Introduction to General Management and Competitive Strategy
BY JOE SHEEHAN I SEPTEMBER 7, 2008
University College Dublin
Michael Smurfit Graduate School of Business
The games console market is essentially an oligopoly composed of the global companies Microsoft, Sony, and Nintendo. Each has highly developed brand strength and products with strongly established market positions. With the exception of Nintendo's Wii, game consoles are sold at a loss and players rely upon high profit margins of games in order to recoup costs (Datamonitor, 2007). Maximising sales volumes of consoles is of key importance to console manufacturers. Long product life-spans exists for consoles (approximately five to six year cycles) meaning that a large proportion of overall sales volumes are from first-time purchasers. Software developed for one manufacturer's console cannot be used with a competitor's hardware, and can be expensive.
The three companies have very different business models: Nintendo specialises in consoles with holdings in American sports teams, Microsoft draws most of its revenue from a wide range of systems and application software, while Sony is active in businesses from consumer electronics to media content. The distinction of Nintendo's sales strategy from that of Sony and Microsoft can most likely be explained by the wider industry diversification of the last two, which allows for a greater degree of offsetting.
This Japanese company dominated video-gaming in the 1980's before being deposed by Sony. Nintendo is engaged in the manufacture and distribution of interactive entertainment products. The products include hardware and software for its home video game systems. The company operates in the home entertainment and handheld market. Its new console, called the Wii, is inspired by a radically different strategy than its rivals. Nintendo set out to reach beyond existing gamers and expand the market. It has targeted a broader audience by simpler, shorter games with real life scenarios and "Brain Training". Its key innovation is the console's wireless controller, which can detect motion and rotate in three dimensions. It does not have the ability to match certain aspects of its competition in the area of high definition graphics.
By April 2007, the Wall Street Journal declared that Nintendo had "become the company to beat in the games business" with the Wii outselling its home system rivals and overshadowing the better selling Nintendo DS portable. Nintendo's profits were up 77% on the fiscal year due to Wii and Nintendo DS sales (Associated Press, 2007).
Sony, a global company operating in 150 countries worldwide, is engaged in the development, design, manufacture and sale of various kinds of electronic equipment, instruments and devices for consumer and industrial markets.
The company operates through five business segments: electronics, games, pictures (TV and Film), financial services, and "all other".
The games segment operates through a subsidiary, Sony Computer Entertainment, which controls the development and production of Sony's flagship video games console, the Playstation. Sony is plugging the PS3 as the most advanced console, with a powerful new processor chip and a high-definition "blue-ray" optical drive. Sony faces strenuous competition with the recent launch of the Microsoft Xbox 360 and Nintendo Wii.
Traditionally Sony, regarded as a premium brand with a reputation for quality, innovation and reliability, was able to command a price premium. Competitive pricing and advances in quality amongst competition is making pricing at a premium difficult. The company is now intensely focused on its several "champion products" such as the: Playstation 3 (PS3), Playstation PSP, walkman and LCD televisions.
Microsoft develops, manufactures, licenses and supports a range of software products including the windows operating system. Microsoft's strategy is based on bundling as much as it can into the operating system. By doing so, Microsoft seeks to create an environment where a growing number of web-based applications function only with computers and servers driven by windows. This has been the source of an anti-trust legal challenge in the US and more recently in the EU, based around the practice of integrating its internet explorer software with its windows operating system which effectively shut out its main competitors.
Microsoft entered the gaming business in 2001. The home and entertainment division is responsible for development, production and marketing for the Xbox video game system, including hardware, third-party games, games publishing under the Microsoft label, Xbox and Xbox live operations, marketing, research, and sales and support. The launch of the Xbox 360 is the most visible example to date of Microsoft's march into new markets beyond its traditional business of making software. Being released one year ahead of its competitors, the Xbox 360 was the market leader throughout the first half of 2007. However on September 12, 2007, it was reported by the Financial Times that the Xbox 360 had been surpassed by the Wii in terms of worldwide console sales.
However, despite these sales figures, Microsoft's gaming division is losing money. Up to 2005, the Xbox gaming division had lost over $4 billion dollars (Murphy, 2005). Microsoft expects the console will start making money in 2008 (Bach, 2007). The losses are due to the market strategy of selling consoles below cost in order to obtain market saturation and turn a profit on software and peripherals that have a much higher profit margin.
Political and Social
In 2005, videogames and politics became wrapped up with one another like never before. An unprecedented run of legislation termed Hot Coffee, become the most politically charged twelve months the video game industry faced. The year began with multiple politicians' reacting to Rockstar's late 2004 release of Grand Theft Auto(GTA): San Andreas. This GTA series has been amongst the favourite for critics for years, and San Andreas seemed destined for a similar fate.
Despite past constitutional failures, legislation restricting the sale of violent games to minors received serious consideration in a number of U.S. states. In April 2005, Senator Hillary Clinton and several other politicians called for a study on the effects of media on children, with a total fund of $ 99 m. Senator Clinton then announced in July 2005 that she would introduce videogame content legislation to Congress. At the same time, she called for a Federal Trade Commission (FTC) investigation into the marketing practice of Rockstar and their parent company Take Two Interactive. Days later, the U.S. House of Representatives voted 355-21 to ask the FTC to investigate whether GTA publishers had lied to avoid the "Adult Only" rating for San Andreas. The Federal Trade Commission also uncovered that 42% of children under 17 were able to buy an M- rated game without a parent or guardian. In response to these statistics, a bill was passed in December 2006 so store managers could now be fined $1000 and community service of 100hrs for selling to minors.
In September 2007, Gov. Arnold Schwarzenegger appealed a federal court ruling that permanently struck down the state's ban on selling explicitly violent video games to children and was attempting to save a 2005 prohibition that has never been enforced.
The republican governor signed the high profile law two years ago blocking anyone under the age of 18 from purchasing or renting some games that depict acts such as the "needless mutilation of the victim's body." He said in his statement, "These games are for adults and the law I signed ensures that parents have a chance to determine which video games are appropriate and suitable for their children." The opposite has occurred in Indiana and Washington; state courts there have overturned the same law restricting the sale of violent games because they violated First Amendment rights.
Legislation in the gaming industry is not only being drafted in the United States. In Germany, new legislation was drafted December 2006 in reaction to a school shooting. A poll taken after the shooting showed 72% of respondents blaming the incident on violent games and 59% supporting a ban. Under the legislation, developers must cut violent content from the German versions of their video games. The legislation also allows for developers, retailers and players of videos featuring cruel violence to face up to a year in prison if in violation of the law. This strict penalty sent shockwaves through the 2 million strong German online gaming communities. In the UK, video games that are particularly realistic or feature sex or violence, must be classified by the BBFC (British Board of Film Classification) under the Video Recording Act of 1984. The act states that it is an offence to supply such a game to anyone below the age limit, and it is punishable.
Economics and Technology
The game industry is no longer a niche market. Top selling game series such as Halo and Grand Theft Auto sell millions of copies worldwide. The overall industry is currently estimated in excess of $30 billion. According to a report released earlier this year, by 2011 the global gaming market will be worth $ 48.9 billion. The games and conoles that make up this figure are mainly produced in the U.S. and Japan. In Canada, a growth surge in the game industry has recently seen the country surpass the UK to become the third biggest producer of games. This growth surge is due to Canada's R & D credits and tax breaks aimed at attracting game developers. One Canadian tax credit, The Ontario Digital Media Tax Credit, refunds 30% of the cost of labour, marketing and distribution for a game created in Ontario. A further tax credit, The Sound Recording tax credit, refunds 20% of costs relating to a games background music and script. These significant benefits have led many game developers to move their companies to Canada.
The online games market is highly competitive, requiring companies to respond rapidly to advances in technology and continually find new ways to stay ahead of the competition. Full time availability is crucial for online games as players quickly turn elsewhere if a game is not immediately accessible. These new web services have smashed the old paradigm of software. Past companies had traditional barriers of on increasing cost of product development, infrastructure, sales, marketing and distribution. The new companies, however, have built in new technology and are heavily budgeted to become big in matter.
There is a technological revolution happening in the gaming industry. The Games 1.0 epoch, from early 1980-1995 included Sega, Atari and the Nintendo games consoles that culminated with the radically different Sony Playstation. The next evolutionary step was Games 2.0 that ran from 1996- 2004 and produced the "next gen" consoles. Sony followed Playstation with the enormously successful PS2 and Microsoft entered the market with Xbox. Nintendo had one word for this increased competition in the market, "Game Boy". Casual games were emerging as fun, simple entertainment that legitimised the download and buy model. During the Games 2.0 era, consumers found online gaming, using the internet as a platform, to be a more preferable gaming experience. As a result, the greatest significance during the Games 2.0 era was the gaming console's ability to interface with the internet. This was achieved with the release of Microsoft's Xbox in 2001. Games 3.0 began in 2005 with the launch of the Xbox 360, Microsoft's second generation game console. Through the game console, PC gaming was becoming more and more popular and profitable. The necessary components of the Games 3.0 world include: broadband connectivity, community and user engagement, non- retail business module, user controls and openness, feeds, widgets and viral content. Microsoft took the first bold steps of bringing game consoles to the internet with the creation of the Xbox Live Arcade. Sony has since followed suit, and so have Nintendo by creating a bridge between these worlds with the Wii and internet channel.
Drivers of overall profitability: Porter's 5 forces
There are many features of an industry that determines the competitive intensity and profitability levels (Grant, 2008). Despite criticism, which attacked its theoretical foundations a widely used framework for classifying and analysing competition and profitability is Porter's five forces of competition- Appendix 1. This competitive framework "views the profitability of an industry as indicated by its rate of return on capital relative to its cost of capital as determined by five forces of competitive pressure" (Grant, 2008). There are three sources of horizontal and two sources of vertical competition. The horizontal competition stems from substitutes, entrants and established rivals and vertical competition from the power of the suppliers and buyers.
Porter's framework can be used to analyse the competition and level of profitability in the Games Industry in relation to the oligopoly of key-players Microsoft, Sony and Nintendo.
Competition or the threat from substitutes is determined by the customer's natural tendency or propensity to substitute, which can be governed by relative prices and performance of substitutes. In the absence of close substitutes for a product, consumers are comparatively insensitive to price. However, when there are close substitutes customers will switch based on price. The industry anticipates that it will never see volume sales of (Sony) PS2 beaten by third generation consoles such as PS3 and Xbox360. Despite these consoles having superior graphics targeted at old gamers, the prices are so high that they have effectively priced themselves out of many of the customer markets they were targeting. Families are not willing to follow core gamers; as a result the Wii is attracting a new market and outselling PS3 and Xbox360 (Gapper, 2007).
The threat of entry to the market is likely when the industry earns returns in excess of its cost of capital and other firms are attracted to enter (Grant, 2007). In this industry, the threat of entry to the market is practically zero based on the capital requirement and the need for product differentiation. A new entrant not only has to absorb start-up costs, but also has to overcome the differentiation advantage of incumbents. The games market is an increasingly difficult environment to operate in with rising development costs and small user bases. For example, the hardware used in the Xbox 360 and PS3 is superior to that found in some top-line PC's. Microsoft, in its most recent financial year, had revenues of $3.6 billion in its non-PC division and made losses of $440 million. It is anticipated that the return in investment in next generation games development is unlikely to be achieved by 2008. For Xbox360 the answer is heavily depend on the success of the Halo 3 game.
Rivalry among established competitors is determined by the extent to which profitability is affected by price competition. It is also dependent on the number and size of other firms, product differentiation, diversity of competitors, excess capacity and exit barriers and cost conditions. The diversity of competitors consists of the 3 key-players with brand loyalty existing with established gamers. The production costs of the PS3 and Xbox360 are high equating to a high consumer price. The Nintendo Wii has a wiimote controller with an accelerometer made by an American firm, which can direct movement along three axes. This has helped to make gaming a more social and interactive experience; allowing children, parents and grandparents the ability to play games such as tennis or bowling. The Wii Sports and Brain Training games are proving a hit and encouraging the entry of new gamers. In Japan, at the end of August 2007, the Wii was out selling the PS3 at a ratio of 3 to 1. However, the Wii is starting to be viewed as a party game and the novelty may soon wear off. It is predicted that in five years the high definition resolution now offered by Sony and Microsoft will leave the Wii lagging behind.
Suppliers and Buyers
The two vertical sources of competition, suppliers and buyers, are both affected by the price sensitivity and relative bargaining power of each other. The price sensitivity is based on the cost of the product relative to the total cost, as well as product differentiation and the competition between buyers and suppliers. Buyer's information and buyer's ability to backward integrate or to be able to absorb the cost of switching are other important determinants. In the three horizontal forces previously outlined, the impact of buyers and suppliers are already highlighted. To-date it is estimated that Microsoft is losing as much as $126 on each non-core Xbox360, but Microsoft states that Xbox division is part of a long-term strategy to gain entry to large video game and home entertainment markets. Sony did the same with the original PlayStation and its successor. Only Nintendo, which is dependent on video games sales as its main source of income, has maintained consistent profitability on the sales of consoles. A risk reduction strategy is currently being adopted by the games industry. The strategy involves a combination of outsourcing, releasing games on as many platforms as possible, making sequels to already popular titles and producing games based on popular movies.
Key Strategic Moves
Video games and console manufacturers operate in a cyclical industry, releasing products every five or six years. Sony's Playstation 2 surfaced as the clear winner of the last cycle in 2000, achieving 70% market share and beating Nintendo's GameCube and Microsoft's Xbox. The current cycle sees Sony's Playstation 3 vie against Nintendo's Wii and Microsoft's Xbox 360. Each cycle brings better graphics, games and technology for consumers (Economist, 2006b; Economist 2007c).
Microsoft secured the head start in the current cycle with the Xbox 360, selling 10 million units in a mere 3 months (mainly in America and Europe rather than Japan). Key features of the Xbox 360 are its strong line up of games (e.g. Halo) and the Xbox Live function that allows gamers to download videos and games and to compete against other gamers online (Economist, 2007c). However, Microsoft made a slight mistake by not attaching a high definition (HD) port to the actual console. The port was sold separately and often required confusing cable work. Microsoft corrected the mistake with the release of Xbox360 Elite, but analysts believe it hurt their sales. One area where Microsoft's strategy differs from both Sony and Nintendo is their lack of presence in the handheld market of the gaming industry. However, that will soon change as Microsoft is developing their handheld "Zume" which will no doubt compete well with DS and PSP.
Nintendo looked for a change in strategy, with the release of the DS, to target non-gamers consisting of customers either too busy or too intimidated by the lengthy, complex games that were played by gaming enthusiasts (Economist, 2006b; Economist, 2007c). This simple to use hand held device required little expertise and tapped into the less traditional groups of female and older gamers. Nintendo then looked to emulate the success of the DS with the Wii Console which used a wand-like controller similar to a remote control. It incorporated news channels in the hope that non-gamers would be tempted to flick over to the games channels and try them out (Economist, 2006b). The Wii emerged as a popular new console to the market, selling 6 million units from November 2006-March 2007 (Economist, 2007c). Nintendo have since launched 3 'Wiimote' peripherals: the Zapper for shooting games, the Wii Wheel for racing games and the Wii Balance Board for fitness games. They classify these peripherals as their principal means to increase market share (Chronis, 2007b). Its motion sensor functions allow gamers to play games such as golf, tennis and bowling and appeals to non-traditional gamers and families looking for more active gaming for their children that they too can enjoy.
The Wii is a hot commodity at present, with consumers desperately trying to purchase it for the Christmas period. However, Nintendo have not invested in the high-definition graphics that Sony and Microsoft boast which may be a disadvantage in the future along with a lack of distinctive games (Economist, 2007c). Data indicates that Nintendo's DS and Wii have led to 69% of all videogame industry. Also, between 2002 and 2006 Nintendo was responsible for increasing the portable share of the videogame business from 30% to 50%. The number of over 25-year-olds buying Nintendo products has increased from 14% in 2005 to 23% in the first half of 2007 (Chronis, 2007).
Sony's last generation PS2 is still enjoying success in America, with higher sales than the newly launched current generation Xbox 360 and Wii during December 2006 (Economist, 2007c). Sony's strategy for this cycle's release was to position the Playstation 3 as the most progressive console, "revolutionising" the industry with its powerful "Cell Broadband Engine and RSX technology", "Blu-ray Disc", unequalled "storage capacity" and "free access to Playstation Network where PS3. The Playstation Network allows users to utilize online gaming, connect with other PS3 users, and download games, movies and other content from the Playstation Store" (Sony, 2007). Jack Tretton, President and CEO of Sony Computer Entertainment America, explained the goal of PS3 was to "introduce a system so technically advanced that it could stand the test of time and could take the industry in a whole new direction, which for PS3 was high-definition entertainment".
This new technology, however, has caused the price to rise significantly compared to its competitors' consoles and has resulted in not only a delayed time to market, but a scarce supply on release. Sony's bid to highlight its technological advances was also dogged by numerous PS3 problems and a huge product recall of batteries supplied to other computer-makers (Economist, 2006b). Sony insisted low initial sales were due to a supply shortage but this was contrary to anecdotal evidence. However, on 9 July 2007, Sony announced a $100 price cut on the 60GB PS3, causing sales to increase 113% at Sony's top five retailers within the month following the cut. Sony then went on to release an 80GB PS3 on 6 August 2007, aimed at game enthusiasts seeking a larger hard drive to enable them to download more games and other content from the Playstation Network (Sony, 2007a). A current growing technological sector is within virtual online worlds such as Second Life (Economist, 2006a). The launch of Home, a virtual world on PS3 is hoped to boost sales (Economist, 2007c).
Who will win the next round of warfare?
In the lead
"IDC, a market-research firm, predicts that the Wii will be the bestselling console by 2008, and Merrill Lynch predicts that 30% of American homes will have a Wii by 2011"- Appendix 2.1 (Economist, 2007c).
As a new console, the Wii has enjoyed high sales and surpassed its rivals, the Xbox 360 and PS3. Some say that the novelty of the motion sensor games will be short-lived and will not be able to sustain its leadership against the high definition graphics of its competitors. Sony's price reduction has resulted in an increase in PS3 sales, especially in Japan. Games consultants have suggested that the release of further PS3 games will add to its sales. This cycle, along with previous cycles, highlights how each manufacturer can assume the leader position at different points of the "console cycle" (Economist, 2007e).
It is often the sale of games (software) rather than consoles (hardware) that will determine which manufacturer will come out as the most successful. It has been acknowledged by Sony that sales have fallen behind the Wii and Xbox 360 due to a lack of 'must have' games. Although they have enticed loyal Playstation gamers, other consumers are waiting for something more. Third-party game developers need to sell a minimum of 500,000 units to break even with a game. This has presented a significant challenge for PS3 game developers considering slow PS3 console sales. Current PS3 game on the market are also seen as not yet capturing the full potential afforded by Sony's new technology (Chronis, 2007a). Online gaming is also growing in popularity with gamers downloading add-ons to console games and through subscription to multi-player on-line games (Economist, 2007c).
However, if all consoles continue to play a strong role, games companies may have a case for consolidation of games that play on all consoles (Economist, 2007e).
The future of gaming
Electronic Arts have called for an open, standard platform rather than a series of incompatible consoles. Nick Parker, games analyst/consultant, believes that dedicated consoles do not fit with the long term future of gaming. He believes that competition between manufacturers such as Sony and Microsoft has driven innovation but that this will be less important in the future. "Gaming will require potentially a ₤49.99 box from Tesco made in China with a hard drive, a wi-fi connection and a games engine inside. It's basically a boiled down PC. Games will be provided over the net. There might not be a need for a PS4 or dedicated consoles". Mr. Parker sees a future for key players such as Sony, Microsoft and Nintendo as content providers and licensors to other manufacturers with the possibility of "a Nintendo channel, a Play-Station channel and an Xbox channel on your set-top box". (BBC News, 2007)
The gaming industry will no doubt consistently grow over time. It will be the technology that changes and as Nintendo have proven recently, even the consumer. Many aspects may threaten to hurt the industry, such as the legislation brought against the industry or the expense involved in gaming. However, these negative aspects pose no real threat to slowing down the surge in gaming. Nintendo is seeing tremendous success by developing the family friendly gaming console. Microsoft and Sony have taken a more multimedia systems approach to their consoles and have so far been beaten. However, Nintendo has always played the family strategy, and it has really been their technological innovation that has won over customers. Microsoft may have opened a new door to gaming by interfacing with the internet and bridging the gap between console and PC. The company that can walk through that door and develop a virtual and realistic game using the internet platform will reign supreme.
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