In a 92-page report initiating its coverage of the video game industry, UBS Investment Research outlined its views on the sector and provided forecasts for the big three console makers.

Analyst Benjamin A. Schachter said that ultimately, it's all about the games. It obviously sounds simple, "but history is rife with examples showing just how difficult this seemingly simple goal can be to achieve," he said. Now that the three new consoles have been on the market for a while, what it comes down to is providing great content to drive the respective platforms. This is especially key to Sony's PlayStation 3, which has had a bumpy ride in its early life.

Schachter is concerned that if things don't shape up for the PS3 in the near future, that it could hurt the top publishers and retailers in the sector. "The weak launch of the PS3 may be rectified by price cuts and new drive titles, but there is no guarantee. If PS3 continues to disappoint, it could impact the entire group," he said. "We think Sony needs not only to make a price cut, but also buy or develop 'must have' exclusive content in order to drive hardware sales."

That said, Schachter believes the PS3 will be just fine, just not as dominant as the PS2. By 2010, he forecasts that the PS3 will have sold over 21 million units in the U.S., just slightly behind the Xbox 360 with over 22 million, but ahead of the Wii (nearly 19 million). In Europe, the numbers by 2010 are also expected to be fairly balanced: 14 million for PS3, 15.5 million for 360, and 12.5 million for Wii. Interestingly, in Japan he believes the discrepancies will be far greater. By 2010 in Japan the 360 will have sold 900,000, but it's the Wii that dominates with 20.5 million compared to the PS3's 11.7 million.

On a worldwide basis, Schachter believes the Wii will slightly out pace the PS3, 51.9 million vs. 47.2 million. The 360, he predicts, will come in third globally with 38.9 million.

Looking at the state of the industry in this new cycle, Schachter also pointed out that strong first-party lineups could end up hurting third-party publishers. "We are concerned that first-party strength this cycle may come at the expense of third-party publishers. A key to the successes of many publishers during the last cycle was market share gains at the expense of the first-party publishers. We are concerned that this cycle may revert back to greater share gains for the first-party publishers, particularly as Nintendo rebounds and Microsoft focuses on and improves its AAA titles," he explained.

A positive for publishers, however, is that Schachter expects higher MSRPs to stick, and other revenue generators (e.g. advertising, online gaming, downloads) should become more important. "We think the AAA price point shift from $50 per game last cycle to $60 this cycle will hold. We also think that online gaming, advertising, and mobile will become increasingly important throughout this cycle," he said. "Whereas during the last cycle, it always seemed as if these ancillary revenue streams were five years away, we think within three years, the industry will begin to see meaningful revenue from each of these areas."

Although consoles are booming, Shachter is not very optimistic for the PC gaming market. "PC gaming has been declining in importance over the past few years as sales have been falling about 10%-15% per year in the U.S. (though sales leveled out in 2006). Aside from high profile hits such as the Vivendi's MMORPG super hit, World of Warcraft, there have simply been fewer drive titles. As the console gaming experience continues to improve versus PC gaming, we expect continued slow growth in the PC space," he predicted. "With Internet connectivity growing among the consoles, better graphics, and access to large HDTV's, there are fewer areas where PC gaming can offer consumers a superior experience. At the end of the day, there will likely always be a market for PC games, but we do not look at the PC market as a growth driver."