Process First: Pros and Cons of the Busienss Models

[GotchayeA]

It seems to me that the reasons that favor the sort of business model MS and Sony are using have collapsed in the current market.

The idea is, as you've said, to get lots of consoles in homes by pricing hardware as low as possible (taking a loss, even) and then to make the loss up, and then some, with increased software sales. The reason that this ends up selling more software is that the market is competitive - if you can make your console more attractive earlier in the game, you build momentum which steals sales from other companies and attracts more third party support.

This can absolutely devastate competitors who don't practice the same strategy. They're selling their hardware for a profit, and so aren't able to offer as many features for the same price. There's no reason for consumers to pick the profitable piece of hardware and many buy the loss-leading console. The loss-leading console is then able to build up to a critical sales mass where it starts turning an overall profit on the strength of software sales to existing users. It can also leverage this momentum to begin selling the hardware for a profit later in its life.

In essence, the strategy is to take a loss at launch so as to steal the competition's sales in later years.

This worked beautifully for Sony on two occasions. With the PS1, Nintendo was following a traditional model and got creamed. With the PS2, Nintendo again got creamed while MS tried using a model similar to Sony's. However, MS couldn't compete with the Playstation's brand with the first XBox, and so was largely ignorable.

The interesting thing here is that Sony wasn't really trying to offer more capable systems for the same price, but similarly capable systems for much less than Nintendo was selling theirs for. Consumers are price-sensitive, and they knew that being $100 less was more important than being a bit more powerful. Loss-leading is obviously more effective with weaker hardware, as selling a $300 console for $200 taps into a much larger additional market than does selling a $400 console for $300.

However, the last generation was the beginning of the end for this business model. It was disastrous for MS - their only option was to take the strategy to extremes in order to compete with Sony's brand. Where Nintendo could hunker down and continue making a profit, albeit a smaller one, the business plan that MS and Sony use requires all-out war if the dominant position in the market is at stake.

By the end of the last generation, MS had built up their brand considerably. In designing their next systems, both MS and Sony had to consider what the other was going to do. Sony couldn't just make a PS3 that was to the PS2 what the PS2 was to the PS1. Another XBox, sold at a loss for the same price as the next PS and significantly more powerful, would be able to compete much more effectively this time around thanks to better branding. Sony had to both keep prices low while offering competitive features. MS had the same thought - they couldn't compete with Sony on branding alone and badly needed either a pricing or a features edge.

This resulted in both companies coming out with systems that were far, far more powerful than they should have been. Both had to assume that the other was going to try to one-up them, and both had to try to turn the tables on their competitor. Sony had some particularly bad luck when the Cell turned out to not be as capable or as cheap as they'd hoped. MS was therefore able to sell at only a moderate loss while Sony was forced to both take a significant loss and sell their machine for a very high price. This is the only thing that let MS go without a price cut for so long and save themselves from where this would have taken them - neither would have profited from the ensuing price war had the PS3 had the same production costs as the 360.

Meanwhile, Nintendo, which didn't have to try to guarantee market dominance, did what they always do, with the added twist of a motion-sensitive controller and a better marketing campaign. As the only console in a reasonable price range, it's achieved market dominance and now has sufficient momentum that it looks nearly impossible for either other console to get back in the game, even with a massive price cut.

Basically, the sort of plan that MS and Sony use is only suited to a market in which no existing competitor is using a similar strategy. It's about throwing money around and outspending the competition early on, and this easily gets into a mutually destructive loss-leading/features war when more than one company tries it.

It's essentially a Prisoner's Dilemma. Both MS and Sony would be much better off if neither followed this strategy, but if either one breaks off alone, the other will take over the market. The risk involved in continuing this pattern is far greater than the potential reward, but only because two companies are doing it. At this point, both are merely trying to continue on until the other decides that it's lost enough money. Edit: It's also worth noting that neither MS nor Sony would be nearly as successful as Nintendo is with Nintendo's business model. The reason that Nintendo isn't doing what MS and Sony are doing is mostly that it doesn't have to - it has an out to the Prisoner's Dilemma that the others don't have. Its out is an absurdly strong first party. Look at Gamecube and PS2 first party million-sellers. You'll note that the GCN was actually pretty competitive with the PS2 in this regard. It's obvious that first party software is much more profitable than third party software. A much higher percentage of software sales on Nintendo consoles is first party, which means that Nintendo makes a lot more money on software per console sold. It also means that Nintendo consoles have enough compelling titles to guarantee a certain minimum level of sales. They can therefore opt out of this Prisoner's Dilemma by selling highly lucrative first party software to a dedicated but limited player base. This is why even the Gamecube was reasonably profitable. If I remember correctly (I'm probably wrong), it's believed to have been something like a third as profitable as the PS2 on about 1/6 of the install base. It's first party software that makes the difference.