Video Game Console Industry Analysis 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 339932 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.5 1 http://en.wikipedia.org/wiki/List_of_best-selling_game_consoles#Atari 2 http://www.census.gov/cgi-bin/sssd/naics/naicsrch 3 http://finance.yahoo.com/q/in?s=MSFT+Industry 4 http://finance.yahoo.com/q/in?s=SNE+Industry 5 http://www.tse.or.jp/english/ 1 Video Game Console Industry Analysis 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. 6 http://en.wikipedia.org/wiki/Video_game_console 7 http://en.wikipedia.org/wiki/Video_game_console 8 http://gamrfeed.vgchartz.com/story/2752/totals-statistics-and-analysis-of-the-2008-world-videogame-market/ 9 http://finance.yahoo.com/ 10 http://www.nintendo.com/ 11 http://gamrfeed.vgchartz.com 2 Video Game Console Industry Analysis 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 Manufacturing Storage and Retail Customers and Design and Production Warehousing -Business to -Business to Business sales Consumer -Hardware R&D -Mass Production -Ship back to -Prototyping by Suppliers be stored (Retail Stores sales -Product Testing -Electronic -Marketed to and Online -Individual Packaging and Distributors Stores) consumers Final Assembly - purchase the Microsoft Microsoft systems Sony Foxconn Sony Wal-Mart Nintendo Flextronics Nintendo Best Buy ASUStek Game Stop 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 2008.13 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 three- year span, Nintendo has produced and sold substantially more consoles than Sony and Microsoft which follows the information found earlier under the geographic scope. 12 http://mosaic.cnfolio.com/M528Coursework2008A108 13 http://gamrfeed.vgchartz.com 3 Video Game Console Industry Analysis Table 1: Annual Output in Millions for the Three Competitors Company 2006 2007 %YOY 2007 2008 %YOY Nintendo 30.33m 45.08m 48.63% 45.08m 59.36m 31.68% Sony 22.28m 28.73m 28.94% 28.73m 30.75m 7.03% Microsoft 7.47m 7.93m 6.16% 7.93m 11.37m 43.38% Total 60.08m 81.74m 36.05% 81.74m 101.48m 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 1967 The first video game console was called the brown Magnavox begins production of the first 1972 box and was designed by German born Ralph Bare commercial video game console, The Odyssey. 1975 Atari sells the first home version of Pong. Atari releases the 2600 SPACE VCS. This is the first console that can play multiple games. 1977 1980 Mattel releases the Intellevision to challenge The Nintendo Entertainment System is released in 1985 Atari. the U.S. 1989 Nintendo introduces the first Game Boy. Sega also introduces the Sega Genesis. The Super Nintendo is released. 1991 1995 Sony releases the PlayStation 1. Nintendo 64 is released marking the last console to use cartridges. 1996 1999 The Sega Dreamcast is introduced by Sega. Microsoft enters the video game system industry 2000 Sony releases the PlayStation 2. with their introduction of the XBOX. 2001 2002 Nintendo releases the new Game Boy Advance. The Nintendo DS is released. 2004 Sony releases the PlayStation Portable (PSP) to Mass release of the Nintendo Wii, Sony’s 2005 challenge Nintendo’s dominance in the PlayStation 3, and Microsoft’s XBOX 360. 2006 handheld gaming market. 14 http://www.time.com/time/covers/1101050523/console_timeline/ 4 Video Game Console Industry Analysis 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 2011.”15 From 2005-2006 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 2006. 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 percent of overall revenues and profits that come just from gaming for Microsoft.21, 22 15 http://www.theesa.com/gamesindailylife/economy.asp 16 http://www.theesa.com/gamesindailylife/economy.asp 17 http://www.12manage.com/images/picture_product_life_cycle.gif.