The red ink now gushing from Atari, Mattel Electronics and other companies that had been big winners in video games confirms what many experts believe is a key shift in the industry.
The first generation of the technology that spawned the video game revolution, they say, is dead.
For a while, video games were the hottest things ever to streak across the consumer electronics landscape. In just under five years, they exploded into a $7 billion business. What quarters teenagers didn't pump into video arcades ended up spent on home video games.
But the technology and the marketplace have both changed. Yesterday's Pac-Man is tomorrow's dinosaur. Arcade games revenues are off more than 40 percent from their high of 1981, says Play Meter magazine, and inventories of game cartridges have swelled, forcing steep price-cutting. Meanwhile, Mattel Inc. said last week that it expects to report a loss of more than $65 million by its consumer electronics division for the quarter ending today. Atari has reported a $310 million loss for its second quarter.
That's not to say that electronic entertainment is about to disappear. On the contrary, the growth of personal computer and software sales continues unabated. But the era of the dedicated games machine--such as Atari's VCS 2600 and Mattel's Intellivision--appears over. Though millions of those machines have been sold, they are rapidly assuming the status of a Model T--a classic, perhaps, but no longer a best-seller.
Even more painful to the industry, the easy money that used to come with a hit games cartridge is also gone. What had been a business filled with "hits" is now a crowded, competitive field with lots of product and sliding margins. Several video games companies have turned belly up. Others are hoping that Christmas will rescue what stands to be a year of no real growth.
"At best," says Christopher Kirby, an analyst with Sanford C. Bernstein in New York, "the video games cartridge business will end up as a stepchild industry of personal computers or an extension of the toy business."
On the surface, the video games business seems to be thriving. According to Atari and other leading industrial sources, sales of video games cartridges--which store the actual games--are up 50 percent over the first six months of last year.
That surge is deceptive, however. There is an enormous "inventory overhang" of video games left over from last year, when the industry wound up with 15-to-20 million cartridges unsold. (At the end of 1981 there were none.) Literally dozens of new video games cartridge companies sprang up to try to snag a piece of the market. The more established churned out game after game, believing that the public's demand was somewhere between insatiable and infinite.
As a result of the glut, manufacturers have taken hundreds of millions of dollars in inventory write-offs. (Most of Atari's second-quarter loss resulted from inventory write-offs.)
They also are cutting their prices, both to unload that inventory and to boost sales. With those cuts in price come cuts in margin. As margins go down, so do profits.
"Unit sales of cartridges may be up 10 to 20 percent," says Lee Isgur, an analyst with Paine, Webber. "But I think that cartridge prices will be down 30 percent to 40 percent by the end of this year."
Bernstein's Kirby is more conservative. "The average cartridge price will drop from $16 in 1982 to $14 in 1983--a drop of 12 percent. So, overall, revenues in the industry will contract. But margins will contract even more than revenues."
Indeed, contends Susan McKelvey, a spokesperson for K mart, one of the nation's largest sellers of video games cartridges, "We expect the category to do well this fall and Christmas primarily because manufacturers will be promoting at lower price points."
Video games companies already have slashed prices on many of their older games. Cartridges that once retailed for $39.95 can be had for under $10. "Imagic reduced the prices on its first six products to keep them on shelves," says Kurt Garehime, a sales manager with the Los Gatos-based company. "The retailer has only so much shelf space."
Former monster hits, such as Pac-Man, are now bundled into and given away with the sale of games consoles. A hot new game can still fetch top-dollar prices of $40 or more, but now, say industry experts, the life cycle of those games is shriveling. Games that used to sell for months now only sell for weeks. And games that used to sell for weeks don't even budge off the shelves unless their prices drop.
"Prices are dropping," agrees David Pardo, executive vice presidnet of Crazy Eddie, a major New York consumer electronics retail chain. "I think that cartridges are going to sell for $1.99 one of these days."
Choking down inventories of failed games has made video games companies far more selective about what they choose to release into the market. Moreover, the major games companies like Activision and Imagic are now designing games for home computer systems to wean themselves away from their dependence on the machines that only play games, such as Atari's VCS.
Indeed, many observers attribute the drop in the cartridge video game market as a function of the rise in home computers. Consumers, they contend, want the better quality graphics, sound and game play that home computers and their software can provide. The old games machine, they say, just doesn't make the grade in comparison.
"When those companies say there is a 10 million base of games machines out there," says Crazy Eddie's Pardo, "I think a lot of them are in the closets or in the garbage. The computers are taking over."
"That's not a natural assumption," insists Donald Kingsborough, Atari's president in charge of sales and distribution. In fact, he maintains, video games machines are still selling well, and the video games cartridge remains a vital growth market.
"We think it's a very healthy business," says Kingsborough. "The business is up substantially over last year--our share of new release sales is up to 67 percent."
What's more, he contends, the cartridge market will grow 35 percent this year, another 35 percent in 1984 and 35 percent yet again in 1985. And, says Kingsborough, in sharp contrast to the industry consensus, Atari's margins per cartridge sale will remain firm.
Kingsborough also says Atari will begin to produce cartridges with educational merit to market to special segments, as well as cartridges with a "personal improvement" slant. In addition, the company will even upgrade the technical quality of its VCS cartridges by exploring such options as expanding their memory capacity and possibly even making it "smarter" by adding a microprocessor.
That's for the future. But even now, the company claims, it has the product that will sell. "We'll have the biggest hits this year," Kingsborough asserts.
Others are extremely wary of Kingsborough's and Atari's optimism. They point out that the Sunnyvale, Calif.-based company's second quarter loss of $310 million does little to encourage the belief that Atari's sense of the market is particularly acute. What's more, they contend, Atari's optimism builds expectations--and if those expectations are not met, the company may further corrode investor confidence in Atari's parent company, Warner Communications.
What's particulary unusual, say several experts, is Atari's belief that the games market and home computer market will stand side by side. "If we looked at this three years from now," says Kingsborough, "you'd be saying how surprised you were at how healthy the video games business was. There would be two distinct markets--games for entertainment, and home computers that were tied to daily living. Atari will be a key player in games and a major one in home utility."
That is the minority view. Most industry participants and observers believe that the trend is away from games machines and towards computers. They see the video game being absorbed by the new generation of home computer systems. Atari's perspective is perceived as shortsighted
"We've always believed the home computer and video games business were very much the same," says a Coleco spokesman, "Colecovision Coleco's game machine is the first part of Adam the company's computer system . We have never distinguished one from the other."
"There is no evidence that there is a distinct market between the two," says Bernstein's Kirby, "All indications are that the two are merging."
Indeed, even Atari has announced that it will begin making its software compatible for competing computer systems. The company has to leave behind the very technology that created it.
Whether future generations of computer-based games can capture the public fancy and explode an industry into profitability is also unclear. But those companies that are unable to adapt and provide for the new technologies seem certain to perish.
"A lot of the companies that had best-selling games last year," says Paine, Webber's Isgur, "won't be around next year."
The reasons for that range from simple bad management to excruciatingly bad games. But the underlying reason is most likely to be that the public wants more for its money and more from the technology. The companies capable of providing that in the context of home computers, observers say, are the ones that stand to survive.