Sony Whistles In Console Dark, Outmaneuvered by Nintendo, Microsoft

It always seems presumptuous to sound a death knell for an enormous company. So perhaps this is more a bell closing round seven of a fight, but on the gaming front, Sony is looking bad. Really bad. And because of the company’s overall financial position, it will take far more than posturing to keep the console division in the game at all.

On the largely disappointing recent holiday retail front, and, indeed, in the face of the entire economy last year, the year’s results, Sony was hurting, according to NDP Group’s data. The top two sales spots were Nintendo’s Wii and DS. Microsoft’s Xbox 350 was a solid third place. But the Sony PlayStation 3 couldn’t even beat the million unit mark, although the PSP just squeaked by into that territory.

As Ben Kuchera at Ars Technica puts it, “You have to dig deeper into Sony’s performance to find the positive talking points.” Frankly, I’m not sure that even financial spelunking offers any real bright points. Looking at the company’s 2008 annual report, sales, converted to U.S. dollars, were about $14.7 billion. As the company points out, that was a 26.3 percent revenue increase over FY 2007, but still with a net loss of about $1.4 billion, or almost 10 percent.

It’s difficult to directly compare Microsoft, because the division that has gaming supports general consumer marketing costs, so the paper loss probably does not accurately reflect the actual situation. But we can look at Nintendo’s six months ending September 30, 2008: about $9.5 billion in revenue, or about a 20.4 percent increase over the same period in 2007, with about $1.6 billion in net income. And the same period in 2007 also showed a positive net income. Not only is Nintendo walking away with market share, but it clearly knows how to operate efficiently.

The question of how to make console designs pay off is a critical one, because it takes time to ramp up production and drive down costs so that units are profitable. I once spoke to someone at Microsoft who said that the general model has been to create units that sell at a loss in the first three years and then turn profitable over two additional years, with royalties off game titles turning the whole thing into a long-range profitable venture.

Nintendo has shattered that model with the Wii, bringing it out in the Americas in the fall of 2006 and running profitably by the next year. That is remarkable. The underlying business model of the industry is changing. What is Sony’s answer? Wishful thinking.

Sony claims that the PS3 is a ten year system. This has to be one of the most ridiculous arguments someone in the tech industry has ever offered. Consumer electronics product lifecycles generally run in the six month range. The gaming consoles are different because they have a much bigger nut to get to break even, so they can’t turn around that fast. But ten years? The company claims that the product is ahead of the market. Odd, because it doesn’t seem to do much of anything that can’t be done by the other consoles, except maybe Blu-ray compatibility, and as we’ve seen before, that’s not necessarily something people care about.

But Sony is serious because it’s probably going to take that long to actually make a profit on the device. According to an iSuppli report, the PS3 currently costs just over $448 to build, which doesn’t include software, packaging, and royalties. In other words, after having the system on the market for about as long as Nintendo’s Wii, the company is still losing money on every sale. And the current $399 or so price tag is what retail gets. Sony will get significantly less after the retailers take their cut. Given that the unit cost used to be over $690, Sony has an enormous collective loss to overcome.

But it can’t catch up to Nintendo and Microsoft because the console is just too flipping expensive compared to a Wii or Xbox 360. Such features as built-in Wi-Fi and Blu-ray and even free online gaming are nice, but consumers clearly don’t care. Regular people don’t view the capabilities as compelling enough.

Unfortunately for Sony, it probably doesn’t have the financial wherewithal to really compete on price by dropping prices to a competitive level. The company may report its first net loss in 14 years this spring. Shareholders will clamor for restructuring. Unfortunately, CEO Sir Howard Stringer is running into strong opposition to change from old guard management.

Sony’s is also in no financial shape to develop a new system. By the time it is, Nintendo and Microsoft will have moved ahead to something grander, leaving the PS3, and Sony itself, in the dust.