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Film Format Could Decide Console Battle

In a lengthy report on the state of the interactive entertainment industry Wedbush Morgan Securities predicts that more than the quality and quantity of the content for the next-generation video game systems, the deciding factor for most consumers will be the high-definition DVD format.

"In the past, we have relied on a thesis that the main driver of console hardware sales will be the quality and quantity of the underlying available content. This cycle, we think that there is an important new development that will impact console purchases: the format war between Sony and Toshiba for supremacy in high definition DVD manufacture," state analysts Michael Pachter and Edward Woo. "In our view, Sony's decision to allow Microsoft to gain a first mover advantage with the latter's 2005 introduction of the Xbox 360 was almost certainly the result of the former's desire to dominate the high definition DVD market, and this decision will either allow it to win the 'console war' or will allow Microsoft to sustain its first mover advantage."

The report continues, "Notwithstanding the efforts of all three console manufacturers to deliver compelling exclusive content, we believe that the ultimate outcome of the console wars will be decided by the motion picture studios. Should the studios embrace Sony's Blu-ray standard for high definition DVDs, we think Sony will gain an insurmountable advantage over Microsoft; should the studios embrace Sony rival Toshiba's HD-DVD format, we think that Microsoft can maintain its first mover advantage and will dominate software sales for years to come."

In the end, however, WMS believes that the PlayStation 3 will become the dominant console, primarily because WMS anticipates Blu-ray to win the format battle. That said, the Xbox 360 will remain ahead of the competition through 2007.

"We expect Microsoft's Xbox 360 to enjoy a first mover advantage for the next two years, capturing approximately 42% of U.S. and European combined next generation hardware unit sales through 2007. We forecast the PS3 and Nintendo's Wii to capture approximately 39% and 19%, respectively, of the next generation hardware market in this same period," state Pachter and Woo. "As consumers begin to purchase a second console, we think that market shares will normalize, with Sony capturing around 45% of the total market, Microsoft capturing 35%, and Nintendo capturing 20%. These estimates do not include market shares in Japan, which we expect to be dominated by Sony (65% through 2010) and Nintendo (25%)."

As important as the HD DVD/Blu-ray battle is, developing or securing intellectual property exclusives will still play a "wild card" role in determining hardware sales.

"Nintendo has a large advantage over its competition with a deep library of internally developed games/brands (e.g., Mario Brothers, Zelda, and Pokemon), all of which are likely to be offered exclusively on the Wii," states WMS. "Microsoft has developed both Halo and Halo 2 as exclusives on the Xbox, and is expected to deliver another installment for the Xbox 360. Its other exclusives have received good reviews, but have not driven sales of hardware to the same extent as the two Halo games, and the company has had some success in obtaining limited exclusivity (around six months) for certain games. Sony enjoyed a large first-mover advantage in the last cycle, with a handful of contractual exclusives (including the Grand Theft Auto games)."

"In the upcoming cycle, we expect the playing field between Sony and Microsoft to be more level, and think that Nintendo will have the largest library of exclusives," conclude Pachter and Woo.

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