Posted by: seanmalstrom | June 30, 2009

Investors, What Are You Paying For?

I am becoming more and more convinced that just as the masses read funny pages for amusement during their morning coffee, investors read analyst reports for chuckles. Why else are they paying for this? I am, of course, referring to Pachter’s latest analyst report.

The sources I am pulling quotes from are IndustryGamers and Wired.

It would be a waste of time to refute Pachter’s report. For each page Pachter writes, it would take three in reply. Replies end up being longer because a refutation demands a tear-down of the original argument and then explanation of what is actually happening. A refutation would be long-winded and boring. I have another idea.

Let us have Pachter, himself, refute Pachter. Yes, folks, this report is boiling with contradictions.

We expect the dominant console at the end of the this cycle to be the Wii, as we think that the console’s low price point, innovative control mechanism, and compatibility with standard definition televisions will provide it with a competitive advantage over the next two years. 

Then he contradicts this statement by saying Nintendo will be coming out with a Wii HD. A Wii HD would be losing that competitive advantage of compatibility with standard definition televisions, yes? Why would Nintendo want to lose its competitive advantage? Pachter sees a Wii HD of expanding the competitive advantage strangely enough:

We expect Nintendo to sustain this competitive advantage by introducing a high definition version of the Wii, perhaps as early as the end of 2010, in order to convert its large installed base into true ‘next generation’ households.

Because we all know Wii customers are interested in graphical improvement, right? Pachter, again, disagrees with himself:

Moreover, Wedbush Morgan estimates that “over half of Wii households are nontraditional, meaning that they would not have bought a console but for the novelty of Wii.” 

So if Wii customers didn’t buy the Wii for the ‘graphics’ but for the novelty (meaning the motion controls), why would Nintendo put out a Wii HD? Wouldn’t Nintendo, instead, upgrade their motion controller? It could be a small adaptor plugged into the bottom of any Wii-mote. You could call it Motion Plus. And this is exactly what Nintendo did. It is one thing to say that Wii HD is going to come out, but it is another to ignore that Nintendo has already signaled which way they are headed by upgrading the motion controls, not the graphics.

I am going to re-use an earlier quote from Pachter.

We expect the dominant console at the end of the this cycle to be the Wii, as we think that the console’s low price point, innovative control mechanism, and compatibility with standard definition televisions will provide it with a competitive advantage over the next two years. 

The price of the Wii is $250 in the US. Now let us listen to Pachter disagree with himself:
 
Xbox 360 and PlayStation 3 still have massive room for growth over the next few years, he says. Pachter points out that 90 percent of all consoles sold in the last generation were at prices under $200, which only the Xbox 360 has reached thus far — and even then, the “core” 360 SKU, the one that comes equipped with a hard drive, has not yet reached that magic price point. (To say nothing of the PlayStation 3.)

Obviously, Wii’s sales aren’t entirely connected to the low price as the Wii is above $200. This is not my logic I am using, dear reader. This is Pachter’s logic. This is pitting one Pachter against another Pachter. With Pachter in the news cycle almost daily, the idea that there are cloned Pachters running around saying stuff and coming up with different predictions is amusing. Pachter could debate himself!

Moreover, Wedbush Morgan estimates that “over half of Wii households are nontraditional, meaning that they would not have bought a console but for the novelty of Wii.” While Pachter points out that this is a good thing for the industry because it widens the market, it means that Nintendo may not have crowded Sony and Microsoft out of the market — there might still be room for many more sales of traditional consoles.

Everything else Pachter says contradicts this statement here. If Pachter believes that over half of Wii households are nontraditional gamers (a fact I likely believe to be more true than not), then what does that say about the core market? If the nontraditional gamers are the expanded audience, and they make up half of the Wii customers, shouldn’t that have been logical that the vast PS2 install base and other gamers from previous generations be flocking to the PS3 or 360? Where the hell did all these core gamers go?

Perhaps what Nintendo said prior to the Wii’s launch was correct. Dismissed as ‘marketing spiel’ at the time, both Iwata and Reggie said that the Core Market was slowly dying. Therefore, new gamers must be made or else all we could do is just sit by and watch gaming slowly die. If Nintendo is right about that, which they likely are since Nintendo was right about the DS and Wii, what does that mean to Pachter’s longterm predictions on the PS3 ‘comeback’? Exactly.

Miyamoto said that the Xbox 360 and PlayStation 3 are just giant dinosaurs fighting one another not realizing they are on the way to extinction.

In order for the Xbox 360 to improve its marketshare, PlayStation 3 marketshare must decrease and vice versa for PlayStation 3’s success. 360 and PS3 are clearly fighting for the same market as they feast over the rotting corpse of Core Gaming. The Wii is getting new blood into it. Make no mistake though, the collapse of the Core will harm the Wii too since the Wii had a foot in the Core Market. But the Wii can take its foot out and place it back in the Expanded Market. PS3 and 360 have no expanded markets to do so. Even if they start them now, such as 360 attempting to do with Project Natal, the Core could crash before a 360 expanded market is large enough to cushion the blow. Think of newspapers collapsing before they got their online news fully profitable.

One more Pachter vs. Pachter showdown:

By the end of 2011 (the extent of our current forecast), we see Nintendo ‘winning’ the console war by maintaining its share, with 48% of this market. 

Versus…

Notwithstanding the projected finish, we truly believe that all three manufacturers should be considered ‘winners’, with Microsoft selling twice as many Xbox 360s as Xboxes and building a robust Xbox Live business, and with the other two companies generating significant profits from their respective shares. 

What profits? There won’t be any profits when you factor out the billion dollar costs that it took to get there. The point is that the Xbox 360 and PlayStation 3 would have been pulled from the shelves if they were not ‘bailed out’ by other parts of the company (and even if that did not happen, who knows, the United States Federal Government could have ‘bailed’ them out. They are bailing out other disrupted companies so why not?).

Nintendo made a respectable profit from the Gamecube. Microsoft blew up billions of dollars over the Xbox. Both sold around the same. Yet, last generation Xbox was the ‘winner’ while Gamecube was the ‘loser’.

I’m a cashflow type of guy. I don’t have any respect for something that doesn’t become an asset. PS3 and Xbox 360 are ‘losers’ because they have not become assets when counting all the costs, including the ‘360 warranty’. Nintendo is interesting not because it gained so much marketshare lately but because Nintendo is consistent in making profitable consoles. Sony isn’t. Microsoft isn’t. Sega wasn’t.

—-

As an addendum, at the end of the Wired piece on Pachter’s latest report, Kohler says this:

That said, there seems to be one crucial piece missing from this analysis: Disruption. Any analysis of the current console cycle that was written in 2004 would have been completely wrong, since it would likely have concentrated heavily on Sony and Microsoft, counting Nintendo out of the equation.But Kohler, someone did predict this generation perfectly back in 2004: Iwata. Nintendo even invested billions of dollars behind the Wii (as is required for a console research and launch). Why could Nintendo predict the disruption and everyone else of the game industry couldn’t?

 

It is a cop-out to excuse the analysts that *no-one* could predict what would happen this generation. In 2004, they were calling the DS the worst mistake since the ‘Virtual Boy’. In 2005, they were filled with crazy quotes about the upcoming generation of consoles. Even in 2006, with the DS success apparent, they still were saying crazy quotes. Even today, in 2009, we STILL get crazy quotes like Wii HD right around the corner. We are making progress, however. Analysts have dropped the notion that PlayStation 3 somehow magically becomes the best selling system this generation. Now, PlayStation 3 has dropped to second place in their predictions.

Has any analyst demonstrated any understanding or curiosity about Nintendo’s strategy? Have they ever mentioned Blue Ocean Strategy or disruption? Nope.DS was not a disruptive product. It was innovative, not disruptive. Blue Ocean, yes. Disruption, no. DS’s touchscreens and dual screen allowed handheld games to attract new audiences such as Nintendogs or Brain Age. But it did not disrupt the PSP as the PSP is living quite happily in Japan. Handheld gaming did not fundamentally change with the DS. But with the Wii, console gaming will never be the same thanks to the Wii-mote.

Indeed, Pachter even points this out in the report, noting that the DS kicked off the current hardware generation “without fanfare” in 2004 and that “few observers appreciated that the Nintendo DS signaled a change in game play” that foretold the Wii’s innovations

 

Sony feels it HAS to put out a motion controller (even just a demo). But it showed no sign of making a touch screen or dual screen handheld or even just demoing one.

To simply look at Sony, Microsoft, and Nintendo and assume that their current strategies, extrapolated outward, will tell the future of the game business is to court disaster. Should a disruptive idea come from an outside company, it could change the ways that Sony, Microsoft, and Nintendo do business, perhaps forcing them to introduce new hardware to respond to a clear shift in consumers’ wants.

In order to disrupt gaming, it is going to have to come from a gaming company. The only game company I see that is in a position to disrupt gaming will be Nintendo who will disrupt the Wii for its new console.

Here is what is going to happen in the future:

-Nintendo will make more motion control games.

-Microsoft will attempt to do a co-opt counter-attack. It will reform the games studio to make a first party with interface being its orientation. Microsoft will attempt to carry these interface innovations to the rest of its platforms to attack Apple with.

-Sony, like a clueless doofus, will keep doing their ‘ten year plan’ and will have motion controls only as a tack on way, a “cram”. Some FPS and ‘heavenly sword’ type games will be made with the motion controllers. But the cram won’t work and won’t steal sales from the Wii.

-Microsoft will do a full brand reboot and launch a new console with interface devices. Whether this includes Natal or something else doesn’t matter. It will have new interface devices though. Microsoft will ‘relaunch’ the 360 with this newly rebooted 360.

-The 360 core gamers will explode with anger and feel Microsoft is abandoning them. Microsoft will have a massive fire on their hands. It will cause them to back down from the co-opt disruption counterattack.

-One thing is for sure, motion controls will improve faster than customers can absorb the benefits resulting in a overshooting of the market. This will provide the cover for a new disruptor to come in. (In order to have disruption, you need overshooting. Wii could disrupt because 360 and PS3 were overshooting the market with their HD consoles whose graphical upgrade most people couldn’t tell as well as ridiculously expensive consoles).

-The Depression takes its toll and works against the incumbents and for the disruptor. Core Gaming becomes a niche. Core Gaming becomes to the game industry as Harleys became to the motorcycle industry. Sony’s PS3 has its pins knocked from under them as well as the 360.

-Disruption is complete. Aside from the few pockets of core left, Wii stands triumphant on top of the wreckages as having a practical monopoly on the Expanded Market. The Expanded Market becomes the new Core Market.

-Nintendo will ride this victory as long as possible. Another competitor, maybe Sony or Microsoft, will do either a Red Ocean attack or (if they are smart) a disruptive attack on the Wii. Then, Nintendo launches their new console which disrupts the Wii, upsets the apple cart again.

-Nintendo then becomes a Wheel of Disruption which only a handful of companies have ever achieved.


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