MEMORANDUM. Nicole Huber Kyle Lubbers Nanette Brames Billie Heilman

Transcription

1 MEMORANDUM Subject: Video Game System Industry Analysis Date: July 14, 2010 To: Professor Ford From: Matthew Roetting Nicole Huber Kyle Lubbers Nanette Brames Billie Heilman Introduction As requested, an industry analysis for video game systems has been conducted. In this report, we have evaluated the attractiveness of this industry in terms of the potential for sustained profitability over time. The main focus throughout the analysis is Michael Porter s five forces model and how they relate to the history and future of video game systems. Industry Analysis for Video Game System Industry Industry Name. Video game systems is the industry that is going to be analyzed. The scope is going to be worldwide and is only going to include the three major system producers: Microsoft, Sony, and Nintendo. It is valid to establish these three competitors as the industry, because they produce and sell 90% of the world s video game consoles. Atari, Mattel, Magnavox, and Sega are the other competitors who have existed sometime throughout the history of video game consoles. When combined, these other companies have produced and sold the remaining 10%. 1 This analysis only includes video game consoles which are the hardware that operates the gaming software. Industry Classification. The North American Industry Classification System (NAICS) code for video game systems is titled Game, Toy, and Children s Vehicle Manufacturing. 2 Yahoo Finance categorizes the sector for Sony as consumer goods and the industry as electronic equipment. For Microsoft, they are in the technology sector where the industry is application software. 3,4 Since Nintendo is not publicly traded in the United States, they are not classified under Yahoo finance, however are classified as other products in the Tokyo Stock Exchange

2 Output Description. The video game console is the product that defines this industry. A video game console is defined as an interactive entertainment computer or modified computer system that produces a video display signal which can be used with a device such as a television or monitor to display a video game. 6 The term "video game console" is used to distinguish machines designed for playing video games from a personal computer, which has many other functions. 7 The machines considered throughout this report are: Microsoft s XBOX 360, Sony s PlayStations 2 and 3 as well as their PlayStation Portable (PSP), and Nintendo s Wii and DS. 8 These are not the only consoles still available on the current market, however, are the latest produced, and thus are the basis for this entire report. Geographic Scope. Microsoft is home-based in Redmond, WA; Sony is based in Tokyo, Japan; and Nintendo is based in Kyoto, Japan. 9,10 The following pie charts represent the geographic markets the video game system producers primarily serve. 11 Figure 1: Geographic Markets for Video Game System Industry as a Whole The second set of pie charts divide the geographic scope of the entire industry into the three individual competitors. This is a more specific breakdown and suggests a couple of things. First of all, it portrays the relationship of domestic versus foreign markets for the three competing organizations. As noted earlier, both Sony and Nintendo are based in Japan. According to the charts, roughly 85% of both of their revenues come from foreign markets. Microsoft, based in the U.S., receives the majority of their revenues from domestic markets. Another interesting observation is that the geographic scope of Nintendo is the same as the industry breakdown shown in the first comprehensive pie chart. This could suggest that Nintendo dominates the video game console market since their geographic market mirrors the industry as a whole

3 Figure 2: Geographic Markets for Microsoft, Sony, and Nintendo Individually Microsoft Sony Nintendo Supply Chain. The following diagram is the supply chain for video game systems. In a sense vertical integration exists in this industry because the three video game competitors fall under two steps in the supply chain: development and design and storage and warehousing. 12 Figure 3: Supply Chain Distribution Development and Design -Hardware R&D -Prototyping -Product Testing Microsoft Sony Nintendo Manufacturing and Production -Mass Production by Suppliers -Electronic Packaging and Final Assembly Foxconn Flextronics ASUStek Storage and Warehousing -Ship back to be stored -Marketed to Distributors Microsoft Sony Nintendo Retail -Business to Business sales (Retail Stores and Online Stores) - Wal-Mart Best Buy Game Stop Customers -Business to Consumer sales -Individual consumers purchase the systems Industry Size. For our video game system industry, size is measured in annual output (specifically in units). In the following table, we have broken down the number of units sold for each of the three competitors: Nintendo, Sony, and Microsoft in millions; as well as provided output over a three year span: 2006, 2007, and The table shows the amount of video games sold over the three years has increased steadily. This is due to increased demand of the systems and expansion into different markets. It is also noteworthy to mention that for the threeyear span, Nintendo has produced and sold substantially more consoles than Sony and Microsoft which follows the information found earlier under the geographic scope

4 Table 1: Annual Output in Millions for the Three Competitors Company %YOY %YOY Nintendo Sony Microsoft Total 30.33m 45.08m 48.63% 45.08m 59.36m 31.68% 22.28m 28.73m 28.94% 28.73m 30.75m 7.03% 7.47m 7.93m 6.16% 7.93m 11.37m 43.38% 60.08m 81.74m 36.05% 81.74m m 24.15% Age. The video game system industry had their major debut in 1967 when the first console, called The Brown Box, was introduced by Ralph Bare. Since then there have been dramatic improvements and innovations throughout this industry s history. The following timeline lays out the major breakthroughs that have occurred and shows how video games have evolved over the last 43 years. 14 Figure 4: Video Game System Timeline Magnavox begins production of the first commercial video game console, The Odyssey. Atari releases the 2600 SPACE VCS. This is the first console that can play multiple games. The Nintendo Entertainment System is released in the U.S. The Super Nintendo is released. Nintendo 64 is released marking the last console to use cartridges. Microsoft enters the video game system industry with their introduction of the XBOX. The Nintendo DS is released. Mass release of the Nintendo Wii, Sony s PlayStation 3, and Microsoft s XBOX The first video game console was called the brown box and was designed by German born Ralph Bare Atari sells the first home version of Pong. Mattel releases the Intellevision to challenge Atari. Nintendo introduces the first Game Boy. Sega also introduces the Sega Genesis. Sony releases the PlayStation 1. The Sega Dreamcast is introduced by Sega. Sony releases the PlayStation 2. Nintendo releases the new Game Boy Advance. Sony releases the PlayStation Portable (PSP) to challenge Nintendo s dominance in the handheld gaming market

5 Industry Life Cycle. Since the video game system industry has been around for a while it would be easy to assume it is in the maturity stage of the industry life cycle. However, comparing the growth rate of the industry to the growth rate of GDP shows us that we are actually in the growth phase. From 2003 to 2006, the entertainment software industry s annual growth rate exceeded 17 percent. Over the same period, the entire U.S. economy grew at a less than four percent rate. In fact, according to PricewaterhouseCoopers, the sector will remain one of the above-average growth segments of the global entertainment industries through From the industry s real rate of growth was more than double the real rate of growth for the entire economy. 16 This extreme growth is mainly due to the introduction of Sony s PS3, Microsoft s XBOX 360, and Nintendo s Wii in The follow diagram represents the four phases in the industry life cycle and highlights where the video game system industry lies. 17 Figure 5: Industry Life Cycle Video Game Systems Competitors. As noted in earlier sections, there are three main competitors in the video game systems industry: Microsoft, Sony, and Nintendo. Microsoft is home-based in Redmond, WA; Sony is based in Tokyo, Japan; and Nintendo in Kyoto, Japan. 18,19 Microsoft was founded in 1975 and operates five different business segments. The following are their main operational divisions: client, server and tools, online services business, Microsoft business division, and entertainment and devices division. 20 The following table represents the 21, 22 percent of overall revenues and profits that come just from gaming for Microsoft

6 Table 2: Microsoft Video Game Revenues & Profits (in thousands of U.S. dollars) % YOY 2007 % YOY 2008 % YOY Revenues 1,555,000 2,381,000 53% 3,068,000 29% 4,107,000 34% Profits (226,000) (665,000) -194% (973,000) -46% 163,000 83% Before going any further, it is important to show how we came up with these figures for Microsoft. Microsoft s annual report lumped gaming into a segment titled Entertainment and Devices Division. We had to assume the revenue and profit amounts that pertained to the video game industry. As seen in the table Microsoft s revenues steadily increased over these last four years. From , revenues nearly tripled most likely due to the release of the XBOX 360. Profits, however, didn t perform as well. From Microsoft took a loss most likely due to the development of the XBOX 360. From though, a profit was finally realized. Sony was founded in 1946, and like Microsoft operates multiple divisions. Their four main operations are categorized as electronics, game, pictures, and financial services. 23 Again, the following table displays the percent of overall company revenues and profits that come from their game segment only. 24 Table 3: Sony Gaming Segment Revenues & Profits (in thousands of U.S. dollars) % YOY 2007 % YOY 2008 % YOY Revenues 7,923,789 10,376,999 31% 11,006,044 6% 13,771,056 25% Profits 487,146 98,316-80% (2,625,776) -2771% (1,406,885) 154% These numbers came from Sony s annual report; however were in Japanese Yen so we had to convert them to U.S. dollars. 25 Sony s revenues have steadily increased over the last four years. From , revenues have nearly doubled. Profits, however, didn t do as well. As you can see from , profits decreased significantly and a loss was taken in 2007 and 2008 most likely due to the development of the PlayStation 3. From the loss began to decrease

7 Nintendo was founded in 1889 originally as a playing cards company by Fusajiro Yamauchi. Since then they have become a company that solely produces video game consoles and the software that goes along with them. 26 Since Nintendo devotes their entire industry to gaming, their company-wide revenues and profits are shown in the following table. 27 Table 4: Nintendo Revenues & Profits (in thousands of U.S. dollars) % YOY 2007 % YOY 2008 % YOY Revenues 4,812,970 4,348,951-11% 10,920, % 16,724,230 53% Profits 816, ,842 3% 1,969, % 2,573,426 31% These numbers were found in of Nintendo s annual report and were given in U.S. dollars. Based on these figures, it s clear to see how much Nintendo has been increasing. From both revenues and profits more than tripled. The reason for this increase was the release of the Nintendo DS in 2004 and the Wii in 2006 both of which have dominated this industry. We believe the main reason that Nintendo has been so successful is due to their level of specialization in the industry while Sony and Microsoft are more diversified in their product offerings. One final important summary note to make regarding the competitors is that all of Nintendo s revenues come from the video game industry, whereas for Sony and Microsoft, video games are just a segment. Video game revenues for Sony account for around 12% of their total revenue. For Microsoft, video game revenues account for around 6% of their total revenue. This shows that should the video game industry take a big hit, Nintendo will be more at risk then Sony and Microsoft because they have so much more invested in the gaming industry. Market Share. One way to calculate the market share of the three competitors is to determine how much of the market each individual console produced by the three companies holds. The following pie chart represents this for the year ending in 2008 and includes the six major consoles presented throughout this analysis

8 Figure 6: Market Share of the Six Leading Video Game Consoles in 2008 When combining the market shares of the consoles produced by the same company we come up with the following market share figures in the next pie chart for the competitors as a whole. It is interesting to note that Nintendo controls well over half of the video game system industry. Figure 7: Market Shares of the Three leading Video Game Competitors in 2008 Financial Data. The following two tables supply the revenue and employee data for the video game industry as a whole. This first table shows worldwide video game industry sales from 2005 through Table 5: Worldwide Video Game Industry Revenues (in billions) Year Revenues % YOY % % %

9 This second table shows U.S. video game industry employment from 2006 through As you can see, there has been a significant increase in jobs in this industry especially from 2006 to Table 6: U.S. Video Game Industry Employees Year Employees % YOY , , % , % Key Trade Groups. The Entertainment Software Association (ESA) is exclusively dedicated to serving the business and public affairs needs of companies that publish computer and video games for video game consoles, personal computers, and the Internet. The ESA offers a range of services to interactive entertainment software publishers including a global anti-piracy program, business and consumer research, government relations and intellectual property protection efforts. The ESA also owns and operates the E3 Expo. The E3 Expo was recently held June in Los Angeles. Key Trade Publications. In recent years there has been a growth in the amount of journalism based on the video game industry. The Internet has allowed serious gamers to begin blogs and websites discussing video game news. Therefore, it can become difficult to recognize the publications that are reputable. However there are a couple that seem to receive consistent recognition in the industry. The first magazine to cover the video game industry is Play Meter Magazine and it is still in publication today. 31 Game Developer is a monthly trade periodical and is distributed to approximately 35,000 readers. 32 Force 1: Intensity of Rivalry According to Michael Porter, rivalry occurs in an industry because one or more competitors either feels the pressure or sees the opportunity to improve position. 33 Many times organizations are mutually dependent on each other, meaning competitive tactics performed by one firm have highly noticeable effects on their close competitors (Porter 17). There are two main forms of rivalry: price based and non-priced rivalry. The concentration of an industry can be assessed by calculating the concentration ratio of the 4 largest firms (CR4) and the herfindahl index. Specific assets, stability of demand, product differentiation, and buyer switching costs are all factors that can increase the level of rivalry in an industry. Price-Based Rivalry. As with most technologies, the price of video game systems are decreasing. This is typical for this industry because when a new system hits the market it is priced high due to expected consumer demand. However, once that system has been on the shelves for a considerable amount of time, the price decreases in order to keep the sales level high. The following table represents the beginning prices of the three original systems introduced Porter, Michael E. Competitive Strategy The Free Press. Pg. 17 9

10 in 2006: Sony s 20GB PS3, Nintendo s Wii, and Microsoft s 20 GB XBOX 360. Also included are the prices for the same systems in 2007 and ,35,36 Table 7: Prices for PS3, XBOX 360, and Wii from Year System %YOY %YOY Sony: PS3 (20 GB) $499 $ % $400 $ % Microsoft: XBOX 360 (20 GB) $299 $ % $280 $ % Nintendo: Wii $249 $249 0% $249 $249 0% As seen in the preceding table, there are consistent pricing differences between the three competitors. The most notable difference is the significantly higher starting price of Sony s PS3 20 GB console as opposed to the starting prices of the other two competitors consoles that were released in the same year. It nearly doubles the price of both Microsoft s XBOX 360 and the Nintendo Wii, and continues to sell at a higher price throughout the following two years. An important note to make is most of the original systems were discontinued after a short period of time and replaced with consoles that had higher gigabytes of memory. This is the major contributing factor to the reduced price over the following years. Another factor that needs to be considered is every retail store offers different prices so the prices listed above are just estimates of what the consoles were going for on average during that three year period. Notice also that the price of the Wii remained constant over the three-year period. The company claims that they are selling every Wii system that they produce and thus said, We'll stay at $249 for the foreseeable future. 37 Overall, according to the changing price trends of the three consoles, it appears that price-based rivalry exists between the three companies. We would suggest that Nintendo is the price leader since the price of the Nintendo has remained constant. Over the three-year period, both Microsoft and Sony reduced the prices of their consoles to a price that more closely matched the price of the Nintendo Wii. Non Price-Based Rivalry. The main non-price based rivalry occurring in this industry is product innovation. Each company wants their product to be the most up-to-date technology on the market. An example of this is both Sony and Microsoft are coming out with motion based controls in an attempt to compete with Nintendo s Wii. 38 The following table outlines the new video game consoles introduced by the three competitors over the past 15 years and is a good

11 illustration of how product innovation is the biggest non-price based rivalry factor for this industry. 39 Table 8: Video Game Consoles Released by 3 Competitors over the Past 15 Years Consoles Released Year Nintendo Microsoft Sony 1995 PlayStation I 1996 Nintendo PlayStation XBOX 2002 Game Boy Advance 2004 Nintendo DS 2005 PlayStation Portable 2006 Wii XBOX 360 PlayStation 3 Industry Concentration. As displayed in the following table, concentration for the video game system industry is very high. 40 Since Nintendo, Sony, and Microsoft control 90% of the worldwide video game console industry, it is not necessary to calculate the CR4. Therefore, we will use the herfindahl index. If the herfindahl index is greater than 1800, then it can be assumed that the potential for rivalry is reduced. It is evident in our HI calculation of 4,502 that the preceding statement is true for the video game system industry. Table 9: Amount of Video Game Systems sold in 2008 for the Three Competitors Company Units Sold (in millions) % Share of Units Sold Nintendo Sony Microsoft Total Herfindahl Index: 4,502 Herfindahl Index= 10,000 (Σ Si 2 ) = 10,000 ( ) = 4,502 Specific Assets. Given that all video game system production is outsourced, there is no need for the companies in this industry to possess a large amount of specific assets. The firms do have regular operating assets such as warehouses to store the finished products before they are shipped, office space, and knowledgeable employees to keep the business operating. The

12 following tables show the amount of property, plant, and equipment assets each of the three competitors hold on their balance sheets. Table 10: Partial 2008 Balance Sheets for Microsoft, Sony and Nintendo Microsoft Assets Amount of PPE at 2008 (In millions) Land $518 Buildings and Improvements 4,302 Leasehold Improvements 1,728 Computer Equipment and Software 4,475 Furniture and Equipment 1,521 Total PPE 12,544 Accumulated Depreciation (6,302) Net Total PPE 6,242 Sony Assets Amount of PPE at 2008 (In millions) Land $1,789 Buildings 10,205 Machinery and Equipment 28,058 Construction in Process 629 Total PPE 40,681 Accumulated Depreciation (26,632) Net Total PPE 14,049 Nintendo Amount of PPE at 2008 (In Assets thousands) Buildings and Structures $167,846 Machinery, Equipment, and Vehicles 17,346 Tools, Furniture, and Fixtures 60,722 Land 302,670 Construction in Process 2,920 Net Total PPE 551,504 Stability of Demand. Due to the fact that the video game console industry is still in the growth stage of the industry life cycle, the stability of demand is uncertain. Since higher growth encourages optimism, the companies may want to consider investigating into more suppliers in

13 order to match this demand growth. Therefore, the suppliers would need to invest in more capacity additions to meet the demand not Microsoft, Sony, and Nintendo. Product Differentiation. Inside this industry there is a great deal of product differentiation between the three competitors. Some of the distinguishing features include the physical looks of the console, the image quality of the games, and the ability to play other electronic media. For example, the Sony PlayStation 3 can play blue-ray disks and DVDs while the Nintendo Wii has the ability to sync up with your existing NetFlix account and allows you to watch movies on your playlist immediately. Since the three competitors all produce different features, this product differentiation factor also reduces the level of rivalry in our industry. Switching Costs. Switching costs for this business are relatively high for two reasons. For one, when a consumer wants to switch to a new system, they have to buy a whole new console and all of the necessary controls and accessories. The following diagram lays out all of the expenses that were necessary to buy the latest consoles introduced in 2006 and shows how expensive switching from one console to the other can be. 44 Figure 8: Switching Costs between Consoles in 2006 The second issue that arises with switching systems is the games that go along with it. Every competitor has their own games that can only be played on that specific system. Thus these two switching costs reduce the level of rivalry dramatically and encourage consumers to steer towards one particular system maker. Summary of Intensity of Rivalry. After taking all of the preceding factors into consideration, we can conclude the video game system industry has reduced rivalry which increase the potential for profits. The biggest factors that lead us to conclude this is there are only three main competitors in this industry making the herfindahl index high. Further, product differentiation leads to high switching costs associated with the changing consoles

14 Force 2: Availability of Substitutes. Recognizing a substitute product requires identifying products that perform the same function as the product of the industry. When an industry has a low threat of substitute products the result is that the industry appears to be more attractive which in turn increases profit potential. A high threat of substitute products has the opposite affect; the industry becomes less attractive and decreases profit potential. In April 2010, the video game industry suffered a 37% loss year-over-year. 45 Considering that overall sales of units sold have increased year-to-year, industry insiders are not too alarmed by this decrease. They believe the drop is related to the fact that the Easter holiday fell early in April. Easter is a popular buying time for the industry and analysts believe those sales probably occurred in the month of March. 46 However, industry analysts would be remiss if they didn t consider those lost sales might have gone to a substitute product. In analyzing the threat of substitute products for our industry, we will focus on the usage of personal computers as a video game console. We will also discuss the effect the Iphone/ITouch/IPad has had on handheld gaming devices. Finally, we will consider the switching costs associated with choosing a substitute to a video game console. Personal Computers. In 2003, according to the US Census Bureau, 61.8% of households had a computer. 47 In 2007, computer game software sales made up approximately 5% of the overall size of game sales. 48 In 2008, the Entertainment Software Association reported that computer game software sales totaled $701.4 million. 49 While this number pales in comparison to the $8.9 billion in game console software, it represents 10% of the overall size. 50 It seems reasonable to believe that a 5% growth in computer game software sales should make gaming on a personal computer a consideration by the industry as a potential substitute. Another consideration that could give PCs the potential to steal market share away from the gaming consoles is the recent announcement by Valve to release its Steam content delivery platform to Macintosh operating systems. 51 Previously the Steam platform was used solely for Windows machines. By expanding it to Macintosh-based machines, Apple computers will become a more viable option for gamers to consider since the Steam online distribution center will give Mac users several cross-platform benefits. For one, those who already own the Windows version of Valve games will receive the Mac version at no extra charge. Secondly, the Steam Cloud feature allows players to save games players have in-progress. Gamers can begin a game on their Windows based home computer and pick up where they left off using their Macbooks nintendo%20sales 46 nintendo%20sales

15 Also to consider, NetApplications reports that Apple s PC market share had reached 10% in 2008 while Window s market share during that same time period had dropped.94%. 52 At first glance, a 1% drop may not seem to alarming, but reports indicate that this was the steepest decrease Windows has suffered since NetApplications began tracking the data. Taking Apple s increases in market share into account, their chances for success as it relates to video games should be considered by the game console industry as a real threat. Handheld Devices. When the IPhone was originally released in 2007 no one considered the impact it could have on handheld gaming devices. Recent statistics, however, show that the IPhone is a force to be reckoned with when it comes to using it as a gaming device. Since July 2008, over 30,000 games have been released in the IPhone App Store. 53 By 2009, Apple was responsible for the sale of 19% of all portable game software, which is an increase of 5% from their 2008 numbers. 54 Apple is clearly taking market share away from Sony s PlayStation Portable and the Nintendo DS. While Apple s numbers have been rising, Sony and Nintendo have dropped. In 2009, Sony reported a 9% drop and Nintendo reported a 5% drop. 55 With the recent introduction of Apple s IPad, it is believed that the situation for Sony and Nintendo will worsen. Switching Costs. Determining the threat of substitution can also be done through analyzing the amount it would cost the consumer to switch to one of the strategic substitutes mentioned above. For the video game industry the cost to switch to a substitute product would be relatively low. Since a large portion of US households already own a computer and games are readily available on most computers via existing software or the Internet then a consumer could easily decide to just use their computer versus investing in a gaming console. Furthermore, consumers may be more likely to purchase an IPhone over the PlayStation Portable or the Nintendo DS because of the multiple uses the IPhone offers. Summary of Substitute Effects. It appears that the video game industry is certainly losing ground to substitute products. The efforts being made to make gaming on a personal computer more attractive will make a dent in the market shares of the big three video game console manufacturers: Sony, Microsoft, and Nintendo. Also, the recent introductions of the IPhone 4 and the IPad along with their multi-use platforms could persuade consumers away from handheld gaming devices. Further, consumers do not have to be overly concerned with the switching costs associated with choosing a substitute product. All of these factors make the overall threat of substitutions for the video game industry high, which makes the industry look less favorable and decreases profit potential. Force 3: Bargaining Power of Suppliers Supplier power refers to the ability for suppliers to exercise control over participants in an industry. When the bargaining power of suppliers is strong, industry profitability is negatively affected. There are several factors that need to be considered when the determining the

16 bargaining power of suppliers such as supplier size, concentration, substitutes, inputs, and the threat of forward integration. Supplier Overview. In this industry the suppliers handle all the manufacturing of the gaming consoles and some of the big ones are Foxconn, Flextronics, ASUStek. 56 The big three will provide the manufacturer with the design plan of the console and then it s up to the manufacturer to get them done on time in order to meet the intense demand of customers. They also will outsource for any hardware and software parts that go into the production of the consoles. Supplier Size. The suppliers in this industry are relatively large. Foxconn for example has been associated with manufacturing for Sony, Microsoft, and Nintendo as well as other big electronic companies such as Apple. Foxconn in 2008 reported nearly 62 billion in revenues and also has over 480,000 employees. 57 Supplier Concentration. The suppliers in this industry are very concentrated to ensure consistency with the manufacturing of the gaming console. This will allow a better relationship between the suppliers and the companies in our industry; however having concentrated suppliers could potentially decrease future profits. Supplier Substitutes. This industry tries to maintain good relationships with fewer suppliers because they want consistency in the production of their consoles. As mentioned before, the demand of these systems is huge which puts a lot of pressure on both the manufacturers and the big three. Importance of Supplier Input. The suppliers depend on the design offered by the big gaming producers like Sony, Microsoft, and Nintendo. The suppliers then manufacture the gaming console as well as provide feedback on how to be more efficient and cost effective. Threat of Forward Integration. Even though the suppliers have the manufacturing know how, we feel the threat is very low because Sony, Microsoft, and Nintendo have already established themselves as brand leaders in this industry. The cost to design a console as well as the games can get very expensive. Sony s Playstation 3 for example was first released in 2006 and it just broke even in The suppliers also don't have the design process nor do they know what the customers want. 58 Summary of Supplier Power. After taking all these factors into consideration, we can conclude that bargaining power of suppliers is high for this industry. Since Sony, Nintendo, and Microsoft outsource their manufacturing of consoles that gives a lot of power to the suppliers because they control the day-to-day production. The big three are depending heavily on their suppliers to have the consoles built to their specifications as well as having them done in time in order to meet the expected demand of future customers

17 Force 4: Bargaining Power of Buyers. Buyer power refers to the ability for buyers to exercise market power over sellers. When the bargaining power of buyers is strong, the industry profitability suffers. There are several factors that need to be considered when the determining the bargaining power of buyers such as buyer size, switching costs, availability of full information, and the threat of backward integration. Buyer Overview. Video game consoles are manufactured and sold to brick-and-mortar stores and online only retailers. Microsoft, Sony, and Nintendo do not sell directly to the consumer. On Sony s website, for instance, they list their products, but they state that their products are to be purchased through authorized retailers. 59 Consideration should also be given to the buyers of the product from the retailers. With all the new technology that is being integrated into the games, growth of players in every age group is expected to continue to rise. According to Jesse Schell, instructor of entertainment technology at Carnegie Mellon University There are games now for pretty much every age, every demographic. More and more women are going online. It comes down to everybody is playing games. Games are just evolving like species in order to fit into every little niche of our lives. 60 In 2009, 250 million video game units were sold in the United States alone. Buyer Size. The retailers selling video game consoles are some of the largest and most influential operators on the planet. Wal-Mart has tremendous control over their suppliers and vendors to get a low price. 61 Best Buy is the leader in electronic retail space. They have gained bargaining power with suppliers over the past few years due to retailers like Circuit City leaving the business. 62 If we do run into problems with the big box retailers, we have the ability to sell our products over the Internet or from other independent retailers which could decrease the bargaining power of the big box retailers. Switching Costs. Retailers will run into some switching costs between the industry suppliers. Many of the costs for the big box retailers will not be monetary in nature. However, there are also psychological and effort and time based switching costs to take into consideration. Switching between suppliers may mean different ordering systems, purchase agreements, and possible shipping standards. 63 Availability of Full Information. Basic information on different products in our industry will be available through trade groups, news articles, and key publications. However, the specific design plans are generally only made available to outsourced manufacturers. Threat of Backward Integration. We could have some threat of backward integration. Even though the industry requires a great deal of in house design teams and third party developers, a theesa.com companies+++industries a-recipe-for-companies-to-hold-customers-for-life/ 17

18 big box store like Wal-Mart could get someone to design a console for them. Large retailers have been known to produce private label items. These store brands are likely to cost less and have fewer features. Summary of Buyer Power. After taking all the preceding factors into consideration, we can conclude that the video game system industries buyers have substantial bargaining power. But, we must remember that factors change with time and company strategies. This can cause the power of buyers to rise and fall. If we would stop selling to big box stores for some reason, the buyers would not have substantial bargaining power over us since there would now be numerous independent retailers. Force 5: Threat of Entry Every industry has circumstances that create disadvantages for new competitors attempting to enter the market. According to Porter, new entrants bring new capacity, the desire to gain market share, and often substantial resources (Porter 7). When barriers to entry are high, then the threat of entry is low. Economies of scale, product differentiation, capital requirements, access to distribution channels, excess capacity, the learning/experience curve, government policy, and historical entry data are all aspects of entry that need to be analyzed for our industry. Economies of Scale. According to Porter economies of scale deter entry by forcing the entrant to come in at a large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage (Porter 7). Both of these scenarios are far from desirable. In the video game system industry economies of scale do play a role, especially since all production of the systems is outsourced. The best way to receive a discount from the suppliers is by the volume that is ordered. Product Differentiation. Each company in this industry is known for its own specialty. Nintendo is renowned for its touch screen on the DS and its motion sensing controls on the Wii. Sony is well known to have the best graphics on its PlayStation Portable (PSP) and the PlayStation 2 and 3 gaming systems. Microsoft s Xbox 360 is well regarded for having the best online gaming network. 64 There are many people who will only play one of these systems because they are partial to one of these specialties. A new entrant would have to invest in research and development in order to produce something that could potentially break existing brand loyalties. The following table represents the amount of money Microsoft, Sony, and Nintendo have put into research and development in Table 11: Research and Development Figures Microsoft Sony Nintendo Research and Development Spending $8.2B $5.882B $.37B

19 One important note to keep in mind with the preceding table is the fact that the figures for research and development are companywide. Since Microsoft and Sony operate multiple divisions other that just gaming, their R&D spending is a lot higher than Nintendo who is a purely gaming company. Therefore, Nintendo accurately portrays the amount of R&D spending that is necessary to compete in only the gaming industry. Capital Requirements. The majority of major capital expenses for this industry is in warehousing, office space and equipment, brand development, and research and development 68. We feel the most important cost considerations to be brand development and research and development. Overall, It is very difficult to estimate the capital requirements to enter this industry. The capital needed to enter would depend on whether the potential new entrant would want to just operate as a stationary console producer or if they would want to do both stationary and hand-held gaming systems. The one thing that is certain upon entry, if they want to be competitive they will have to invest a large amount of capital in research and development. As seen above, Nintendo spends nearly half a billion dollars in R&D annually. Access to Distribution Channels. Sony, Microsoft, and Nintendo use retailers as their distribution channel. Since retailers, both brick-and-mortar and online only retailers are abundant, the access to them is easy to obtain. The main consideration each company must have is to have a product that consumers want. As long as demand for the product exists in the market, the retailers will want to capitalize on it and purchase the consoles. Excess Capacity. Neither Microsoft, Sony, or Nintendo produce any of their consoles, but capacity can also be associated with product development and branding. As previously mentioned, these three companies put a lot of their resources towards research and development. This shows that they have to have a large amount of capacity to develop new products. They all also need excess capacity for brand development. In 2008 Microsoft, Sony and Nintendo spent $ billion, $6.902 billion and $1.14 billion respectively in selling and advertising expenses We can also look at the capacity needed for the companies that do manufacture their products. Foxconn, the major electronics manufacturer in the world, used to be the sole maker of the Xbox 360, the PlayStation 3 and Nintendo Wii. Then some other manufactures such as ASUSTeK and Flextronics began to realize opportunities in this industry. Learning/Experience Curve. The learning curve for this industry is steep. A company, like Microsoft, which has been in the industry for several years, is becoming more efficient with their research and development dollars. They spend less money to achieve the same technological advances that they have in the past. Because of this change, they are able to sell their consoles for less as time progresses

20 Figure 9: Learning/Experience Curve Video Game System Industry Cost Per Unit Video Game System Cumulative Volume Government Policy. The government does not regulate the video game industry very closely. However, with current interest rates being low entry into an industry is generally more appealing. A potential negative that may arise from government policy is that all of the manufacturers are based in Asia. Therefore, American or European company may have to pay a tariff on the systems that are made and shipped to them depending on the amount of imports already coming in from that specific country. Based on these finding government policy has little effect on this industry. Historical Entrants. Over the 43-year life of the industry, only seven competitors have entered into the industry. 73 The most recent new entrant into the industry occurred when Microsoft entered around ten years ago. 74 Currently, the concentration and size of the existing companies would make it difficult for a new company to enter and obtain a portion of the market share. We believe the most realistic threat of new entrants will come from already existing technology companies that want to expand their business portfolio. In the global business world, there are many other companies that could potentially fit this profile. Even if one of these technology companies have the money and know how to get started they may come to find that the opportunity cost of entering this well defined industry will be much higher than pursing other endeavors. Summary of Entry Threats. It appears that economies of scale, product differentiation, capital requirements, the learning/experience curve, and historical entrants are all factors that would discourage new entrants from coming to this industry. Capacity and access to distribution channels seem to favor new entrants and government policy seems pretty neutral. With all this considered we conclude that the threat of new entrants will be low for current companies in the industry

21 Five Forces Results: The following table summarizes our five forces findings. Table 12: Five Forces Summary Force Evidence Rating (+/-/0) Intensity of Rivalry Price-based rivalry (+) Non-price based rivalry (+) High concentration (+) High Herfindahl Index- (+) Specific Assets (0) Stability of Demand (0) Product Differentiation (+) High Switching Costs (+) (+) Threat of Substitution Usage of Personal Computers (-) Usage of Other Devices as Handhelds (-) Low Switching Costs (-) (-) Bargaining Power of Suppliers Outsource all Production (-) High Supplier Concentration (-) Importance of Supplier Input (-) Low Threat of Forward Integration (+) (-) Bargaining Power of Buyers Large Retailers (-) Low Switching Costs (-) Availability of Full Information (0) Threat of Backwards Integration (-) Threat of Entry Economies of Scale (+) Product Differentiation (+) High Capital Requirements (+) Access to Distribution Channels (-) Capacity Requirements (-) Steep Learning Curve (+) Government Policy (0) Historical Entry Data (+) (-) (+) Total Rating 1- Preliminary Assessment. By using Porter s five forces model, we find this industry to be a one minus industry. Strategic Map. For the strategic map, we decided to compare product quality and age of competitors. Both dimensions compared to each other really give a good idea of how the video game industry has evolved. As you can see by looking at the map, Nintendo first came out a while ago, however it continues to dominate this industry. For product quality we focused on current features and image quality of the different consoles. Sony got the highest mark for product quality solely because the PlayStation 3 has the ability to 21

22 play Blue Ray Discs. Microsoft and Nintendo are not far behind them especially with Nintendo s recent ability to offer NetFlix movies immediately. Sega fell around the middle of product quality with Mattel and Atari at the very bottom. For age of competitor we focused on each company s first major entry into the video game industry. Atari came into the industry in the mid 1970 s followed by Mattel s Intellevision in the early 1980 s. In the mid-80 s, Nintendo came out with its first video game console called the Nintendo Entertainment System (NES). After Nintendo, Sega introduced the Sega Genesis. Six years later Sony releases its first console, the Playstation. In 2001, Microsoft releases its first console called the Xbox. Figure 10: Video Game Console Industry Strategic Map High Strategic Map: Video Game Industry Competitors Microsoft Sony Nintendo Product Quality Sega Low Mattel Atari Young Age of Competitor Old 22