DFC: 'Chasing After the Elite Consumer'

The latest report from analyst group DFC Intelligence asks whether Microsoft's Xbox 360 Elite may end up simply "confusing and alienating those consumers just looking for a solid game system," and whether Microsoft has learned Nintendo's prior lesson about focusing on "the hard-core user." The full text of the report, released on the analyst firm's website, follows below: "The video game hardware market can be a tricky beast. Video games are true mass market technology and it can be hard to comprehend just how pervasive console system hardware has become in society. However, the big three hardware manufacturers are not resting on the historical industry model. Microsoft, Nintendo and Sony are all radically trying to expand their markets in different directions. It is still way too early in the lifecycle of the new console systems to make definitive conclusions. Nevertheless, it is worth looking at some of the problems that could arise from the path each of the players has taken. Some of the actions of the video game hardware manufacturers might be chalked up to a case of Apple envy. Of course, Apple Computer has definitely created a buzz with its line of iPod music players that come in a wide range of styles and features. However, when you compare iPod sales with game console sales the numbers are compelling. This month, Apple announced iPod sales had passed the 100 million unit mark since its launch in 2001. This number is impressive, but in a similar time period Sony shipped over 100 million PlayStation 2 systems and Nintendo shipped over 100 million portable game systems. Furthermore, the iPod has been launched in over 10 models with a price range from under $100 to as much as $500. The basic iPod is already on its fifth generation and there are several versions of iPod nanos, minis and shuffles. Storage on an iPod can range from less than 1 GB to as much as 80 GB. Compare the iPod to the Sony PlayStation 2. The PS2 has come in two, arguably three, basic form factors with almost no range in price or core functionality. With the PS2, Sony kept things simple and cheap. Consumers are still snapping up the system over seven years after it first launched in Japan in March 2000. Meanwhile, it is hard to imagine anyone that is still using a first generation iPod. Considering that before the PS2, the first PlayStation also sold over 100 million units, Sony seems to have a pretty good business model going. Sony would probably like to argue they invented the business model for the video game console market. Actually Sony just followed and perfected the model used by Atari and Nintendo. Meanwhile, both Atari and Nintendo changed their successful business model and found themselves marginalized in the console business. The Atari 2600, released in 1977, was the first true mass market console game system. The convoluted story of Atari and its multiple business missteps has been told in many places. To make a long story short, the Atari 2600 was basically a cheap (about $200) toy with hundreds of really bad games. Atari tried unsuccessfully to merge successor video game systems with personal computers and quickly became a historical footnote. It took Nintendo to come along and pick-up where the Atari 2600 left off. With the NES and, to a lesser extent the SNES, Nintendo dominated the game hardware market. However, Nintendo noticed that of the hundreds of games released for its system, the high quality ones from Nintendo and a handful of third party manufacturers like Square, Enix, Capcom and Konami, outsold other titles by an order of magnitude. Thus, for the Nintendo 64 launch in 1996, Nintendo changed its model to only focus on core high quality expensive games from a handful of developers they called the “Dream Team.” Top Nintendo 64 titles did soar to the top of the best seller list and significantly outsold the top PlayStation titles. But beyond the top titles there wasn’t much to the Nintendo 64. In terms of hardware units the PlayStation outsold the N64 by three to one. With the GameCube, Nintendo found themselves further marginalized and the PlayStation 2 outsold the GameCube by over five to one. The success of the PlayStation systems shows that video game hardware does best when it creates a core ecosystem for a wide variety of products from many different developers. It is extremely rare for an individual video game title to sell over 10 million units. To reach 100 million consumers it is essential to have a huge range of products for multiple consumer tastes. Mario, Pokemon and Zelda are arguably the three leading video game franchises of all-time and they are all owned by Nintendo. However, it seems those franchises are only enough to move about 20 million hardware units. With the launch of the Wii, Nintendo is definitely expanding the appeal beyond its core franchises. However, the biggest ace for Nintendo may be lack of competition in the mass market price range. The launch of the Xbox 360 Elite means Microsoft is now chasing Sony after the high-end market. The strategy of both Sony and Microsoft seems very similar to the one Atari and Nintendo unsuccessfully tried. The Xbox 360 Elite is a $479 system that adds a larger hard drive and an HDMI port and cable. It now sits on the shelf with the core $300 SKU and the $400 SKU (which is the one people are actually buying). The goal of the Elite is to target consumers that want to download and play high definition video. However, there should be concern that what the Elite may end up accomplishing is confusing and alienating those consumers just looking for a solid game system. The video game business model depends on building a huge user base in a relatively short time period. Therefore, from a macro perspective the core question with a product like the Xbox 360 Elite is not what it adds for the high-end consumer, but what does it mean for those cheap skates that are only willing to spend $400. This brings us to the first problem we have with the system: the name. For years, DFC Intelligence has discussed the challenges of going with multiple hardware configurations in the video game hardware market. One of the biggest issues is consumer confusion. We have argued that for a successful multi-SKU approach to work there needs to be a pretty wide difference in both price and functionality. Furthermore, it must be made clear to the consumer that the difference in functionality will not make a difference when it comes to actual video game play. With the word “elite” Microsoft is implying that their existing users and all potential future Xbox 360 buyers that if they only spend $400 they are not elite. At the same time Microsoft announced the Elite, Sony was announcing that they were eliminating the low-end $500 PlayStation 3 SKU. Sony claimed that demand for the $600 PS3 SKU was over 10-to-1 that for the $500 SKU. This illustrates a basic rule about the video game consumer: when you are talking big bucks consumers do comparison shopping. When video game systems are priced in the $200 range and lower a small price change can really move product and consumers tend to be very price sensitive. However, in the $300 and up range consumers tend to be a little more careful with their purchase. Consumers don’t want to spend $400 on a piece of hardware and be told they are not “elite” and only getting second best. At that range the tendency is to want to spend the money on the best or else wait until you can afford the best. The Xbox 360 Elite seems like Microsoft’s attempt to chase Sony for the high-end video-centric consumer. However, this is a power race that Microsoft simply can’t win. The Elite targets a very niche, possibly imaginary, consumer that wants a bleeding edge high-definition system but wants to cut corners when it comes to video playback by using a comparatively low-tech video game hardware system. Of course, the Elite doesn’t include an HD-DVD player or even built-in Internet Wi-Fi, so, for high-definition video, the PlayStation 3 is both more powerful and more cost effective. The Elite kind of migrates the Xbox 360 towards a high-definition video recorder/player much the same way Atari tried to migrate its video game system into a PC over twenty years ago. But the issue of what the Elite lacks is not the primary concern. It is fine to try and satisfy the high-end consumer, but if doing so alienates your mass market base it can spell doom. Sony has more flexibility to go with a high-end strategy because they are still satisfying their core PlayStation 2 consumer base. With hot new products like God of War II, Sony Computer Entertainment is showing existing consumers they don’t need to rush to upgrade to the PS3 (or competing system). Compare this with Microsoft that basically slammed the door on the original Xbox and is now basically telling initial Xbox 360 purchasers they need to buy a whole new system if they truly want to do high-definition. The biggest problem with the Xbox 360 Elite is probably the issue of HDMI output. Consumers can understand what a bigger hard drive means and can also feel comfortable knowing that they can always upgrade their hard drive. However, it is a safe bet that the vast majority of consumers aren’t quite sure what an HDMI port means. You can be sure that the sales clerks in your average retail store will probably be telling a lot of different stories. One can envision the following scenario: Consumer: “why does this one cost $80 more than this one.” Sales Clerk: “the Elite has a bigger hard drive and HDMI.” Consumer: “what is HDMI.” Sales Clerk: “oh HDMI is just for if you want to do high definition.” Of course, this ignores the fact that a year ago Microsoft was arguing that you don’t need HDMI to do high definition and for the vast majority of consumers regular component cables will in fact work just fine. However, in the average consumer mind they don’t know that. All they know is that one day they may want a high definition system and if they are spending this kind of money they better go with the high-end system. Or maybe, they should just go home and play with their PlayStation 2 while they research the issue some more and let the market shakeout. Sony had originally planned to not have HDMI on its lower end SKU, but because of this exact issue of potential consumer confusion, added HDMI to both PS3 SKUs shortly before launch. Of course, finally they just scrapped the lower end SKU completely. It is surprising that Microsoft didn’t learn from Sony’s PS3 struggles in 2006. It is even more surprising that Microsoft feels a need to chase Sony when it seems the one they should really be chasing is Nintendo. For fiscal 2007 Nintendo announced that revenue was up 90% to over $8 billion. Initial sales of the Wii were extremely strong and it is now the system with the momentum. The Xbox 360 could win a hardware power contest with the Wii, but probably not at nearly double the price. The lesson Nintendo learned from the N64/GameCube era was that by focusing mainly on the hard-core user you are eventually left with just the hard-core user. Microsoft has talked a great deal about creating development tools that will make it easy for developers to create products for Microsoft platforms (which also include PCs and increasingly handhelds). However, the best way to get developers to create content for a platform is to get the platform in the hands of a whole lot of consumers. If the box moves off store shelves you can bet game developers will find a way to create product to sell to consumers. In the end, Nintendo and Sony are the ones that probably benefit the most from the Xbox 360 Elite. Among new game systems, the Wii now clearly stands alone in a mass market consumer price range. However, for the millions of power video game users the Wii is clearly not a complete long-term solution. For many consumers the Wii is a cool little second system to have and the real long term choice will come down to Xbox 360 or PlayStation 3. Sony now has a little breathing space and they can compete on a more even head-on comparison between the 360 and PS3. The huge PlayStation 2 user base now becomes a much bigger ace up Sony’s sleeve. For the Xbox 360 Halo 3 is looking more and more like make or break title for Microsoft’s entire game business."