Bodhesatva said:

>>Simple point: ignoring Microsoft's extended warranty for a moment (and I agree, that's not entirely fair -- but we're trying to look at normal operating losses from development, production, and sales of games and game hardware)

Yep, it's a delicate balance. Every dollar spent is essentially a gamble.

I think Sony and Microsoft are both viewing this as a Windows-esque monopoly situation, where someone, somewhere down the line is going to become the nigh-uncontestable producer of video game systems and software, and they are going to make a lot of money. A whole lot of money. Windows is still dominant -- even though almost no one thinks its the best platform -- because, well, everybody already uses it. And since everybody already uses it, I guess I will to. And guess what? That means even more people are still using it, which means the next guy in line is even more likely to continue the trend. It's a very lucrative and extremely difficult monopoly to break, and the same logic applies to video game systems; I buy systems, in part, to play with my friends, and if my friends all own console A, I'm probably going to buy console A, no matter how super awesome console B is.

So it sounds good, in theory. Lots of money, somewhere in the future, and both MS and Sony are after it. But what if they're wrong, and the "convergence" box doesn't really materialize? Or what if they're right, but they lose out (as in, MS or Sony gets marginalized, and the other takes over... or even Nintendo takes over, although they've shown no proclivity towards it) . In short -- what happens if MS/Sony spend billions and billions of dollars... and then don't get that enormous, theoretical mother load payout in the end? Well.... that hurts, really badly. It's a gamble. It's why both Sony and Microsoft seem to be willing to lose billions of dollars years on end, with no clear end in sight. If this were the toaster business, they would have been out so long ago! There has to be a limit as to how far they're willing to go, but it's unclear what that limit is. Are they willing to go a few billion dollars in the hole? Clearly the answer is yes. Are they willing to begin significantly hurting their other assets in order to pump money in to the 360/PS3? I think that's where they'd draw the line, but we'll see. 

Not just the corporations, but the consumer as well.  If both Sony and Microsoft both pack up shop, it could create another videogame crash. If third parties are dumping millions of dollars into next gen projects, only to have Sony or Microsoft jump ship, it could spell diaster for third parties, who are already (like you said) barely breaking even or loosing money.  All the internal studios would get shut down too.  Nintendo may be fine, but not everybody will want to play Nintendo esque games all the time, and yearn for the wiggle free days of Gran Turismo, Halo, God of War and Fable.

But they're losing money because of Microsoft and Sony platforms. The companies that put their money behind MS and Sony are seeing their profits fall. The companies that put their money behind Nintendo are seeing their profits increase.

If anyone is going to cause a crash here, it's MS/Sony, who are making everyone lose money (including themselves), while Nintendo (and the few companies that backed them from the start) see their profits increase (and in the case of Nintendo, skyrocket). 

I'm not meaning this to be cheeky, I just don't understand how you reached this conclusion. How could Nintendo cause a crash here? Everyone who invested heavily in the other systems is bleeding money, or seeing their profits free fall! Evidence: of the few companies that announced significant support for the Wii pre-launch, all have seen increased profitability (this includes, to my knowledge, Majesco, Ubisoft, and of course Nintendo itself):

http://www.gamesindustry.biz/content_page.php?aid=25380
http://www.cubed3.com/news/7832/1/Majesco_Profits_from_Nintendo
http://ds.ign.com/articles/783/783710p1.html

By contrast, several of the major companies that publicly stated that they were backing Sony and Microsoft have seen their profits fall or have even seen significant losses:

http://www.ibtimes.com/articles/20070508/electronic-arts-earnings-shares.htm
http://www.vgchartz.com/news/news.php?id=453
http://seekingalpha.com/article/38017

The middle being, of course, Sony itself, which has lost well over a billion dollars since the PS3's launch. 

Bodhesatva, that is both really interesting AND really creepy. People thought I was crazy when I said that the PS3 and 360 were alienating some gamers, looks like I might have been more right than I thought. 0,o

Bodhesatva is absolutely right, but few things you should notice about Sonys (gaming divisions) increasing losses is, that in the Q4 2006 you can see the affect of overproducing the PS3, it hurts in short term a lot more than any pricecut Sony is capable to make. So Q4 2007 won't be as bad as Q4 2006. Also Q3 and Q4 2006 was affected by PS3 launch, which will not affect Q3 and Q4 2007.
But, Sony has increased its 1st party development, which costs turn into money in somewhere between Q1 2008 to Q4 2009 (for PS3, PSP development makes money earlier).

@Frasman: I don't see a crash in a situation, where M$ and Sony would leave the business. Games in development would be made ready or games at early stage of development would be made for Nintendo platforms and publishers would know about it early. They simply would start to make games for Nintendo platforms. But monopoly wouldn't be a good thing. In a way i see more problems in a situation, where developers are making games for a platform which is expensive to develope for and has bad sales. For example, one (failed) PS3 game can easilly bankrupt any smaller publisher.

A good point here is knowing just how much the market can support in terms of major consoles. The only generation to ever have close to an even split was the SNES/Genesis days to my knowledge. The last few generations, PS & PS2 have dominated while the 2nd and 3rd place finishers were far and away below them.

My opinion is that if you assume a completely profitable industry (not one that is subsidized by their parent company profits), the gaming market will support at most 1 winner and 1 runner up with near break even or slight profit. Look at last gen with DC/PS2/GC/Xbox, it was just too crowded, in fact it was so bad that DC died before the gen wars even started.

This is essentially correct.

Right now, the market can support 3 home consoles and the PC because the makers of some of those consoles are willing to lose billions of dollars to stay in this race. Once the market has apparently reached fruition, then people won't be willing to do that anymore.

I had started rambling over on Gamefaqs about something fairly related to this discussion of consoles dropping out and monopolies. Some is fairly similar to some of what Bodhesatva has been saying. It wasn't all one post originally, and some of it is a response to questions, but I think it flows well enough, especially with some editting.

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Yeah, but [Sony and MS] going to keep trying [to become a monopoly]. Both MS and Sony are convinced that the video game market is going to converge with home entertainment in general, creating the potential for a natural monopoly similar to what MS has with Windows.

I have a niggling suspicion that Nintendo may have accidentally secured that position for themselves. They've just shown the industry that launching at around $200 does wonders, but a lot of what they've got now is due to the Wiimote. Everyone's going to be looking for something innovative to add to a next-gen system, but, really, what else can you do? It seems like the logical thing for Nintendo to do is to adopt a Windows-style business model, releasing a Wii with a hard drive, more accurate motion sensing, Blu-Ray/DVD playback, and modest hardware improvements. New games would still be compatible with older Wiis, but the newer ones would run them somewhat better.

To clarify, the Windows model, as I use the phrase, is a strategy of maintaining full forwards and backwards compatibility for at least one generation. New software is optimized for the current model, but it can run on last-gen's model and it will run on next-gen's model. The idea is to leverage a successful console's install base into the next generation - this is the point of backwards compatibility, but it doesn't really go all the way. This way, developers want to develop games for the new model because they know that they don't have to worry about only serving a market of a few million people - the tens of millions of owners of the older model that haven't upgraded can still play the game. It's senseless to develop an application for OS X when you could develop it for Vista because there are tons of people with XP that would still buy it, since they can run it decently.

The beauty of that sort of business model is that you only need to have one third of your base buy the new system in order to maintain your monopoly. If everyone buys the Wii, and Nintendo implements this strategy with the Wii 2, then they only need one third of those people to upgrade. Then they only need one third of the original base (half of the people who still have the Wii) to upgrade to the Wii 3. Then they need what's left of the original Wii's base to move to the Wii 4, and then they keep leapfrogging - Wii 2 to Wii 5, Wii 3 to Wii 6, etc. It's perfectly rational for each group of people to upgrade to the newest Wii because there are already large groups of people who own a similar system.

This is why MS has such a stranglehold on the OS market, and I think it may happen with games.

[Nintendo has been trying to avoid media center consoles?]

Ashley, that's why I say that they did it 'accidentally'. All along, Nintendo has just been trying to stop MS or Sony from coming out with a media center console that they can run the Windows model with. Achieving this sort of monopoly seems to be the entire point of the 360 and PS3 - if either one was successful, its parent company would be in excellent shape to leverage it into the next generation. Nintendo was just trying to disrupt things enough to stay in business, but I think that they'd have to be blind not to realize the opportunity that's just been handed to them.

I'd guess that they'd need to get through two models in the span of a normal generation. Any faster and you're going to burn people out and fragment the market, but if you go too slowly your current games, because they need to be compatible with an older model, are vulnerable to another company releasing a newer machine that isn't shackled to older technological limitations. Since the market seems happy to live with the same technology for four or five years, I'd say that the optimal introduction rate is every two and a half.

...I'd be surprised if Nintendo doesn't incorporate some PSN and XBL marketplace type stuff into later models (with hard drives). Downloadable HD video and games are a large part of creating the sort of network effects that guarantee these monopolies. Consider what would have happened (or would happen, if you don't think it's too late) if the 360 absolutely dominated this generation. MS would already have a great deal of infrastructure set up to allow people to buy and download HD movies, they'd have the largest library of downloadable games, and they'd almost certainly have the content advantage regarding just about every online feature. Their next console would launch with the ability to tap into all of that, and, along with backwards compatibility with 360 games, it would have been a tremendous selling point.

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The upshot of all this is that these companies are more than willing to lose money to stay in because they see this convergence happening very soon, and that Nintendo has almost accidentally made themselves the front runner in capturing this monopoly. 

Truly, in any normal business situation, the PS3 and Xbox 360 would be out of business months ago.  However, in a market with 2 corporate giants and one small company with 3000 employees worldwide, the 2 losers can simply milk their multi-billion dollar parent companies for all they're worth.  Of course, this situation again wouldn't work if those companies had a goal of profit, but Microsoft's goal is a monopoly of home entertainment and Sony's goal is a monopoly of the much more lucrative movie market.