Sony’s PS3: Why Losing Money Makes Sense for Them

Sony’s been maligned recently for their PS3 strategy. If you don’t know about it, let me get you up to speed here:

Sony made the PS3, which they’re selling for around $600, a rather high price point for a gaming system in the eyes of most people. It’s that expensive because the PS3 is also a Blu-Ray DVD player, able to play one of the competing next-generation DVD formats coming out. (The other is the HD DVD.) Because of the Blu-Ray player, Sony is losing money on each unit, a lot of it, since Blu-Ray players are more expensive. Still, that’s OK, since gaming console company always make money in licenses from the game. Problem is, Sony has to sell about 30 games in order to make the money back for one unit. That’s a lot of games! The gaming community and the press have been making fun of Sony for this obvious bout of fiscal stupidity, especially since their competitor, the Nintendo Wii, has sold so many units, each at a profit from the start.

While conventional wisdom would tell me that Nintendo’s won this round, I’m not so sure they have. Sure, when it comes to gaming systems and profitability, Nintendo has both Sony’s and Microsoft’s geese. But Sony’s business plan has a lot less to do with gaming and a lot more to do with the total entertainment package, a market in which Nintendo doesn’t play, and Microsoft barely shows up. The key here is the Blu-Ray technology.

Recently, I’ve observed that everywhere the PS3 is being sold, adjacent to the PS3 display is another display, full of Sony films. Films in the Blu-Ray format. Call me crazy, but wouldn’t it make sense that Sony is banking on BOTH the sale of games and movies to get them the profit they need? I mean, what are you more likely to buy, 30 games, or 10 games and 20 movies?

This makes a lot of sense if you think about the crowd they’re going after, the “Get more bang for your buck even if you have to pay a bit more for it”. (In addition to the “must…have…latest…and greatest” crowd.) Why have they not made as many units? Not because there won’t be a demand, and not because they can’t, but because their intended audience, the video/audiophiles who *would* buy 10 games and 20 movies are the ones most likely to purchase the units anyway, and they don’t want to have many units in storage. Remember that companies have to pay for storage, so if you can eliminate that cost, you can increase your bottom line. Once production costs go down for them, over the next year or so, the rest of us (who are waiting until the price drops to get a PS3) will purchase them at a point where they’re at least breaking even on the units, with all game and movie profits going towards the bottom line.

Think about it: Has Sony made another Blu-Ray player which they’re losing money on? Probably not. They’re banking on two specific crowds to get them to profitability. Additionally, by spreading a Blu-Ray player around along with a popular gaming system, you make the format more acceptable. Finally, making this many Blu-Ray players will lower the costs of production for other Blu-Ray players.

Here’s the scenario Sony is banking on: parents buy Blu-Ray player (PS3) for their kids. Kids play it in parents’ 52″ flat screen. Parents, who had a DVD player before, decide to try Blu-Ray, since now they’ve gone out and spent $600 on the darn thing. (They might as well use it to, and get more bang for their buck, right?) They fall in love with the higher quality and more features of the Blu-Ray movies, so they start buying all their movies on Blu-Ray. Kids play games and watch movies, parents buy movies, and then, a few years later, the system burns out from overuse. The family now has to buy another. (Anyone had this experience with their PS2? The overuse/burnout thing, I mean.) This is great, because BestBuy is selling the PS3′s for only $299 by this time. The gaming entertainment systems are profitable to produce. Sony has just made their profit from both ends.

True, this business scenario is, at best, a gamble. But it’s a calculated risk, and Sony’s people are no dummies. If you’re only looking at this from the gaming side, it’s stupid and makes no fiscal sense. If you’re looking at the total package, its a pretty smart move on the part of Sony.

In the long run, I think Sony will succeed with this strategy. In the short run, they won’t see a dime in profit, but I don’t think they care. They’ve learned their lessons from both the MiniDisc and PSP UMD’s. They may have another lesson to learn, but I think they’ll continue pursuing this business model, what I call the unified entertainment system model. (This, I believe, is why Microsoft named Sony as their biggest competitor during the US anti-trust trials. MS is going for the same end, a unified entertainment system, although they bring other things to the table.) Provided they have enough cash to keep it going, I think this strategy will — again, in the long run — work for Sony.