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TECH TALK: Tech@Enterprise: Creating a Virtuous Cycle: Gaming Consoles

November 13th, 2001 · No Comments

On the face of it, gaming consoles and next-generation wireless services may have little to do with increasing the penetration of technology in countries like India. But, as we will see shortly, they make an interesting proposition to customers – and have been hugely successful.

The video industry (including hardware and games) was worth USD 15-20 billion in 2000. The market size has tripled over the last decade. The worldwide installed base of consoles is about 120-140 million, which means that there is still plenty of room of growth. (By comparison, there are about 500 million PCs and 1 billion cellphones). The video game console is also seen as a Trojan horse: at the centre of a digital (and Internet-enabled) home entertainment system.

What gaming consoles like Sony’s Playstation, Nintendo’s Gamecube and the soon-to-be-launched Microsoft Xbox do is offer the base product at below cost-price, hoping to recover the money over time through sales of video games and royalties (from other game makers). For them to succeed, they have to build a virtuous cycle: first build an installed base of consoles, thus attracting the best game developers (the software), thus hoping to lead to an increasing base of users. The hardware (the game console) is the razor, while the video games are the blades.

Take Microsoft Xbox, for instance. The Xbox is as powerful a machine you can get in the home (an Intel 733 Mhz Pentium III processor, 64 MB memory, a 250-Mhz graphics processor, 256 audio channels, a DVD, a hard disk and a high-speed connection to the Internet). The Xbox is being sold at USD 299, which means Microsoft stands to lose about USD 125 on every box. In this market, Microsoft is the upstart, fighting Sony and Nintendo who have years of experience and an installed base running into tens of millions.

What makes Microsoft prepared to lose hundreds of millions of dollars in selling consoles (even without taking the account the USD 500 million marketing blitz)? The answer lies in understanding the business model of the video games industry. Writes Henry Blodget of Merrill Lynch (March 6, 2001):

The video game business has a virtuous cycle that is similar to the one in Microsoft’s core desktop O/S software business. An analogy can be drawn between the two business models:

Initial sales of operating system software (video game consoles) create an installed base that attracts third party application (game) developers. The availability of these third party applications (games) increases the value of the operating system (console), driving further sales of the operating system (console) and further growth in the installed base, which attracts even more third party application (game) developers, and so on.

More simply, the virtuous cycle for video games can be stated as follows: Xbox sales drives growth in the Xbox installed base, which attracts more 3rd-party game developers to the Xbox platform, which increases the number of 3 rd party games for Xbox, which makes Xbox more attractive to consumers, which leads to more Xbox sales, and so on.

Before we look at how ideas from the video games business can be applied to enterprise technology, we will take a look at the approach used by NTT Docomo’s i-mode to build an incredibly successful mobile Internet business in Japan.

Tags: Tech Talk

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