An interesting article where they talk with Chris Crotty of iSuppli. Oh, and it's good to see an analyst finally giving some perceptive reasoning as to why he discounts Nintendo.
tgdaily said:Redmond (WA) - For well over a decade, we've heard the word "convergence" used to refer to the evolutionary paths of digital electronics, communications, and computing devices. And yet nothing more clearly demonstrates the difference between the console gaming industry and almost any other consumer electronics category than this fact: Both retailers and customers are embracing the choice they're about to be given, between Microsoft's Xbox 360, which premiered yesterday; Sony's upcoming PlayStation 3; and Nintendo's upcoming DS.
For almost every other CE market, both customers and retailers demand either a single industry standard (as is the case with DVD) or a clear industry leader (as is the case with Apple's iPod). Where there's too much duality or multiplicity, the market looks for or even demands a shakeout (case in point: satellite radio) or some form of mutual compromise (Blu-ray vs. HD DVD for the next high-definition video disc standard). At least today, the gaming market is an exception to the rule. But how long can this continue to be the case?
As we reported this morning, electronics analyst firm iSuppli revealed today in its teardown analysis of Xbox 360 that Microsoft is spending as much as $550 per unit in equipment and manufacturing costs, for a unit whose base sticker price is $399. So here is evidence of one aspect of console game marketing that truly is showing signs of convergence with consumer electronics as a whole: The same way HP is willing to lose money on printers to secure future customers for inks and supplies, and Comcast and other CATV suppliers are willing to lose money on digital cable deployments in order to secure customers for premium programming, Microsoft is willing to invest as much as $150 per customer, perhaps even more, to secure a broader customer base.
"Right now, Microsoft is very interested in gaining market share," says Chris Crotty, iSupplies senior analyst for consumer electronics, and co-author of today's teardown analysis report. "In order to do that, they need to take advantage of the fact that their console is out before the PS3 launches."
The interval between Xbox 360's premiere and next spring's Sony PlayStation 3 launch gives Microsoft a window in which to grow its market share base. During that interval, there are very lucrative deals to be made in the licensing of rights to produce game titles for Xbox 360, as well as opportunities for Microsoft to produce a few more "Halo"-level mega-hits for itself. If the rate of such growth during this window is impressive, the company may be able to wield a pre-emptive strike against Sony by securing development deals with one or more top-tier game producers. Such deals can have explosive yields: Whereas in the 1990s, video game titles were created from licensing deals with movie producers for the rights to develop off of movie franchises, today, it's the other way around. "Halo," "Doom," and "Tomb Raider," among others, have become global entertainment franchises, with the game creators now calling the shots.
So for the near term at least, $150 or so per customer is not a bad investment to make, if you're looking at the potential for not just one, but perhaps a string of gold mines. And that cost will even out over time, believes Crotty and iSuppli. Microsoft's costs are so steep now, he told TG Daily, because Xbox 360's two core components - its CPU and its graphics processor - were in large part tailored for it. ATI's graphics processor costs Microsoft about $141 per unit, iSuppli estimates, because it was designed for Microsoft by ATI. But as the design costs are paid off within the next twelve months, Crotty told us, "I think they have the opportunity to potentially break even. There's still good opportunity to wring cost out of the two main ICs - the CPU and the GPU - as they improve the yields for production."
But rather than start reaping the harvest from $20 or $30 sales margins, Crotty believes, Microsoft will make a new set of investments in a particular kind of Xbox 360 upgrade. "At some point in early 2006," he predicted, "Microsoft is probably going to be adding next-generation DVD functionality. So that'll increase costs somewhat...but when they do that, I think it's more probable that the overall console price will just remain the same, and the additional cost of doing that would be offset by some of the cost savings. They have to put that in there because the PS3 will have Blu-ray support, and they really want to be competitive."
Along with Intel, Microsoft is a major supporter of HD DVD - one of the few remaining proponents not straddling the fence. Here is where the story starts to sound more like a traditional consumer electronics industry evolution tale, and where that term "convergence" re-enters the picture. As Crotty pointed out, the company co-developed, and maintains a major investment in, the iHD interactive layer, which is the XML-based language that supports the underlying interactive functions. Microsoft is interested in iHD for more than just HD DVD; it will reportedly play a role in the company's upcoming PC operating system, Windows Vista, as well as in its "Live" online services, which have received considerably more attention of late. Meanwhile, the Blu-ray standard which Sony championed, and which it will reportedly include in its PS3, utilizes BD-J, a competing interactive standard based on Sun Microsystems' Java.
All of which is why the company must, and probably will, introduce an HD DVD version of Xbox 360, Crotty believes, either at or just before the point it just begins to break even on its costs for the current version. "The new interactive layers will have functionality that will connect to online options," he noted. "So if you're Microsoft, that idea is probably very enticing, because you're always trying to expand your connection to your existing online businesses as well. And if you are Microsoft, and you're maybe envisioning a future in which you're part of whatever Media Center there is in the future, I think you want to be involved with that interactive layer, especially if it has some connection to the Internet.
"The other part of Microsoft's grand plan," continued Crotty, "seems to be that they are making a lot of investment and development in IPTV and IP set-top boxes. So again, this is an opportunity where Microsoft is seeing a future in which they are a key participant in the sort of next-generation living room device, or devices, and that future involves connection between the hardware and the Internet as well. You can think of it as Microsoft coming at it from a few different angles, hoping that everything will meet in the middle."
The unscheduled convergence between high-def games and high-def discs
As TG Daily has pointed out on multiple occasions - but most often in reference to the development of Vista, not Xbox - Microsoft is a platform company. It foresees, and to some extent engineers, the convergence of all transactions on the Internet on a grand scale. By contrast, there may be some very innovative and popular networks for community building around certain Sony PlayStation titles, but Sony's primary investments to date have centered around content, not platforms. Blu-ray's current dependence upon BD-J may do little to promote Java as a platform, even if Blu-ray ends up being the dominant, or even the only, high-def disc format. The reason is because Java is a cross-platform standard that supports processors on the receiving end of communications; whereas XML is an Internet standard that's centered upon distribution. Java has considerable strengths as a cross-platform development language, which XML is not; but you can't build a network around Java the way you can around XML. And if Microsoft can distribute iHD in Vista, IPTV, Media Center PCs, and Xbox 360 as the way to interact with network-distributed content, it could be perceived in the market as the company that achieves convergence. Whereas its competitors would be deemed "incompatible" - which is an all-too-familiar situation for competitors to Microsoft.
Despite this impressive game plan, there remain too many ways in which Microsoft can still fumble the ball. In fact, some believe, the company may have already done so. As we reported yesterday, there were way too few Xbox 360 units to go around, with nearly all major retail outlets selling out in the first day of release. Many pre-ordering customers have been told not to even expect their orders shipped before the end of this year. As a result, Crotty noted, some enterprising capitalists have been reselling Xbox 360 units on eBay for thousands of dollars, and getting hits. "So the first thing that might leap to mind," he remarked, "is to say, 'Wow, did somebody at Microsoft really screw up pricing here?' If the demand is that high, why couldn't Microsoft have priced this box at $800?" If Xbox 360 suddenly appears underpriced, potential partners may come to appreciate the PS3's projected premium.
The other possibility is that one of the objectives of Microsoft's platform play may fizzle. Consumer demand for either next-generation video disc format may not culminate, especially in the wake of public squabbles among both formats' supporters, and recent criticism of highly aggressive copy protection schemes - which both formats will reportedly embrace. "Maybe it'll turn out that it doesn't matter. Maybe the fact that Blu-ray and HD DVD will be fighting so much that supporting, or trying to add, next-generation DVD might be a bad thing," said Crotty. As a result, he added, "Maybe not having it will turn out to be a blessing."
In either scenario, there remains the question of which end of the stick Microsoft ends up with. The company may be planning to leverage its platform-building capability to seize market share, and perhaps leadership, from Sony. But if HD DVD fails, and customer interest in IPTV remains low, even Vista's likely success may not be enough to sustain iHD as a standard unto itself. In which case, the question of Microsoft's gaming leadership will rest once again on whether it has wrested the long end of the stick, or retained the short end it currently has. In no other consumer electronics market throughout the last two decades have customers openly embraced dual competing formats. They openly reject the notion of competing high-def disc standards; how long will they support two competing game consoles?
Did I say "two?" I meant "three." "I don't foresee Nintendo faring well in this next-generation battle," stated iSuppli's Crotty. "I just don't think that the market will continue to support three major players, because it's so expensive to develop content now for these consoles, and to be developing the content for three consoles, I'm not sure that that's viable going forward. And I think, from a global brand standpoint, Sony and Microsoft have a much stronger position."
So a shakeout already appears under way. The arguments justifying this shakeout are strikingly similar to the argument entertainment content providers and movie studios use to justify not producing products for two major players. It seems their arguments, like their technologies, are converging after all. If that's the case, then Microsoft's window of opportunity is narrowing. It might not have time to wait for costs of production to even out. If it's going to make a platform play, it had better make sense, and it had better be quick. Judging from yesterday's performance, it might have a lot of ground to recover.