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Game Within the Games

Posted on: Sunday, 20 November 2005, 15:00 CST

By Mike Hughlett, Chicago Tribune

Nov. 20--Robert Aguirre will be waiting in line at a video game store late Monday night, waiting for the clock to strike midnight. That's when the next generation of Microsoft's Xbox -- the Xbox 360 -- goes on sale.

Aguirre has already ordered the new game console from a South Loop GameStop outlet. "This is even better than the [original] Xbox," said Aguirre, who's tested the 360 at GameStop. "It's like night and day."

Microsoft Corp. is banking on such sentiments to help it win a war: The battle to dethrone Sony Corp. and its reigning PlayStation game console.

It is a high-stakes affair. Microsoft is hoping that by getting a jump on Sony -- the PlayStation 3 isn't due for several months -- it can gain share and finally put the money-losing Xbox on the path to profitability.

Sony, meanwhile, is defending a profitable and important niche. Video games have been a buffer against hard times in Sony's other consumer electronics lines, including televisions.

Microsoft "has a good chance with this system," said Aguirre, who also has a PlayStation 2 and plans on buying Sony's next edition. "It all depends on what Sony has up its sleeve. We'll have to wait and see."

Sony's PlayStation 2 has dominated the console market since its introduction in 2000. It had about 43 percent of the U.S. market last year, compared to 19 percent for the Xbox and 14 percent for Nintendo's GameCube, according to JupiterResearch.

Nintendo, too, has a new console coming out next year, dubbed "Revolution."

Each consolemaker knows that a new hardware cycle levels the playing field, at least temporarily. And they know that enthusiasts like Aguirre determine whether their wares will get off to a fast start.

They are the ones who'll drop $399 for an Xbox 360, or $299 for the stripped-down Xbox 360 Core. (The former includes a wireless controller and 20 gigabyte hard drive.)

"It's pretty much the hard-core enthusiast crowd that will go for it this holiday season," said David Cole, an analyst with video game researcher DFC Intelligence in California.

Gaming Web sites are full of Xbox chatter. One site, GameSpot, noted in a recent post that gamers in the Pacific time zone were only "167 minutes and 59 minutes away" from being able to buy an Xbox 360.

"It's always exciting when a new system comes out," said Aguirre, a 36-year-old carpenter who lives in Chicago's Bridgeport neighborhood. "You always want to see what they make better, and they always amaze me how they do it."

The new crop of consoles goes beyond gaming, featuring music, movie and photo capabilities. But for gamers, what really matters is that they have more computing power, which makes for splashier games with sharper graphics.

"It looks pretty crisp, pretty real," said Kevin Smith as he watched another GameStop customer, Ambrose Jackson, play an Xbox 360 demo model.

On the screen before Jackson, soldiers shoot it out in a desert setting in "Call of Duty 2." Smith pointed at wafting smoke. "The smoke effect is great," he said. "It's just like the real thing. It takes a while for it to disappear."

Smith, a 22-year-old box sorter at UPS, said the new Xbox's controller is better, too--less clunky than the current version. "It's much sleeker," said Smith, who lives in the Englewood neighborhood. "And I like the response I get from it."

Smith has already ordered an Xbox 360 and he says he'll buy a PlayStation 3 too.

But Jackson is going to stick with Sony. "Xbox 360 is cool and all," he said as he blasted away on "Call of Duty 2,""but I'm going to be really hyped when PS3 comes out."

A 23-year-old student at the University of Illinois at Chicago, Jackson has a PlayStation 2. He prefers Sony because its consoles play a broader lineup of games.

In other words, a console can have all the pizazz in the world, but it's the games that matter most. Analysts who track the video game industry agree, though several also say the lineup of new games for Xbox 360 is "solid."

In video game industry economics, profits are in the games--the software--much more than in the consoles. A consolemaker's goal is to at least break even on the boxes.

The bulk of the software profits come in two ways. First, consolemakers have their own self-produced games. For instance, Microsoft's "Halo" game has been a huge seller that has helped move Xboxes.

Second, independent gamemakers--like Chicago-based Midway Games--must pay a licensing fee to consolemakers for every game disc they produce.

Nintendo, though it's third in market share, still makes solid profits because it develops a lot of its own games--iconic franchises like "Mario" and "Zelda," said Chris Kwak, an analyst at Susquehanna Financial Group in Pennsylvania.

Sony's strength, meanwhile, is its leading market share, or as Kwak said, its huge "installed base" of consoles. All those consoles require lots of games, which means lots of licensing revenue from independent gamemakers.

And the more market share a consolemaker grabs, the more incentive gamemakers will have to produce software for that console.

Microsoft is betting that by being first to market with the Xbox 360, it will grab business from Sony. The original Xbox came out in late 2001, more than a year after PlayStation 2, a gap Microsoft believes hurt it.

Being first this time "is very important," Kwak said. "That's enough to get more market share this time around."

Of course, whether it will be enough to turn the Xbox into a moneymaker for Microsoft remains to be seen. Kwak said profitability may still be a few years away.

But Microsoft has shown a lot of patience with Xbox.

"The first generation of the Xbox was a learning proposition and they knew it would be a learning proposition," said Michael Gartenberg, a consumer electronics analyst with JupiterResearch. "When you've got a $45 billion war chest and you're willing to be patient, there's a lot of opportunity."

Gaming attracted Microsoft for a couple of reasons. First, console-based gaming is a fast-growing business, and it's a big market with about $9 billion in U.S. sales, according to Jupiter.

Second, gaming is important for Microsoft's goal of becoming a hub for home entertainment, Kwak said. "They own the PC, but they have to get into consumer electronics."

Still, even if Microsoft fails to make a big leap with the Xbox 360, it won't be as bad off as Sony will be if PlayStation 3 loses significant ground to the Xbox, several analysts say.

Microsoft's home and entertainment sector, which is largely Xbox-related, normally makes up about 8 percent of the company's revenues, and of course loses money.

At Sony, gaming accounted for 13 percent of sales in Sony's most recent quarter. More important, gaming is "an important profit center," said analyst Cole.

In the console war, "the stakes are higher for Sony," Cole said. "They have more to lose. They have nowhere to go but down."

IS GAME BATTLE A PREVIEW OF FUTURE DVD FORMATS? The better Sony fares in its console battle with Microsoft, the better off it may be in another war: The fight over the technology behind the next-generation DVD player.

Sony's Blu-ray format is up against Toshiba's HD DVD technology. Only one format is likely to survive, analysts say, and the sooner one wins, the better for consumers.

Here's why this matters in the game console war: Video games are played on DVDs. A Blu-ray DVD player will be standard on Sony's PlayStation 3, the coming rival to Microsoft's Xbox 360. The more PS3s sold, the more potential demand for Blu-ray discs, some analysts say.

On the other hand, tech industry heavyweights Microsoft and Intel support HD DVD because it allows video content to be copied from discs to computer hard drives.

Microsoft's Xbox 360 hits stores this week with a current-generation DVD player, but Microsoft has indicated that future versions may come with HD DVD technology.

But PlayStation 3 could help "tip the scales" toward Sony in the DVD war, said Michael Gartenberg, a consumer electronics analyst at Jupiter Research in New York.

Few gamers are likely to choose the PlayStation 3 specifically because it has a Blu-ray DVD player, but when they realize they have it, they'll have an incentive to buy content in the Blu-ray-format, he said.

"PS3 has the potential to be the Trojan horse in that format war," Gartenberg said.

Chris Kwak, a stock analyst at Susquehanna Financial Group in Pennsylvania, agreed.

He noted, too, that PlayStation 3 effectively allows Sony to subsidize the spread of the Blu-ray standard. The next wave of DVD players, be they Blu-ray or HD DVD, are expected to hit stores next year and cost $800 to $1,000.

The PlayStation 3 is likely to cost around $500, Kwak said. Sony can price the Blu-ray game console lower because its video game profits come primarily from the sale of games, he said.

Technological format wars are nothing new. Sony was involved in one of the more famous ones in recent years, the videocassette battle of the 1970s and '80s.

Sony's Betamax format lost to Matsushita's VHS standard. While many thought Betamax technically superior, it failed at least partly because Sony's strict licensing terms turned off movie studios.

In the current DVD fight, though, Sony has plenty of allies in Hollywood. While most studios have said they will use both Blu-ray and HD DVD, Sony's Blu-ray technology has more piracy protections than HD DVD, a big plus to moviemakers.

But HD DVD entails less retooling of the DVD manufacturing process than Blu-ray.

But Blu-ray discs will hold five times that of conventional DVDs, compared to three times for HD DVD.

Analysts see no truce between the two camps.

In fact, the PlayStation 3 gives Sony an extra reason not to compromise, said Paul O'Donovan, a London-based technology analyst for market researcher Gartner Inc.

"Why compromise when you control the game console market?"

Bloomberg News contributed to this report.

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Source: Chicago Tribune

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