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Wii the Death Knell of the Bleeding Edge Console?

By Kris Graft

 Nintendo has shown that it doesn’t need to sell consoles at a loss to be a mainstream success. Could this be the last generation of the high-cost, "bleeding edge" console? This generation, videogame console manufacturers somewhat literally went for broke when they entered the new interactive entertainment technology arms race. Built-in Blu-ray drives, standard connectivity features, hard drives and high-horsepower multi-core processors drove losses for both Sony and Microsoft who sell their machines at a loss.

Nintendo, on the other hand, has never been one to sell its consoles at a loss. Puttering past competitors with what detractors called "GameCube 1.5" technology is the Nintendo Wii, which distinguishes itself not by sheer power, but by unique gameplay mechanics. It’s clear that Sony and Microsoft’s razor strategy is lost on Nintendo execs. In June 2006, prior to the Wii’s launch, Nintendo president Satoru Iwata said, “It is a strange notion that a game console always leads to mounting losses in the beginning. We can't promise we won't even have a one yen loss, but we are not expecting an enormous loss."

The end of costly consoles?

For the uninitiated, console makers rely on the razorblades-and-razors business model, which follows the model of razor companies who sell razors at a loss, and offset those losses with high-margin razorblades. In the games business, consoles are the razors and software are the blades. Nintendo's current razor, the $250 Wii, isn't a money-losing piece of hardware.

“I think the results of this cycle will have a strong influence on the next cycle, in that cheaper consoles will be expected,” says analyst Billy Pidgeon, program manager for IDC's Consumer Markets: Gaming program. “Microsoft and Sony will attain successful business on this generation, but catering to the early adopter hardcore gamers with a technology leader strategy will be difficult in 2011.”

There are two main “evils” that manufacturers would have to choose from if they decided to stop taking (or significantly lessen) losses on consoles. First, they could charge even more for consoles in order to break even right off the bat (imagine if the PS3 launched at $900 and Xbox 360 launched at $550). Or, they could adopt less-advanced, less costly technology. Nintendo has shown which one is the lesser of the two evils.

Building razors is expensive. With US launch prices of $600 for a 60GB PS3 and $400 for an Xbox 360 Premium, Sony and Microsoft lost an estimated $240 and $125 per unit sold, respectively. That drove hundreds of millions of dollars in losses as the companies sought to establish big installed bases for their machines. Since the 2001 launch of the original Xbox, Microsoft is just this fiscal year forecasting its first full-year profit for its games business, a delay in profits attributed in no small part to the razor and blades model.

Maybe a lower-cost PS3.5 or an Xbox 540, both with intuitive control options and incredible online services (and with relatively low manufacturing costs), will more than suffice next time around.

“…It is entirely possible that the PS3 is the last bleeding edge console hardware we will see,” says Pidgeon. “I think it will be very hard for consoles to compete with PCs in five years, or for dedicated handhelds to compete with smartphones.

“…The platforms of the next cycle may not be a console at all, but software distributed by network to convergent devices like PCs, set top boxes and smart phones.”

Razors still a sound model

But the razors and blades model isn't necessarily doomed. With connected consoles and high-def movie formats, the business model has expanded considerably, and continues to grow. All of this “war for the living room” talk isn’t mere rhetoric. We can see today the war raging across digital distribution platforms such as Xbox Live Marketplace, PlayStation Store and Wii Store, and that’s not even to mention on-demand TV and PC-to-TV bridges like Windows Media Center or Apple TV. All of this digital content can bring in big revenue for someone willing to make an initial financial sacrifice to get a multimedia box into homes.

Wedbush Morgan analyst Michael Pachter expects physical media to make an impact as well. “Sony's expanded the [razors and blades] model to high definition movies," he says. "The only reason for a Blu-ray player in the PS3 was to get a bigger installed base for Blu-ray and to beat Toshiba's HD-DVD early. Now that Sony has won, its royalties will be movie and game royalties combined. Well worth the gamble.”

Nintendo hasn’t really attempted to put its toes out there to test out the multimedia waters. The Wii is almost strictly a games machine, and so far, the strategy is paying off. More than ever, as its competitors become jacks of all trades, Nintendo is able to capitalize on the fact that it is first and foremost a videogame company.

“Nintendo does not necessarily consider Sony or Microsoft competition,” says Jesse Divnich, analyst with virtual stock market The simExchange. “Nintendo has always tried to differentiate their consoles by targeting the markets that Sony and Microsoft have typically neglected or made poor attempts to exploit.”

Of course, Nintendo isn’t a mega conglomerate with various divisions that have interlacing objectives that would benefit from a high-po, living room-based multimedia machine. Sony has its aforementioned Blu-ray business, as well as music and film branches, all of which are tied in some way to the games business. Microsoft seems quite keen on digital content downloads and IP TV, which also tie nicely with Xbox 360.

But Nintendo isn't so far removed from Sony and Microsoft's strategy. “Nintendo Wii is arguably closer to the traditional razor/razorblade model in that the console (the razor) is offered cheaply with enclosed (Wii Sports) content (the blade) is a profitable business from launch and quickly establishes a platform to deliver additional content,” Pidgeon observes. “Unlike Sony and Microsoft, Nintendo makes a margin, however small, on the hardware along with the retailers and then makes more money on the obligatory extra controllers as well as first party software and third party licensing fees.

“And because of the success of the Wii and the sustained viability of the PS2 as a software platform, retailers and third party publishers are calling for lower prices on the high end systems from Microsoft and Sony, while the Wii can continue to improve Nintendo's margins while maintaining a constant price.”



Whether or not console makers decide to stop taking such massive losses on consoles essentially comes down to how much they are willing to sacrifice in terms of horsepower. Nintendo’s decision to introduce a machine called the “Wii” with last-gen graphics alongside powerhouses like Xbox 360 and PS3 was a huge risk, and it paid off, because Nintendo thought beyond graphics. The question remains if Sony and/or Microsoft, both of which have taken no small amount of pride in their consoles’ cutting-edge graphical capabilities and other pricey features, would be willing to take a similar risk, and realize just how much graphics have become a commodity.

Nevertheless, Divnich says that Microsoft and Sony will cling to their strategies as they strive to move into revenue streams beyond the retail box and beyond gaming itself. “…Microsoft and Sony won’t abandon their current model,” he says. “Gaming consoles are the new gateway to a whole range of services including, watching movies on physical formats, listening to music, providing downloadable content, and soon enough offering a DVR service—all of which have substantial profit margins. Getting the upper edge in all these categories means selling as many consoles as possible.

“We live in a free market and businesses will generally take the most profitable route when marketing their products. In our industry, it is unlikely that the manufacturers will drop this model as it has been proven to be one of the best business models for consoles that offer more than just the ability to play videogames.”

 

Interesting, may be right. Another fine article elnino334 but you sure are making a hell of a lot of threads today.

i have noticed that as well...but since they are almost always worth a scan and most of the time a read i am cool with it

yeah, the only proiblem is that they appeared all within 10 minutes...so no chance we can discuss all of them the way they deserve.

Seriously people, just read the 3 first paragraphs (well, you can read it all too). You will recognize Sony and MS strategy right there, and the nonsense of it all (and it reads about razor and blades):

http://malstrom.50webs.com/risingcontinent.htm

Now remember the "gamers" saying that only Sony and MS didn't screw the consumers because they were saying their console at a loss. Talk about short sighted.

 

EDIT:

BTW, this razor and blades model by console manufacturers is a myth, except for Sony, so I must assume the guy who wrote the OP bought into Sony's marketing and so makes erroneous conclusions in this article, which I will now go on reading. 

Nah. There will always be a market for cutting-edge technology. The difference is that now the cutting-edge will shift from "mainstream" (as mainstream as gaming was pre-DS) to "niche," while systems like the Wii and DS take up the "mainstream" banner.

What I find interesting is how short the memory of everyone involved in this industry seems to be. It's simply not true to say "everyone sells their hardware at a loss", because that's NOT the way the gaming industry traditionally worked. Prior to the sixth generation, no company ever used this business model. The PS2 was the first console that was ever deliberately sold at a loss on launch in order to increase the install base as quickly as possible. Since then, three other consoles have followed the same market strategy, and one handheld: the XBox, XBox 360, PS3, and PSP. Aside from the PS2, every one of these platforms has resulted in multi-billion dollar losses for the company involved.

I remember us having a discussion about this last year at VGChartz. The fact of the matter is, the whole "sell your console at a loss" market strategy is about the dumbest thing possible if your goal is to make a profit. The ONLY way that this plan works is if your platform experiences a runaway market victory, like the PS2. In every other scenario, it's a huge loser. Even the PS2 didn't really make all that much profit (about $2 billion dollars lifetime) because Sony relentlessly cut the price again and again, sacrificing profit to drive the install base higher. Sadly, the PS2's dominance (which, frankly, it would have easily achieved even without selling at a loss!) has convinced everyone other than Nintendo that "this is the way the industry works", and thus resulted in massive losses for Sony and Microsoft over the past three years.

If only that were true! As usual, the analysts are clueless.

Not sure if I'd use a term like death knell. The Wii has without a doubt shown that using proven technology in a new and interesting manner is more profitable and enjoyable to more customers than packing a box full of cutting edge technology, but I think the market niche for that kind of stuff is big enough to support at least one console.

Things might be different in a year or two, depending on how completely the Wii hogs up all third party support, but for now the HD consoles are making money.

Garcian Smith said: Nah. There will always be a market for cutting-edge technology. The difference is that now the cutting-edge will shift from "mainstream" (as mainstream as gaming was pre-DS) to "niche," while systems like the Wii and DS take up the "mainstream" banner.

Nonsense, the market was NOT mainstream at all before Wii and DS, so PS3 couldn't shift from "mainstream" to "niche". If the market was mainstream, PS3 or PSP would have had no problem selling and destroying the competition. Confusing market growth with being mainstream is retarded.

Fads have big growths too but never become mainstream, that's not the goal, they collapse even faster.

 

Anyway, the Kris guy is already spewing big stupid nonsense on  2nd page, and hinted at it on the 1st one.

It's funny how this journalist (is he?) is doing exactly what Malstrom described: he understands zig when in fact the Innovator goes zag. So for him, the razor is the console and the blade is Wii Sports. Basically, he has it completely backwards, which is pretty amazing. 

He doesn't even understand what he's talking about anyway, as even bundled, none of Wii Sports or the Wii is sold at a loss, so there's no analogy to razor and blades.

 

But the best revelation is at end of 1st page. That's where you see that, despite an army of fanboys saying the contrary, or even their proponents saying the contrary, Nintendo is the ONLY company that is saving console gaming. Several people had this feeling before (me included), but now it's confirmed.

And it's sad when supposedly gamers defend these people, instead of the only ones that care about them, which is Nintendo.

I'm refering to this sentence:

"…The platforms of the next cycle may not be a console at all, but software distributed by network to convergent devices like PCs, set top boxes and smart phones."

All this because of MS (which was obvious, but many people refuse to acknowledge it to this day) and PS3 (which I didn't see coming, but I should have) strategies.

The only console left that focus on console gaming is Nintendo's one. They are trying to save their core business, console gaming, and the two others don't give a damn, and the blind supposedly "gamers" don't even see it, and drink the stupid marketing of MS and Sony.

Fortunately the journalist is wrong, just because the Wii is there to take it all in 8th gen if it goes on like this.

The part about smartphones and PC with Internet access taking the place of consoles (specifically Nintendo ones) is hilarious when took in context. Could have been with PS3 and XB360only, but unfortunately the Wii and DS destroyed the delusions of this stupid journalist, who is still stuck in pre-DS launch era.

 

And the analysts, this bunch of morons, represented here by Divnich! I call them morons because not a single one of them could predict the Wii's success. As it's their main job, the conclusion is obvious. So:

"Divnich says [...] Microsoft and Sony won’t abandon their current model"

Well, then I guess the 8th generation of consoles' winner is already decided.

And at the end of the article:

"In our industry, it is unlikely that the manufacturers will drop this model as it has been proven to be one of the best business models for consoles that offer more than just the ability to play videogames".

I don't know who said that, but he's a effing retard. 

Parokki said: Not sure if I'd use a term like death knell. The Wii has without a doubt shown that using proven technology in a new and interesting manner is more profitable and enjoyable to more customers than packing a box full of cutting edge technology, but I think the market niche for that kind of stuff is big enough to support at least one console. Things might be different in a year or two, depending on how completely the Wii hogs up all third party support, but for now the HD consoles are making money.

What money are they making?  The 360's so-called profit is a smoke and mirrors trick, as they slapped 3 years worth of loss ($1b) into one quarter so they could claim minor profit margins in following quarters (which is from a division that includes more than just the 360 BTW).   Aside from that, the entire model won't actually be profittable at all until they recoop all the losses - a staggering 6-7 billion.    It is unlikely MS will ever recoop those loses or even actually make a healthy profit when RRoD costs are factored in.

As for Sony, yes, the gaming division is making a profit - off the back of the PS2.  PSP is starting to realize profit too.  But the PS3 is still costing them millions more than it's games earns them.  The PS2 made a nice profit but only because it was a runaway success.  The Gamecube also made a nice profit, more than half of the PS2's despite selling 1/5th the amount of units.   The PS3 clearly is not a runaway success and it's ability to earn a profit will depend very heavily on blu-ray and downloadable content because game sales only can not save it from it's massive incurred (and growing) losses.   To the PS3's credit it did win Sony the format war, and that's definately something - what it's worth though has yet to be seen.

As to if they'll continue with this business model - I think MS might, just because they can and are arrogant/stupid that way.  That is, if they continue in the console race at all.  They'll come dead last this generation and likely with more incurred debt than they entered.  Unless there is motivation beyond selling games, I expect MS to focus more on PC games/downloadable content/TV connectivity and drop the xbox.

Sony won the 6th and 7th generation with under powered consoles compared to the competition, and clearly fighting MS on their terms was a mistake.  A 'PS2.5' sold at $250 or less would likely be either the market leader now or at least giving the Wii a real race to the finish.  I fully expect them to return to their roots and fight Nintendo not MS next generation (but still supporting other Sony interests too).