Monday, January 07, 2008

Console Post of the Week: Narratives

I'm starting off this week with a story from the investment industry, but it actually turns into a console post, so just hang in there.

A few months ago, I wrote about sub-prime and what kind of havoc it was going to wreak on the financial markets. Even though it was easy to see coming, though, there were a ton of people in the financial community who refused to believe that it was going to have any effect at all. For months, the buzzword everyone was using was "contained."


Well, because for most people, their narratives are far more important than the data.

We all have narratives--about ourselves, about our country, and about our world. A narrative, by this definition, is what we believe will happen in the "long distance." Narratives are deeply held, and individual bits of data, to most people, lack the weight of a narrative. So most people tend to just ignore the data that doesn't agree with their narrative (cognitive dissonance) until the evidence is so overwhelming that it just can't be ignored.

Some people ignore it even then.

I mention this because I believe it explains some of the mammoth errors of gaming industry analysts in the last year, particularly in regards to Sony and Nintendo.

The widely-held narrative in November of 2006 was that the PS3 would be wildly successful, just like the PS2, and would sell 100 million units over its lifetime. The Wii, on the other hand, was some kind of novelty toy, and Nintendo couldn't possibly compete in the console space with Sony and Microsoft.

So when Sony's sales fell off dramatically after January, and Nintendo kept selling every single Wii they made, most analysts really didn't respond by saying that Sony was in trouble. Their narrative of 100 million units for the PS3 in its lifetime was so deeply held that data clearly indicating otherwise was just dismissed.

Think about that for a minute. Actual data is dismissed because it doesn't agree with a logical construct that has been extended well into the future.

By October of last year, after eight consecutive months of bad sales data for the PS3, most analysts had come around. Still, though, that is a long, long delay.

Trust data. Do not trust narratives.

And if we're just looking at data, and not at narratives, what should we be looking for in 2008?

Let's look at Sony first. To begin with, the "success of the PS2" ship has sailed. The PS2 sold over 8.5 million units in its first thirteen months in the U.S. market. The PS3 sold just over 2.4 million.

Less than thirty percent, in other words. Another angle: the PS2 sold more units in the U.S. in its first two months than the PS3 sold in the first thirteen months.

So can the PS3 make up a six million unit deficit? Well, take a look at the PS2 numbers for December 2002-November 2003, which (in terms of lifespan) corresponds to December 2007-November 2008 for the PS3:


To put that into perspective, Sony announced on Sunday that they had sold 1.2 million PS3's from November 23, 2007 to December 31.

My guess: take out the sales from the last week in November, and their December sales are less than a million units. So even with the boost from a significant price cut, PS3 sales for December will be a little over a third of what PS2 sales were at the same point in its lifespan.

Let's take a closer look at those PS2 sales numbers. Even if you take out December 2002 and November 2003 (holiday months), that's still an average of 350,000 units a month.

That's well out of reach for Sony. If they settled into the 200k-250k range monthly in non-holiday months, that would still be 2-2.5x their sales in the U.S. in 2007. And based on November 2007 sales (the first month of the $399 unit), I think the 160x-200k range is more likely.

Here's how you can tell if Sony is gaining momentum beyond the price cut: if they're consistently selling over 250k units in non-holiday months in 2008, then the console has traction--not PS2-type traction, but a huge improvement from last year. If it's consistently below 200k, then they're in deep trouble. Anywhere in between? That depends on your narrative.

X factors? Well, another price cut, possibly, although it's hard to imagine how much more of a loss they can afford to take on the hardware. Not that we care, as long as we can buy one more cheaply. Also, the Warner exclusivity deal is a huge blow to HD-DVD, so there might be some collateral momentum for the PS3, although it also removes one of Sony's major incentives (competition) to cut the price of the unit.

As an aside, I'm willing to bet that Sony scratched a check larger than the $150M Toshiba gave Paramount for exclusivity. I'm not saying there's anything wrong with that, just that that's what happened.

Second, let's discuss Nintendo. If they really want to be the PS2 of this generation, they need to sell 350k-450k units in the U.S., at a minimum, every month, with similar success (scaled to region) in the rest of the world. As great a first year as they've had--selling over six million units in the U.S. in the first thirteen months--that's still almost 2.5 million units less than the PS2 in its first thirteen months.

Supply constrained? Absolutely. And it's still an easy win for them in this generation, unless they have some kind of massive screw-up. To be the most succesful console in history, though, they're going to have to keep the momentum.

Microsoft is at a critical juncture as 2008 begins. After incredible issues with hardware reliability, and after a price cut that came several months late, they had a remarkable fall, selling more units in the September-November period than the PS2 did in its second year. If Sony sold a million PS3's in December, I think that means Microsoft may well have sold 1.3M-1.5M million 360's.

In terms of unit sales and game quality, everything is going Microsoft's way.

Does that mean anything if they can't move 250k+ units in non-holiday months in the U.S. in 2008? Not really. We've entered the third year of what will be, most likely, a five year lifespan (I suspect the 360's replacement will be here in November 2010), and there are very few "second chances" from here on out. 360 sales in the U.S. were below 200k for five consecutive months in 2007. They can't afford to have one month like that in 2008.

I expect another price cut to $299 for the "Premium" unit this summer, and I expect monthly sales in the U.S. to stay significantly above PS3 sales ("significantly" is 20%-30%, at a minimum).

Those aren't difficult guesses. Here's one that's more interesting, though: will the 360 be able to consistently sell above 70,000 units a week in the U.S.? To me, that's the bar they need to be above in non-holiday months in 2008.

There have been persistent rumors in the last week of a new 360 SKU with an internal HD-DVD drive, but I don't think that's in Microsoft's best interests. Selling a 360 with an HD-DVD drive standard seems to undercut the movie delivery service on Xbox Live. Selling a drive as an accessory is one thing, but this would take it to a new level, and it would be a mistake, particularly with serious doubt now about HD-DVD's ability to survive as a format. Here's a good rule about product features for the 360, at least from a business standpoint--if the feature encourages the consumer to buy a larger hard drive, which can hold more content that sells via Xbox Live, then it's good. If it doesn't, then it's bad.

I'll probably have an update this week, since CES will have a ton of product announcements.

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