual property of media companies and sports organizations grew
substantially between 1998 and 2002. Securing the license to produce a game based
on a hit movie (for example, Harry Potter) could cost several million dollars. In the
sports market, licenses paid to sports leagues (NFL, NHL, MLB, NBA, FIFA)
typically involved an upfront payment,.plus a royalty of 5% to 150/0 of the wholesale
price for each unit sold.
Not only did software sales exceed hardware sales-software was responsible for
virtually all of the industry's profit. The console makers followed a "razors and
blades" business model: the consoles were sold at a loss; profits were recouped on
software sales-both games developed internally and royalties received from thirdparty games publishers. The result was strongly cyclical earnings for the platform
providers: the launch of a new console would result in massive cash outflows; only
with a substantial installed base would the platform provider begin to recoup the
investment made.

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The Console Suppliers

For the console makers, 2009 was a troubling year. Sony and Microsoft had
achieved revenues that were not far behind Nintendo but both were still losing
money on their video game businesses. During the first two years of product launch,
losses were to be expected-but Xbox 360 had been on the market for almost four
years and PS3 for almost three years. Most observers believed that these losses were
primarily the result of the costs associated with the technologically advanced
specifications of the two consoles. This was particularly the case with PS3. By
contrast, as a result of its inexpensive components, Nintendo had been earning a
contribution from its Wii from the outset.
Moreover, profits from software were failing to fill the gap. Only 3.8 PS3 games
per console were sold in the U.S. by March 2008 and 3.5 Wii games per console. By
contrast, each Xbox 360 user bought an average of 7.5 games. This pointed towards
the emergence of Xbox as the preferred platform both for serious game players and
for games developers.
For Sony, the losses associated with PS3 pointed to the challenges of designing a
console that would be a favorite among game players while also establishing the
video game console as a general home entertainment device. The decision to
incorporate a Blu-ray DVD player in PS3 had little to do its ability to offer a superior
video gaming experience-there were few games that exploited its functionality and
few consumers had HDTV.
As the three leading console providers looked towards the future, two issues
preoccupied them. First, what factors would determine which of them would emerge
as a leader in the competitive battle for the next generation of video game cons~les?
Second, as the games developers and publishers grew in size and strength, had the
console makers lost the capacity to dictate industry evolution and with it the capacity
to reap profits?

.1ppPIHlix: rin;lndai Data on lht' ('unsole

n~allliradllrt'rs

Nintendo

Total sales
Operating income
Net income

Op. incomt;'Av.
total assets (%)
Return on avo
equity (%)

(Yen, billions)
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

534
172
84
10.6

573
156
86
9.9

531
145
56
6.1

463
85
97
9.7

554
119
106
9.5

504
100
67
8.9

514
110
33
10.5

515
113
87
9.7

509
91
98
7.9

966
226
174
19.5

1672
487
257
27.0

14.0

12.9

7.7

12.2

12.0

7.4

3.7

9.6

10.4

16.8

11.0

Sony

Sales of which:
Games

(Yen, billions)
1998

1999

2000

2001

2002

2003

2004

2005 2006

2007

2008

6761
700

6804
760

6687
631

7315
661

7578
1004

7474
936

7496
754

7160
703

1016
974

1284
1219

7475
918

CASE 12

RIVALRY IN VIDEO GAMES

(Yen, billions)

Sony

Operating income
of which:
Games
Net income (loss)
Op, income/Av,
total assets (%)
Return on avo
equity (%)

2001

2002

2003

2004

2005

2006

2007

2008

141

225

135

185

99

114

191

71

374

137
179
5.5

77
122
3,7

(51)
17
3,1

84
15
1.7

113
116
2,2

68
89
1.1

43
164
1,2

9
124
1.9

(232)
126
0,6

(124)
369
2,9

9,8

6,1

0,1

0,1

4,8

3,6

6.3

4,1

3,94

(3,08)

1998

1999

526

348

117
222
6.7
13,2

2000

($, millions)

Microsoft

2000
Sales of which:
Home & entertainment
Operating income
of which:
Home and entertainment
Net income
Op, income/Av,
total assets (%)
Return on avo
equity (%)
n.a.

2001

22956 25296
n.a.

n,a.

11006 11720

2003

2004

2005

2006

2007

2008

28365 32187
2748
2453
11910 13217

36835
2731
9034

39788
3110
14561

44282
4292
16472

51122
6069
18524

60420
8140
22492

2002

n.a.

n.a.

9421
24.4

7346
21,2

(847)
7829
18,8

(924)
9993
17,9

(1011)
8168
10,3

(451)
12254
17,6

(1283)
12599
23,6

426
14065
29.3

(1969)
17681
30,9

26,9

16,6

15,7

17,6

11.7

19,9

28.6

16.45

42.47

not available.

1 Successive generations of video game consoles have

conventionatly been designated according to ptocessor
bit size. In practice, bit size is a pOOt indicator of
processing power. Beyond 32 bits, bit size has little to
do with console performance-processor clock speed is
much more important,

2 "Out of the Box at Last," Financial Times (Creative

Business section), November 20, 2001.
3 "Delays likely for Sony's PlayStation 3," Financial
Times, February 20, 2006.

691