NPD: Behind the Numbers, April 2011

[Gamasutra analyst Matt Matthews examines U.S. retail video game sales during April -- a month that turned 2011 year-to-date growth from negative to positive -- and delves into pricing strategies and other challenges for major consoles.]

For the first time since February 2009, the U.S. video game industry posted its first double-digit growth rate according to retail sales figures released by the business tracking firm, the NPD Group. Building off the particularly weak sales figures recorded a year ago, overall sales were up 21.5 percent in April 2011.

The growth was driven by continued strength in Xbox 360 and PlayStation 3 hardware, the addition of Nintendo 3DS hardware sales, and a rapidly expanding accessories segment. Year-to-date, the industry is up 2 percent overall, however software is still down 4 percent in terms of dollars and 1 percent in terms of units.

Below we will examine the trends going on beneath the surface, including a discussion of hardware and software unit sales, and the accessories segment. Then we'll take an extended look at the issue of hardware pricing, drawing on a historical comparison to the last generation of hardware and looking at the recent PSP and Wii hardware price cuts.

Growth and Contraction

The market has been going through a period of swift and dramatic changes, and we now take stock of the larger trends and the underlying movements which are driving them. First, let's look at the top line revenue figures, covering all three primary segments – hardware, software, and accessories.

According to the latest figures from the NPD Group, total video game revenue at retail for the first four months of 2011 is up 2.3 percent year-over-year. One has to look back three years to April 2008 for the last time that kind of year-to-date growth happened. That was a memorable month: Grand Theft Auto IV launched on the PlayStation 3 and Xbox 360 while Mario Kart launched on the Nintendo Wii.

Even so, revenue in 2011 is still far below that historical high point. Below is a comparison of total industry revenue for the first four months of each year since 2006. As you can see, the year-over-year growth from 2011 to 2010 is marginal – around 2.3 percent or less than $100 million – while the growth in 2008 was a far more substantial 31 percent or $1.3 billion. So while a gain is a gain, it's still modest compared to the height of the retail business just a few years ago.

Just last month the year-to-date (YTD) retail industry revenue for 2011 was behind that of 2010 by about 1.3%, so the move to positive YTD growth can be attributed primarily to the single month of April. Scanning back through the historical data, April 2010 was a very weak month with a mere $766 million in total revenue, by far the weakest month of revenue since the industry generated only $643 million at retail in October 2006.

The NPD Group breaks the total revenue figure up into three segments: hardware, software, and accessories. Each of these has had its own dynamics over the past few months, and we should look at them separately.

In the hardware segment, it has been established for some time that the Wii market is cooling rapidly while the Xbox 360 market has heated up significantly and the PlayStation 3 market has continued at a slow burn. The figure below makes this point graphically.

Despite having no price cut since August 2009, the PlayStation 3 is continuing to eke out growth over last year. The same is true for the Xbox 360 which hasn't had a proper price cut since September 2008, although the top-line model was cut to $300 from $400 in August 2009.

While we can attribute some of the Xbox 360's growth to the ongoing success of Microsoft's Kinect initiative, the case is harder to make for the PlayStation 3. It would be advantageous for Sony to attribute that growth to its own motion-control system, PlayStation Move, but there is simply little indication that there is any causation.

The Xbox 360 has reached its peak rate of sales since its launch, with an annualized rate of 7.1 million systems, based on sales since May 2010. The PlayStation 3, by comparison, is running at about 90 percent of its peak rate of 4.9 million systems (achieved in the 12 months from September 2009 to August 2010).

With January – April sales falling to half the level demonstrated in 2008, the Wii is truly on a downward trajectory. We will deal with pricing and the Wii's successor – "Project Café" – in the next section, but we can say for now that the Wii has had an extraordinary and successful run that is in its final phase.

Will the Wii outdo sales of last generation's industry leader, Sony's PlayStation 2? We believe it will come close, but not surpass the final installed base for the PlayStation 2.

The PlayStation 2 has just passed the 46 million system level in the U.S. by our estimates, and that puts it about 10.5 million systems beyond the Wii's 35.4 million unit installed base. At its peak the Wii was selling over 10 million systems per year in the U.S. but in calendar 2010 it moved only 7.1 million and its annual rate has dropped to 6.6 million systems, judging by the last 12 months of sales.

If the price cut to $150 fails to reignite the system's sales, it has at most two Christmas seasons remaining – one in 2011 and one in 2012. If sales recover to their 7 million unit level for 2011 (certainly not a guaranteed outcome), we believe that news of Project Café is likely to diminish interest in Wii sales in 2012 pushing the system's lifetime sales to around 44-45 million unit level in the United States.

On the handheld side, the Nintendo DS and Sony PSP are also experiencing significant declines. The figure below shows this as well as demonstrating just how dominant the Nintendo DS has been over Sony's system in the U.S.

The extraordinary January – April sales for the Nintendo DS in 2009 are from the introduction of the Nintendo DSi, which launched at the end of March that year. Without the boost from that model, and the introduction of the Nintendo DSi XL in 2010, the system's sales would have declined even more quickly.

As we have said several times before, the PSP has ceased to be relevant to the U.S. game industry. Its annual sales rate is at an all-time low of 1.7 million systems, and we expect that that trend will continue for the remainder of the year (and, in fact, the system's lifetime).

Taking all the figures above into account, we can see that total hardware sales fell from 7 million units in the January – April period of 2010 to 6.7 million units in the same period in 2010. Remarkably, that decrease in hardware sales did not translate into a decrease in hardware revenue; in fact, hardware revenue grew from $1.47 billion to $1.57 billion during that period.

The explanation, we believe, is fairly straightforward: the least expensive platforms – Wii, PS2, Nintendo DS, and PSP – have all seen their sales decrease at the same time that the most expensive platforms – the Xbox 360 and PS3 – have seen increases. Xbox 360 Kinect bundles (driving up the average Xbox 360 price) and the launch of the 3DS (adding about $148 million in hardware revenue) also contributed to new hardware revenue in 2011.

Results for software from January through March (covered in last month's column) were not rosy. Unit sales were down 6.6 percent year-to-date and the average sale price (ASP) of software was also down over 3 percent. Both of these measures rebounded substantially in April. Moreover, for the six month period from May through October 2010, the rate of software unit sales was extraordinarily low compared to the rates this year.

If unit sales can maintain their level or increase modestly through that six-month period this year while maintaining a richer mix of sales for the Xbox 360 and PS3 (which carry higher prices), then the result should be stronger software revenue for the remainder of the year. With a loaded slate of big games in the second half of the year, with more probably being announced at E3 in June, the prospects for growth for software at retail seem healthy.

The accessory segment has shown very strong growth this year, up 15 percent or $115 million year-to-date. Obviously this is driven in large part by the success of Kinect, but also by Move accessories and the increase in points cards for Xbox Live, the PlayStation Network and the Wii Shop.

To return to the big picture one last time, the figure below shows annual revenue for each year since 2005, subdivided into monthly revenue segments.

While the rest of the year could hold many surprises, if the first four months are any substantial indication of how the full year will turn out, it appears that 2011 will hit somewhere between the level of sales seen in 2009 and 2010. Along with the growth that we presume is taking place in the purely digital side of the market, a segment which is not measured by the NPD Group's monthly report, then the industry should be well on its way to touting discernible, industry-wide expansion for the first time since 2008.

Pricing is Tricky

With hardware fortunes in flux, we find it worthwhile to examine what role pricing is playing, and will play, on sales of current and future game systems.

We begin by looking at the history of the last generation of consoles and comparing it to the current generation. For this discussion, we will take the October 2000 launch of the Sony PlayStation 2, at $300, as the beginning of the last generation of hardware. The Nintendo GameCube ($200) and original Microsoft Xbox ($300) followed the next year, in November 2001.

Each system got a price cut in May 2002, with the Xbox and PS2 falling to $200 and the GameCube to $150. In May 2003 the Xbox and PS2 had their prices cut to $180, and in September the GameCube dropped to $100. In March 2004 the Xbox price dropped to $150 and the PS2 price followed suit in May 2004.

For the current generation, the Xbox 360 started in November 2005 with $300 and $400 models, and now has two basic models at $200 and $300, with a variety of game and Kinect-focused bundles. The PlayStation 3 launched in November 2006 with $500 and $600 models, and now offers $300 and $400 models, again with a variety of bundles. The Wii also launched in November 2006, but at $250, and did not cut its price until September 2009, when it fell to $200. Nintendo just announced its second price cut to $150, effective 15 May 2011.

We can make this more concrete. Using sales figure from that generation and the price cuts above as a guide, we can estimate the average price of last generation's consoles (PS2, Xbox, and GameCube) to be $188 at the point 5.5 years into the generation (i.e. approximately the same point the industry is now, measured from the launch of the Xbox 360). Moreover, each system's price had been cut in half since launch.

Compared to last generation, the current generation of systems launched at higher prices and have cut their prices less quickly. Moreover, price cuts have generally happened independently, whereas Microsoft and Sony fought directly on price in the previous generation. We estimate that the average price of hardware this generation, for just the Xbox 360, PS3, and Wii, is $265 and possibly more. That represents a $77 increase over the average for the same point in the last generation, and $10 more than the launch price of the Wii.

That price differential in itself is remarkable, but even more remarkable is that more systems have been sold this generation at the higher prices than were sold during the same period in the last generation.

Here's how it breaks down:

It would be very interesting to know the driving forces behind these changes in the console market. Certainly, it appears that Nintendo's Wii, and motion gaming in general, have introduced (and reintroduced) many millions of new consumers to the console gaming experience. Moreover, it is possible that consumers who came of age in the 1980s are more amenable to game systems as a standard part of home entertainment, and are more likely to buy systems for themselves and their children.

While lowering the price of a console may increase its sales, it is not necessarily the case that a less expensive console sells better than a more expensive one. We have merely to look at the GameCube last generation and the Wii this generation to see that pricing is but one factor in a system's success.

Moreover, the effectiveness of a price cut depends on when that cut happens in a system's life. For example, Sony's PSP just got a price cut to $130 in March 2011 after maintaining its standard $170 basic price and $200 bundle price for many years.

Sales in March more than doubled from the rate in February, and were up 55 percent over the figure for March 2010. However, sales dropped back to just above their previous rate again in April, and we estimate that they will continue to erode until the system is discontinued within a year's time.

This is an example of a price cut that came too late in the system's life to actually make a meaningful contribution. The successor to the PSP, known only as NGP, has already been publicly announced, and this price cut fits more with the ending of the system's life than with a move to reach a wider audience and substantially increase the installed base.

Likewise, we speculate that Nintendo's announcement that the Wii is now $150 could follow a similar trajectory. Wii hardware sales are already accelerating downward, and the price cut could briefly forestall the inevitable collapse of the platform as the system known as Project Café comes to the fore.

Nintendo and Sony must also keep in mind how they intend to price their future systems. Take the current example of Nintendo's 3DS, which has sold just under 600,000 systems since its launch in March. We believe its $250 price tag is responsible for the much slower sales during the second month. The system, as defined by its features and software, simply does not offer enough value at this point to justify its price.

Whether Sony's NGP can avoid that same predicament is unclear at this point. We think that Sony and its third party partners may be able to deliver with a strong slate of software at the system's launch, but we are very dubious about Sony's ability to price the system competitively. More details should arrive around E3 in June, but at this point we expect the NGP to launch eventually in the U.S. with slow sales similar to those of the 3DS.

Finally, if Nintendo is serious about making Project Café a system at or above the specifications of the Xbox 360 and PlayStation 3, then it may have to price the system above the $250 price that the Wii launched at in 2006. At the very least, the company may have to sell its hardware with a smaller margin than it has enjoyed with its last two consoles.

[As always, many thanks to the NPD Group for its monthly release of the video game industry data, with a special thanks to David Riley. Thank you in particular to NPD Group analyst Anita Frazier for her monthly analysis notes. Additional credit is due to Michael Pachter, analyst for Wedbush Securities, for his perspective, instrucive conversations, and entertaining anecdotes.

Finally, many thanks to colleagues at Gamasutra and particularly regular commenters on NeoGAF for many helpful discussions.]