As we approach the May 21 announcement of the new Microsoft (NASDAQ:MSFT) Xbox, this is a good time to talk about 4 revolutions which I expect to hit this new generation in full. Each of these will set the new generation gaming consoles quite a bit apart from their previous generations.
So here we go …
The 3rd generation of gaming consoles, made up by Sony's (NYSE:SNE) PlayStation 3 and the Microsoft Xbox 360, were tremendous loss leaders, in that the gaming machines were sold at a significant loss, with both Sony and Microsoft hoping to recover their losses by getting a cut of each game sold. It was the classic razor-and-blades business model at work.
The model, however, might have been pursued with too much vigor. There are indications that Microsoft lost as much as $3 billion during the life of the Xbox 360, whereas Sony might have lost as much as nearly $5 billion (Source: vg247.com).
This generation promises to be somewhat different. Instead of being based on rather unique silicon, this generation will use a more-generic APU from Advanced Micro Devices (NASDAQ:AMD) with its guts derived from traditional PC components. This APU will not require a massive investment in custom silicon and should thus be available at a fairly cheap price - I'd estimate around $100 per unit, given the pricing on AMD's CPUs and Radeon 7850 GPUs and figuring cut-throat conditions. With the APU being the most costly component on the gaming console, that leaves around $250 for the rest of the console, from Blu-ray reader, hard disk, controllers and miscellaneous hardware. It thus seems possible to price the consoles at the rumored initial $350-$400 and take no loss on the hardware. The previous generation debuted around $399 and implied losses of $126 and more per unit.
This will be the first revolution: it seems possible for the hardware to be sold at breakeven so Sony and Microsoft shouldn't be taking huge losses at launch, which will be quite different from what happened in the last generation (Source: neowin.net, graph below illustrates Microsoft's entertainment division around the launch of Xbox 360 and beyond).
Even more strongly than with the current generation, the next generation gaming consoles will get most of their software through digital delivery over the internet. Be it through Xbox Live or PlayStation Network, digital delivery will be the main mode for getting games. Indeed, many of PlayStation 4 new features are geared towards making it easier and faster to download games, including enabling partial downloads and downloads while the console is "sleeping" on in the background. It's likely that Microsoft's new console will follow the same model.
While it will still be possible to use physical media, it's highly likely that this will be the last generation able to do so. Neither of the new consoles will demand an "always on" connection to the internet, but increasingly a connection to the internet will indeed be the favored way to get software into the machines, much like it already happens with tablets and smartphones.
As the market moves towards this mode, there are deep implications for software retailers. As it happens with smartphones and tablets, it's to be expected that the vast majority of software will be bought through OS-integrated stores. This leaves out retailers like Amazon.com (NASDAQ:AMZN), whose media sales will inevitably suffer. In time, it also leaves out retailers like GameStop (NYSE:GME), since it's likely that as soon as sales go digital, it will become much harder to trade used games.
This is the second revolution. It's already ongoing, but quite likely to accelerate immensely with the new generation.
The third revolution is the likely arrival of "free-to-play" to the console world. As consoles get most of their content digitally, their OS-integrated stores will be better able to handle micropayments. Micropayments are a necessity to make "free-to-play" games economically viable. "Free-to-play" is already a force in PC Gaming (namely in online games hosted by Facebook or Steam). Free-to-play also dominates smartphone and tablet gaming.
Consoles have no way to stay out of this revolution. It won't be possible to compete with free games by demanding $60 upfront for console games for much longer, so it's highly likely that this new gaming console generation will embrace "free-to-play" with Microsoft and Sony getting a cut of the micropayments that result.
Another important revolution will be how consoles will be more PC-like. This will happen because their APU (CPU+GPU) will be basically a PC APU from AMD. Such reality will make it way friendlier to adapt games between PC and gaming console, and between each gaming console. It's a smart decision in that it makes the underlying market much larger for game publishers, something which has been a worry for Microsoft and Sony as console sales have been sliding.
At this point, Sony sold 14.3 million PS3 during 2012, to Microsoft's 10.1 million Xbox 360s (Source: ITCandor.com). This makes for a 24.4 million unit market, which will probably expand somewhat in the next year as the new generation is launched. At 30 million units, if each APU is to bring in around $100, this would mean $3 billion in additional revenue for AMD or around 60% of AMD's TTM revenue of $4.92 billion. Even if margins are tight, this kind of revenue injection is likely to be a powerful lifeboat for AMD.
The new gaming consoles from Microsoft and Sony are expected to lead 4 different revolutions. They shouldn't generate too much in the way of upfront losses, they should massively adopt digital delivery, free-to-play should finally overwhelm the gaming consoles and the consoles will be PC-like in their hardware.
These revolutions will each have a set of consequences, from them not affecting Microsoft and Sony negatively, to them affecting Amazon.com and GameStop negatively (after what might be an initial positive bump, it must be said). The consoles also seem significant enough to, by themselves, assure AMD will survive financially (unless the terms are too draconian).
Disclosure: I am short AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.