Tuesday, February 03, 2009

Console Post Of The Week: Headaches

Nintendo shocked almost everyone last week by announcing lower earnings for their third quarter than expected and cutting their annual forecast.

Let's take a look.

First, they lowered their annual profit forecast from Y345 billion to Y230 billion (the lower number is £1.8 billion). That's quite a hicky, lowering an annual profit forecast by 1/3 with only two months left to go in the fiscal year.

Here's Ninendo's explanation (from their quarterly results presentation):
The operational profit was 501.3 billion yen, and along with the net sales, marked a record high for Nintendo’s 9-month financial results.

However, due to the significant appreciation of the yen since the global financial crisis in October, 174.2billion yen of foreign currency reevaluation loss was incurred as we reevaluated the foreign assets held in currencies other than Japanese yen. As a result, the recurring profit was 352.4 billion yen, and the net profit, 212.5 billion yen.

That looks a bit more benign, at least in terms of operating health. They lowered their annual profit forecast by Y115 billion, but they took a currency loss of Y174 billion in the last quarter.

More troubling, perhaps, was their cut in the annual Wii shipments forecast, from 27.5 million to 26.5 million. According to Nintendo, the reduction is due to weak sales in Japan, while European and U.S. sales remain strong.

On the one hand, I'm as surprised as anyone that Nintendo cut their forecast. On the other hand, though, it needs to be considered in context. Sony forecast a 7% increase in PS3 sales (about 750,000 more units) and they're probably going to hit it. Nintendo forecast 55% growth (ten million more units) and is missing by a million units. They're still going to sell 27 million Wii's in the fiscal year--or, at least, that's the current forecast.

I don't think there's any question that Nintendo is having issues in Japan, even though they're still beating the hell out of the PS3. However, the amount of software that's being released in Japan this year appears to be greatly increased, so we'll see if that has an impact on sales.

As for the rest of the world--well, the Wii is cool as hell, but they need to do something with it this year. With the improved motion control afforded by the Motion Plus add-on (which is coming out in March, I believe), the opportunity is there, but they need third-party developers to use the controller in a more substantial way.

As an example, Motion Plus is perfect for a game like Tiger Woods, which could now have extremely precise motion tracking. But it would be typical EA lameness to not use it (for incomprehensible reasons that make no sense to anyone except EA), and Nintendo has to bang on them and make sure it's supported.

In general, though: okay, everyone's got one. Now make us want to use it more often.

I saw several headlines last week that, when combined, must have Sony very, very concerned.

Jan. 30 (Bloomberg) -- Plunging DVD sales threaten to reduce profit for studio owners Time Warner Inc.,Walt Disney Co.,Viacom Inc. and News Corp., and may force them to write down the value of movies, analysts said.

Fourth-quarter shipments fell 32 percent in the U.S. and Canada to 453.6 million DVDs, according to Los Angeles-based Digital Entertainment Group. The drop is the biggest since the industry-funded researcher started keeping track in 1997.

The decline is being fueled by viewer shifts toward rental services such as
Netflix Inc., the U.S. recession and technology that makes it easier to stream Web videos to televisions.

DVD sales may fall 11 percent this year and cause studios to write down new and recent titles that miss internal forecasts,
Michael Nathanson, an analyst at Sanford C. Bernstein & Co. in New York, wrote in a report this month.

The article refers to "home video sales and rentals" as a $60B business in 2008. And what is the size of the Blu-Ray market in 2008? Article two:
Speaking at a press briefing organized by DEG: The Digital Entertainment Group here Nov. 14, Warner Home Video president Ron Sanders and Sony Pictures Home Entertainment president David Bishop each put their estimates for total Blu-ray software sales in 2008 around $750 million.

So the Blu-Ray software market is roughly (and this is a very rough estimate) 1.25% of the size of the DVD market, and even though Blu-Ray sales are growing, the market is still so small that its increase is nowhere near making up for DVD's decline.

This, in essense, is PS2 Syndrome, part two. Sony's PS2 sales are now forecast to be down over 5 million, but PS3 sales are forecast to be up less than 1 million.

I think one entirely reasonable scenario is that video streaming becomes much more popular than buying physical media. Popping over to Netflix, clicking on a selection, and streaming it instantly is the shit. It's absolutely fantastic, and there's no waiting. And for 99% of the viewing public, they won't be able to tell the difference between streamed, compressed video in HD and Blu-Ray.

Video-on-demand has been touted for so many years, even long before the infrastructure existed, because it's a brilliant concept from a business perspective. One of the most basic principles of business is that when people want to spend money, you let them. Letting people pay for movies without having to leave their couch, from a business perspective, removes almost every barrier possible to the consumer. Yes, they have to have a broadband connection, but that's probably the demographic (in an economic sense) that you should be targeting, anyway.

Here's what the CEO of Netflix said during last week's quarterly earnings call:
...Netflix CEO Reed Hastings noted that there were millions of subscribers using the Watch Instantly feature, and that Netflix had seen a "substitution effect" among subscribers who do so.

"We are seeing early signs of less DVD usage with some subscribers who are also watching instantly as compared to subscribers who only receive DVDs," said Hastings. "Time will tell whether this substitution effect is an attribute of early adopters or a mainstream behavior."

Sony has two problems here. First, even if they stream movies via Home, it's a technology where they don't have a monopoly (unlike Blu-Ray disc royalties). Second, and I mentioned this before, very few people will be able to tell the difference in quality, and video on demand is both much cheaper and much more convenient.

Plus, video-on-demand doesn't have to outsell Blu-Ray to hurt Sony's financials. It just has to cannibalize Blu-Ray beyond the point that Sony projected, and I bet that point was quite low.

The well isn't totally dry. Sony has some good thinks to look forward to this year in terms of games--Killzone 2 and God of War 3 will both sell quite a few consoles. But they've made so many mistakes at the strategic level with the PS3 that tactically, they spend most of their time doing corpse runs.

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