Pandora’s black box

Playstation 3 reps a major gamble for Sony, DVD biz

It’s all about a simple black box.

When it debuts next month, the Playstation 3 will represent an unprecedented collaboration between numerous units of Sony Corp. on a console that not only plays videogames, but Blu-ray DVDs and a broad array of Internet content.

The device represents billions in research and marketing and is the first major example of CEO Howard Stringer’s vision for a “Sony United.” Beyond Sony, dozens of partners in the movie and videogame biz have a lot riding on its success.

But to the surprise of many in the entertainment biz, the PS3’s status as a hit is far from certain. Its development has been beset by highly publicized delays. Due largely to the inclusion of Blu-ray, the PS3 will be one of the most expensive vidgame consoles ever. And competitors Microsoft and Nintendo are coming on stronger than ever with lower-priced consoles that offer unique advantages.

“The more problems the PS3 has had, the more chips Sony has pushed in,” says one senior videogame industry exec. “At this point, it’s a huge gamble.”

The fate of the PS3 will not only determine the future of the videogame industry, but the battle over hi def DVD formats as well. Because every PS3 is a Blu-ray player, its success could help drive the success of the Sony-backed format over Toshiba’s HD DVD. If it’s a flop, studios aligned with Blu-ray will undoubtedly start switching sides.

In other words, a lot more players in Hollywood will be watching the launch of the PS3 than typically pay attention to a new videogame console.

“My primary focus is to establish Playstation 3 as the de facto next generation interactive entertainment device,” says Kaz Hirai, head of Sony’s U.S. vidgame division. “But we also want to offer a host of other entertainment opportunities to consumers which could be an excellent by-product for Sony and others in the motion picture and music industries.”

Playstation 3 is unquestionably key to the future of Sony Computer Entertainment, the vidgame unit that’s not only the conglom’s most consistently profitable division, but one that has completely dominated its market for the past decade.

Sony’s consumer electronics business, which is backing Blu-ray in a wide array of devices, has a lot at stake as well. So does Sony’s semiconductor division, which has invested heavily in Cell, a state-of-the-art processor it developed along with IBM and Toshiba. The highest-profile device to use the Cell? Playstation 3.

Even Sony Pictures, which has typically not been part of major corporate initiatives, has a stake in PS3 since it’s a key backer of Blu-ray. Unlike other studios, Sony Pictures would have an awkward time switching to HD DVD if PS3 sales falter, given its corporate relationship.

Not too long ago, tying the rest of the company to Sony’s next generation videogame console seemed like an obvious win. The Playstation 2 has sold over 100 million units worldwide, more than double the combined total of the competing Microsoft Xbox and Nintendo GameCube.

But in the past year, several problems for Sony and surprisingly strong moves by its competitors have made the success of the PS3 far from a sure thing:

  • After planning a worldwide launch in the spring, Sony pushed the date back to November. Then in September, Sony delayed the European launch until March and revealed that a relatively paltry 2 million units will be shipped to North America and Japan by the end of this year.

  • Though most expected the PS3 to be expensive, industryites and consumers were shocked at the E3 confab when Sony revealed that the system will cost $599, or $499 for a stripped-down unit. Not only is that $200 more than Microsoft’s Xbox 360, it’s one of the most expensive videogame consoles of all time, even accounting for inflation. The high cost is attributed largely to the inclusion of the Blu-ray player.

  • Microsoft revealed that the next installment of the hugely popular “Grand Theft Auto” franchise, which has previously been a Playstation exclusive and thus driven sales of Sony’s vidgame console, will also be available on the Xbox 360, along with extra downloadable content Sony won’t have.

  • After falling from its previously dominant position to third place with the GameCube, Nintendo wowed the industry at E3 with its new Wii. Though it has significantly less processor power than the PS3 or 360, the Wii’s innovative control mechanism and $250 price point has got gamers and third party publishers excited about Nintendo’s new system, making it a much more formidable than expected foe for the PS3.

As is typical in the videogame industry, Sony will lose money on every Playstation 3 it sells, at least in the first few years. Industry estimates peg the loss per box as high as $200, which, despite the steep retail price, would make it one of the costliest loss leaders the vidgame biz has seen.

Microsoft has lost billions on its Xbox and Xbox 360 for the exact same reason. But console manufacturers expect to make that up through licensing revenue for every game and, in the case of Sony, Blu-ray movie sold.

That requires high-volume sales, as Sony achieved with the PS2. So far, momentum doesn’t seem to be on Sony’s side. Research by gamer Web site IGN found that, as of August, vidgame fans were significantly more excited about the Wii than the PS3.

To the extent that games drive platform sales, Sony is in a tough spot as well. Its highest-profile launch title, “Resistance: Fall of Man,” is only the No. 10 most anticipated game among fanboys, according to IGN, well behind Nintendo exclusive “Legend of Zelda: Twilight Princess” and Microsoft’s “Gears of War.”

Also complicating things: One of the most important elements for modern gamers is online play. In that regard, PS3 will be playing catch-up to Microsoft, which already has a highly developed and popular system called Xbox Live. After largely failing with online play for the PS2, Sony promises to have something similar to Xbox Live for the PS3. However, several prominent game execs said they still hadn’t seen a working demo as of September and few thought it would be up to the standards of Xbox Live by launch.

That service could prove incredibly important within a few years if, as many are predicting, it’s used for more than online play and starts delivering music, TV shows and more through the PS3 onto the TV. Already, Microsoft is using Xbox Live to offer movie trailers and other promotional content from studios and labels.

Despite its many uses, industryites agree that the PS3 will sell primarily on its core vidgaming capabilities.

“PS3 is first and foremost about games,” states Hirai. “That really is the entry point for the majority of people. Oh, and by the way, they’ll get a great Blu-ray player. It’s an excellent by-product.”

That “Trojan horse” strategy is what persuaded many studios to jump aboard Blu-ray, figuring that PS3 sales would put Blu-ray in tens of millions of homes where someone loves to play vidgames.

While some of those studios are taking a wait-and-see approach on the impact of PS3, others are already starting to feel burned by the delays and pricing concerns.

“PS3 was a huge deal in our coming aboard Blu-ray,” confirms one top home entertainment exec. “I’m not sure we would have signed on if we had known then what we know now.”

Such comments are undoubtedly bringing a smile to the backers of HD DVD, including former Warner home entertainment topper Warren Lieberfarb, who serves as Toshiba’s high-profile U.S. consultant. As many of their predictions about delays and high prices for Blu-ray have proven true in the past year, the HD DVD side has gained momentum after seeming like an also-ran in late 2005.

A key benefit for them has been the support of Microsoft, which unexpectedly became an HD DVD supporter late last year in a move that made little business sense beyond a desire to stick it to Sony. This November, Microsoft is releasing an HD DVD add-on drive for the Xbox 360 that costs just $199.

Given the 360’s $399 sticker price
, Microsoft’s sales pitch will be attractive: Get a hi-def DVD player with our vidgame system for the same price as a PS3, but only if you want one.

Despite all that, few doubt that the 2 million PS3 consoles will sell out this holiday season. But by next year, once Sony has sold to the hardcore, gotta-buy-everything gamers, it will have to convince the mass market that a PS3 is worth $200 more than a 360 and $350 more than a Wii.

Doing that based solely on the appeal of games could be tough. Though Blu-ray and the Cell processor theoretically make the PS3 more powerful than the 360, most major game franchises are being produced for both consoles and publishers say they will look almost identical.

“Gamers have never been willing to spend extra money for something in the hardware like a Blu-ray drive,” observes Jason Hall, head of Warner Bros.’ videogame division. “Sony has to convince people that it enables really awesome games, or reach a broader audience who also want to play movies.”

If Sony is able to pull out a win with PS3, many expect that latter strategy could be the key. By staying competitive with Microsoft and Nintendo for gamers’ hearts and drawing another group of consumers looking for a good value on a hi-def DVD player, Sony may end up with a winning combination, especially if other factors make Blu-ray a winner.

“There are legitimate questions about the PS3, but it’s worth remembering that when the PS2 was about to launch, there was reams of paper about how screwed Sony was,” recalls Chris Charla, exec producer of development at independent developer Foundation 9.

Even today, despite the launch of the 360 in 2005 and all the anticipation for Wii and PS3, Playstation 2 remains the best-selling videogame console so far this year.

If that trend continues, Stringer and everyone backing Blu-ray could very well be the powerhouses behind digital home entertainment within a few years. If it’s the last good sign before a big disappointment, there will be a lot of angry studios and investors asking some hard questions.

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