The big idea: As the holidays approached, video-game-console makers Sony and Microsoft released new machines. What factors and market dynamics will determine the winner in this latest gaming-industry battle? An analysis of the most influential drivers of previous rounds can help us place our bets and, in the process, show the changing nature of technology and the industry.

The scenario: Since the 1977 release of Atari, nearly eight generations of consoles have fought fiercely for preeminence in generating the greatest sales, developing the best in-house games and attracting the most talented software developers. Each console entails a large investment, with early production costs often outstripping the price per unit. This makes early losses inevitable but potentially secures future console and game sales.

The “attach rate” of a console — the average number of software titles owned per consumer — is critical. This rate is driven, in turn, by the motivation of the best software developers to create games for a platform. Thus, both the market penetration in terms of consoles and the attach rate are important lifetime profitability factors. Software sales are as critical to platform profitability as margins on the units themselves, yielding royalties of nearly 20 percent of game prices. Yet dedicated top developers are hard to attract, because blockbuster games can require a $25 million to $100 million investment.

The resolution: In the most recent generation, hand-held controller functionality played a critical part in attracting buyers. In particular, the Nintendo Wii rose in status from an also-ran to a market leader on the strength of its motion-detecting controller. Demographics mattered, too — Nintendo’s success was due largely to its ability to attract non-core gamers, such as the young-family market.

Another critical component in sales generation has been the integration of the game player into other household activities. The Sony PlayStation 3 included a Blu-ray player. Microsoft’s Xbox included online access to video content from the likes of Hulu and Netflix. With each new generation, an array of consumer technologies competes against gaming systems for the buyer’s attention. This year, it might be the iPad Air and other tablets, which weren’t available when the PS3, Wii and Xbox first battled it out in 2006 — or it may be the newest generation of multifunction HD televisions that claim dollars that otherwise might have gone to an updated gaming system. An ever-changing assortment of blended-function technology stands at the ready to siphon away market share, should the giants fail to deliver.

The lesson: Competitive strategy plays out over time in the face of evolving market dynamics. Winners and losers are driven by a host of factors, including timing, functionality and the ability to leverage complementary providers, such as software developers. Understanding the competition helps companies prioritize investments and know when to enter the market. Whoever wins the 2013 video game console matchup will most cleverly integrate an irreplaceable box into the American home.

Mike Lenox and Rebecca Goldberg

Lenox is a professor at the University of Virginia’s Darden School of Business and academic director at Darden’s Batten Institute for Entrepreneurship and Innovation. Goldberg is a management consultant and educator at Goldberg Productions. Darden Professor Jared Harris co-authored the original case.


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