NPD: Behind the Numbers, March 2010

As expected, the U.S. retail video game industry returned to growth with the release last week of March 2010 sales figures by the NPD Group. Outside of December 2009 – when revenues grew by a modest 3.9% – and September 2009 – when revenues were flat – the industry has experienced mostly double-digit year-over-year declines.

Simultaneously Sony's PlayStation 3 has finally demonstrated that it has the strength to dominate the software scene. Consider this simple comparison: more money was spent on PlayStation 3 software in March 2010 than November 2009, even though the latter is one of the biggest shopping months of the year.

However not all is well in Sony's house, as its PlayStation Portable (PSP) was bested by the Nintendo DS platform by a nearly 6-to-1 margin in hardware units and an 8-to-1 margin in software dollars.

Below we'll cover all these nuances beneath the top-line figures and try to provide some insight into where the industry will go from here.

The Numbers At A Glance

While total revenue was up for the month compared to March 2009, only the software and accessories actually realized increases. Even though 157,000 addition systems were sold in March of this year, downward pressure on hardware prices depressed revenue further.

According to Anita Frazier, analyst for the NPD Group, console hardware prices were down 16% year-over-year in March 2010. However, average handheld hardware prices were up over 10% year-over-year in February 2010 (two months ago), according to data provided exclusively to Gamasutra, and we expect that average handheld hardware prices increased further last month with the introduction of the Nintendo DSi XL at $190.

Out of this mix of shifting hardware unit sales and prices, we see that the total money spent on hardware in March 2010 dropped nearly 4% to $440.5 million.

Figures for all segments, along with year-to-date (YTD) figures, are given in the table below.

Software revenue was up 10% in March, based on an 11% growth in unit sales with a very modest 0.5% decline in average prices. That's the first real growth in the software segment since February 2009 over a year ago.

Although data for March 2010 was not available as of this writing, data provided to us on accessory sales in the first two months of 2010 reveals that the situation is quite different in that segment. In particular, accessory prices were up 13% year-over-year through February. However, given that that segment has seen only single-digit growth in its revenue, there must have been a corresponding 10% or more decline in unit sales.

Finally, we note that the data provided by the NPD Group does not reflect sales of games, add-ons, or subscriptions purchased through online outlets like Xbox Live, the PlayStation Store, or the Wii Shop channel. The lack of hard data on this segment of sales will continue to blur our view of the state of the industry, especially as that segment inevitably grows in the coming months and years.

Sony Software Surges

With seven titles in the top 20 software list for March 2010, Sony's PlayStation 3 finally appears to be coming into its own. While its two key rivals, Microsoft's Xbox 360 and Nintendo's Wii, have outsold Sony's flagship system for many months there is some evidence that PlayStation 3 software sales are accelerating.

Regrettably, the top 10 and top 20 software lists provided to us each month are an imperfect tool for analyzing software sales. As part of an extended analysis, we can reveal that Sony's PlayStation 3 had an increasing share of the top 50 titles in the first two months of 2010 and likely had an even bigger share in March. (Final information for March 2010 was not available as of this writing, but will likely be included in a first quarter analysis later this month.)

From that data we have seen, it appears that 12 PS3 titles placed in the top 50 SKUs for the month in January 2010 and 14 PS3 titles in the top 50 SKUs for February.

These titles accounted for a growing share of the software unit and dollar sales in those two months. For context, we estimate that the top 50 titles in each month can account for between 30% and 40% of all software units sold in a given month.

Given that seven PS3 titles placed in the top 20 in March 2010 and that sales of existing titles probably continued to do well throughout that month, we believe that the PS3 took an even greater number of titles in the top 50 for last month.

Estimating dollar sales for the seven titles already known to be in the top 20, it would appear that PlayStation 3 software in the top 20 for March 2010 generated more revenue than the 14 PS3 titles in the broader top 50 for February.

For Sony, this has been a long time coming. The last time it could point to a single-month million-seller exclusive like March's God of War III was in June 2008. Even then, Metal Gear Solid 4: Guns of the Patriots reached a million units by combining software-only copies with the copies bundled in with a special edition of the PlayStation 3 hardware.

Recall that precisely one year ago, in April 2009, the only PS3 title published by SCEA with unit sales in excess of 1 million units was Resistance: Fall of Man, a launch title from November 2006. Only LittleBigPlanet had surpassed 750,000 copies at that point with other key titles like Uncharted: Drake's Fortune, MotorStorm, and Ratchet & Clank Future: Tools of Destruction falling well short of that figure.

Were we to rank sales of more recent games, we'd list Uncharted 2: Among Thieves with sales in excess of 1.15 million and God of War 1 & 2 Collection with sales topping 650,000 units, both from late 2009. Titles from 2010 that have done quite well on the PlayStation 3 are the first-person shooter, MAG, which we estimate has now topped 350,000 units and Heavy Rain with sales over 325,000 units.

Third party software has also continued to do well on the PlayStation 3, with Assassin's Creed II likely to pass the 1 million mark in the next few months and Call of Duty: Modern Warfare 2 already past the 3.5 million mark.

One way to view Sony's software success this year is to compare current-generation console software revenues from March 2009 with those for March 2010. Recall that Resident Evil 5 launched on the Xbox 360 and PlayStation 3 that month. The Xbox 360 got Halo Wars as an exclusive while the PlayStation 3 saw its second month of Killzone 2 sales. Wii Fit and Wii Play were the leading Wii titles that month.

According to comments made by Michael Pachter, an industry analyst for Wedbush Securities, we estimate that the total current-generation console software market (not just the top 50 discussed above) broke down in the following way for March 2009, with respect to dollars of revenue.

With the turnaround seen in the first quarter of 2010, the momentum has shifted to the PlayStation 3. We might well consider software sales in March 2010 the best possible situation for Sony, one in which they have a million-selling title leading the software chart and several other strong first- and third-party releases just below it.

In that nearly ideal situation, here is what we estimate for the software dollars among the current-generation systems.

Given the hardware installed base differentials (the PlayStation 3 is trailing and will always trail the Xbox 360) one probably can't expect software to favor the PS3 any more than this.

After the stumbling after the PlayStation 3 launch, Sony's mission shifted from leading (which it had done with the PlayStation 2) to keeping pace as best as possible and making its platform as essential as possible for the profitability of cross-platform games.

This is why games like Final Fantasy XIII and Battlefield: Bad Company 2 exist on both the Xbox 360 and PlayStation 3. Third parties can maximize their investment in these expensive games by reaching out to an audience of 32 million users rather than just a single-platform subset.

Having established that continuing support, Sony has been freed to some extent to focus on distinguishing its platform with its own exclusive software like God of War III and Heavy Rain. In this light, the software growth on the PlayStation 3 has to be seen as making the best of a difficult situation.

Hardware: Mixed Signals

The hardware sales results in 2010 appear to show a market in flux. Both Sony and Nintendo have reported that they are experiencing supply difficulties with their systems, the PlayStation 3 and Wii, respectively.

Sales of the Nintendo Wii rebounded slightly in March, up 3% over the rate it averaged throughout January and February. This could signal an easing of the supply constraints Nintendo had noted or it could simply be a small statistical variation.

On the other hand, PlayStation 3 sales were down 20% relative to the rate established throughout January and February. Sony first mentioned in mid-February that it would have trouble supplying enough PS3 hardware in the “coming months”.

The timing of the announcement suggested to us that sales in February would be low, but in fact February sales were unexpectedly strong while it was March sales that showed a sharp decline.

According to comments made by GameStop's COO, even they don't “have clarity” regarding the supply issues for Sony (or Nintendo).

Regardless, it is truly unfortunate for Sony that at the very moment when its software begins to shine it also has to explain away hardware numbers with vague comments on its supply chain.

Microsoft continues to execute well on its hardware, and its March 2010 sales figures are right in line with the last comparable month's figures in September 2009.

In that month, prior to the 2009 holiday sales rush, the Xbox 360 sold approximately 70,000 units per week, or just over 350,000 units for the five-week month (as measured by the NPD Group). With sales of just under 68,000 units in March, we believe that Xbox 360 sales are stable.

These hardware figures may provide clues for how each of the platform holders will maintain or drop prices in the coming months.

Wedbush analyst Michael Pachter expects that price cuts will come due around September of this year, and that Microsoft holds the first-mover advantage on this point. The stable Xbox 360 hardware sales figures above lend credence to Pachter's argument for a price cut, but we would argue for sooner than September. The last time that Microsoft seriously cut the prices on its hardware was in Fall 2008, and a price cut timed to hit with EA's Madden NFL 2011 in August would be most advantageous this year.

One key is that we believe Sony will continue to hold its PS3 pricing as long as possible, probably until after September. Sony held its ground on pricing for an excruciatingly long period in 2008 and 2009 as the company focused on profitability and attempted to rein in losses on PS3 hardware.

We believe that Sony will again show patience in the face of calls for lower prices from publishers and retailers throughout the coming months. If Sony cuts the PS3 price in 2010 (and we're not convinced it will), the cut would probably come in October or November, at the very last moment before Christmas sales begin in earnest.

Therefore, Microsoft would ideally drop its prices in early August – say $170 for the entry-level system and a higher-end system with a commensurately lower price – and garner the positive press coverage for high hardware and Madden sales just before the September launch of Halo Reach. A subsequent launch of Microsoft's Project Natal would keep Microsoft in front of consumer eyes for the longest possible period prior to the sales rush of the holiday months.

A colleague once said to us that launching a Halo game in September allowed Microsoft to “add another holiday month to the end of the year”. Along the same lines, we feel that Microsoft could add August to that end-of-year rush with the right kind of price cut and software promotions. By the time Sony relents and cuts its own prices, Microsoft will have recorded two or three months of superior sales.

Obviously this position will have to revisited if Microsoft's sales significantly decline in the coming months or if its sales are overtaken when Sony's reported supply issues are resolved. As it stands now, Microsoft holds the upper hand and a price cut will certainly mitigate any momentum Sony might build throughout the year.

As for Nintendo, we see no reason for it to modify its pricing in the next few months. A supply-constrained Nintendo system doesn't need a price cut if it still averages nearly 110,000 systems per week during a first quarter with no major new first-party titles.

Handheld Battle of 2010

Since our last report, Nintendo has announced that it will launch a successor to the Nintendo DS, currently called the Nintendo 3DS, before the end of its current fiscal year (ending March 2011). The new device will incorporate a screen technology that allows 3D effects with the naked eye and will be backward compatible with the existing Nintendo DS and Nintendo DSi.

Should that device come to market on time, it seems likely that Nintendo will have four different devices on the market at the same time that all play Nintendo DS software as well as their own specialized software. We find that possibility disconcerting, to say the least, especially from a company which has generally maintained a simple line of hardware models.

As we've outlined previously, we also expect Sony to announce a successor to its PSP handheld, probably within the next six months, with the launch at the end of 2010 or early 2011.

If things play out as we currently expect, then the two companies are again on a course for what many will view as a head-to-head competition. (For our current feelings about Sony's position, please see last month's article.)

Just looking at the American market, we admit to being somewhat baffled by Nintendo's motives. While the Nintendo DS platform has shown a very slight weakness, it is still crushing its competition and outselling its competitor, the PSP, by a tremendous margin.

It has also demonstrated over the past five years that consumers are content with the graphical and sonic fidelity of Nintendo DS software.

Consider the comparison below of software dollar sales in the handheld segment during March 2010, showing that Nintendo DS software outsold PSP software by an 8-to-1 ratio.

The success of Pokémon SoulSilver and HeartGold during March skews these results, but not by as much as one might suppose. During a usual recent month Nintendo DS software is likely to outsell PSP software by a factor of 5-to-1 or 6-to-1. A year ago, during the beginning of 2009 and back into 2008, the ratio was closer to 4-to-1.

However, we must admit that Nintendo appears to have a deep understanding of what its consumers want. In the past few years its presentations to investors regularly include results of extensive demographics studies, data that appears soft at first glance but which is clearly guiding the company's hardware and software plans.

For example, the figure below from Nintendo's April 2009 briefing to investors shows the age and gender distribution of Nintendo DS users in the U.S.

Nintendo has also made a habit of not introducing new hardware until it was affordable for the general public. The current $190 price of the Nintendo DSi XL is what we would consider to the extreme ceiling for a new Nintendo handheld.

We expect that by the time the Nintendo 3DS is introduced Nintendo will be phasing out the Nintendo DS Lite (currently $130), and move the Nintendo DSi down to below $130. That will leave a sufficient headroom for the new model to sufficiently differentiate itself from the older ones.

In the meantime, it seems likely that Nintendo DS platform sales will be dominated by the Nintendo DS Lite and the Nintendo DSi, which have previously split the market evenly. Already with only 7 days of sales, the larger DSi XL has garnered 141,000 units in sales, according to Webush analyst Michael Pachter.

While this isn't nearly as robust as the launch of the Nintendo DS Lite (which helped move over 500,000 units in its June 2006 launch) or the DSi (58,000 units in one night during March 2009), it still outsold the PSP for the month by 20,000 units.

In a recent conversation Pachter said he believes that Nintendo will reduce the prices on the current three models in time for the holiday this year. He expects a $99 Nintendo DS Lite to take about 45% of the DS platform market, with a $150 DSi claiming 30%. The DSi XL, he said, will probably hold its price at $190 and make up the remaining 25% of DS unit sales.

[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 for his assistance and Anita Frazier for her analysis. Additional credit is due to Michael Pachter, analyst for Wedbush Securities, for his perspective and information. Also we consulted the comments of Doug Creutz of Cowen & Co. in the preparation of this report. Finally, many thanks to colleagues at Gamasutra and commenters on NeoGAF for many helpful discussions.]