Does Wii Stand To Gain Or Lose With its $50 Price Cut

A few weeks back both Sony and Microsoft did a $100 price cut on their respective  game consoles. Sony was the first to do the price cut and was immediately followed by Microsoft. At that time I wrote that Sony’s decision to cut prices by $100 means it needs to generate 23% incremental sales, above and beyond what it would it have achieved without the price cut. The 23% number was based on gross margin and customer margin assumptions I made. Now the third game console maker and the market leader in the next generation game consoles, Nintendo announced a $50 price cut on its Wii. Is  this the right move? For Nintendo? For the market profit?

Let us use gross margin and customer margin numbers of $100 and $200 for each Wii. Customer margin here is the net present value of profits from sales of games, complements and other accessories that a console owner buys over the period they own the console.

According to Bloomberg News Service, Nintendo has sold 52 million Wii, Sony 24 million PS3 and Microsoft 30 million. So their units market share numbers are 49%, 22.7% and 28.3%. Nintendo says the addressable market in US is 50 million units. If Sony and Microsoft had not cut their prices, we can assume their share of the addressable market would remain the same. Let us assume Nintendo’s models show Sony selling 23% more units than they would have normally sold due to $100 price cut. Let us also assume Microsoft gains the same – both PS3 and XBox gaining at the expense of Wii. This means  Wii stands to lose 5.86 million units sales (email me for numbers).

The drop in total profit to Nintendo, based on $200 customer margin per console is $1.17 billion.

With the $50 price cut, its customer margin falls to $150. If this price cut negates the effects of PS3 and XBox price cut, Nintendo can manage to keep its market share of 49% in the addressable market of 50 million. That is 24.5 million units. The lost profit here is the $50 price cut which comes to $1.226 billion.

In other words their lost profit from price cut even if it helped them retain market share is more (by about $50 million) than the lost profit from loss in market share. But only barely. Since we used assumptions about margins, it is possible that Nintendo’s models showed the price cut would deliver them incremental profit over letting Sony and Microsoft gain market share.

This in the end is a good move for Nintendo. But as a whole, on the 50 million US market identified by Nintendo, because of Sony’s price cut the total market profit  shrank by $4 BILLION. That is value destruction!

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 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.