Gamers Push Pause
Delays and shortages put console sales on hold, leading major software makers to lay off workers
Perhaps it was with a sense of irony that Nintendo booked the Black Eyed Peas to perform at the video game company's reception this week at the Electronic Entertainment Expo in Los Angeles. The band's best-known hit, the tension-building "Let's Get It Started," pretty much sums up the anticipation that lurks over the video game industry at this moment.
After setting a new high score in U.S. sales last year--$10.5 billion, which rivals the motion picture industry's box office numbers--the games business is pressing the reset button this year, as new hardware from Sony and Nintendo will join Microsoft's Xbox 360 on store shelves. That's if you can find an Xbox 360 for sale--and there's the problem. Each hardware shortage or delay means software makers can't sell their products, which in turn means lost profits and layoffs. And, as the pursuit of the most awesome playing experience drives the consoles and the games to become more sophisticated and expensive to produce, the stakes for companies climb higher than ever. "It's a year of an uncertain market and a shift in platforms, which makes for extremely uncomfortable times for manufacturers and developers and gamers," says Paul Jackson, an analyst with Forrester Research.
Pacesetter. Sony's showcase probably will be the main attraction at this year's E3 convention. Having sold more than 101 million of its PlayStation 2 consoles worldwide, the Japanese corporation is the runaway industry leader. The success of that device's heir, the PlayStation 3, will have a deep impact on the fortunes of Sony and the overall industry. Earnings for the PlayStation division of Sony dropped 62 percent last year, as gamers squirreled away money in anticipation of the PS3.
The device was originally expected to arrive in Japanese stores in June. But that launch date has been pushed back to November--when it is also slated to launch in the United States--because of production concerns related to the console's new technologies. For example, to deliver the fast action that game players want, the PS3 will be powered by an innovative chip called the Cell processor, jointly developed by Sony, IBM, and Toshiba. And, just as the PS2 also doubles as a player for DVD movie disks, the PS3 will be able to play feature films stored on the new Blu-ray disks, one of the two formats competing to become the standard for watching movies on high-definition television.
Sony already has spent $445 million developing the PS3. "It's incorporating a lot of radically new technology, which also means Sony's looking at a higher production price per unit," says Jackson. Sony has not announced the retail price yet and is not expected to do so at E3 this week. One Merrill Lynch report estimates it will cost the company nearly $900 to make each PS3. But it's generally thought that the most customers will pay for a video game console is around $500.
These devices typically start off as loss leaders. But at a gap of $400 per PS3, it could take several years of successful hardware, software, and online game service subscription sales to offset the production costs. Sony President Ken Kutaragi says the company intends for the PS3 to have a 10-year life span on store shelves, double the typical five-year turnover between generations of video game consoles. Analysts still question the economics. "By the time that this thing becomes obsolete, you might break even," says tech analyst Rob Enderle.
The company best positioned to take advantage of a Sony slip is Microsoft. More than 3.2 million of its Xbox 360s ($400 and up) have been sold worldwide since its U.S. launch last November, the company says. That number undoubtedly would be higher, but Microsoft couldn't keep pace with demand during the holiday season.
The Xbox Live, the online gaming service Microsoft packages in tandem with the console, already has been a hit. More than 10 million items--simple games, video clips, game enhancements--have been downloaded from the subscription-based Xbox Live service, Microsoft says. Much of that activity has been fueled by the popularity of casual games, like Geometry Wars, that can be played beginning to end in a few minutes, rather than the more sophisticated head-to-head competitions between players around the world for which the hardware was built.
Competitor. A third video console, the Wii (pronounced "wee") from Nintendo, will make its formal debut at the E3 convention. Slated to go on sale this fall, it aims to take advantage of the company's reputation for innovative games (Donkey Kong, Pokemon, Nintendogs), not the high-powered technology favored by Sony and Microsoft. For example, the Wii's controllers will be motion sensitive so players can wave an arm to move in a game rather than push a button with a thumb. The Wii also is expected to be more affordably priced, around $250.
The uncertainty in the hardware market as gamers wait to see which system will best suit their tastes has had a heavy effect on the software companies that make games for the consoles. Electronic Arts, the industry's largest third-party developer and maker of the perennially bestselling Madden football series, laid off 5 percent of its staff (more than 300 people) shortly before announcing a 31 percent drop in third-quarter profits in February. "We underestimated the impact of consumers sitting on the sidelines," Electronic Arts CEO Larry Probst said then. Last week, the company's shares fell 7 percent after it announced an equally bleak outlook for the new fiscal year. Other heavyweights, including Activision and Midway, have been similarly hard hit.
These transition game woes are not unprecedented: Electronic Arts did lay off about 200 workers in the spring of 2001, during the switchover to the Xbox, GameCube, and PS2. The difference this time is that the advancing technology of the PlayStation 3, Xbox 360, and Wii means that software companies have to spend more money developing games that deliver the best action and graphics. And they're likely to have to redevelop the same game so that it takes advantage of each system's unique capabilities. "It used to be that for 10 to 15 percent of the PlayStation 2 budget, you could move from one platform [device] to the next," says Rob Kotick, CEO of Activision, maker of the Tony Hawk and Spider-Man games. "This time around it's a completely different experience. It's a much more expensive process than in the past." The average video game now costs more than $20 million per title to produce, according to Bear Stearns estimates.
Away from the console market, there are some bright spots in the industry. Online games for personal computers such as NCsoft's City of Heroes and Blizzard's Worlds of Warcraft--which now has 5 million subscribers--are proving that large audiences will pay monthly fees of $10 or more if the game is good enough. This PC game audience could be bolstered by the arrival of Microsoft's new Vista personal computer operating system (though Vista's release has been pushed back to early next year). Games played on cellphones also are catching on, as the devices now have the display screens and processing speed to play quick games, says Scott Rubin of Namco Networks, which offers the classic Ms. Pac-Man arcade game for mobile phones. Just as that title has endured through all the changes in video games, the industry is expected to overcome its current woes. In a few years, the industry may even be able to--in the words of the Black Eyed Peas--"pump it."
This story appears in the May 15, 2006 print edition of U.S. News & World Report.