PS3 Price Drop Not A Game Changer

Sony was used to being the market leader in gaming consoles prior to PS3. Their previous model, PS2 sold 138 millions units worldwide, far ahead of Microsoft’s XBox and Nintendo’s Gamecube. That all changed in the next generation of gaming consoles. Now Nintendo, with its Wii and its  innovative wireless controller is the leader with 50 million units sold in the three years since its introduction. Sony managed to sell only 24 million units so far.

In an effort to drive up its market share, Sony cut the price of PS3 by $100. Technically it is on a different model they introduced called PS3 Slim.  Is this a good profit maximizing move?Is low market share a concern that requires such drastic price cuts?

I have written before the need to focus on profit share over market-share. In the case of gaming consoles, it is a platform market. The sale does not end with the console rather starts with it. There are many revenue opportunities from sale of games and accessories over the lifetime of the console. Now there is also a new opportunity for subscription revenue from online gaming. It is not enough to just look at gross margin on the hardware, we should include margins from all the complements. In other words, the customer margin.

Larger the market share, larger is the number of games available for it as more developers will commit to developing games for that platform. With marker leadership comes exclusivity. A console maker can convince the game developers to  make certain popular games available only for their platform, at least for a limited time. But this has not been the case lately as Financial Times reports

With many third-party game developers no longer willing to make games exclusive to PlayStation, Sony has also suffered from a lack of hits by its in-house games division compared to Microsoft’s success with its Halo franchise, Mr Baker said.

Suppose we assume the gross margin on the new PS3 is $120 per console. Assume that at current market share and growth rate the incremental margin from sale of games and accessories over the lifetime of the console is $150.  So the total customer margin today is $270. With the price cut of $100  and the expected increase in market share from it, let us assume that the incremental margin per unit goes from $150 to $200. There is however  no reason or data to believe this, given the point made by Mr.Baker in  the FT.com story.  So the total customer margin in the new case is ($120-100+$200) $220.

Sony will be  losing $50 in customer lifetime value per unit sold with its price cut. To make up for it, its sales have to increase (over its current sales rate) by  50/220 = 23%.

The price cut would have given them competitive sales advantage only if Microsoft and Nintendo could not do the same. But it is not the case. Microsoft cut its prices by $100 and Nintendo might do the same (although doubtful).

Microsoft acted to consolidate its lead over Sony in the current generation of games consoles as it cut the price of its top-end Xbox 360 on Thursday to counter a similar move last week by its Japanese rival.

It is now questionable whether Sony can deliver a sales increase of 23% from its price cut. Note that this number will be much higher if the customer margin numbers we used are lower.

The net is, price cut is not going to be a game changer for PS3 sales.