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Responding to the Wii? 9-709-448 R E V : J A N U A R Y 4 , 2 0 1 0 ________________________________________________________________________________________________________________ Professor Andrei Hagiu prepared the original version of this case, “Microsoft Xbox: Changing the Game?” HBS No. 707-501. This version was prepared jointly by Professor Andrei Hagiu and Professor Hanna Ha aburda. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009, 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. A N D R E I H A G I U H A N N A H A Ł A B U R D A Responding to the Wii? Kazuo Hirai, chief executive of Sony Computer Entertainment Inc. (SCEI), had just gotten off a conference call with journalists. It was late August 2008, and the reporters were inquiring about Afrika, a new safari videogame for Sony’s PlayStation 3 (PS3) console that allowed players to watch wild animals and take virtual pictures. Hirai could not help feeling frustrated. Most of the conversation—like many others with Sony outsiders in the past month—had revolved around two questions: Was Afrika Sony’s answer to the casual games that were partly responsible for the runaway success of rival Nintendo’s Wii videogame console? And more generally, how was Sony planning to respond to the Wii, which was leading Sony’s PS3 and Microsoft’s Xbox 360 consoles in sales?1, a To Hirai, the notion that anyone would view Sony as needing to respond in the battle for videogame console supremacy was profoundly disconcerting. Ever since Sony’s entry in 1994 with the original PlayStation and through two generations of console hardware, Sony had dominated the videogame industry and largely defined its course. But the tables had turned dramatically with the current generation. Although the Wii was technologically far less advanced than PS3 and Xbox 360,2 the Wii’s ease of use, innovative motion-sensitive controller, and simple but fun games had made the console a hit with all demographics: 9-year-olds to 65-year-olds, males and females. As a result, Nintendo had stolen a march on its two larger rivals by appealing to people who were traditionally not avid videogame users. Microsoft’s and Sony’s more powerful machines remained targeted at the traditional, “core gamer” audience: 18- to 34-year-old males.3 Formerly the head of Sony’s U.S. game operations, Hirai had replaced Ken Kutaragi at the helm of SCEI in April 2007 after (and according to some, because of) half a year of disappointing sales for PS3.4 Kutaragi was widely known as the “father” of the PlayStation franchise, which he had led to 10 years of uninterrupted supremacy. Hirai was determined to restore that supremacy, in the current generation or the next. He knew that whether or not he publicly defined SCEI’s strategy as a response to the Wii, he had to find a way for his company to deal with the new order of the videogame industry that Nintendo had created. In seeking to do so, Hirai might find guidance in the history of the industry, which had been marked by rapid and frequent changes of fortune. a 32.4 million units for the Wii vs. 15.5 million and 20.9 million units for the PS3 and Xbox 360, respectively. For the exclusive use of M. Yonatan, 2022. This document is authorized for use only by Milkias Yonatan in MGMT 430 Spring 2022: Full taught by David Sirmon, University of Washington from Mar 2022 to Sep 2022. Mohamed Mohamud Mohamed Mohamud 709-448 Responding to the Wii? 2 Market Birth, Collapse, and Rebirthb The videogame industry got off to an uncertain start in 1972, when television maker Magnavox introduced Odyssey, the first home videogame console. Priced at $100 (the equivalent of $516 in 2008 dollars),c Odyssey needed a television screen to project its very limited action. The system came with 12 games, including versions of tennis and ping pong, each on a printed circuit board.5 However, partly due to some uninspired marketing and distribution decisions, Odyssey’s appeal proved limited. Magnavox sold more than 100,000 game systems by year-end, but sales quickly declined and Odyssey was pulled from the market.6 Enter Atari Around the same time, a young entrepreneur named Nolan Bushnell was developing arcade games with the use of then-new microprocessor technology.7 In 1972, the company he started, Atari, launched its first hit game—an arcade version of ping pong.8 In Pong, two players batted a ball of light back and forth between on-screen paddles. The game instructions were simple: “Avoid missing ball for high score.”9 Pong was an immediate success: 8,500 arcade consoles were sold in the first year.10 Bushnell and Atari then went on to create the home videogame industry. In 1974, the company developed a home version of Pong. While most retailers were wary of the videogame market after the failure of Odyssey, Sears took the plunge in 1975, and by the end of the year it had sold more than 150,000 Pong systems for $100 each ($400 in 2008 dollars).11 At the same time, thanks to a chip developed by General Instruments, dozens of toy makers were able to introduce Pong clones. By 1977, almost 75 types of clones were available, each selling for a few dollars.12 All of these early game systems came with one or several games hardwired in their circuits; they did not allow consumers to add other games.13 This changed in 1976 when Fairchild Camera introduced Channel F, the first videogame console that could play multiple games stored on interchangeable cartridges. Fairchild sold each cartridge for $19.95 and the Channel F console for $170 ($644 in 2008 dollars). In 1977, Atari introduced the Video Computer System (VCS) 2600 with games on interchangeable cartridges and a novel peripheral—a joystick.14 With consoles and games now separated, Atari (and its competitors) had more flexibility in how they priced their products. Computer makers at the time were giving away software to sell more hardware, from which they earned their profits. Atari turned this model upside down. The VCS retailed $199 ($708 in 2008 dollars), which was just a small margin over the console’s manufacturing cost. Each cartridge cost less than $10 to manufacture and sold for $30.15 The Atari VCS did not sell particularly well, however, until Atari licensed the popular arcade game Space Invaders in 1980. One million copies of the game were sold during its first 18 months on the market, while Atari sold over 15 million VCS systems between 1979 and 1982. By 1980, Atari commanded an 80% share of the videogame market.16 According to an Atari history website, “designers had unknowingly created a console whose hidden potential was quickly discovered by b This case focuses on the market for home videogames played on consoles; it does not cover arcade games and videogames played on handheld devices. c All conversions to 2008 dollars were calculated using the Federal Reserve Bank of Minneapolis’s “CPI Calculator,” available at http://www.minneapolisfed.org/. For the exclusive use of M. Yonatan, 2022. This document is authorized for use only by Milkias Yonatan in MGMT 430 Spring 2022: Full taught by David Sirmon, University of Washington from Mar 2022 to Sep 2022. Responding to the Wii? 709-448 3 programmers who created games far outperforming what the console was originally conceived to do.”17 One group of such designers was Activision, founded in 1979 by four programmers18 who had left Atari. Activision was an instant success, which stimulated further defections of Atari employees to independent game-design houses. Atari perceived these first independent developers as a threat to its business. It sued Activision for $20 million, claiming unfair competition and conspiracy to appropriate trade secrets.19 Eventually, Atari had to agree to allow any independent game designer to market games for the VCS 2600, on the condition that Atari receive a fixed royalty for each cartridge sold.20 Since Atari had not foreseen this arrangement before VCS 2600’s launch, it had not designed the console with the technological capability to lock out unwanted developers. Therefore, it had very little success enforcing the payment of royalties. Most independent game makers developed their games without obtaining permission from Atari—or paying anything to Atari. Soon, more than 100 independent developers were marketing more than 1,000 games of highly variable quality for the Atari system.21 Too Much of a Good Thing—Prices and Volumes Crater The quick growth of the home videogame market ended abruptly in 1983. After reaching a peak in 1982, the industry lost 97% of its annual sales volume in three years. Many blamed the industry’s crash on the proliferation of cheap and uninspired game software.22 Independent software houses collapsed into bankruptcy like dominoes, unloading their unsold game cartridges with retail prices as low as 99¢, lowering demand and depressing prices for all other games in the process. According to one source, of more than 130 significant videogame software firms in 1982, only five or six survived the crash.23 One of the most notorious examples of the inventory nightmare associated with the market crash involved an Atari game based on the movie ET: