How the West is won

Ben Parfitt
How the West is won
NORTH AMERICA

Market Overview

The video game market in North America reached record levels in 2006, as the Xbox 360 and DS gained momentum and the launch of the PlayStation 3 and Wii created an abundance of reasons to shop during the Christmas holiday. Retail software sales reached over $7.9 billion, up six per cent from $7.5 billion the year prior, and hardware sales jumped by 37 per cent to $4.7 billion. Even the PC software market, which had seen steady declines since its peak in 2001, returned to growth with a two per cent increase to $1.09 billion.

On the surface, four themes drove the market during the year: the superlative launch of the Wii, the below-expectation launch of the PS3, the rapid expansion of the DS handheld market and the longevity of the PS2. Unike previous cycle transitions, where market structure shifted from one platform oligopoly to a new-but-similar oligopoly, the environment for game development and publishing is showing signs of fractured and more specialised markets.

With six different active platforms, each with significantly unique feature sets and (to some degree) target audiences, the need for platform-specific and optimised content is becoming increasingly important if a publisher hopes to show financial success on a project.

At the same time, development costs continue to escalate. Projects that previously could break even on 300,000 units sold now require double that volume if the game is to keep pace with the high-definition values of ‘next-gen’. More significantly, it is more difficult to simultaneously develop a title on multiple platforms without reinventing the game to take advantage of each system’s internal design.

If consumer spending is any measurement, however, the industry’s efforts are being rewarded with stronger sales for titles that leverage an individual platform’s strengths.
These trends reflect a deeper structural shift in the North American game publishing equation. With no clear market share winner for several years to come, diversification and platform optimisation are clear lessons learned.

Beyond the inevitable first-party succesful exclusives like Gears of War (Xbox 360), God of War 2 (PS2) and New Super Mario Bros. (DS), third-party publishers are attempting to have it both ways: to get the benefits of platform ‘exclusivity’, without being constrained to a single platform. In this way, fans and consumers of each console maintain a belief in the exclusive value of their purchase while the publisher reaches the broadest possible audience.

In the long run, it may not be possible to get something for nothing. While consumers may be pleased when the library of software grows for their system, the counterweight is that none of those software titles take full advantage of the underlying machine. The differences between the current generation of consoles are much more substantial than the oversimplified factors of graphics, sound or processing power.
The on-going challenge, then, will be to find economically feasible ways to offer platform-specific content without requiring full commitment to an individual platform.

Outlook For 2007
The coming year looks to set new records again, with total software sales reaching nearly $8.5 billion. For the first time since the launch of the original PlayStation, a non-Sony platform – the Xbox 360 – will almost certainly generate the greatest software dollar sales (although the PS2 will still sell the most software units). More significantly, the largest share of software dollars will be spent not on Sony platforms, nor on Microsoft platforms, but on Nintendo.

The rapid and prominent return of Nintendo is an interesting story, not only because of the speed at which the DS and Wii have gained traction, but also because of the relative surprise by the industry. Even now, with months of instatiable demand for the Wii and an installed base of over 10 million DS handhelds, skepticism remains as to whether anyone besides Nintendo and a few key publishers will be able to profit in Nintendo’s markets or whether these are simply transient and secondary blips in the larger battle between Sony and Microsoft.

The skeptics may be correct that Nintendo’s strategy has led it away from the technology arms race, but companies that discount the impact of that strategy place themselves at significant risk. With neither the PS3 nor Xbox 360 likely to achieve a dominant position in North America for several years, and with considerable expense involved in developing content for both, industry economics have become much more complex.

EUROPE

Market Overview
As in North America, the European market for video games grew by over 14 per cent in 2006 to $3.9 billion in hardware and $7.1 billion in software (including VAT). Both hardware and software volume saw double-digit percentage increases as well, with the PS2 and DS capturing nearly 60 per cent of console and handheld unit sales respectively.

The PS2 also remains the largest single software market by a factor of nearly three-to-one over all other consoles combined.
Despite Microsoft’s extended period of next-gen market exclusivity, sales of Xbox 360 hardware and software have seen a slower adoption rate than the original Xbox.

In aggregate, sales volumes for Western Europe have been 28 per cent lower in both hardware and software volume (although Euro spending has been higher, due to the higher prices of 360 products). Over 50 per cent of these sales occur in the UK, which is reflective of both greater receptiveness to US-style shooters in the UK and weaker brand resonance in the rest of the Continent. Southern Europe has been particularly weak for both Xbox 360 hardware and software, with software-to-installed-base tie ratios more than a full point lower in Italy and Spain than North America or European averages.

The strongest growth for 2006 came instead from the Nintendo DS, which was the single largest hardware product ($1.1 billion) and the second largest software market (20m units or $900m). The European market has shown a closer resemblance to Japan than to North America in this regard, with Nintendo’s Touch Generation casual label showing very strong success in most countries.

The debate surrounding video games and potential impact on children due to violence has received increasing attention in parts of Europe and in Germany in particular where several high profile titles were refused classification by the country’s software ratings board. For example, top selling titles Gears of War, Dead Rising and Crackdown were all denied access to the German market by the country’s game ratings board. German legislators have also been lobbying for common EU rules on video game violence.

The future political outcome remains uncertain, but could potentially cause signficant challenges for developers and publishers.

Outlook for 2007
IDG’s expectations for 2007 are very bullish, particularly for hardware sales where the ramp-up of the PS3 and Wii are expected to contribute in excess of  $3.3 billion in 2007. Despite our conservative sentiments, the PS3 is expected to see a strong and enduring run in Europe and to ultimately replace the Xbox 360 as Europe’s high-def console of choice. Microsoft will continue to have a noteworthy presence, but despite efforts to the contrary, the Xbox brand remains less desirable than the PlayStation brand to most Europeans.

The coming year will also be a very successful one for Nintendo of Europe, as DS sales are expected to continue their aggressive sales pace. Because the DS is the only new platform expected to reach a 20m unit installed based in all three regions (North America, Europe and Japan) and because of its less expensive development prospects, from a publishing point of view the DS has much to offer.

Several of the legacy platforms – the Xbox, GameCube and GBA – will fade from European shelves during the year. The PSP will not start to wane quite yet, but is at risk of contracting in both hardware and software sales at the end of the year in the absence of changes in the hardware design, pricing structure, or software library.

Lastly, it bears mentioning that the PC market will be the largest sector in Europe in 2007. Nearly $1.7 billion or 61.2m units are projected this year, representing over 20 per cent of value or 30 per cent of sales volume. For some markets, such as Germany and northern Europe, the PC platform will remain the dominant gaming platform for the foreseeable future.

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