Commoditization is hell

In an AP dispatch† from the distant reaches of San Francisco, the San Jose Mercury News today reported that the life of a videogame developer ain’t what it used to be:

Nintendo President Satoru Iwata said in the conference's keynote speech Wednesday morning that "game development is drowning" because of the rise of cheaply made and priced mobile and social games. He expressed concern that those platforms have "no motivation to maintain the value of gaming" and that they lower gamemakers' ability to make a living.

In other words, 99¢ iPhone games have killed the market for $60 console games.

Hmmmm...let’s see. Consumers would rather have a cheap portable way to pass the time rather than an expensive immersive experience that requires they sit in front of a TV all day.

Actually, the concerns of developers are exaggerated. The industry is cyclical, chronically depending on the latest hit console — at a time when the major console developers are stretching out platform life cycles, trying to milk their cash cows for all they’re worth.

The problem seems to be that the industry believed its own hype that it would soon surpass the movie industry in revenues and societal impacts.

There’s no reason to suspect that videogames would be immune from the commoditization pressures facing any other industry.

As with any technology-based industry, the growth of performance eventually slows downs — or efforts to add features no longer increase the value perceived by customers. As Clay Christensen noted, the threat in these cases is that a cheaper technology soon becomes good enough.

Time to face reality: commoditization is not going away. The 99¢ games will become more compelling as the mobile devices become more powerful, siphoning off business from the high end formerly mainstream product.


† Apparently the Merc had to close their San Francisco bureau due to budget cuts, or perhaps they decided to stop covering videogames since ace reporter (and author) Dean Takahashi jumped ship.

Microsoft finds products trump business models

With its smash hit Kinect, Microsoft found itself with a conundrum: it was such a great sensing device that researchers and hobbyists wanted to buy it even without buying an Xbox 360.

Normally a smash hit is not a problem. But gIven the Kinect had the same razor & razor blade model as the Xbox, people buying it without buying Xbox games meant that the MS was not making the margins they hoped for.

For a while, Microsoft was fighting the hackers. I argued they shouldn’t fight, they should switch:

Microsoft is missing a significant market opportunity by not being open to third-party enhancement of the Kinect hardware. Although the volume will not be as big as for a hit game — as predicted by Karim [Lakhani] and his research — third-parties will identify markets and solutions that Microsoft never anticipated.

Sure enough, Microsoft has seen the light. On Monday, Microsoft announced it will release a noncommercial SDK for the Kinect in the spring:

While Microsoft plans to release a commercial version at a later date, this SDK will be a starter kit to make it simpler for the academic research and enthusiast communities to create rich natural user interfaces using Kinect technology. The SDK will give users access to deep Kinect system information such as audio, system application-programming interfaces, and direct control of the Kinect sensor.

The timing is right for Microsoft to continue to deepen its ties to industry. With Nokia pulling back from university research alliances — and Apple, Nintendo and Sony abdicating the fight — the Kinect win is a rare example of success at a time of decline for its core businesses and its chronic failure to win share for cellphones.

Wired observes:

Microsoft was particularly impressed by the University of Washington’s research into telerobotic surgery. Researchers at the university hooked up a Kinect to a PHANTOM Omni Haptic, a stylus-based device that gives resistance feedback to the user, to build 3D models that the user can actually feel.

So hand it to Microsoft to (as I suggest) work on building a platform around the successful Kinect technology, rather than protect its otherwise conventional razor (console) and razor blade (game) business model.

Microsoft vs. Open Kinect

This week’s dead tree Business Week has an extensive article on Microsoft’s war against the hackers trying to repurpose its pathbreaking Kinect hardware for other purposes.

It turns out Microsoft’s cool new hardware is the ideal platform for all sorts of robotics and machine vision applications, at consumer off-the-shelf prices. Primesense, original Kinect manufacturer, is planning on supporting developers with a special developer version.

It goes without saying that firms need to leverage their extremely loyal customers and that it’s risky (if not stupid) to tell them they can’t use a product the way they want.

Reporter Ashlee Vance quotes Utah’s most famous and perhaps America’s most oft-quoted) open source executive, my friend Matt:

Microsoft has succeeded despite themselves in creating something really cool," says Matt Asay, a prominent open-source blogger and executive at software startup Strobe. Yet a number of critics say the relationship between Microsoft and Kinect-loving geeks is already strained, and that Microsoft's early reactions to their playful tinkering suggest it could squander a once-in-a-generation opportunity. "Here was a chance to throw themselves deep into the bowels of the open-source hippy movement," Asay says. "They are kind of trying to do it, but they don't want to touch anyone in the mosh pit."

Adds another well-known expert (and friend):

"Companies should make it easy for people to hack," says Karim Lakhani, an assistant professor at Harvard Business School who studies open-source projects. "Why wouldn't you want people going crazy with your products?"

Business Week does a good job summarizing the situation and Matt and Karim why such hacks should be made an asset rather than a distraction or a liability.

The fundamental problem is Microsoft’s business model: they brought the hardware to the market cheap assuming they’d make all their profits off of games (which generate either direct or royalty revenue). They thought they were making a peripheral that made the Xbox 360 platform more attractive — but instead they were creating a entirely new platform.

It reinforces a point I emphasize with my technology strategy students: cross-subsidies are always dangerous, because someone will find a way to arbitrage the subsidy. If you give away razors and make it up by gouging people for razor blades, then someone will sell cheap blades that don’t need a subsidy.

One might argue that Microsoft couldn’t such hacking coming, but that wouldn’t compute. Almost nine years ago, hackers figured out how to take (the heavily subsidized) original Xbox and turn it into a cheap Linux machine.

Microsoft is missing a significant market opportunity by not being open to third-party enhancement of the Kinect hardware. Although the volume will not be as big as for a hit game — as predicted by Karim and his research — third-parties will identify markets and solutions that Microsoft never anticipated.

Over the past few years, Nokia faced a similar conundrum as university scientists hacked N-series phones (such as the N95) to use as a mobile sensing platform. At least a few people in Nokia Research (back when there was a Nokia Research) understood this and were working on even better unlocked hardware for this purpose.

It’s not too late for Microsoft to turn things around. The Kinect COGS will continue to fall. Instead of more aggressively pricing the hardware, it can use the savings to increase the gross margin, reduce the subsidy and make the Kinect a self-supporting stand-alone device.

In the short run, Microsoft can also (quite inexpensively) support a university or hacker conference on other applications of Kinect. MIT, Stanford, Carnegie Mellon or even its hometown UW would be glad to take the lead.

Michael Vick joins EA's last hurrah

Michael Vick is finally back. No, I don’t mean in the NFL or in the public eye. I mean back in Electronic Arts’ John Madden football game.

In an annual ritual, the latest EA football game (now Madden NFL 10) went on sale at 12:01am Friday morning for Wii, Xbox360, PS3, PS2 and PSP console owners.

However, the announcement of the new Philadelphia Eagles backup quarterback came long after the game had been released for duplication. Instead, the EA developers in Marin County had to scramble to add the backup quarterback to the game for the next online update.

The Madden NFL title has been the perennial EA blockbuster, and the Merc even speculated that it could help the overall industry:

"Madden" arrives just in time for the video game industry, which has suffered from flagging sales due to both a lack of blockbuster titles and the decline in the economy.

According to market researcher NPD Group, sales of video game software, hardware and accessories came in at $848.8 million in July, down 29 percent from a year earlier.

"While year-to-date results are weak, there are some big titles set to be released over the next several months, including 'Madden' this month, which should help spur sales," NPD analyst Anita Frazier said, according to our friends at The Associated Press.

I see this instead as the last hurrah for the best-selling sports game of all time.

I first heard of Madden as the coach of the last decent Raiders team (which brought him the familiar plaque at SFO airport). Most sports fans know him as the quirky sportscaster who refused to fly on an airplane. But now that he’s retired, a new generation of teenage boys will say “who???”

Meanwhile the secular trend for the software products business has been down, down, down. Kids steal software, or they play crappy free stuff online, or they don’t bother. The recession has converted their $500/year videogame habits from a “must” to a “nice to have,” particularly if mom or dad no longer has a job.

My guess is that in two years, NFL football from EA will be available as a fully subscription (SaaS) model, the way that Google already is and big software companies like Microsoft, Adobe and Intuit are heading towards. Hopefully EA will be able to charge more than Google for their subscriptions (or reap billions of dollars in ads for their free offerings).

A Clever Rickroll

Unless you’ve been living under a rock, you probably have heard that Electronic Arts has released a videogame called Spore, developed by Will Wright, the author of The Sims, SimCity, etc. etc. etc. Among other features, Spore uses a clever approach to a user-generated content to attract volunteer labor that makes the value of the game higher for prospective buyers (and to increase add-on sales).

The game has an obvious creation vs. evolution tension. Despite its evolutionary tendencies, some Christians think it can also be interpreted as consistent with Intelligent Design. After all, if the game buyers are intelligent (perhaps debatable?) and designing creatures, that would be intelligent design if not Intelligent Design.

But what was funny this morning was to discover the term “Rickroll” and how it was used by a nominal Spore critic. Rick Astley was a 1987 one-hit wonder, and “rickrolling” is an Internet joke that quotes from that hit, often by using the YouTube video of that hit, “Never Gonna Give You Up.”

The website Antispore.com (complete with Google adwords) claimed to be a Christian response to the alleged heresies of the EA game. In the Sept. 11 posting, the author quoted from the Astley lyrics before adding an even more direct tipoff (emphasis and hotlink added)

But the Bible teaches us that God was not done with man. For we were His creation and He then spoke to Noah in Genesis 8:21-27 after the flood.

“21. The LORD smelled the pleasing aroma and said in his heart: “Never again will I curse the ground because of man, even though every inclination of his heart is evil from childhood. And never gonna give you up. 22. “Never gonna let you down.” 23. “Never gonna run around and desert you.” 24. “Never gonna make you cry.” 25. “Never gonna say goodbye.” 26. “Never gonna tell a lie and hurt you.” 27. “Never truly believe anything you read on the Internet. There will always be cases of Poe’s Law.”

It’s these teachings that I’ve spent my life learning, believing and becoming, that have made me the woman that I am today.

Not exactly what my copy of the NIV Bible says for Genesis 8:21-22 (there is no 23-27).

Somehow, a few of the 2,252 comments on the article did not appear to get the joke, but one of the more amused readers wrote:

Best spoof site I’ve ever seen; you’ve succesfully proved atheists are bigger whiners and every bit as petty, venal, abusive, aggresive, malicious and generally unpleasant and enormously f***ing stupid as the God squad. And you’ve proved it in such a short time.

Mr. Astley is now 42 and apparently doing the British equivalent of the County Fair circuit. Still, this is the sort of immortality (or at least 15 minutes of fame) that no one can buy, unless perhaps your first name is Paris. Meanwhile, a few more people have learned what “Rickroll” means.

Microsoft’s Halo effect

For the first half of its 2007-2008 FY, Microsoft’s Entertainment and Devices Division has finally gotten around to making money, posting a $524 million operating income for the first six months, vs. a $423 million loss for the year before.

Revenues climbed 25% to $4.99 billion. While the division includes PC games and Zune music players, the gain is mainly attributed to Xbox 360, specifically Halo 3. So one game (with some help) accounted for a $950 profit swing and now the division is delivering 8% of the company’s profits. The Xbox team finally has a new GM, formerly of Electronic Arts.

Is this a longterm turnaround? Or is this just the upswing of a long cycle that will go negative again? Of course, we don’t have the financial transparency to understand the cross-subsidies between Xbox games and consoles (which are expected) and between Xbox, PC games and Zune (which are being used to bury Microsoft’s losers).

Microsoft is now making money off of videogames. Supported solely by games and consoles, Nintendo has turned a profit each of the past five years, but improved its margins to 20% and expecting to net over $4 billion in the current fiscal year. They left more than $1 billion in revenue on the table due to an inability to meet Christmas demand.

With Microsoft’s long predicted game profits finally here, maybe even Sony will make it into the black sometime soon. The PS3 losses have been dragging down the corporate parent’s profits for more than a year.

Wii will rip you!

When the whole Wii saga began, my daughter wrote (in an obvious homage to the 1977 hit song)

Wii will wii will rock you

Going on intuition, I showered early this morning and drove to my nearest Fry's superstore in search of the mythical console. It was not that wacky — Fry's runs its big ads on Fridays while Circuit City and Best Buy do it on Sundays. Since I can't stand in line this Sunday, this could be my only shot before Dec. 16.

Sure enough, I got to Fry's at 8:40 am and joined the first line I saw — which naturally was the line for the Wii. The store had opened at 8 am, and I was told that I was 3 shoppers too late — it sure looked like I should not have stopped to buy the newspaper. But somehow they miscounted, and $530.33 later I owned the “Wii Hardware Bundle” for my niece and nephew.

It turns out I was being unfair in blaming Nintendo for price discrimination (gouging customers). This was not a Nintendo-required “hard” bundle but a Fry's “soft” bundle, with $250 of Wii console and $240 of mandatory Wii accessories sold at list prices.

I estimate that $150 of the $240 is actually useful stuff, notably the Super Mario Galaxy game that my nephew is dying to get and also a spare controller. But the rest of the bundle is comprised of products that are either total drek, or extra accessories that they were unlikely to ever want (like the Nunchuk controller).

Thus it's not Nintendo trying to milk extra bucks out of its customers, but the dealer. This actually explains (and fits) the Costco bundles mentioned by Wii Tracker: to increase average selling points and avoid commoditization (and perhaps manufacturer wrath), Costco has tried to take hot products and throw in extra doodads to add “value” rather than sell the base product for a lower price. Standard Merchandising 101 sort of stuff.

My apologies to Nintendo, and of course my embarrassment at playing along with this whole sordid game.

Wii R price discriminators

In my thus far futile search for my niece & nephew’s Wii console to deliver by December 24, I found the Wii Tracker website. It’s a website that offers links to places that sell Wii consoles.

They link to a Mercury News interview (excerpted on a blog) in which Reggie Fils-Aime, the president of Nintendo of America, explains the sales frenzy:

Q: The Wii console has been a big hit to date, with you guys having a difficult time meeting demand. This is going to be a bad Christmas for folks still wanting to buy one, isn't it?

A: We have been sold out worldwide since we launched. . . . Every time we put more into the marketplace, we sell more, which says that we are not even close to understanding where the threshold is between supply and demand.

Q: What is it about your manufacturing system that doesn't allow you to catch up with demand?

A: The issue is not a lack of production. The issue is we went in with a curve that was aggressive, but the demand has been substantially more than that. And the ability to ramp up production and to sustain it is not a switch that you flick on. We're working very hard to make sure that consumers are satisfied this holiday, but I can't guarantee that we're going to meet demand. As a matter of fact, I can tell you on the record we won't.

Given this supply constraint, Wii Tracker makes Nintendo’s strategy quite clear: it’s quite easy to buy a Wii today, as long as you’re willing to pay $500-$600 for a “bundle” rather than $250 for just the base console. Increasingly, parents are paying twice what they were willing to pay in order to have the “must have” game in time for Christmas.

If course, this is exactly the sort of price discrimination (versioning) that Hal Varian advocates in Information Rules: charge more money to those who are willing to pay more, less to those who are not, and keep the two groups separate. So those who want to buy a Whttp://www.blogger.com/img/gl.link.gifii for junior's birthday in February will do fine, but those who want to be a hero on Christmas morning are hosed. That's me: in fact, my niece and nephew have birthdays in December, so I can't even try the wait-until-February ploy.

Update 12:45 p.m.: This morning’s WSJ says the Wii shortage is caused by 2007 sales exceeding Nintendo’s forecasts by 25%, by extremely conservative supply chain management, and by huge lags in ramping up production because it is 100% outsourced. Upon further investigation, I also found that the profiteering is not (directly) due to Nintendo, but its dealers.

Wii R Number One!

Today I spent an hour shuttling between two Best Buy stores in hopes of scoring a $250 Wii console for my niece and nephew. Not having bought a videogame console before, it didn’t occur to me to show up at 8 a.m. for a store that opened at 10 a.m. At both stores we were too far back in line to get one of the allocated units (125 and 80, respectively).

My 9-year-old wanted to know why a year-old console was in short supply, and I couldn’t answer — other than the Wii is obviously this year’s hottest Christmas gift. Reporters are writing stories about the shortage while consoles are going for twice the asking price online. Unlike in college football, it’s very clear who’s number one in the latest round of the videogame platform wars. (Even if Sony beat Nintendo for one month in one country).

The customary lesson from the VCR wars and various generations of videogame platform battles is that time to market and software are everything. The conventional wisdom is: line up content, and the customers will follow. But wandering through Best Buy (while my wife waited in line), it was obvious that there was more than enough content for Xbox 360 and a fair amount for PS3; in contrast, the Wii content was selling out. And some of the most important content is available for all platforms, like the Guitar Hero that my young relatives don’t know they’re getting to go with the Wii they don’t know they’re getting.

Instead, the Wii was the surprise winner against two behemoths fighting each other over gigahertz and polygon rendering frame rates. The Xbox was even first to market this time. Maybe price was part of Wii’s success, but my sense is that the motion-sensitive controller and fun games — i.e. innovation — were what made the difference.

So the next time someone assumes that network effects are the be-all and end-all, they should remember the Wii and the idea that (as Liebowitz and Margolis reminded us) sometimes the better mousetrap actually does win.