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Sony's PS3 Problems Cast a Long Shadow

The game console's failure to hit even internal sales targets raises doubts about the electronics giant's 2009 turnaround forecast
by Kenji Hall

If only Sony (SNE) could fast-forward to March, 2009. That's when the Japanese technology company expects its video game business to finally make money after two years of hefty operating losses. But the prospect of Sony's PlayStation 3 gaming console dragging down earnings for another two years shouldn't have fazed anyone who attended the company's fiscal-year earnings announcement on May 16. Financial analysts have been offering a similarly gloomy forecast for months now.

However, investors were in for a nasty surprise on May 16: Sony failed to hit its own PS3 sales targets, Chief Financial Officer Nobuyuki Oneda said. Although the company had forecast global shipments of 6 million machines by the Mar. 31 end of its fiscal year, its factories made and sent off just 5.5 million. Worse, the actual number of PS3s in stores was closer to 3.6 million. The remaining 1.9 million were either sitting in warehouses or en route to stores, leaving as much as $1.1 billion in inventory. Perhaps that's why the company chose to stick to a more conservative sales forecast of 11 million units this year.

The results confirmed that Sony's newest console, launched last November, is off to a slow start. The one-time king of gaming consoles now trails both of its chief rivals, Nintendo (NTDOY) and Microsoft (MSFT). Earlier this month Nintendo said it had shipped 5.84 million Wiis in the same four and one-half month period. Microsoft, which had a 12-month head start, upped its tally to 10.4 million units through March.

A Drag-Down Effect
The shortfall raises questions about Sony's ability to meet its own timeline for a turnaround in the video gaming division. Making the PS3 a commercial success is crucial if Welsh-born Chairman Howard Stringer is to deliver on his promise of rebuilding the Japanese electronics and entertainment giant. While games account for just 14% of overall sales, their losses have bogged down the company's overall earnings.

Last year Sony booked an overall operating profit of $598 million—a 68% drop from the previous year—even though sales rose 10.5% to $69 billion. The gaming unit's losses alone exceeded $1.9 billion. (The previous year, the division booked a $72.5 million gain.) Had the unit been profitable, Sony's earnings wouldn't have looked so dreadful. Morgan Stanley (MS) analyst Masahiro Ono reckons the gaming division will lose another $240 million this year despite an expected 50% rise in sales, before things turn brighter.

Video games also play an outsized role in the company's image as a leader in digital technologies. The PS3 represents the first outing for two brand-new technologies: the high-definition Blu-ray DVD player and the blazing-fast Cell chip. Those newfangled technologies are expected to end up in other Sony products, possibly as early as this year. Lowering the cost of producing them would lead to the efficiencies that executives have been counting on for years.

Discount the Console?
To be sure, two years of losses are to be expected for a new machine that's crammed with the latest whiz-bang technologies costing billions of dollars. Sony executives have long argued that's a small price to pay for five years of steady profits, as production cost-cutting take effect and software licensing fees come pouring in.

But Sony is now under immense pressure to find a way to close the gap with the competition. One possibility: discount the console. That would likely spur demand among ordinary consumers and keep game-software developers from shelving their own plans for rolling out future PS3 games.