Microsoft vs. Sony: Mortal Combat

Gates & Co. must see something really really big to be taking on the Japanese giant of video games. What could that be?

By Brian Bremner

Disclosure: My familiarity with gaming is caught in a late-'70s time warp. Video games in those days meant a coin-operated, beer-soaked number like Asteroids tucked away in the corner of a college bar. And after tipping back a few jars, I wasn't half bad smashing to bits enough space rocks to make it into an advanced round or two.

I didn't think much about Asteroids again until last summer, when I met a twentysomething South Korean gamer named Kim In Kyung. She and some other like-minded souls are part of a professional online-gaming crew sponsored by Samsung Electronics.


  First thing I asked Kim is why fritter away hours racking up huge body counts in an intergalactic conquest called Star Craft. The answer: She's one the world's best and is pulling down serious cash in prize winnings and endorsements at competitions in the U.S., Europe, and Asia. She's toying with the idea of becoming a game designer, or perhaps a consultant, in a video-gaming industry that, directly or indirectly, generates $20 billion in revenues, more than Hollywood's global film receipts.

Which brings me to Microsoft and Sony. They like this business, too. And are about to bang heads in the lucrative line of making Internet-linked game consoles and the games that run on them. Sony has taken this market by storm with its Playstation and Playstation 2 (PS2) series. Nintendo also is a world-class player in game software, but thanks to its Game Boy machines, it's more of a powerhouse in handheld or mobile-game playing.

Sony and Nintendo, points out Merrill Lynch analyst Henry Blodget, billed combined sales of $11 billion and earnings of $2 billion selling these gadgets and all manner of game software to a legion of 15- to 25-year-old gamers around the world or by collecting licensing royalties from third-party game developers.


  It's a tough business. Manufacturing the game players usually is a money-losing proposition. The fate of your product depends largely on coming up with a smash-hit gaming title that you produce or contract out. Gamers can be as fickle as moviegoers, it seems. Product life cycles run all of five years, so you need to keep raising the bar to keep everyone's interest.

Still, optimists say as the consoles get more sophisticated, with more networking capability and the promise of seamlessly hooking up with other players on the Internet, the whole business could make a huge platform shift -- beyond gaming. If so, that could mean another big growth wave for the industry.

Nevertheless, why would Microsoft want to take on established Japanese rivals that already enjoy undisputed leadership? Bill Gates was in Tokyo last week, talking up, among other things, the Xbox, his company's video-game system due out this fall in Japan and the U.S. that promises three times the graphic power of the latest generation of players. Microsoft is ponying up $500 million to promote the thing, which as Gates noted, isn't pocket change -- even for a company as well-heeled as his.


  When Sony Chairman and CEO Nobuyuki Idei was asked about Xbox by BusinessWeek's Ken Belson during a reporters' briefing on Sony's new management policy, in early April, Idei didn't seemed concerned -- or, at least, he wasn't letting on. Two years go, both sides talked about collaborating, but little came of it. Idei points out that since Sony already makes an array of info-gadgets, including personal computers, designing sophisticated game devices wasn't a big stretch. "But for Microsoft, it's a whole new business," he adds.

It could be an expensive fiasco if Microsoft doesn't deliver a knockout. That challenge falls to Robbie Bach, who calls himself chief Xbox officer, or CXO. So, I put the question to him: Why make an expensive foray into the video-game world when the other guys already enjoy a huge installed base, experienced in-house game designers, and entrenched relationships with the independent game creators?

One theory out there is that Microsoft is hedging its bets: Maybe sophisticated game consoles and the coming of broadband access to the Net will turn the Xbox or PS2 and its descendents into full-fledged devices to surf the Net, chat, send e-mail, and so on. And it might start to make the PC a little dull, or perhaps harder to use, in comparison. If so, Microsoft might not be there to reap profits from the next big thing.


  Bach politely shot that theory down. Gates, of course, continues to pedal the idea that we still primarily live in a PC-centric world when it comes to serious applications and mining the depths of the Internet. It's also true that since 1998, as Bach points out, Gates has been urging his dream team to focus on "anytime, anyplace, anywhere computing." When Bach asked the big guy to sign off on the Xbox project in early 1999, it took just three months.

Maybe this isn't a defensive move, but rather an offensive one that plays off Microsoft's strengths. The Xbox borrows heavily from Windows/Intel technology. Intel is making the console's high-powered chips, and the operating system and development tools shouldn't be that unfamiliar to game designers for PC platforms. While Sony and others dispute that the Wintel technology is much of an edge, Bach thinks it will help attract game designers to Xbox.

On top of that, Microsoft on Mar. 30 announced a deal with Sega to create 11 game titles for Xbox. Though Sega is dropping out of the hardware side of the business by ditching its Dreamcast product, it's still well-regarded for its games. With these titles plus the efforts of Microsoft's own in-house designers, Bach thinks that by the time Xbox is launched this fall, enough software will be available to support the product.


  The real test is whether Xbox will live up to its billing as the hottest gaming machine out there. Coupled with more broadband access from homes to the Net, the online-gaming experience in which players match their wits with rivals real-time anywhere on the planet will have a profound impact on the industry, Bach says. "This would be a platform shift and a totally different gaming experience -- like the shift from 2-D graphics to 3-D graphics," Bach figures.

And he thinks Microsoft boasts the technology, the financial wherewithal, and the creative talent to ride that next wave in a very profitable way. Merrill's Blodget says that will take at least five years. By then, Microsoft might generate $3 billion in sales and $600 million in operating profits, which he forecasts will be less than 5% of its expected income in 2006. Not bad, but hardly spectacular for Microsoft.

As I said, I'm kind of a 2-D guy in a 3-D world when it comes to these things. So what do I know? Maybe Microsoft won't prevail, or the forecasts of greater broadband access to consumers won't be realized in the U.S. and Japan. But I have to think Bach and his team see a far bigger haul than just $600 million in operating profits five years hence.


  Microsoft has roughly $27 billion in cash on hand, Blodget notes, and the company hates to lose. If it chooses to turn this into a protracted market-share campaign, it could be one of the more interesting cross-Pacific business rivalries since Toyota knocked the stuffing out of the Big Three auto makers back in the '70s and '80s.

In fact, that might make for an intriguing concept: a new corporate-conquest game where you get to play Bill and your online-gaming opponent plays Nobuyuki. The quest: Run either guy into the ground with technological wizardry, brilliant game designers, and your cash horde. And if that doesn't work, you can always use state-of-the-art weaponry, handheld nukes, and a battalion of attack cruisers in outer space.

Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BW Online

Edited by Beth Belton