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Wii the Death Knell of the Bleeding Edge Console?
By Kris Graft
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.”