MEMORANDUM
Subject: Video Game System Industry Analysis
Date: June 27, 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 are the industry that is going to be analyzed throughout this report. The scope[mwf1] is going to be the three major system producers[mwf2]: Microsoft, Sony, and Nintendo and only the newest systems available on the market. Not included in this analysis are the games that are played on the varying systems[mwf3].
Industry Classification. The North American Industry Classification System (NAICS) code for video game systems is 339932 titled Game, Toy, and Children’s Vehicle Manufacturing.[1] 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.[2],[3]Since Nintendo is not publicly traded in the United States, they are not classified under Yahoo finance, however are classified under other products in the Tokyo Stock Exchange.[4]
Output Description. The video game console[mwf4] is the product that defines this industry. 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.[5] These are not the only consoles still available on the current market, however, are the latest produced, 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.[6],[7] The following pie charts represent the geographic markets the video game systems primarily serve.[8]
Figure 1: Geographic Markets for Video Game System Industry as a Whole
A more specific way to breakdown the geographic scope of our industry is to break the preceding pie chart into individual competitors. The following series of pie charts represent the geographic scopes of Microsoft, Sony, and Nintendo individually.[9] An interesting observation is that the geographic breakdown of Nintendo is the same as the industry breakdown shown above.
Figure 2: Geographic Markets [mwf5]for Microsoft, Sony, and Nintendo Individually
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 as seen in the figure. [10]
Figure 3: Supply Chain Distribution[mwf6]
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 2008.[11] It is pretty obvious from the table that 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.
Table 1: Annual Output in Millions [mwf7]for the Three Competitors
Company / 2006 / 2007 / 2008Nintendo / 30.33m / 45.08m / 59.36m
Sony / 22.28m / 28.73m / 30.75m
Microsoft / 7.47m / 7.93m / 11.37m
Total / 60.08m / 81.74m / 101.48m[mwf8]
Market Value. The market value[mwf9] of the video game console industry has been growing very rapidly and is expected to continue this trend in the future. As of 2005, the estimated market value of the industry was $29 billion[mwf10]. Analysts predict that in 2011, the market value will have grown to $44 billion [mwf11]and will only continue to thrive[mwf12].[12]
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 and it will continue to grow in the future. The following timeline lays out the major breakthroughs that have occurred in this business and shows how video games have evolved over the last 43 years. [13]
Figure 4: Video Game System Timeline
Industry Life Cycle.Since the video game system industry has been around for a while and still continues to evolve and grow, it is practical that they are in the maturity stage of the product life cycle. As noted earlier in the timeline, this industry probably peeked in the maturity stage in 2006 when the following games were all introduced around the same time: Sony’s PS3, Microsoft’s XBOX 360, and Nintendo’s Wii. [mwf13]The follow diagram represents the four phases in the industry life cycle and highlights visually where the video game system industry lies.[14]
Figure 5: Industry Life Cycle
Competitors. As noted in earlier sections, there are three 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 is based in Kyoto, Japan[mwf14].[15],[16] Microsoft was founded in 1975, Sony in 1946, and Nintendo in 1889 originally as a playing cards company by Fusajiro Yamauchi.[17],[18]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.[19]
Figure 6: Market Share of the Six Leading Video Game Consoles in 2008
When combining the market shares of the consoles [mwf15]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[mwf16].
Table 2: Video Game System Industry Revenues
Worldwide video game industry revenues(in billions)
Year / Revenues / % Change
2005 / 29.00
2006 / 31.60 / 8.97%
2007 / 41.70 / 31.96%
2008 / 54.00 / 29.50%
This chart shows worldwide video game industry sales from 2005 through 2008. We felt like this was a very important piece of information because it clearly shows how this industry has changed over the years. As you can see, revenues have been significantly increasing and we believe that they will continue to increase for years to come[mwf17].[20]
Table 3: Number of Employees for the Gaming Industry
U.S. Video Game Industry EmployeesYear / Employees / % Change
2006 / 24,000
2007 / 39,700 / 65.42%
2008 / 44,400 / 11.84%
This second chart shows U.S. video game industry employment from 2006 through 2009. As you can see as well here, there has been a significant increase in jobs in this industry especially from 2006 to 2007. We feel that these numbers will continue to increase which is great for the industry, but even greater for the U.S. as unemployment continues be a major economic issue in our country[mwf18].[21]
Key Trade Groups. The Entertainment Software Association (ESA) is the U.S. association 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 15-17 in Los Angeles. If you go to e3expo.com, you can check out their reviews for new Microsoft, Sony and Nintendo games that were just released, as well as trailers and much more.[22]
Key Trade Publications[mwf19]. 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.[23] Game Developer is a monthly trade periodical and is distributed to approximately 35,000 readers.[24]
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.”[25] Many times organizations are mutually dependent of [mwf20]each other, meaning competitive tactics performed by one firm have highly noticeable effects on their close competitors, thus this may spark efforts to counter the move (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 CR4, the concentration ratio of the 4 largest firms, 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 prices of video game systems are decreasing. This is typical for this industry, because when a new system hits the market it is priced incredibly high due to consumers’ excitement about the newest product innovation. 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 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 2008.[26],[27],[28]
Table 4: Prices for PS3, XBOX 360, and Wii from 2006-2007
YearSystem / 2006 / 2007 / 2008[mwf21]
PS3 20 GB[mwf22] / $499 / $450-$349 / $349-$299
XBOX 360 20 GB / $299 / $280 / $249
Wii / $249 [mwf23] / $249 / $249
An important note to make is that 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 the fact that every retail store offers different prices depending on whether or not they are offering discounts, so the prices listed above are just an estimate of what the consoles were going for on average during that three year period. Notice that the price of the Wii remained pretty 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.”[mwf24][29]
Non Price-Based Rivalry. The main non price-based rivalry occurring in this industry is product innovation. Each producer wants their product to be 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 order to compete with Nintendo’s Wii[mwf25].[30] As in all industries, quality improvement is also a major non priced-based rivalry tactic used by video game system makers in order to ensure consumers are fully satisfied with their end product.
Industry Concentration. As displayed in the following table, concentration for the video game system industry is very high.[31] Since this is only a three company industry, it is impossible 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 5: Amount of Video Game Systems sold in 2008 for the Three Competitors
Company / Units Sold (in millions) / % Share of Units SoldNintendo / 59.36 / 0.59
Sony / 30.75 / 0.30
Microsoft / 11.37 / 0.11
Total / 101.48 / 1
Herfindahl Index: 4,502
Herfindahl Index= 10,000 (ΣSi2)
= 10,000 (.592 + .302 + .112)
= 4,502
Specific Assets. Given that all video game system production is outsourced[mwf26], there is no need for the companies in this industry to possess a large amount of specific assets. The firms, however, do have regular operating assets[mwf27] such as warehouses to store the finished products before they are shipped, office space, and knowledgeable employees to keep the business operating.
Stability of Demand. The stability of demand for this industry is high and is forecasted to continue to grow in the future. According to a series of new reports from DFC Intelligence, “The worldwide video game and interactive entertainment industry is expected to grow from about $29 billion in 2005 to as much as $44 [mwf28]billion in 2011. This forecast includes revenue from video game hardware and software, dedicated portable system hardware and software, PC games, and online PC and console games.”[32]Capacity additions will not be necessary for this expected growth in the coming years, because all production is outsourced[mwf29]. The companies will, however, need to consider investigating into more suppliers in order to match this upcoming demand.
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, whereas, the Nintendo Wii cannot. Since the three competitors all produce different features, this product differentiation factor also reduces the level of rivalry in our industry.
Buyer Switching Costs.Switching costs for this business are relatively high for two reasons. The biggest switching cost to consider is the fact that 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 that go along with the new system. 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.[33]
Figure 8: Switching Costs [mwf30]between Consoles in 2006
The second issue that arises with switching systems is the games that go along with it. Competitors have 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 that the video game system industry has reduced rivalry, and thus based solely on this single force, has the potential for increased profits. The biggest factors that lead us to conclude this is the fact that there are only three competitors in this industry making the herfindahl index really high, the fact that product differentiation exists, and the high switching costs associated with the changing consoles[mwf31].
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.[mwf32][34] The question to ask becomes did a portion of that lost market share go to a substitute product? In analyzing this question, 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.[35] Further, the Entertainment Software Association has reported that computer game software sales totaled $701.4 million.[36] While this number pales in comparison to the $8.9 billion in game console software, [mwf33]it has the potential to become a real threat should the industry begin to shift.[37] One such factor 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.[38] 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 [mwf34]for gamers to consider. Considering Apple’s recent increases in the market share of personal computers[mwf35], in particular premium priced units, their chances for success as it relates to video games should be promising.