Sony's Surprising PS3 Price Cut

The 17% cut aims to woo buyers from Nintendo's popular Wii. Will Microsoft follow suit with the Xbox 360?

In the latest sign Sony is stumbling in its battle for control of the $30 billion video game market, the electronics giant slashed the price of its PlayStation 3 game console by $100, to $499, after just seven months on the North American market.

The 17% price cut comes days after a company executive denied a change was imminent and will probably increase financial pressure on an already unprofitable division at Sony (SNE). The move could put pressure on Microsoft (MSFT) to cut prices on the Xbox 360, itself plagued by an unusually high number of glitches. It also serves as a reminder that Sony's console—feature-rich as it is—carries too high a price and lacks enough exclusive games to woo buyers from Nintendo's popular Wii. On the eve of the E3 games expo in Santa Monica, Calif., the pricing move is a nod to the increasingly important role independent developers will play in deciding the outcome of the three-way game console battle.

After the introduction of new consoles over the past two holiday shopping seasons, it has become crucial for each company to deliver innovative and exciting games that will entice shoppers to buy its system over another. Sony plans to release more than 400 games from now until the end of March across all its game platforms, though it has yet to offer a breakaway exclusive with the PS3.

Unexpected Timing

Meantime, the company is showing it is willing to stomach further losses in its gaming business and, in particular, the PS3, which includes a high-end Blu-ray DVD player, wireless Internet access, and a powerful custom processor, to keep wavering developers from jumping to those rival systems. "This is good for everybody—but, potentially, our competitors," Jack Tretton, president and CEO of Sony Computer Entertainment America, says of the cut.

While widely expected to happen sometime before the important holiday shopping season, the announcement was nonetheless surprising after a top company official in Japan on July 6 denied a price cut was in the offing. Sony has been reluctant to reduce the price too quickly in part to avoid appearing desperate this early after the introduction of a console.

Another reason for reluctance to trim prices: The game division is a drag on earnings. Last fiscal year, Sony's operating profit tumbled 68%, to $598 million. That's due in part to gaming division losses that exceeded $1.9 billion. (The previous year, the division booked a $72.5 million gain.) Morgan Stanley (MS) analyst Masahiro Ono reckons the gaming division will lose another $240 million this year despite an expected 50% rise in sales.

Software Key to Profitability

Much of the blame lies with PS3, which is failing to meet expectations. Sony Chief Financial Officer Nobuyuki Oneda said in May the company failed to reach its PS3 sales targets (see, 5/16/07, "Sony's PS3 Problems Cast a Long Shadow"). Although Sony had forecast global shipments of 6 million machines by the Mar. 31 fiscal yearend, its factories made and sent off just 5.5 million.

When the PS3 launched in November, 2006, analysts estimated Sony lost more than $200 for every console sold (see, 11/16/06, "Nothing Cheap About the PS3"). Console makers typically are willing to take huge losses in the first two years after the introduction of a new model. They often recoup the investment and post big profits as the cost of components falls sharply and as they grab huge profits from the software that accompanies the systems.

But by reducing the price tag to $499, Sony is probably now selling the console at cost rather than pocketing profit left by falling component prices, estimates analyst Michael Pachter at Wedbush Morgan. "It's a signal to everyone—the consumer and the developer—that as fast as they come down the cost curve, they're going to pass it on to spur sales," Pachter says.

Chasing the Wii

Hoping to mitigate its losses, Sony will introduce another unit for the less price-conscious. That PS3, which will start selling for $599 in August, increases the hard-drive size from 60GB to 80GB and includes the game MotorStorm released earlier this year.

However substantial the drop in component costs, Sony's playbook needed a significant overhaul. Nintendo's Wii remains the hardest-to-find item at retail. In June, the Wii outsold the Xbox 360 by a 2-to-1 margin and outstripped PS3 sales nearly 4 to 1, according to product tracker NPD Group. Nintendo President Satoru Iwata predicts the company will sell more than 14 million units in its current fiscal year. Sony's sticking to a conservative forecast of 11 million units for its fiscal year.

As necessary as the price reduction was, analysts say it is unclear how much the move will brighten Sony's prospects vs. Nintendo. It may increase demand by 50%, estimates Pachter at Wedbush Morgan, yet the Nintendo Wii, at less than half the cost, still is likely to outsell the PS3 by a wide margin.

Capitalizing on Xbox Hiccups

The impact of Sony's gambit may be felt more acutely by Microsoft. Sony officials were quick to point out that the core gaming audience gets more per dollar from the PS3 than the Xbox 360, which does not offer wireless Internet access or a built-in high-definition DVD player. "We have a lot to talk about with the PS3, and the pricing is just one thing," Tretton says. "We want to get down to a mass-market price that appeals to consumers."

The new price may also appeal to consumers put off by Xbox hardware hiccups. Microsoft on July 5 said it will take a $1.05 billion to $1.15 billion charge to extend warranty coverage on repairs and replacements (see, 7/6/07, "Microsoft's Billion-Dollar Fix"). Microsoft said a months-long investigation into an "unacceptable number of repairs" to Xbox 360 consoles has helped it identify several flaws that caused the system to crash, indicated by three flashing red lights on the front dubbed the "Red Ring of Death" by gamers.

The ball now rests with Microsoft, which has failed to reach a target of shipping 12 million units of the Xbox 360 since its introduction in November, 2005. The Redmond (Wash.) software giant likely will be forced to cut the price of its console by at least $50, analysts say, further evidence of the cutthroat competition in gaming consoles, and confirmation of the Wii's ascendancy, at least for now.

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