For the past ten years Sony Computer Entertainment (SCE) has been the king of the video game market. The first PlayStation (PSOne) and PlayStation 2 (PS2) platforms were THE platforms on which the leading third party publishers made the majority of their revenues. For third party publishers other game platforms had become of secondary consideration to the Sony driven gravy train. Even in 2006, the PS2 continues to sell the most units at retail.

DFC Intelligence has always said that as the dominant market leader, SCE was largely in control of its own fate. Microsoft and Nintendo had to hope Sony fumbled or significantly changed its strategy so that they could get an opportunity to capture some of that PS2 audience. Now it is clear Sony is handing its competitors a golden opportunity.

DFC Intelligence has just released a 600 page report with our latest forecast for the interactive entertainment industry. In this report we predict several different scenarios for the individual game systems. We emphasize that there is a great deal of uncertainty because much will depend on how individual players execute their strategies over the next several years. However, two things are clear: 1) the high price of the PlayStation 3 is going to slow overall industry growth, especially for software and 2) if Sony does not change its current strategy for the PS3 the system will probably end up in third place in installed base. Microsoft and Nintendo have been handed that golden opportunity and both companies have a chance to make their systems the market leader. However, it looks like under any scenario the video game market is going to be severely fragmented, with several incompatible platforms having strong market share and even the possibility of a platform doing well in one region and struggling in another.

As we have mentioned in past briefs, the big concern with Sony is not only the PlayStation 3 launch price, but the signs that Sony has gotten itself into a business model that is not conducive to the mass market video game audience. There has been a lot of talk about positioning the PS3 as not just a video game system, or even entertainment system, but instead as a computer system.

In fact, SCE chief executive Ken Kutaragi told Japanese computer magazine PC Watch in June 2006 that the PS3 is a computer, not a game console. Kutaragi was quoted as saying "we don't say it's a game console, the PS3 is clearly a computer unlike PlayStations so far." In other words, Kutaragi no longer sees the PlayStation brand centered on a specific hardware configuration that has a life of five to seven years, during which time that hardware is steadily reduced in price as production becomes more efficient. Kutaragi views the PS3 as a computer platform that evolves with new features and capabilities on a constant basis. Kutaragi was further quoted as saying "Since PS3 is a computer there are no 'models' but configurations. We'll want to upgrade the hard drive size very soon. If new standards appear on the PC, we will want to support them. We may want the Blu-ray drive to write. In the PC business, if you fix the spec for two years you'll be caught by competitors. Computers should be changing, right? It's inevitable that 60GB hard drive will become too small, and memory may become too small as well."

The problem with that computer strategy is that it means prices do not come down. By fixing its hardware standard for several years, video game console systems have been able to significantly lower prices over time by not having to upgrade to the latest technology. Kutaragi has also talked about what he sees in common between the PS3 and current Apple Computer philosophy and products. There is clearly a little envy behind such quotes from Kutaragi like: "If Mr. Jobs adds an Apple logo to the PS3, I think users will say it can be sold at $2,000. However it's not possible for the PlayStation brand. That is the difference in the computer world between the PlayStation brand and the Apple brand."

We would point out that another major difference between Apple and the PlayStation brand is that the PlayStation 2 had a share of over 60% of the video game console market, while Apple's computer market share has hovered in the 2-3% range. We believe that under Kutargai's techno-elite PlayStation 3 strategy, the PlayStation 3 could end up with a market share more resembling Apple products as opposed to the dominant PlayStation 2 market share.

In other words, we think that for the PlayStation 3 to maintain Sony's number one market share position, Sony will have to shift the current stated strategy of SCE. It should be remembered that SCE is only one part of the much larger Sony Corporation entity. Ten years ago SCE was a non-factor for Sony overall, but the video game business has now become very important. Over the past five years, SCE's video game business has averaged about $7.4 billion in annual revenue and brought in average annual operating income of around $500 million. Can Sony afford to lose this video game business in order to go after the smaller base of elite consumers?

Right now the PlayStation 3 could be considered a relatively inexpensive part of a household looking to go to a high definition system. Consider this mid-level high-definition home theater budget:

High-definition television: $2,500
Stereo Receiver: $600
Speakers: $1,200
Cables: $400
Installation and Calibration: $1,000
Movie/CD/Game Player: $600

Under this budget, a PlayStation 3 is a fairly small line item in what is a $6,000+ take out a home equity line of credit project. Kutaragi is right, for this consumer the PS3 is a bargain. However, we must ask how big that consumer base is and if these are the type of consumers shopping for bargains. Furthermore, when we are talking about Sony's video game base we are looking at a worldwide business. Consumers in markets like Europe lag behind the U.S. when it comes to spending thousands on a new home entertainment system.