Why the PlayStation 3 Will Bankrupt Sony

For video game players, the competition among the three game console manufacturers must seem like a Dead or Alive tournament. There's always a winner and a loser, but someone else is always lined up for another bout with the winner.

Few tears were spilled when the No. 4 console maker, Sega, dropped out of the market a few years ago. But can you imagine if, in a year from now, there were only two console game makers?

Not only could it happen, but we're going to tell you why it will happen.

Can Video Games Bring Down a Multinational Corporation?

Sony has a book value of $27 billion. It has nearly $9 billion in cash. Sony's not going anywhere. Or is it?

Sony is looking at a potential for demise it has never faced before. With the failure of its TV and music electronics businesses and its up-and-down movie business, it has relied more and more on the video game business to keep profits up.

But now even its video game business can't save the company. In fact, it's the video game business that could put the whole company right down the toilet.

Here's a story of a company in trouble. Sure, you think you could help it by buying a new PS3 at the end of the year. But purchasing a PS3 this year could be the very thing that pushes Sony over the edge.

The Seeds Are Sown

Sony's troubles didn't just begin this year, but we all started to realize the wheels were falling off the train when Sony started delaying the release of the new PlayStation 3. The first excuse Sony made was that licensing issues were causing the delay from Spring 2006 to November 2006.

Around the same time Sony was putting off the release, analysts released a disturbing story about the disparity in the cost of raw materials for the PS3, compared with the estimated purchase price.

Analysts had predicted the PS3 cost would be in line with the cost of the Microsoft XBox 360 consoles.

In a February story for CNet, it was estimated that the total cost of components for the PS3 would be in the neighborhood of $725 to $905 -- and that was before it was rumored that Sony would have to put PS2 components in the box because the new chip lacked the ability to emulate the earlier PSOne and PS2 games.

The CNet story said, "The materials price estimates do not include marketing, software development, advertising or other costs, which will push Sony's total cost per console even higher."

That there is such a disparity between the price of materials and the suggested retail price for a new console is not unusual because most new consoles are sold as loss-leaders, with the game maker making up the difference with the high margin of profit they get by selling games for the console.

In contrast, the materials cost for the XBox 360 is estimated at only $501, and should continue to drop as the console ages. While Sony pays $200 to $300 for each raw Blu-ray drive, Microsoft pays only $20 for the simpler DVD drives.

The Truth Hits Home

With such estimates for raw materials, video game fans should have known that the new machine would need to cost a lot more. But a huge audience that was prepared to cheer the announced price of the PS3 instead sat in stunned silence when the suggested retail price was announced at the E3 conference: $499 for the basic system and $599 for the premium one.

Of course, the single most costly item in the PS3 is the Blu-ray drive. Analysts originally figured Blu-ray would add at least another $200 or so to the price of the machine, but that figure has gone way up.

First, there's more than just the mechanical equipment to figure in. Sony must also pay for all the codecs that must be licensed.

Second, the slow adoption of high density DVD technology will keep prices high for years.

Finally, all manufacturers of the blue lasers that are required for high density DVDs are having problems getting up to speed in creating the machines. This will result in low yields, further driving up the price of the drives.

Sony Computer Entertainment president Ken Kutaragi was not ambivalent about the pricing of the console -- he kept saying it was a premium machine, sold at a premium price. Want a PS3? Work a little harder!

"Our ideal," Kutaragi said, "is for consumers to think to themselves, 'OK, I'll work more hours and buy it.' We want people to feel that they want it, no matter what."

But the consumer reaction was swift -- and harsh. Even the Official Playstation Magazine had a bold cover headline that asked, "Is It Worth $600?"

In June, a month after Sony announced its price points for the PS3, analysts at Merrill Lynch estimated Sony would lose more than $1 billion in the console's first year of existence. By comparison, Sony lost only $458 million during the first year the PS2 was available. The company followed that with two strong years of profit -- $759 million in Year 2 and $1.3 billion in Year 3.

But Merrill Lynch warned that this generation of consoles was not like the last. Microsoft beat Sony for the next generation consoles by a year and a price reduction for the XBox could result in additional losses for Sony -- $730 million in Year 2 and $457 million in Year 3. That's nearly $2 billion in losses over three years.

The Cost of Doing Business

Of course, analysts questioning Sony's moves is nothing new. More than 10 years ago, just six weeks before Sony introduced the original PlayStation, the head of the project team quit amid rumors of difficulties in getting the console out on time.

Analysts at the time believed Sony could lose as much as $200 million on the project in the first year.

Sony's answer at the time was to require retailers to bundle the packages with one or two games, which still left Sony underwater, but not as much as it would have been.

This, of course, begs the question, "Will Sony pull the same thing this year?" It makes sense, especially considering that Sony will be charging a premium price for its games (above $59 and below $99, according to most sources).

The bad news for Sony this year isn't restricted to video game competition. The company is also liable for a large share in the laptop battery recalls being conducted by Dell and Apple. Nearly 6 million batteries have been recalled in the past two months -- all of them manufactured by Sony.

The battery fiasco alone could cost Sony as much as $500 million.

"The most important thing for Sony is maintaining the No. 1 quality, whatever the category or area," Sony Marketing (Japan) Inc. Senior Vice President Kiyoshi Shikano told MarketWatch this month. "So in that sense, unfortunately, the recent happenings have caused some small damage for the business."

In addition, Sony is far behind its competitors in the fast growing LCD flat-screen TV market and has lost its decades-long edge in portable music devices to Apple Computer's iPod players.

Sony is also likely to face a fight in Europe over its partnership with Betlesmann AG. A European court ruled in July that the European Commission was wrong to approve the venture. The court decision means Sony and Bertelsmann will have to re-apply to win European Commission approval for their venture.

At the movie box office, Sony has had great success with its Spiderman franchise, but must wait until May 2007 for the next installment to arrive. The company's biggest film this year has been Will Farrell's Talladega Nights: The Ballad of Ricky Bobby, which has made $145 million thus far, but lags far behind Disney's hit sequel for Pirates of the Caribbean, which has already made more than $1 billion worldwide this summer.

The Market Leader Goes Into the Cellar

Although the PS2 captured more than a 70 percent share of the previous generation of console sales, it is entering the next generation at a distant third, with Microsoft predicted to sell 10 million XBox 360 consoles and Nintendo selling 4 million of its new Wii consoles, while Sony will be able to push out only 2 million consoles to consumers by the end of this year.

That fact alone has analysts betting that Sony will introduce price cuts quickly. But price cuts, in combination with the losses Sony takes on each machine it sells, are a double-edged sword.

"By reducing the price, it appears that Sony may have prolonged its recouping period of initial investments on the PS3 by a few years," John Yang, a Tokyo-based analyst with Standard & Poor's, told the Wall Street Journal today. According to the Wall Street Journal article, Yang estimates the PlayStation 3 will be unprofitable for at least three years.

The Journal story brings up another point that may draw the most fear in the ranks of Sony -- the PlayStation will no longer dominate game developers. When the original PlayStation and PS2 were introduced, Sony had an impressive lineup of developers who made games exclusively for its consoles. That won't be the case with the PS3.

"We don't want the PlayStation 3 to be the overwhelming loser, so we want to support them," Michihiro Sasaki, senior vice president of Square Enix, told the Wall Street Journal. "But we don't want them to be the overwhelming winner either, so we can't support them too much."

So the price cuts have already begun. On Friday Sony announced a price cut for Japanese buyers (about $410 in U.S. dollars for the low-end version), there was no indication that such a price cut would be given to American customers.

In addition to lowering the price of the low-end model, Sony added an HDMI port to the machine, which further increases the price of raw materials. Sony will undoubtedly be losing even more money than ever before.

Do the Math

As a result, Sony is forecasting an $862 million operating loss for the current fiscal year. But that's going to seem like chicken feed, compared to the loss it's liable to see in 2007.

How much will Sony lose in the next 12 months? Let's count it up.

Sony plans on making 6 million PS3 units before April. Let's say that they sell every one of them at full retail price. With what we know about the materials price -- particularly the price of Blu-Ray players -- let's say that they will lose only $300 for every PS3 they sell.

     6,000,000 x
          $300
= $1.8 billion

That's the same amount that analysts figure the PS3 will cost the company over the first three years. Why the disparity?

The analysts are counting on Sony making up the sales of machines with the sales of video games. But it's not going to be as easy for Sony this time. Few game developers are making games exclusively for the PS3.

Also, Sony has already said that games would be at least $10 more than the games for the XBox 360 and at least $20 more than the games for the Nintendo Wii. With everything being the same, would you pay $10 or $20 more for the same game that you could play on your XBox 360 or Wii?

In addition, Sony will be nickle-and-diming you at every opportunity -- particularly with the HDMI cable, which will likely cost between $99 and $129. (That's surely why they added an HDMI port for the low-end PS3. They'll make their money back on the cable for it.)

Surely the discounts will come quickly, but they'll all be a drag on Sony's bottom line. Let's say Sony loses $400 on every box they sell. Here are the numbers:

     6,000,000 x
          $400
= $2.4 billion

That really starts taking a mammoth chunk out of Sony's cash. Add to that the half-billion dollars of free laptop batteries they've got to give out and the losses start approaching $3 billion.

But a company like Sony can afford to lose $4 billion, can't it? Once upon a time, that might have been true, but Sony is a much different company today than it was just a few years ago.

The Japanese people who owned shares in Sony could see the value in building for the future. But, with its purchase of Columbia Studios and Columbia Records, Sony has become much more of a multinational company. Today, for the first time in its history, less than half of the company is owned by Japanese investors. Investors in the West demand more short-term benefits.

Devoting nearly half of its cash reserves to losses in the video game and computing sectors, with no guarantee of future profits for another two years, could send the company's stock into a tailspin, once its investors realize the full measure of the grave situation for the company.

In such a situation, Sony could start selling off large chunks of the company. But even that would come at a large cost. For example, selling off the movie division would result in the loss of the Spiderman franchise for the PlayStation. Without an exclusive there, Microsoft and Nintendo would gain the edge in game sales, since their games cost less than Sony's.

Sony has become a minor player in the music player and TV industries, so they wouldn't be able to make much money off selling their stake in the aging Walkman and Trinitron franchises.

When things are all said and done, the most valuable piece of the pie at Sony is its video game division. They could very well put it up for sale. And who could be the potential buyer?

Microsoft.

That's right. I said it. Just think about it.

Who could benefit the most by purchasing Sony's video game division?

Microsoft.

You might say there's no way the U.S. government would allow such a thing. Anti-trust, you say.

Just remember who's running the government. A Microsoft takeover would be treated with the same kid gloves that created DaimlerChrysler.

Who knows? This time next year you could be playing games on a PlayStation 360.

Want a PS3? Work a Little Harder!

So you want to save Sony. What can you do?

Well, as Sony's Kutaragi says, you need to work a little harder and make a little more money.

Stop complaining that the PS3 costs $600. It doesn't. In order to cut down on its losses, Sony is liable to do the same thing to consumers that it did 11 years ago at the original Playstation launch -- it'll require that you buy two games in order to get a machine. That'll boost the price for you to around $725 or so.

But there's more! Want an HDMI cable? That'll be another $100 to $125. Now we're at $850 or so. You've got a Blu-ray player, so you'll want a few Blu-ray movies -- Sony titles only, of course. Buy six of them while you're at it! At an average list price of $25 each, we're talking another $150. That pushes our total price to an even $1,000.

That'll go a long way to saving Sony.

Now who's going to save you?

Comments

[joshua fenton:]

You make a good case to sell the stock but your case for bankruptcy fails.

2006 Sep 27 10:21 AM

[Tom B:]

I'm glad I sold at 50-ish earlier this year.

Sounds to me like the cost/benefit for game consoles has hit a wall-- for SNE AND MSFT. Same thing happened in the PDA space. You want computer functions-- buy a computer.

I think we'll see a shift back to PC games. One hopes AAPL will plan for this by making their platform more title-competitive with Windows......

2006 Sep 27 02:36 PM

[Rajeev Mantri:]

How about Apple buying the PS3 division?

(Interesting food for thought - though Steve Jobs is known to be against acquisitions in general)

2006 Sep 27 11:09 PM

[Gerry B:]

OK, it's inevitable that Sony will make a sickening loss after the launch of the Playstation 3 but it's just a means to an ends. In the long run (or should I say marathon run) Sony WILL reap substantial rewards for the gamble. Over the past 10 years MILLIONS of gamers have become LOYAL fans of the Playstation and they WILL buy the next generation of the brand, I have no doubt.

They WILL eventually bring the price down to a more affordable and competitive price to maintain their market share. According to Sony the Playstation 3 will be creating NEW markets (what they mean by that is yet to be seen) appealing to NEW customers with in a different demographic. The more I read/hear about the Playstation 3 the longer investment seems.

The Blu-Ray gamble is a big one. DVD is still relatively new technology if you compare it to VHS. Switching the format AGAIN is risky especially as the industry as a whole isn't co-operating - HD-DVD. However, the odds seem to be in Sony's favour as more of the industry big boys are siding with them. The Playstation 3 is Sony's baby, its their main product and its a 'game console'. What's evolutionary is that it will be the FIRST consumer Blu-Ray device on the market and its a 'game console!' Or is it? it is....but not as we know it.

Sony wants the Playstation 3 to take pride of place in the centre of family living spaces (where the main TV is). It's a lot more than a games console. The child gamers of the original Playstation 1 are having kids of their own today, so the NEW Playstation is going in the living room not the bedroom (because daddy said so). So the Blu-ray gamble might just be a good one if the Playstation 3 ends up being the MAIN 'recorded media player' in the house. It will probably be even more common to find more than one console per household!!!!

The main thing Playstation need to remember is: its GAMES that sell consoles NOT features. If they lose too many of their exclusive games then it might suffer hugely. Many gamers are dreaming of the next <B>Grand Theft Auto</B> game, this I believe to be a VITAL game for the success/failure of the Playstation 3.

<B>Stock</B&g...
Short term investment = sell now
Long term investment = HOLD TIGHT!!!!

As always, time will tell. I don't know about you, but I'm excited!

2006 Sep 27 11:33 PM

[Dustin Sals...:]

I utterly concur with the article (and it certainly helps that it's so well constructed). That said, I also agree with Gerry B.'s final thought regarding the real selling point of a game console. That point is GAMES, and the reality that Sony is an electronics company, NOT a software company, is becoming painfully evident.

Sony's early success that continues in PS2 began with little more than a loosened licensing structure that made it a very attractive platform for developers who'd been disgruntled with Nintendo's grip on licensing. After all, the PSX was overpriced for its market, too, but the jaw-dropping library of third party games was enough to convince a lot of people to spend a few bucks replacing their Super Nintendos (c'mon, who really bought a Saturn back then?).

However, we now live in an era that hosts two major manufacturers that play ball with third parties, and the concept of an exclusive third party title is all but dead. Now the smart money is on the company that has the strongest first party intellectual properties, and Sony just doesn't cut it. As mentioned earlier, Sony is simply not a software company. Their God of War franchise may be popular, but it's no Halo, and Forza is a likely Gran Turismo killer.

There is, simply, nothing else worth playing on a Playstation X, 2, 3, 4, 5 or 10. Couple this woefull reality with the strikingly poor hardware decisions of the PS3 (a high density disc can't make their singly 3.2gHz processor suddenly as fast as three of them in the XBox 360), and you have a console with no worthy first party titles, a high price point, and a slightly worse capacity for handling the shared third party titles.

And yesterday Micsrosoft shows a pre-rendered trailer for Halo Wars, a brand new addition to the Halo universe, and announces an exclusive partnership with Peter Jackson's new Wingnut Interactive game studio that will bring a Halo MMORPG. It's starting to look like Sony hunting season.

2006 Sep 28 10:09 AM

[Tom B:]

Disagree. SNE can buy developers, like MSFT did with Halo. Programmers are cheap, compared to the costs they've put into hardware dev so far.

2006 Sep 28 10:47 AM

[Christopher...:]

Sony has been a sell for awhile. The CEO doesn't speak Japanese. What does that tell you?

2006 Sep 28 08:59 PM

[Dustin Wilson:]

It's true, an HDMI cable will NOT be shipped with either of the units. So if you want to watch any Blu-ray movies or play any HD games you must buy this cable.

RE: Gerry B "Many gamers are dreaming of the next Grand Theft Auto game, this I believe to be a VITAL game for the success/failure of the Playstation 3."

Hate to tell you this but the next Grand Theft Auto game is going to be released on October 17, 2007 on the Xbox 360 and PS3. It's no longer a Playstation exclusive launch.

Oh and if you want to use this primarily as a Blu-ray player...think twice. If you take a look at Playstation 3's website you'll find a bit of scary news.

Look at the "about" section, then question 10 "Can I still play my PS2 games, etc... on PS3?" In the fine print you will read <b>"Blu-ray discs and other media may not operate properly on the PS3 system</b>. This is primarily due to variations in the manufacturing process or encoding of the software"

So you're "cheap" answer to a Blu-ray player now might not even play your blu-ray movies.

2006 Sep 28 09:00 PM

[sam cook'd:]

The reason for this disclaimer is because sony CANT gaurentee everyone else's software will work on their machine. I can promise you will find this same or simular disclaimer on almost consumer electronics. Its to cover themselves if you decide to burn a file to a blu ray disc and if the PS3 doesnt recognize the file you cant go whining to them that their drive is broken when actually its an error with the way the disc was burned.

And so wat they not including the HDMI cable was it a big deal that the PS3 or Xbox didnt come with a S-Video cable??? NO, it was it. The reason is simple percentages. 'If only a small minority can take advantage of the higher cost cable why spend X dollars on including one when the cheaper more that more people will use. Besides you dont need HDMI to get HD Gaming or HD movies(movies for now the movie industry has agreed not to enforce the constraint token untill 2011 and even then they can decide to push that date further back). Composite Video is capable of handeling 1080p signals the problem is most TV sets only except 1080p over HDMI. Most 1080p TV's will take 1080i over a composite connection.

Since Sony was the main developer of the Blu Ray standard i doubt it cost them 2-300 a drive....maybe if you include the lisencing agreements will it be that high. The CELL processor is the next expensive piece and is the tru revolutionary brute that will power the PS3 to greatness i believe. 7 (8 total only 7 active in the ps3) highly developed processor cores controlled by a 3.2Ghz "primary" processer that can easily punch out GFLOPS is astounding. The same processer that is going into the next generartion of super computers and medical imaging devices is going into a consumer gaming machine. What more can you ask? Thats not including bluetooth, 20GB HD MINIMUM(the same as the only 1 available in a 360), memory card reader, wireless lan connectivity, a next gen graphics card and more!

Yes Sony will bleed line a headless chicken over the next 2- 4 years but as production ramps up, the cost of the components will come down. I predict a $2.5 Billion loss next year with an only marginaly better $1 Billion loss in 2008. I can see the PS3 churing a profit by 2009/2010 timeframe. And dont forget Sony predicts a 10 year lifespan on the PS3 (PSX only stop production THIS YEAR!) Sony will not crumble and fold......it will be weaker in the near term but far from flat lined.

2006 Sep 30 07:52 PM

[white sanjuro:]

you guys are totally disconnected with reality (the typical "analyst/investor"-typ... problem).

-- a 10' hdmi cable retails for 4 billion USD loss (as of early 2006) on all xbox-related ventures. less than

2006 Sep 29 12:48 AM

[Gerry B:]

RE: Dustin Wilson "Hate to tell you this but the next Grand Theft Auto game is going to be released on October 17, 2007 on the Xbox 360 and PS3. It's no longer a Playstation exclusive launch."

Why do you "Hate to tell" me? Thank you for telling me Sony doesn't have exclusive rights to GTA anymore. Simultaneous release isn't as bad as Microsoft having exclusive rights.

HDMI cables? You only need one if you have a HD TV, don't you? And people with HD TVs can afford a cable, can't they? Things never change, consoles always supply the 'lower end' cables - I'd be very surprised if they did supply the HDMI cable, the vast majority of customers won't even have a HD TV.

This Blu-ray issue seems to get worse by the day. Now they're telling us it won't play some disks. Are they joking? Things are looking bleak for Sony and Playstation 3, hopefully, and I mean hopefully (for Sony's sake), they are just covering their backs and this isn't going to be a real issue when the stupid thing is finally released.

Like I said before, time will tell.

2006 Sep 29 11:25 PM

[David Banner:]

You must not forget One of Sony's cash cows, the ps2 is still alive and well. In fact it still outselling the other consoles and still has new titles being developed. A smart moe on Sonys part on keeping support for this console.
Yes the ps2 will bring money in to Sony for years to come.

2006 Dec 14 11:29 AM

[Dubs:]

Wow, this is really sad, one of the worst websites I have ever visited.
The PS3 will make more money then the 360 next year, I will bet on it.
The 360 hast lost MS more money then Nintendo has gained off the Wii. The PS3 will be an easy winner and you will start seeing why soon enough.

2007 Oct 03 10:47 PM

[Matthew Davis:]

This article seems to be based on the unsteady idea that Sony is experiencing financial problems in other divisions thus relying on the games division to make up for those losses. As far as I am aware this is not the case. Sony Pictures has had continuous years of outstanding performance thanks to movie releases such as Spiderman, the latest of which brought in revenue of over $1 billion internationally. The LCD division is also in a very strong position with the high end Bravia 1080p products being the best selling of that particular part of the market. While the PlayStation division may be unsteady at the moment, it is far from possible of tumbling Sony.

2007 Oct 03 11:54 PM

[Matthew Davis:]

This article seems to be based on the unsteady idea that Sony is experiencing financial problems in other divisions thus relying on the games division to make up for those losses. As far as I am aware this is not the case. Sony Pictures has had continuous years of outstanding performance thanks to movie releases such as Spiderman, the latest of which brought in revenue of over $1 billion internationally. The LCD division is also in a very strong position with the high end Bravia 1080p products being the best selling of that particular part of the market. While the PlayStation division may be unsteady at the moment, it is far from possible of tumbling Sony.

2007 Oct 03 11:54 PM

[User 111197:]

your an idiot and i hope u die.....this is a well structured write up you have...too bad you count soo much bullshit for the future which is unknown...thanks though. i love reading shitty journalist's load me with there bullshit. i have a PS3 and Xbox 360... and i like them both. there are millions of hardcore fans that will buy into sony's next-gen, franchise.

2007 Oct 05 12:05 PM

[User 111197:]

your an idiot and i hope u die.....this is a well structured write up you have...too bad you count soo much bullshit for the future which is unknown...thanks though. i love reading shitty journalist's load me with there bullshit. i have a PS3 and Xbox 360... and i like them both. there are millions of hardcore fans that will buy into sony's next-gen, franchise.

2007 Oct 05 12:05 PM

[zunes:]

A fantastic article ! Rich of information ! I just hope that the future of PS3 won't fall in shadow :-(

2007 Oct 06 03:32 PM

[MisterTwoTurbo:]

I love laughing in the face of old articles that are dreafully wrong.

2008 Apr 09 05:43 PM

[Limited363:]

So what is there to laugh about MisterTwoTurbo?

Sony had a terrible holiday season for holiday 08. Microsoft sold more 360s then PS3s and Nintendo continues to dominate with the Wii.

Sony will also show a company wide loss for the first time this decade. What the analyst predicted in this article is coming true. Sony continues to lose money on each console sold and cannot lower the price to XBOX 360 levels or risk losing more. Unfortunately, Sony is still in 3rd place after 2 years on the market. The company is cutting jobs and closing factories. It is scary how correct this article is.

So although the article was wrong about Grand Theft Auto 4 being exclusive to PS3, $100 HDMI cables, and Sony forcing people to buy games in order to buy consoles, it was very right about Sony being in a bad financial position after the PS3 launch. And THAT is no laughing matter.




On Apr 09 05:43 PM MisterTwoTurbo wrote:

> I love laughing in the face of old articles that are dreafully wrong.

Jan 13 07:08 AM