Graduate School of Business Administration University of Virginia Brad Verde and the Microsoft X-Box On September 15, 2001, Brad Verde, a recent graduate of a top ten business school, sat at his desk playing with his wedding ring and sighing. While he was glad to be finally finished with his MBA program, he missed the discussions he had enjoyed with his classmates. In particular, he was reminiscing about an E-Business II class he took during his second year at B-School. Brad had just started a job at Microsoft in the X-Box product development Group. Software giant Microsoft had only recently announced in March 2000 their decision to enter the lucrative multi-Billion dollar video gaming industry. As the only freshly-minted MBA in the venture, the task of creating an Internet strategy fell to Brad. He was charged with developing a message to attract potential gamers to the X-Box. Microsoft’s X-Box had greatly enhanced features over the reigning titans of the video game console industry, Sony. It had “movie quality” 3-dimensional graphics, and most importantly, connection to high-speed Internet Services that would allow users to take part in Multi-player games as well connect to the World Wide Web and send and receive e-mail Brad scratched his head and wondered if could get in touch with one of his E-Business II professors. The Video Game Console Industry. According to industry analysts, the video game console industry generated over $15 Billion world wide.1 Since the popular inception of Atari and others in the late 70’s and early 80’s, video games had achieved a significant market presence. In 1998, the “big three” console manufacturers, Nintendo, Sega, and Sony, had achieved a remarkable penetration of 38% of U.S. households vs. 49% for Personal Computers.2 In theory, video game consoles were very similar in nature to their PC counterparts. With graphical user interface devices (controllers), CPU boxes (the console itself), and separate display monitors (television), it was believed that the differences between the two would become blurred in the future. According to Don Coyner, director of marketing of the newly formed Microsoft gaming division, “The PC and Xbox are complimentary devices. Currently, there about 29 million console players, 11 million PC game players, and 7 million who play both…The consumer pool is large enough for multiple companies to do well.”3 Robbie Bach, vice president of Microsoft’s Home & Retail division, further commented, “Our success in PC games has afforded us the opportunity to invest more into PC game[s] and extend our efforts into the entertainment hub of the home—the living This case was prepared by Brian T. Green, Darden 01’(hopefully.) All rights reserved. This case was not written to describe inefficiencies in Strategic Planning, rather it was meant for Mr. Green’s final E-Business II paper submission. Any questions regarding this submission should be addressed to [email protected]. BTG-EBII886-1213 room.”4 Once dominated by the television, the definition “living room” entertainment had changed to include PC’s and the Internet. The ubiquity of the Internet had begun the change gamers’ expectations on what exactly a video console was supposed to do. As a result the “big three” console manufacturers, Nintendo, Sega, and Sony were in various stages of launching the next generation of Video Game Consoles. Nintendo: With the Nintendo 64-bit N64 Game Console and the hand-held Game Boy and Game Boy Color, Nintendo had had a banner year in 1999 with greater than $4.8B and a 1yr sales growth of 19.7%.5 Firmly entrenched as the number two player in the industry, Nintendo was the only one of the “big three” that did not currently use the cheaper CD- ROMs as the game media for its system. Instead they used game cartridges, which had become all but nonexistent since the mid-1990’s. Still with outside software licensing agreements with gaming software giants Electronic Arts and wildly popular titles like Super Mario and The Legend of Zelda, they held a firm grip on roughly a third of the U.S. market.6 Originally scheduled for December 2000, Nintendo was in the process of preparing its next generation console for launch in the U.S. for the Christmas 2001 season. With the successful recent launches of new consoles by its two main competitors, Sega with the Dreamcast in 1999, and Sony’s Playstation 2 in 2000, Nintendo was under severe pressure to maintain its current market position with its new console, the Dolphin. Both the Dreamcast and the Playstation 2 offered significant upgrades over the N64’s 64-bit memory, including memory-processing speeds of 300Mhz as well as Internet connections. Additionally, the PS2 also doubled as a DVD player, acting as “Trojan” horse to enter gaming enthusiast’s living room entertainment centers.(Exhibit 2) With all of the recent hype and media blitz surrounding the two recent launches, Nintendo had decided to shroud the Dolphin in secrecy, choosing instead to build demand through curiosity. A recent MSNBC article had indicated some of the new features of the Dolphin would include 128-bit processor, DVD capabilities, and an Internet connection.7 Just recently Nintendo had announced a strategic partnership with IBM in the development of the Dolphin.8 While it was expected to be part of the Dolphin product launch media blitz, how Nintendo planned to use the Dolphin’s Internet connectivity abilities remained largely uncertain. Sega: Once the dominant player in the industry, Sega was a distant third among the big three console manufacturers with only $2.2B in sales in 1999.9 In the early to mid 90’s Sega led the industry with its Genesis and Saturn consoles. All of that changed once the Sony Playstation hit worldwide markets in September 1995.10 Since that time the only words associated with Sega were complete market capitulation. The Saturn had approximately the same specifications that the Playstation did with two 28.8MHZ, 32 bit Hitachi Sh2 CPU’s. (Exhibit 1) However the color resolution was much better on the 2 BTG-EBII886-1213 Playstation with 640x480 pixels with 24-bit true color as opposed to320x224 pixel with 24- bit true color on the Saturn. Better color resolution meant there was more flexibility for game developers to write more creative and exciting games for the Playstation. Better games heightened the gaming experience for enthusiasts, which ultimately led to the defections from Sega to Saturn. Ironically, Saturn was the first home video game to provide an accessory for Internet connectivity. (Exhibit 1) However this feature had remained largely underutilized. Faced with an ultra-competitive market place, Sega decided the only way to regain market leadership was to develop a technologically superior product that was able to expand the definition of console gaming through the use of the Internet. Sega’s new console, the Dreamcast launched in September 1999 with a 56kbps modem embedded in the console rather than add on accessory as with the Saturn. Just prior to the Dreamcast’s launch, Sega signed AT&T as the preferred Internet service provider for their consoles.11 They planned a joint marketing venture for the service, which they branded as the “Sega Dreamcast Network.” Monthly charges to each subscriber were $9.95 for 10 hours, $19.95 for 150 hours, and $21.95 for unlimited services.12 However the partnership was fraught with setbacks over transmission speeds and online game launches. Sega switched network partners to GTEI and Sega announced plans to launch a separate online gaming company called SegaNet in November of 2000.13 While some industry analysts indicated that while Internet access was a necessity for console viability in the industry, it was not clear if it would be a defining competitive advantage. Gary Gabelhouse, CEO of Video game industry watcher, Fairfield Research Inc. indicated, “Sega having Internet access with their game machine is not a platform maker. However, it could be a platform breaker if they didn’t have it.”14 Actual sales seemed to support this with 2 million users in May of 2000 with an estimated 4 million more by May 2001 as opposed to 23 million Sony Playstation users and Nintendo N64 users.15 Further, the Playstation 2 was backward integrated such that all of the original Playstation games would be compatible with the Playstation 2. Sony Sony’s PlayStation was the reigning king of the industry. With an installed user base of 23 million users and well over 1500 game titles, Sony had achieved unprecedented success in the video game industry.16 Not resting on its laurels as the dominant market leader, Sony planned to ensure its leadership with its next generation console, the PlayStation 2. The Playstation 2 was a gamer’s paradise. The key feature of the PS2, its CPU had a 300MHz Emotion that had twice the performance of a Pentium III-700. This allowed the PS2 to drive 3D games with graphics power unheard of on conventional PC’s at a fraction of the cost.17 Other key attributes included backward integration of original PlayStation games, a vast potential for upgrades with USB and broadband internet ports, and DVD compatibility.18 Anticipated upgrades in the near future were a keyboard, a mouse, a hard drive, and a Sony Broadband Internet Service.19 3 BTG-EBII886-1213 The October 2000 launch of the Playstation 2 was frenetic. On October 26, 2000, the initial 500,000 console shipment to the U.S. sold out on the first day.20 Jack Tretton, spokesman for Sony Computer Entertainment America, commented, “We’re talking about $400 million in retail revenue in a matter of hours in software and hardware.