King of the hole

A collection of banknotes and coins from various countries

Over the past several years, there have been three major players in the console market, Microsoft, Nintendo and Sony.

A console-maker has a number of avenues for drawing revenue from its console. It charges for console development kits, and code-signing, which allows it to pull a share of all third-party games revenue. It can charge network subscription fees to draw ongoing revenue from the console’s customers, it can produce its own first-party games with a greater margin than third-party developers, and – of course – it sells the actual console hardware and accessories. In short, the console-maker has the most opportunity to pull revenue from every part of the console ecosystem.

So, how much actual profit does that amount to for a console-maker? Well, in the case of Microsoft and Sony, the simple answer is none at all.

Sony’s console division hasn’t generated any profit since the Playstation 2, and Microsoft’s console division has never made a profit.

With all of these revenue streams open, Microsoft and Sony are losing millions every year, vying to be the king of the deepest money-hole, essentially.

Nintendo, paradoxically, is making money. You might wonder just how.

In the normal course of things, a console-maker usually sells the console hardware itself for less than it costs to make. A console generally being about the cost of a low-end budget-PC to manufacture, let’s call that US$600 (and upward) for argument’s sake. The actual unit itself, however, retails to the customer for US$300 and upward.

Selling below-cost means that the more units you sell, the more money you lose. You’re essentially selling the unit at half the price that it costs to make. That hole gets very deep, very fast.

The question then becomes, why would you even do this?

Actually, it’s not that uncommon. Most printer manufacturers will sell you a printer at a fraction of the cost, knowing that you’ll keep coming back for overpriced consumables. They can’t sell you printer ink at US$5.50 per millilitre unless you have the actual printer. The same goes for games consoles – since they’re not compatible with PC games (or with other consoles) the only way to sell the games to you is if you’ve bought the actual console hardware.

That’s the strategy that Microsoft and Sony employ, using the hardware as a loss-leader so that you’ll buy first-party and third-party games. Nintendo, on the other hand, doesn’t subscribe to this philosophy, instead producing less powerful hardware, sold at a price that generates actual profits. Since the hardware is less-expensive, it can still hover near the consumers’ sweet-spot without having to retail at huge discounts.

Microsoft and Sony can afford to keep digging their holes ever-deeper, for the moment, since those divisions are subsidised by the profits from the many other products that the respective companies produce. Both companies are playing the long-game, hoping that the competition will run out of money first, leaving them the king of this vast hole, into which money vanishes – and hopefully, lever that market dominance into an actual profit someday.

As I see it, though, the next generation of consoles is not going to change the landscape to any significant degree. Microsoft and Sony will keep digging deeper holes – battling their way to the bottom – and Nintendo will probably keep profiting comfortably (unless it makes an egregious error). As for third-party developers, there seems to be less and less money per-title to be made in the realms of console games, though some of them are still grimly hanging on.

4 thoughts on “King of the hole”

  1. I do have to wonder how many of those Wii’s that’re now collecting dust will have an effect on long term sales of the Wii-U, especially once the shiny new MS and Sony consoles are officially announced. Those new consoles will presumably have better specifications than the Wii-U, and if we as consumers are lucky, the manufacturers will be wary of US$500+ prices this time around. Not designing your own Cell processor or something might help there. Valve is someone to watch here too with a box that may be based on all or mostly off-the-shelf components if the rumors have any veracity, as well as a ready to go online marketplace that has a good reputation with gamers and developers alike.

    I’m obviously not the entire market out there, but I never bought a Wii, as I was one of those curmudgeonly people who think that video games and exercise are mutually exclusive ideas. I don’t have a PlayStation Move, or an MS Kinect (although I want a Kinect for my PC to experiment with mocap).

    And yeah, the eye candy mattered to me. We had just gotten a new 50″ 1080p television, and we wanted the console that would make the most of it. For us, that was the PS3. The 360 had 720p games, but no Blu-ray. And the Wii… no thanks. So for me it’s the PS3 for (mostly) easy, just start-and-go gaming, and the PC for those games that I want to mod or tweak.

    I want to be clear that this isn’t a Wii bashing post. There’s clearly a ton of people who enjoy the console and it’s games. But for me, it’s just not the right fit.

  2. I bought myself the PS3 just after Christmas, the version with 12GB of flash memory to replace the hard drive. This is only just enough to play a game. It was deeply discounted in the sales. For less than half the saving, I bought a decent size HDD and fitted it myself. I’ve saved a couple of hundred dollars.

    I’m using it mostly as a media-player machine.

    I doubt I shall be spending heavily on games.

  3. Isn’t it illegal to sell things too cheaply (way bellow manufacturing cost) to try to kill the competition?

    1. Sometimes, yes. It’s called ‘dumping’ and is very strictly defined in anti-trust legislation in quite a number of countries. Usually, however, ‘dumping’ refers to using the profits from one market (say, one country where your profits are high) and use them to subsidise the products in another market. ‘Bundling’ can also be an anti-trust violation (packaging different services together, like cable-tv and mobile phones) – but again, the definitions are (a) rather specific, and (b) don’t kick in until you hold monopoly power on a market (usually defined as 40%+ market-share) at which point most of the anti-trust rules kick in.

      So, the answer is ‘yes’ – but it’s only illegal under certain very specific circumstances. Certainly Microsoft’s been hammered on such issues before, and the DOJ has raised it as a matter of concern in the past, as I recall.

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