Chapter 14 I use this case in the section of my strategy

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CASE 14

Video Game Console Industry in 2015

TEACHING NOTE

■ SYNOPSIS ■

The eighth generation of video game consoles was a three-way battle involving Nintendo’s Wii U,

Microsoft’s Xbox One, and Sony’s PS4. Although each new generation of consoles involves a familiar

quest to exploit the dynamics of network externalities, the current round of competition presented some

unusual challenges. The rising power of the software publishers meant that the console makers could no

longer enforce exclusivity on their game developers. Video games were increasingly shifting to mobile

This is a case where it is easy to allow the class to take the lead: every MBA class is likely to include

video game enthusiasts and typically the knowledge of the students about the products and the industry

extends beyond that of the instructor and beyond the information included in the case.

■ TEACHING OBJECTIVES ■

I use the case to examine strategy and competition in a technology-based, global industry where there is a

complementary relationship between hardware and software and, as a result, a propensity for the market

to converge around a single platform.

The case allows students to learn about:

 the sources of network externalities and the industry characteristics that result in the emergence of

technical standards

and the tendency for digital technology to cause different product markets to converge. Thus, a critical

difference between competition in the new generation of video game consoles is that competition is no

longer just about the video game market. Now that video game consoles can be used to watch DVDs,

■ POSITION IN THE COURSE ■

I use this case in the section of my strategy course that deals with competition and strategy formulation in

technology-based industries.

■ ASSIGNMENT QUESTIONS ■

1. What are the key success factors in the video games hardware industry?

2. In what sense and for what reasons is this a “winner-take-all” industry?

3. What factors have changed the dynamics of competition and the basis for competitive advantage in

■ READING ■

R. M. Grant, Contemporary Strategy Analysis (9th edn.), Wiley, 2016, Chapter 9 (especially the sections

on “Standards, Platforms and Network Externalities” and “Platform–based Markets” pp. 255–262).

■ CASE DISCUSSION AND ANALYSIS ■

What Are the Key Success Factors in the Video Games Hardware Industry?

I find it useful to review the history of the industry in order to identify patterns in market leadership and

to understand the basis of competitive advantage. I start by asking, “Which companies have been

successful in each of the product generations of video game consoles?” and then, “Why?” This results in a

table on the blackboard that looks something like this:

Product

generation:

2nd (4/8-bit)

3rd (8-bit)

4th (16-bit)

5th (32/64-bit)

6th (128-bit)

7th (256-bit)

Dates:

1978–85

1985–90

1991–5

1995–8

1999–2005

2006–2012

From the many factors that get mentioned as “success factors” in each product generation, I ask one of the

class members: “Looking across these different phases of the industry’s history, what common key

success factors emerge?”

This should elicit something like this:

1. Technological progressiveness in hardware. The market leaders were typically also technical leaders.

Aspects of technological leadership relate to multiple factors:

 The successful companies were typically leaders in introducing machines with more powerful

processors which offered faster clock speeds and the capability to support more sophisticated

2. Quality and availability of software.

 A wide range of software. Unlike application software for business computers, consumers of

video game consoles seek variety. A small range of games drastically restricts market appeal.

3. Marketing. Central to the success of all the market leaders was the building of consumer awareness and

establishing brand strength. But which customers to target? While “hard–core” gamers are the key lead

4. Timing. With the exception of Atari (the pioneer of home video consoles), all the other companies

entered a market that was dominated by an incumbent. The ability to take market leadership from an

5. Coordinated launch. Timing relates not simply to the market launch, but also to the ability to

coordinate all aspects of market launch. Capturing market share requires the simultaneous release of both

Is This a “Winner-Take-All” Industry?

Winner-take-all industries are those that tend to be dominated by a single company that scoops the major

So, what are the forces driving such single firm dominance?

1. Conventional scale economies. Development and launch costs for a new games machine are very high.

For seventh and eighth generation consoles, development costs run into several billions of dollars. Before

2. Network externalities resulting in convergence around a single platform. As different games consoles

use different hardware components and configurations and different operating systems, the software is not

interchangeable between them. Two types of network externality result:

 User externalities. Game players converge around the most popular console in order to permit

Yet, despite these forces that strengthen market leaders, the evidence of the industry is that seemingly-

impregnable market leaders are deposed: Atari by Nintendo, Nintendo by Sony. How has this happened?

Several factors appear to be important:

 Technological advantage. The opportunities for innovation are constantly presented, giving outsiders

and underlings the potential to leapfrog incumbents in technological progressiveness.

Managing network externalities is a central feature of strategy in the industry: the key is the management

of expectations. Long before the launch of a new console, the console manufacturers are engaged in a

complex process of managing the perceptions of game developers and potential consumers.

Changes in the Dynamics of Competition and Basis of Competitive Advantage

A feature of the past two generations of consoles is that no single firm has emerged as dominant: in the

seventh and eighth generations the market has been split between Sony, Microsoft and Nintendo. What

has happened to the power of network externalities? Several things:

1. Growth and segmentation of the market. The video games market has grown in size and breadth. As

Figure 1 in the case shows, each new generation of consoles has surpassed its predecessor in terms of

2. Shifting balance of power between hardware and software producers. Although software always been

the major source of revenue (and the most important determinant of the consumer experience), in the past

the console producers were dominant players in the market. I ask why is this so—particularly since in the

personal computer market, the reverse is the case? The answer is in control over the operating system

3. Multifunctionality of consoles. The widening range of functions offered by games consoles also has

implications for competition. To begin with it broadens differentiation opportunities. In the previous

generation, PS3 emphasized its advanced DVD technology; Xbox emphasizes its online capabilities.

Other factors upsetting the usual dynamics of the industry were:

 The strange case of Wii. Finally, Nintendo’s massive success with its Wii console undermined

much of the conventional wisdom about the industry’s key success factors. The conventional

 The rise of mobile gaming. The biggest growth in video gaming during the past decade has been

games for mobile devices—mainly smartphones and tablets: Angry Birds and Candy Crush are

the most widely played games of all time. One result is that home video game consoles are in

many ways a nice market, and increasingly the preserve of the Serious Gamer. Another has been

Strategy Recommendations for Sony, Microsoft, and Nintendo

Given the situation in 2015, we can then evaluate the strategies being pursued by the major players and

offer recommendations for the next product generation that take account of the recent developments in the

sector.

1. Sony. For Sony, the past two generations of video game consoles have been difficult. After

dominating the world market with its PlayStation and then PS2, Sony was humbled by Nintendo

whose Wii outsold the PS3. Moreover, as Table A2 shows, Sony’s video games business has made a

loss over the period 2008 to 2015. However, with PS4, Sony has regained both market leadership and

profitability. Clearly video games are a core business for Sony, contributing 16% of total sales and

2. Microsoft (MS). A key issue for MS is its strategic goal in its video game business. Xbox is one of the

strategic options MS has created to hedge against the decline of the PC—where it viewed video

games consoles as having the potential to be the primary vehicle for home entertainment and internet

access. Given MS’s failure to make significant headway in mobile devices and the software they run,

the strategic importance of Xbox has probably increased. Hence, then the prospects for short- or even

3. Nintendo. Despite Nintendo’s success with Wii, it lacks the financial and strategic strengths that

Microsoft and Sony derive from their business empires. Yet, as a specialist video games company,

Nintendo also possesses some significant strengths. Its long history in the industry gives it a

considerable reputation – especially in Japan. Moreover, it surpasses its two rivals in one critical area:

it possesses the strongest game development capability and proprietary game library of any of the

three major console producers.

conventional industry wisdom and introduced novel technical innovations. Its strategy can be

interpreted in several ways. As the weakest of the three, it has adopted a contrarian strategy, breaking

away from the leading pack. In pursing occasional rather than core gamers it has encouraged market

segmentation, separating “casual”—often older—gamers from “hard core” gamers. This strategy

■ KEY TAKE-AWAYS FROM THE CASE DISCUSSION ■

The key learning from this case relates to competition and competitive advantage in technologically fast-

moving markets where there are hardware–software complementarities. The result of this

complementarity is a tendency for de facto standards to emerge which offers tremendous profit potential

for companies that can own and control these standards. I summarize the key points as follows:

1. Hardware–software complementarities:

 The basic “razors and blades” business model

2. Analyzing the existence and sources of network externalities:

 User linkages

 Availability of complements (deriving from hardware–software complementarities).

3. How to win standards wars:

 Timing: first-mover advantages/disadvantages

4. Recognizing how industry development can undermine network externalities: critical to the

power of platforms in a market is co-specialization between the platform and the complementary