A Video-Game War That's Just Dandy for Everyone

Rival sets and cool titles put the zing back in Japan's industry

Last year, Japan's $9 billion video-game industry was on a losing streak. Once-mighty Sega Corp. (SEGNY ) teetered on the brink after betting billions on a new souped-up game system, Dreamcast, that failed to catch on with fickle gamers. Execs at Sony Corp. (SNE ) and leading software houses watched nervously as the new PlayStation 2 failed to generate sales of high-margin game software. If that wasn't bad enough, September 11 zapped what hope there remained for yearend sales.

Now, the industry is back in the game. Thanks to an unexpected spending spree in the last three months of 2001, U.S. sales of game hardware, software, and accessories surged 43% last year, to $9.4 billion, says U.S. market researcher NPD Group Inc. In Japan, December sales of game software alone jumped 50%, to $670 million from the year before. "Everyone did well at Christmas," says Lisa Spicer, a game industry analyst at ING Barings in Tokyo. "The industry is now looking at two or three years of significant growth."

The big winners in this scenario are Japanese game developers, who account for $3 billion in local software shipments and $2 billion overseas. Although many games are in the early stages of development, Japan's top ten houses are expected to showcase a wide range of graphics-packed titles at the E3--Electronic Entertainment Expo--game extravaganza in Los Angeles in May. "Expect to see some stunning new game software," says Kazumi Kitaue, head of software at Konami Corp., among Japan's largest developers.

An array of new, cool machines is driving growth. For starters, there's Sony's popular PS2, which has sold more than 26 million units worldwide. But it took the release of new rival platforms to ignite demand. Microsoft Corp.'s (MSFT ) much-hyped Xbox made its debut in the U.S. last November and in Japan on Feb. 22; it'll appear on European store shelves in March. Then there's Nintendo Co.'s (NTDOY ) hip, family-oriented GameCube console and popular Game Boy Advance. "Three powerful platforms is an ideal situation," explains Zachary Liggett, game analyst for WestLB in Tokyo. "Developers can sell more games in a bigger market as well as negotiate better conditions with the hardware companies."

In the game industry, content rules. No matter how technologically advanced a console may be, it's doomed without enticing game titles. For that reason, Sony, Microsoft, and Nintendo are expected to woo top developers to their own platform by giving creators a better deal. Sony has just announced it would reduce by a third--from $2.25 to $1.50--the unit price it charges developers to produce a game disk for the PlayStation. Also, Sony offered to reduce its royalties, what it collects from the sale of each $50 game title, by up to 25%.

Already, leading software houses are reporting upbeat earnings. In the third quarter of 2001, Koei Corp.'s operating profit jumped 36% to $12 million on sales of $33 million, up 41% year-on-year. It helped that its Dynasty Warriors 3, a gory medieval fighting game, became a blockbuster, with sales of 900,000 units in Japan and more than 200,000 in the U.S. Sega, now focused on software development and its arcade center business, expects to return to the black for the year ending in March. It hit the jackpot with Sonic the Hedgehog for Nintendo's GameCube and expects another hit with a new version of Virtua Fighter, a martial-arts game. Sega must "cater to all the console platforms and market globally," says chief operating officer Tetsu Kayama.

Still, the business is wildly unpredictable. Publishers may crank up sales, but games for the new 128-bit consoles that deliver complex 3-D graphics are increasingly expensive to develop. Back in the days of 8-bit and 16-bit machines, in the late 1980s and early '90s, developers spent an average of several months and several hundred thousand dollars to develop a title. Today, it takes two years and costs $10 million.

But as the rivalry intensifies between Sony and Microsoft, developers may be able to convince hardware companies to help defray the costs of R&D. Sony isn't wasting time. Late last year, it came to the rescue of the Tokyo-based Square Co., which last year wrote off $110 million, due to the flop of the film version of its Final Fantasy role-playing video game. Recently, Sony bought the troubled U.S. developer Naughty Dog Inc., creator of the popular Crash Bandicoot games. With its huge pile of cash, Microsoft is even better positioned than Sony to start buying loyalty. It's too early to predict the outcome of this game war. But one thing is apparent: It's good for business.

By Irene M. Kunii in Tokyo

    Before it's here, it's on the Bloomberg Terminal.