Will Sony's Pricey PS3 Pay Off?

The Japanese giant hopes to duplicate the success of the earlier versions. But critics contend that the $600 price tag could cost Sony big

Bring up the PlayStation 3 with Sony Chief Executive Howard Stringer, and you're likely to see the genial Welshman's face get even redder than its usual scarlet hue.

Ever since Sony announced the $600 price tag for its next-generation video-game console in May, Stringer and his team have been busy deflecting criticism from analysts and hard-core gamers that the PS3, despite glitzy features such as a Blu-ray disc, is just too darn expensive. Potential buyers, say the critics, won't be impressed enough to haul one to the checkout counter.

That might not be such a big deal if Sir Howard & Co. didn't have such grand ambitions for the PS3. But Sony (SNE) has tied nearly every piece of its expansive operations—movies, music, chips, and high-definition television—to the console's success. The company plans to use the console as a Trojan horse to dominate the living room and, by extension, much of the entertainment industry.

The machine will have an Internet connection to let users send instant messages, talk to other PS3 gamers, and surf the Web on a built-in browser. And its hard disk and slots for plug-in memory cards will make it a cinch to sift through and play downloaded music or movie files—and allow Sony to funnel buyers toward its vast library of games, films, and music.


  One troubling sign already indicates that the PS3 might not be quite the hit Sony expects. Game makers are steering development resources away from Sony and toward games for machines from Microsoft (MSFT) and Nintendo, says Hirokazu Hamamura, president of Enterbrain, a game-industry researcher in Tokyo. At its autumn games preview on July 13, for instance, traditional Sony ally Electronic Arts (ERTS) spent far more time showing off innovative Nintendo games than it did titles for the PS3. EA announced six Nintendo Wii launch titles and showed long working demos for two of those. But it offered only a short clip of a car-racing game for PS3. EA says it's still testing the potential of the PS3. "Many developers think the console's initial high price will lead to slow sales and are holding off on creating games for Sony," Hamamura says.

As the PS3's worldwide launch in November approaches, some are even predicting that Sony will lose its title as the undisputed king of console makers. Sony's 70% market share could fall by anywhere from 20 to 50 points, figures market research firm DFC Intelligence. Such a decline would be a strong boost to the only other serious players in the business, Microsoft (with 16% market share) and Nintendo (13%). "There is going to be a shakeup in the video-game industry," says David Cole, DFC's president.

No one would be more shaken up than Sony. Its first two PlayStations have each sold more than 100 million units, making them the hottest-selling consoles in history. And their success has helped Sony's games unit grow into a business that should book $9.5 billion in sales this year—almost 14% of Sony's total. Far more important, the unit has generated as much as two-thirds of Sony's operating profits in recent years, though last year that contribution fell to less than 1% of the total, or $75 million, as development costs for the PS3 started to add up.


  Despite Sony's aspirations of pitching the PS3 as a home entertainment hub, games will almost certainly be the biggest draw initially. Although Sony also plans to offer a stripped-down version for $500, it may still be forced to slash prices to stay competitive. The PS3's top rival, Microsoft's Xbox 360, costs $200 less than Sony's machine and has been in stores since November. When Nintendo's Wii is released this fall, it could cost $250 or less, the company says. Hiroshi Takada, analyst for JPMorgan (JPM), predicts the PS3 will cost $500 by September, 2007, then $450 the following year. "It's likely Sony will have to discount more…and faster" than planned, says Takada.

Anyway you look at it, that hurts. Even off the starting block, Sony will be spending more than $750 to manufacture each machine, more than the initial retail price. It's not unusual for console makers to swallow losses in the early years of a new machine's life, making up some of the difference through licensing fees from game developers, and relying on efficiency gains later to turn those losses into profits. Yet Sony could go as much as $2 billion into the red in the PS3's first year, says Goldman Sachs (GS) analyst Yuji Fujimori. With sales of packaged games declining, Sony execs say they're looking to other sources such as fee-based online gaming and downloads, as well as ads for games Sony creates in-house. "Game advertising is likely to be an important part of our strategy," says Izumi Kawanishi, senior vice-president of Sony's Games division.

Sony executives won't comment on the PS3's cost, other than to say they will try to make the machines at a profit as soon as possible. But they note that no one has ever built such a complex console and that the PS3 will feature new technologies such as the high-definition Blu-ray disc and ultrafast Cell chip.

And Stringer says he's happy to take his chances. "The price of the PS3 is high, but you're paying for potential," he told Tokyo journalists in late June. It's the risk of being "revolutionary rather than just evolutionary on the cheap."

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