Microsoft Shows How to Make Video Game Consoles Profitable While It is Game Over for Atari

“With Kinect, Microsoft may have found something unexpected – a long forgotten arcane recipe of how to make the business of making video games consoles profitable. Ever since the company first ventured into console business with original Xbox in 2001, it had to count on other divisions to finance the loss making video games segment. They were not alone. Sonywas also routinely making losses with its PlayStation, and only Nintendo seemed to know how to turn a profit in this industry. Yet, the last two years of the current console cycle may have offered a hint for what’s been missing all along–gadgets!

While some key players of the video games industry are busy preparing for the anticipated launch of the next generation consoles, long forgotten Atari filed for a bankruptcy in the US on 21st January. The firm was one of the original gaming pioneers, producingmclassic titles such as Pong, Asteroids and Centipede. It’s not the first time Atari goes bankrupt  – the original company went bankrupt in 1984 following the 1983 video games industry crash, and has been subsequently split and acquired. However, Atari bankruptcy still comes at symbolic time when some analysts question whether the next gen cycle could be the last.”

Kinect

Kinect lifts Microsoft sales in the last two years of the console cycle

What makes Kinect so likable from the business perspective is how it lifted Microsoft’s video games sales in the last two years of the current console cycle. Kinect launched in the fall of 2010, immediately giving Microsoft a strong boost over the closest rival – Playstation 3. In 2009, Playstation seemed to be catching with Xbox in terms of units sold in Microsoft’s home market – the US. Playstation 3 sold 4.3mn units, below 4.8mn of Xbox 360- but the momentum was clearly on Sony’s side. However, Kinect launch clearly turned the tides in Microsoft’s favour, giving it a very comfortable lead again.

Xbox and Playstation Unit Sales in the US


Xbox and Playstation Unit Sales in the US

Source: Euromonitor International

The last two years of the console cycle may well hold the key to profitability of a console. Console manufacturers typically run massive losses in the first few years following the launch, due to R&D costs and the fact that most tend to sell their products below cost initially in an effort to establish market share. Typical range of losses runs in the billions during the first years.  After such heavy initial outlays, consoles typically become profitable during 3rd-4th year, as manufacturing costs run down and software royalties continue to come in.  As such, strong sales at the end of the generation lifecycle play a crucial role in profitability.

Kinect – technological breakthrough or well fitted consumer niche

With non-core gamer demographic expanding and more females and adults playing video games, gadgets may well be the answer how to sustain console sales. Kinect itself was most likely pre-destined to support Microsoft’s next gen console, but the co-incidental decision to launch it towards the end of the current cycle, likely a reaction to Sony launch of Move, was certainly a good step forward.

% of Adults (Population Aged Over 20) playing video games

ScreenHunter_16 Jan. 25 10.10

Source: Euromonitor International

Kinect wasn’t just a product led by an advancement of remote sensing technology. Microsoft saw the niche behind it from the very beginning and invested heavily. Its launch was supported by US$500 million marketing campaign and Microsoft also pushed developer kits to have more games available for Kinect – an area that Sony forgot.   Effectively, Microsoft did what Nintendo used to do best before – count on gadgets to win the sales, software exclusives are not enough.

Perhaps the industry has outlived the technology driven phase, where video games closely followed hardware innovation, and any new gadget had to justify its existence through close examination of specs. Companies that continued to innovate on the consumer trends happened to be among the most successful last year – Skylanders  from Activision Blizzard is a good example. Other companies like  Atari and THQ, ran out of innovation and now face the consequences.