The Stalwart: A Bloody Video Game Battle

A Merrill Lynch analyst has estimated that Sony would lose $1 billion on its upcoming PS3 gamebox:

Merrill Lynch Japan estimates that the machine's main components--namely its Cell chip, RSX, and BD-ROM drive--will cost about 11,000 yen ($101) each. After adding the other electronics that will be used in the PS3, the machine's production cost goes up to 54,000 yen.

Given that Sony's PS3 will face stiff competition from Microsoft's Xbox 360, the chances that Sony will release its console at its production cost is slim. Under the assumption that the Xbox 360 is expected to sell at around $299, Merrill Lynch Japan predicts that Sony will sell each PS3 at the price of 44,800 yen ($410) in Japan and $399 in America. That would mean Sony would suffer a loss of more than 130 billion yen ($1.18 billion) during the first year of the PS3's release.

By comparison, the PlayStation 2 cost 39,800 yen ($364) in Japan and $299 in America when it launched in 2000. During its first year of release, Sony Computer Entertainment suffered a loss of 51.1 billion yen ($458 million), but it recovered the next year with a profit of 82.9 billion yen ($759 million), followed by 112.6 billion yen ($1.03 billion) the year after.

It is normal for game companies to take a loss on hardware whenever a new console launches, since they typically focus on acquiring market share rather than generating a profit during the first year. During the second year and afterward, they can recover the losses with the savings that come from mass production and with licensing fees from publishers.

However, Merrill Lynch Japan warns that the normal console business cycle may be disrupted if Microsoft cuts the Xbox 360's price when the PlayStation 3 launches. The report goes on to say that such a move could hurt Sony's plans, bringing an additional loss of 80 billion yen ($730 million) in its second year and 50 billion yen ($457 million) in its third year. Thus far, Sony has already invested 200 billion yen ($1.83 billion) into development and production for the Cell chip alone.

I think it's clear where this story is going. The video game industry may not be the huge moneymaker that people expect. First of all, I'd expect the pace of upgrades to come even quicker than the time gap between the first XBOX/PS2 and this generation, meaning there will be a shorter period to recoup profits. Development costs are accelerating rapidly, such that some are expecting a crash in that market (on the other hand, I would not be surprised to see the emergence of an indie-video game scene, marked by niche titles, lower production values and lower costs...who will make the Final Cut Pro for that industry, allowing all of us to build games on our laptops??).

It's not at all unprecedented for fast-growing technologies to be money-losers. In fact, it's almost the norm. That being said, if any company can withstand years of losses in order to outlast its competitors, it's Microsoft.

And here's the latest on the XBOX 360 launch:

Shortages of the hardware at retail have held back Microsoft's console sales, which lag behind the early performance of the original Xbox - which sold 556,000 units in a comparable amount of time after launch back in 2001, despite direct competition from Nintendo's GameCube, launched only three days later.

However, the console has had an incredibly strong launch in software terms, with 1.27 million units of software shipping alongside those hardware units - representing a tie ratio of 3.9, far higher than the original Xbox tie ratio of 2.4.

Whether that healthy figure is down to consumers being "encouraged" to pre-order additional software in order to guarantee the status of their console pre-orders as the imminent shortages became clear in the run up to launch or not is a matter for debate - but for software publishers, it represents a major bonanza from the new launch.

Activision, in particular, will be delighted with this showing; Call of Duty 2 was far and away the most popular launch title for the Xbox 360, and with just over a quarter of a million sales, 77 per cent of all Xbox 360 purchasers brought home the game with their console.

Electronic Arts took the next two places in the inaugural Xbox 360 monthly chart, with Madden NFL 2006 selling some 178,000 units, and Need for Speed Most Wanted selling 108,000, while Microsoft's Perfect Dark Zero - the best selling title in the UK at launch - was the highest ranked first-party game at number four, with sales of nearly 86,000 units.

Interesting that even a renewable resource, like an XBOX 360 can experience shortages.