http://www.theinquirer.net/default.aspx?article=37773

By: Charlie Demerjian

ONE WAY TO FEND OFF the death spiral for a console is to develop a exclusive killer app. If you have a game that will be a blockbuster, you can go to one of the console makers and say, “We will only put this out for your system if we get a bribe.”
That bribe is usually lowered or no kickbacks per disk. If the studio that made Halo was not owned by MS, they could go to MS and say “We figure we will sell 10 million copies of the 360 version of Halo 3 and seven million of the PS3 version. We will not do a PS3 version if you make it worth our while not to, say no fee per disk so we can pocket that $10 per unit and an ad budget worth $5 million”.

The virtuous part is that if five of those seven million potential PS3 customers buy a 360 because they really want to play Halo 3, MS can do the math and see if it is worth it or not to shell out the cash. Conversely, Sony could look at the 10 million potential 360 customers and figure that 6 million might buy a PS3 if Halo 3 was their exclusive. Here is where you get into a bidding war with a lot of zeros behind it.

In the end, the better the games, and the more exclusive the games, the more consoles you sell. The more consoles you sell, the less they cost to make, and the more people buy. Why do they buy? Good games and low cost. Why is the cost low? Good games and lots sold. Why are the games good? Lots of potential customers. It is a positively reinforcing feedback loop.

The flip side of this is that if the games are not there, you don’t sell many consoles. This drives costs up and sales down. Why don’t they buy? Bad games and high cost. Why is the cost high? Bad games and few sales. Why are the games bad? Few customers makes it not worth the effort. This is the classic death spiral.

If you look at the current console wars, 360 vs PS3, you can see where things are at. Last I heard, MS was closing out the year with a profit of about $75 per 360 sold and Sony was losing about $200 per. The exact numbers are not really all that important, but the general trend is. MS has a cost of about $325 for the high end 360 and Sony about $800 for the high end PS3, MS makes money, Sony loses.

Even if you assume both companies are bottomless money pits who see this as a long term struggle, there is a problem. The positive feedback loop will allow the consumer to win, cheaper consoles, better games, and lots of extra goodies that go along with it.

The death spiral means a company has to shell out more and more money to hold their ground. They have to buy more exclusives, subsidize consoles more, and basically bribe people into taking money from them with each console sold. Worse yet, if you buy a PS3 for $-200 as far as Sony is concerned, and then there are not 20 games you want to buy over the next few years, Sony eats that $200.

MS in the mean time can take that $75 they are making and drop the price to around $300, bundle in a couple of games and a controller, or just do something creative. Sony will have to match this and drop their price by $100, bundle games, or whatever else MS does. Instead of it being a zero sum game like it is for MS, Sony will have to sell 10 more games per console or eat the cash.

Sony is treading on some seriously dangerous ground here, dangerous enough to potentially break the company. Their reputation is pretty well mud among the geek set for the DRM infections, rootkit fiascos and general corporate ickyness of the past couple of years. This drove away some early adopters.

The $600 price tag drove away more making it a non-starter as an impulse buy. It was late to market, they couldn’t supply the vastly lowered expectations they set weeks before Christmas, and in general failed miserably on execution. Net result, about half of the sales they were projecting six months before, possibly less than that. To add insult to injury, Nintendo blew by them and laughed.

This did not escape the notice of the software makers either. They are faced with optimistically twice the cost to write a game for the PS3 as the 360 and only a fifth the market to sell it in to. It doesn’t take a genius to figure out that the second generation of PS3 games will have a lot more ROI calculations done on them before they get a green light. Many won’t get that green light.

This is far more than a theoretical problem though, in talking to several game developers, the death spiral for Sony has already begun. Many are telling me they are not writing Cell code any more, just farming it out, the 360 is the development target now.

The problem there is that the 360 will be utilized fully and optimized for. If there are special features of the 360, they will get used, and every tweak and hack explored as well. This will then be shoveled off to some poor third party who has to make it work on the PS3, a very different architecture with a very different set of strengths and weaknesses.

What you end up with is a fully utilized 360 and the ‘same’ game on the PS3 with all the weaknesses of the 360 and all the weaknesses of the PS3. Add in very little budget to optimize the resultant PS3 code, and you get a B-list version of an A-list title. This will be readily apparent to even the most blatantly paid for game reviewer.

Can you guess the result? Slower software sales, slower hardware sales, and higher costs. Those dollars end up going somewhere, people want to play games. So they buy a 360, it has all the cool games. This drives up unit sales, lowers cost, and makes MS very happy.

Sony is on the verge of the death spiral. You can tell they are desperately spinning the rhetoric to keep hope alive, but private conversations with game devs tell me it is not flying behind closed doors. How long can Sony, or more to the point, will Sony keep up the money hose? Can they do it until the ugly duckling called PS3 turns into a swan, or will it stay ugly and die?

Meanwhile, MS is on the verge of a price cut, is the primary development target for every console dev I talk to and is selling like hotcakes. PS3s are languishing on the shelves and getting the cold shoulder from the devs. One company is on the virtuous cycle, the other has their toes over the edge of the death spiral. Dire times indeed for Sony.