Pachter's E3 Analysis

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This year's E3 was among the most impressive in the last decade, with three major hardware initiatives displayed, a tremendous amount of new core content, and extremely crisp presentations from all three console manufacturers.

We think that the most impactful reveal” at the show is the 3DS, which appears to us to be the must have” consumer electronics product over the next few years. The 3DS was truly impressive, and although we expect it to cost upwards of $250, we are confident that Nintendo will sell many millions of them in the first full year of production.

We were less impressed with Microsoft's Kinect (formerly Natal) and with Sony's Move, primarily because we had hands on time with them at prior events. Each device is quite interesting, and we expect each to meaningfully impact the market, but we think unlike the 3DS (which is a truly revolutionary experience), pricing for Kinect and Move will have a profound impact on ultimate sell-through.

Microsoft did not announce a price point for Kinect. We think that the company is struggling with a pricing strategy, as it is logical to argue that the lifetime value of a customer is quite high, due to the user-friendliness of the device. In our view, Microsoft could dramatically expand usage of its 40 million Xbox 360 installed base if it could drive Kinect sales to this audience, as we believe that the non-gamers in the typical Xbox 360 household will find Kinect inviting and unintimidating.

We think that if Microsoft prices Kinect close to cost (which we estimate to be around $70), it will see a very high attach rate, with the potential to drive $200 – 400 in lifetime value from each Kinect household. On the other hand, it is equally logical to charge a very high price for the device, especially if it is expected to be supply-constrained.

We think that one camp within Microsoft would like to charge a low price (probably $99.99), and another camp would like to charge a much higher price (probably $149.99) in order to capture significant profits from sales of a limited supply. We are not yet convinced that the hard core Xbox 360 user, who typically controls” decisions about his/her console, will find the game lineup for Kinect sufficiently compelling to purchase the device at a price point over $100, and think that pricing at the higher point would severely limit sales. We thought that the killer app” for Kinect was MTV Games' Dance Central.

Sony did announce pricing for Move, and we think that the pricing has the potential to confuse consumers. Some games can be played with the PlayStation Eye camera and a Move controller, some with the Eye and two Move controllers, and some with the Eye, a Move controller and a Navigation controller.

In order to be safe, consumers wishing to participate in the Move experience will have to purchase the Eye ($29.99), two Move controllers ($49.99 each) and the Navigation controller ($29.99), plus a game. If purchased as part of a bundle, the all-in cost to play with Move will approach $180, which we think is beyond the reach of the typical household. We think that Sony's Move is truly impressive, but remain concerned that initial sales could disappoint.

The software lineup at E3 was perhaps the most impressive in years. We think that the biggest problem faced by gamers this fall is where to find enough money to buy all of the high-quality shooter games, with Halo Reach, Medal of Honor, Call of Duty, RAGE, Brink and Dead Space all quite impressive. We think that this year's Need for Speed is the most polished version ever, although we expect heavy competition from Gran Turismo 5, launching in the same window.

In all, we think that the new hardware introductions have great potential to reinvigorate the video game market, and think that the core games scheduled for release later this year and early next are sufficient to allow the industry to again begin to grow. We expect investors to remain on the sidelines until they see tangible evidence of industry growth, but we are confident that this will occur over the next several months.

Michael Pachter is the Entertainment Software analyst at Wedbush Morgan Securities