THE BOWEN REPORT

Hardware Transition, Spring, 2002

Hardware transition  (note written Spring, 2002)

THE HARDWARE TRANSITION

To review the state of the three new hardware systems, we spoke with Trip Hawkins, President of 3DO; Bing Gordon, Chief Creative Office, Exec. VP, of Electronic Arts; and a senior development executive. 

Trip Hawkins, President, 3DO

Trip says this is the worst business climate he�s ever seen, with the �quadruple whammy� of  the platform transition, a bad economy, the dot.com bubble and the subsequent fall of the stock market, followed by the 9/11 tragedy which further froze the financial markets.  All of which has made it very difficult for smaller, public companies to raise money for expansion.   While 2002 will probably still be a difficult year, Trip sees 2003 as a �great� year with the growth in the console installed base. 

Overall Trip sees the prospects for X-Box as pretty good, much better than last year.  Now �it�s definitely a legitimate three horse race.�  The weakness of the economy has discouraged Sony from �going for the jugular,� and being as aggressive as they usually are.  Sony has sat tight and kept their price at $299, to keep reaping a decent profit from hardware sales, also perhaps because Sony corporate overall has faced declines and the videogame contribution is an important part of their overall profitability.  Sony�s price staying at $299 has given the X-Box breathing room, given them a chance to establish a beachhead.  Sony had been quite aggressive with Playstation One, it �shocked� people when they dropped the price to $199, but of course it helped make them the market leader. 

If Sony had already dropped the price, �that would have made things a lot more difficult for Microsoft.�    As is, Microsoft has achieved reasonable sales and �settled into what they probably see as a comfortable position.�   The X-Box has good �esteem� from the press and consumers.  The longer Microsoft doesn�t have to face a price cut from Sony, the more committed they are to being a �long term player.� 

Nintendo, on the other hand, �has pretty clearly figured out what their market niche is,� going for the kid segment.   The Game Cube has a lower cost of manufacturing (no hard drive, don�t pay the $20 fee to support DVD, etc.), and a �kid friendly positioning,� which allowed them to continue to address their main consumer segment of age 12 kids and younger.  �Nintendo is in a good position to always be the low priced product among the three, and to be able to do that without a lot of pain.�    This lower price is important because �what they�re really selling is a birthday or Christmas present for a kid.� 

Looking forward, Trip feels a price war is inevitable, and will be a �wonderful thing� for the industry overall.  The present situation is hard for publishers, since retailers are continuing to carry nine old and new hardward sku�s, so they�ve really tightened up on the number of titles they carry per sku, and inventory quantities.  Further, �the open to buy dollars the retailer has in this economy is limited.�  So, there�s an �oversupply� of software, partly because publishers were so eager to get titles out early on the new platforms (which has historically been very successful).  So, the retailers will �get healthy� before the publishers.  The main hardware makers are fine, since they�ve been able to keep their hardware price at $300, and the tie ratios have been pretty good. 

Trip doesn�t see a fundamental change for publishers this year, retailers will remain cautious about taking a lot of inventory on new titles, right up to Christmas.  The software oversupply won�t lessen till Christmas.  This year hardware sales at Christmas will be tremendous, however. 

In 2003 the hardware base will be so much larger that the game industry overall should prosper even if the general economy is still soft.  As of November 1, 2001, the PS2 installed base in the U.S. and Europe was only six million units, and the two new systems hadn�t shipped yet.  As of this spring, the number is 14 million.  Europe�s having it�s first new X-Box and Game Cube Christmas this year.  Many analysts are forecasting the total number of the three consoles to be 48 million by the end of this Christmas.  By the end of 2003 it might be 75-80 million units (in the US and Europe). 

With the ever higher cost of games, with $4-6 million standard, and the �bottlenecks� at retail, publishers will become even more selective about the titles they make.  With somewhat fewer titles, and the tremendous increase in hardware installed base, the prospects for 2003 are incredibly good, in Trip�s view. 

As time goes by, Microsoft just gets more entrenched, and learns more.  Trip feels that all three systems can definitely continue to co-exist.  Sony will be the first to drop price, to $199, setting off the price war.  Microsoft will match it, and Nintendo may go to a lower number.  If it happens this year, the hardware projections will go even higher.  It�s hard to say when the price war will happen, but Trip feels it will happen by next February.  �There�s no incentive for Microsoft or Nintendo to take the initiative, that�d just be throwing money away for them.�  

Given that this is the opening stages of the �battle for the livingroom,� and an eventual set top box product that will combine a computer, game console, TV, etc., can Microsoft be all right as a fairly distant #2?  �They don�t have any choice,� Trip says, considering they came in two years late.  But they won�t be late on the next round.  �I don�t think they had any pretension in thinking� they could unseat Sony, Trip says.  He thinks Microsoft will be �thrilled� if they can sell at half Sony�s numbers. 

Even if most publishers make PS2 their lead system, Trip still feels �All three platforms are going to have plenty of good software.�  That won�t be the main �competitive differentiator� in his view.  All three are working hard to have good first party titles, and have strong third party programs.  They�re �getting settled into a routine, where Sony will lead the market, Microsoft will keep pace and get their piece, and Nintendo will focus on their niche.�  After the price cut, Microsoft will have to decide  how hard they want to push for market share, if they�re losing money on each hardware unit. 

Internationally, Trip would have advised Microsoft to skip Japan, and concentrate on Europe.  PC�s are much more important as entertainment devices in Europe, so the Microsoft name means more.  Microsoft has significant �branding advantages� in Europe.  Further, Europe is �wide open� with no game hardware company being dominant.  Historically, �none of the console brands, like Sega and Sony and Nintendo, have enjoyed the kind of dominance in Europe that they have had in the U.S.�  If Microsoft got aggressive in Europe, they have a chance to dominate.  In mid-April they dropped their price in Europe from $400 to $300.

How about the next round?  How well Microsoft does in this round will determine how aggressive they are next time.  As has been shown time and again, �anybody can take leadership in any new round.�  However, Trip sees lots of obstacles before the grand livingroom multi-purpose device takes hold.  The set top box comes in from the cable or phone company, part of a leasing package, and there�s �tremendous inertia keeping that box from being transformed into a digital box with a lot of advanced features, because there are monopolies battling for control.�  The companies that supply cable boxes, and supply cable services and phones services, and operating system firms like Microsoft, each want to control it all.  The big cable companies like Time Warner or AT+T don�t want to share with Microsoft.  �The cable operators would prefer to have a dumber box, that they have control over.�  �Microsoft�s been banging on that door for ten years now, and Sony could be banging on it for the next ten years.�   A better approach for Microsoft and Sony would be to sell �a sharp digital device� at retail that could turn into the set top box, but a PS2 or X-Box, even with a cable modem, still needs the capacity to process analog TV signals.  This isn�t trivial, however, as the analog circuitry  can be expensive and reduces reliability, says Trip.   So, our wonderful set top box may still be years away.   

Bing Gordon, Chief Creative Officer, Exec. VP, Electronic Arts

Having the X-Box is good, it�s �nice to have another very credible company� in the industry.  Bing sees the X-Box as a strong unit technically.  Still, �every time I�ve done blind taste tests with potential customers,� most consumers �can�t tell the difference� among the three new systems.   These systems are about as similar as the Genesis and Super Nintendo were, ten years ago.  EA is trying to come up with �unique features� for games on each machine; the different dev teams �compete with each other, to see who can come up with the best thing.�   The greater memory and hard drive on the X-Box could be a help, like using the hard drive to download and cache �online� games, and the high Ram is �exciting� to aid development. 

�Typically pricing moves get matched by the other guys,� so that won�t be a big distinguishing feature.  Also �media spend after the first year doesn�t reorder� things, as the companies again match each other. 

�Electronic Arts cannot do a lot of exclusives for any particular platform, and the first parties tend to provide most of the exclusives,� so it�s the first party software that may most distinguish the systems.  He feels Sony and Nintendo are �a little more predictable� in what they�ll do for first party titles, based on what they�ve done in recent years.  Sony has shown strength in titles like Gran Turismo, Spyro and Crash, with Nintendo known for Mario and Zelda.  What Microsoft may do is a harder guess. 

Speaking of sports, Bing says �everyone tries to compete with us for a while in sports,� but he sees the �little guys� having given up and turning their attention elsewhere.  �EA Sports across the board is going terrifically well.�  Companies like Sony�s 989 Studios have certainly done some strong sports titles in recent years, but EA has tremendous advantages.  Pursuing sports was a �vision of the founder,� their Chairman/CEO is �a jock and highly interested, and we have whole development teams that live and breathe their individual sports.  I think it�s really hard for competitors, when you go four levels down in the organization before you find somebody who even watches sports on TV.� 

Bing doubts that a �killer ap� could really change the present hardware landscape.  �We haven�t seen it in the past, after the third year of a generation, (the hardware balance) doesn�t get dramatically reordered.�  Even after the first year, �consumers have attached a psychographic and demographic positioning� for each platform, which doesn�t much change.  In the last 15 years Nintendo has been better at repositioning their platforms �late in life,� as they did with GameBoy, and with SNES bringing out Donkey Kong Country when Sega had given up on Genesis. 

�I suspect the biggest change to come up in this generation is with Nintendo�s IP�s (intellectual properties),� like Pokemon, Mario, Zelda, and Donkey Kong, which we may see at E3.  He notes  Nintendo has been �talking about� Zelda. 

In the U.S. for kids over 14 now X-Box is the �alternative� to PS2, whereas in the last generation  Nintendo was the alternative for Playstation.  Rather than Sony really losing market share, Bing feels that alternative share is just being split between X-Box and Nintendo. 

�Playstation 2 was the most anticipated videogame console of all time, the best supported of all time, and you have to believe the next round will be even bigger.�  So Bing doesn�t see X-Box unseating Sony.  In terms of the battle for the living room, Bing feels  �consumers in general don�t tend to like their electronics being all in one.�  For instance Bing has a fax machine that�s also a scanner and a printer, but it�s no where near as popular as the straight printers.     �I�m not sure a single, combined home entertainment box is really something consumers want.�  Despite Sony�s strength, he �assumes Microsoft will be in the games (hardware) business forever.� 

Senior Development Executive

In speaking with a senior development executive, they noted that the X-Box is clearly easier to program for, but they have some concern that the X-Box has �PC type� product.  Overall, technically, the Playstation one was a tremendous leap ahead, it made 3D possible so that the graphics of titles like Toshinden and Ridge Racer looked tremendously different.  While X-Box and PS2 are improvements, they don�t represent the type of leap the first Playstation did. 

Many publishers are taking the view that the order of machines is PS2, Game Cube, and then X-Box, the executive says.  Having the lead SKU on X-Box is not that common, and many publishers feel they should only do AAA titles on X-Box.  A solid B title, which makes lots of sense (and will make a profit) on PS2, probably won�t be done on X-Box. 

The promise of broadband for X-Box hasn�t materialized, so that�s not a significant advantage for them.  Sony doesn�t really need a �killer ap� to continue dominating, the accumulation of enough good titles will keep them #1, they�ll just �keep the body blows coming.� 

Still, it would be a mistake to count Microsoft out, in the long run.  They �don�t like to be #2.�  As this is the battle of the living room, there�s too much at stake for them to slow down.  If Microsoft continues in a distant #2 position, they may do something dramatic.  What might that be?  Buy Sega?  Buy Rare (but then, what has Rare done lately, and much of their best creative work might be credited to their collaborative work with Nintendo). 

It�ll be interesting to see what Microsoft does in the coming months. 

Editor�s comment

Where does that leave us?  I still think it�s possible for a breakthrough title to upset the present hardware landscape, though perhaps not likely.  Maybe I feel that partly because I just like that this industry is still  driven by creativity.    It does seem that Microsoft will be part of the videogame landscape for quite some years.  The most interesting immediate question is still, what might Microsoft do in the next year.  I for one think they may do something dramatic � they seem the most unpredictable of all the players.  Sony is like a splendid 220 pound full back hurtling down the field, and Microsoft (in gaming) is the smaller, faster defensive back, who may use his body with wild abandon to tackle, or at least slow down, this opponent.