Gamasutra analyst Matt Matthews looks at the U.S. sales data that will serve as the foundation for the upcoming game console transition. The last three new platforms to launch at retail in the U.S. have had significant troubles. Nintendo was forced to cut the price of its 3DS handheld from $250 to $170 in order to stimulate sales of that system back in August 2011, just over four months after release. Sony's PlayStation Vita has sold well only twice, at its launch and during aggressive Black Friday sales after Thanksgiving in 2012. And the Wii U has seen its sales compared first to Nintendo's own lackluster GameCube and more recently to the Sega's ill-fated Dreamcast. On top of that, the conventional wisdom holds that the last generation of hardware, the Xbox 360 and PlayStation 3 in particular, are dying extremely quickly after an extended stay on the market. The industry misjudged how long it could push the current systems on the market, so the theory goes, and consumers are putting their entertainment money in other areas like mobile games. Taken together, the traditional video game market sounds like it is in dire trouble. Occasionally you hear people even talk about a crash, like the industry experienced in 1983 and 1984. That would be the kind of situation in which launching new, more expensive consoles like the PlayStation 4 and the next Xbox wouldn't actually help revive the business at all. Let me offer an alternative read on the situation. I think that the older market is healthier than most observers are giving it credit for. And I think that the challenges recent launches have faced are not indicative of the reception that the PlayStation 4 and next Xbox will encounter. Rather, the market is signaling that it is ready for a new generation alongside a healthy tail for the outgoing systems.

I'm Not Dead Yet

When the NPD Group reported the latest U.S. retail video game industry estimates last week, Microsoft issued a press release in which it touted its Xbox 360 as the best-selling console for the month of April 2013. At a mere 130,000 units for the month, that's the worst month the system has had since its launch. The previous worst month was May 2007, when the system sold a mere 155,000 units. Liam Callahan, an analyst for the NPD Group, commented that the Xbox 360 was the best-selling platform (as opposed to just console). While official figures are not available, I believe that the PlayStation 3 sold fewer than 110,000 units for the month. That's not a record low, since the system fell to a mere 82,000 units during May 2007, but it is the lowest the system has been in four years. With figures like those, it's understandable that observers would see an unhealthy market, and I won't deny that Microsoft and Sony are seeing demand for their products contract. But I do think some important context is missing from that observation. Specifically, this: Hardware sales last generation at the same point in time were half what they are now. Now, we can cut this a couple of ways and neither is perfect, but let me show you the one I decided on. Instead of just comparing all three systems last generation to the three from this generation, I've opted to compare the original Xbox and PlayStation 2 to the Xbox 360 and PlayStation 3. Feel free to take issue, but that's what I felt would be the most relevant apples-to-apples comparison. Here's the data, shown as a trailing 12-month rate. That is, each point on these curves represents the total U.S. sales during the prior 12 months. I've launch aligned the two generations, starting with the PlayStation 2 in October 2000 and the Xbox 360 in November 2005. I've annotated the graph above to provide some historical markers. It seems likely that the August 2009 release of the PlayStation 3 Slim, the June 2010 launch of the Xbox 360 S model, and the huge November 2010 Kinect push all helped to keep the current generation growing through November 2011, a full six years after the generation began. At its height, the current generation of HD consoles was pushing 12 million units over a 12 month period. That is, incidentally, just what the previous generation of Sony and Microsoft consoles was able to reach, albeit within three years instead of six. And in early 2008, the period from last generation which is comparable to where we are this generation, the original Xbox was already dead and the PlayStation 2 was the lone surviving system. It was still moving 4 million systems per year, about half the rate of sales for the Xbox 360 and PlayStation 3 now. On top of that, the retail price for the PlayStation 2 was $130, a full $70 below the going rate for the base Xbox 360 model and $140 below the retail price of the PlayStation 3. What about software? Well, the data I have collected over the years isn't as detailed, but I think it shows the same kind of trend. This generation peaked well above the previous generation and revenues for the last year are still well ahead of the same period in the Xbox and PlayStation 2 generation in the U.S. Moreover, there is a huge part of the market missing in the graph above. That blue curve for the last generation of systems does not include a single penny spent on software sold through Xbox Live or the PlayStation Network. That means that the picture above is conservative on the reality of software revenues on the Xbox 360 and PlayStation 3. These aren't systems that are dead, by any stretch of the imagination, but simply reaching their limits at their current prices. As holiday sale prices have clearly demonstrated, demand for both of these systems shoots right up as soon as the price drops well below that $200 barrier. Sony and Microsoft have the means to keep their system and software sales healthy for at least another two years: price cuts. The Xbox 360's last proper, permanent price drop was to $200 in September 2008, four and a half years ago. The PlayStation 3 got a $250 model in August 2011 but then the base model actually increased in price to $270 with the introduction of the Super Slim model. If prices were to drop on both systems, that would make them accessible to a new class of consumer who has previously only found them affordable during cutthroat Black Friday sales. This should have a knock on effect for software, as new consumers enter the market. Many of these consumers will also likely find used software on the shelves at GameStop and other retailers. I ran my ideas by Wedbush analyst Michael Pachter, and he had his own take on the situation. At the current prices, the new Xbox will "kill the 360" so he predicted that Microsoft will reduce prices to $149 for the entry-level 4GB model and to $199 for the 250GB model. At those prices, Microsoft will "move a lot of boxes," he added. He explained that Sony had less flexibility with pricing, in his estimation, and so cutting prices would "be harder for them." However he described a cut to $199 as "likely." When could we expect these price cuts? "Both should happen at E3," he told me. His pricing seems right to me, but I'm dubious about the timing. Don't get me wrong, I would love to see price cuts as soon as E3, but to my knowledge that's almost never been the place for price cut announcements. In the recent past Sony has lowered prices at GamesCom in August. Stubborn Microsoft has lowered its prices so infrequently, it's basically impossible to know what they are likely to do. And E3 is surely to be about the new systems, not the old. Between the June unveilings at E3 and the presumptive launch of the new consoles in November, there is a big window in which either company could try to make a big splash with a price cut on the older system. With the Grand Theft Auto V and Madden 25 launches due in roughly that same period, the opportunity is ripe for a price cut and possibly a big bundle. Look back at that graph above again, the hardware one. Notice how the PS2 continued to sell at a rate of 6 million down to 4 million units per year in the two years after the PS3 launched. If the Xbox 360 and PS3 both drop in price, and publishers continue to push out new titles for those systems for at least another year (titles that are likely already in development, and have been for some time) then it seems likely that the PS3 and Xbox 360 could sell at a combined rate of 7 million to 5 million units per year for another two years as well. At the end of that period, the combined installed base of old generation HD systems could reach nearly 75 million systems. That would exceed the final installed base of the entire previous generation, including not only the original Xbox and PlayStation 2, but also the GameCube. Far from being dead, the old generation is simply living out a glorious old age, and like it or not, consumers are still buying more hardware and software this generation than they did last, and they're doing it at higher prices.

Enter the Young Turks

And with renewed demand for the older systems, the natural question is whether that will affect the new Xbox and PlayStation 4 due out later this year. The answer, quite simply, is no. The consumers who are likely to snap up a $150 Xbox 360 or a $200 PlayStation 3 are not in the market for a brand new system at a higher price, presumably above $300. There is practically no overlap in these two consumer segments. This leaves two big questions about the new systems: How much will they cost and why will consumers be willing to buy them? In our recent conversation, Pachter let on that he expects the next Xbox to come in around $400 and the PlayStation 4 around $350. With his theoretical breakdown of the costs, he figures the manufacturers could price "at $350/$300, if they want" with the possibility of going to $400/$350 "to make a profit." He added that the "difference between the two [systems] is Kinect (which I assume will be included in the cardboard box with every next generation Xbox)." Personally, I'm on board with $300 and even $350, but I think the market has gotten so sensitive to price that going to $400 would be suicide. But as long as that's not the entry-level price it may not matter. These are not the prices that I expect most consumers to pay. Rather, I expect Microsoft and Sony to both offer service-subsidized models at launch later this year. On Sony's side, the natural plan would be to get consumers into a next-generation version of its PlayStation Plus service. That service currently retails for $50 a year, but with improved service spanning Sony's entire line of products (music and video as well as games) at a higher price that could be significantly more expensive for the PS4. Add in a monthly contract worth at least $10 per month, and Sony could potentially bring the cost of its entry-level system under $300. Microsoft could do something similar, by extending its current Xbox Live service, but Pachter has his own theory. "I think the subsidies come from ISPs or MSOs [multi-system operators, like cable companies]," which would be very much like what wireless companies currently do with mobile phones. (We know that Microsoft has been testing this kind of plan already with the Xbox 360, but its success so far has been unclear.) How big could those subsidies go? They "will be $200 or more, so the boxes could be $199 or less to the consumer," Pachter told me. A system with power comparable to the PlayStation 4 but available for $200 at launch from your local cable company could turn the industry on its head, and cut off both Sony and Nintendo at the knees. Ah, yes, Nintendo. Naturally, one can ask why its Wii U at $300 and $350 isn't finding the same kind of reception that I believe you can expect for the new PlayStation and Xbox. The answer is a mix of what Nintendo isn't doing and what Microsoft and Sony have been doing all along. First, Nintendo failed to sufficiently differentiate its new console from its old one, and also failed to distinguish it sufficiently from what's already on the market. Nintendo itself has admitted this, but I think two key games illustrate this: New Super Mario Bros. U and Call of Duty: Black Ops 2. In the former case, Nintendo itself failed to distinguish itself sufficiently from New Super Mario Bros. Wii on its own previous system. In the latter, one of the biggest third party developers failed to demonstrate that the new hardware was sufficiently more powerful than the Xbox 360 and PS3. The Wii U badly needs a relaunch, and I'm guessing E3 will show us how Nintendo will attempt this. Even if the difference between late-gen Xbox 360 and PlayStation 3 games and early next-generation software is somewhat meager at the start, Microsoft and Sony will spare no expense to make consumers see the differences and also believe in the promise of newer and better games just around the corner. Second, Microsoft and Sony have been focused on third-party publisher and developer outreach for years. Sony has spent tremendous energy since 2006 assisting developers with challenges presented by the PlayStation 3 and its unusual architecture, and Sony is clearly making its new system more approachable. Microsoft has perfected the art of the platform exclusive, and its cousin the timed exclusive, much to the delight of publishers and developers. Nintendo has been utterly ineffective getting publishers on board for the Wii U. Just look at the willingness of Electronic Arts to deny the Wii U a Madden game this year and of Ubisoft to delay a Wii U exclusive like Rayman Legends. Wherever the big publishers go, with titles like Call of Duty and Madden, so will the consumers. Finally, Microsoft and Sony have done as much as possible to increase the stickiness of their services. Any player who has invested any time or money in Xbox Live or the PlayStation Network is much more likely to stay with that platform when presented with an opportunity to upgrade. Even friend lists and trophies may have a significant effect on consumer choice this next generation. As consumers begin to see the people in their friends list move on, so the pressure on them will increase on them to make the same jump. Nintendo's weakness in networked services last generation has clearly put them in a weaker position this generation. The Wii to Wii U transition will go down as one of the biggest debacles in the industry's history. Nintendo itself has confessed that consumers don't yet appreciate the value that the Wii U offers, whatever that may ultimately be. Don't expect the other two platform holders to make the same mistake. In fact, judging from the PS4 reveal, Sony is already hard at work making the difference clear to potential early adopters. Of course, we'll know more soon. When Microsoft and Sony announce more about pricing and launch dates, I'll be back to offer some thoughts on what they're doing.