With costs rising and competition increasing, Sony has laid off one-third of its Sony Online Entertainment division.

205 of the roughly 700 SOE employees received pink slips Thursday as the company shut down three development studios in Denver, Seattle and Tucson. One long-in-development title was also cancelled.

“This strategic decision will have no impact on SOE’s current portfolio of live games,” the company said in a statement. “This strategic alignment of development resources better positions SOE to remain a global leader in online gaming and deliver on its promise of creating entertaining games for players of all ages, and servicing the 20 million players that visited SOE servers in just the past year.”

The move will result in the cancellation of “The Agency,” a massively multiplayer online (MMO) action game that has been in development for over six years. The company says it plans to instead focus resources on two new MMOs based on its “PlanetSide” and “EverQuest” franchises.

SOE was a front-runner in the persistent world genre of gaming. While it was not the first company to create a massively multiplayer title, “EverQuest” was the first breakout MMO and still retains a very loyal group of players, who, with an average age of 38, skew much older than the typical player.

Since “EverQuest’s” release 12 years ago, the MMO genre has exploded. Today, Activision-Blizzard’s “World of Warcraft” is the category leader with a commanding 12 million-plus subscribers worldwide. Electronic Arts is also threatening to steal marketshare away from SOE with its upcoming MMO “Star Wars: The Old Republic,” which is expected to launch late this year.

Sony is hoping to regain a prominent role in the space with a new “EverQuest” title, though that likely won’t release until at least 2012, if not later.

“It’s too soon to talk about,” said SOE president John Smedley in an interview that took place before Thursday’s announcement. “When we do, I will say what we intent to show is not an evolutionary product. It’s a revolutionary product. It’s going to change the way we think about how MMO games are played. … There will be a lot more information out before the end of the year.”

Analysts who follow the gaming space say the layoffs make sense, given the increased competition in the sector and what seemed to be an over-expansion on Sony’s part.

“Sony (SNE) is not making a lot of money as a company and they need to cut where they can,” says Michael Pachter of Wedbush Securities. “I was surprised to learn [SOE] had 700 employees [prior to Thursday]. … They probably built out more than Japanese management believed was sustainable.”

SOE is one of the few companies that have brought MMO games to the console gaming environment. The recently released “DC Universe Online,” an action game set in the comic book world of Batman, Superman and other characters from DC Comics, is one of the only true cross-platform titles in the industry. Players are able to interact and compete with or against each other, regardless of whether they were playing the game via their PlayStation 3 or PC.

That innovation came at a price, though. Smedley says SOE spent $60 million to create “DC Universe Online”.

Sony’s were certainly the most significant layoffs in the video game space Thursday, but they weren’t the only ones. THQ let go 32 people across two studios – Volition and Kaos (makers of the company’s recent “Homefront” action title).

Both studios remain open and the company classifies the moves as “workforce adjustments” that are “a relatively common occurrence in the game development industry.”