Will Blu-ray sink the PlayStation 3?

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Will Blu-ray sink the PlayStation 3?

See pictures of the PS3 and other Blu-ray Disc players …

Los Angeles (CA) – Back in March, when Sony Computer Entertainment President Ken Kutaragi made a brave decision to postpone the release of one of the most critically important and highly anticipated entertainment devices in his company’s history in order to give it time to get one key component – specifically, Blu-ray Disc – ramped up and working properly, his plea for patience met with largely positive response. As the 17 November release date draws nearer, many of the technical issues regarding Blu-ray have been ironed out, though some still remain even as Blu-ray players are made publicly available. The curtain has risen, if partly, on the stage of high-definition video; and if you peek under the curtains, it seems the PlayStation 3 is ready for its debut.

The PlayStation 3 display as seen from the Nintendo booth, during the last (and literally the final) E3 Expo last May.

But the world has changed even since March. The continually skyrocketing price of crude oil has dragged general inflation higher in North America, precipitating a decline in household disposable income. A re-emergence of terrorist threats has dampened general consumer confidence. A lower than anticipated customer uptake for the first HD DVD players, and later the first Blu-ray players, suggests even early adopters remain skeptical about either format’s ability to eventually reign supreme. While analysts accepted news in May of the PS3’s $499 and $599 price announcement as right in line with expectations, recently, opinion has shifted in favor of nay-sayers who believe consumers will find those prices too expensive for a game console, with or without the high-def DVD bonus.

Those negative opinions were given validity by a recent Wall Street Journal article that opened up the old questions again, in light of new economic realities. All of a sudden, a high-dollar game console seems wrong, at least for the North American market. And if it’s Blu-ray – a high-definition disc format whose general direction some say appears pointed towards eventual failure – that’s the reason for the high price that might preclude consumer acceptance of an otherwise magnificent game console, then why is Blu-ray there in the first place?

“I think the key question is whether consumers’ interests in adopting the next generation DVD player is at a point that their decision to buy the next generation [game] console is computed upon that other decision,” stated Michael Cai, director of broadband and gaming for Parks Associates.

When the PlayStation 2 and Microsoft’s original Xbox were first introduced with built-in DVD players, Cai reminded us, they were considered nice bonuses. But DVDs had already been established and accepted by consumers for at least the prior few years, and what’s more, there was only one DVD format for them to consider. As a result, gamers purchased either console for their perceived virtues as game consoles, even – and sometimes especially – if they already owned DVD player consoles.

“At this point, the next generation DVD player market is so nascent,” said Cai. “So it’s difficult to predict whether consumer decisions to buy a console will be heavily influenced by the decision [on] next generation DVD players. I’m sure a certain percentage of the gamers will view a cheap Blu-ray drive, integrated into PS3, as an integral part of the considerations, but I’m just not sure whether the mass market consumers will view it that way.”

“Sony’s got a lot on the line here,” remarked Chris Crotty, senior analyst for consumer electronics at iSuppli. “Last year around this time, Howard Stringer gave that very big public speech saying there were two key technologies to Sony’s future: the Cell processor and Blu-ray. That says a lot right there. They’re not going to give up.”

The PS3’s two markets

Crotty believes the PS3 has enough positive momentum going for it as a game console that it can become a successful product, even if Blu-ray adoption turns out to be poor. “I could see a point at which having the Blu-ray player in there is not necessarily helping it, but I don’t envision that it would hurt it…It doesn’t make sense to me that having that Blu-ray player would be a hindrance.”

Sony continues to project North American sales for the PS3 as approaching two million units before the end of the year – in just the first month-and-a-half – with an additional six million units sold before the end of 2007. Obviously Sony’s near-term projections depend on a key segment of the market: the early adopters, who are less swayed by economic factors than they are by social ones.

“I truly believe that in 18 months, you will see dual-format players on the market.”

Chris Crotty, iSuppli

The PS3 will have zero problems, Cai believes, in attracting early adopters and converting their enthusiasm into sales. The trouble, however, lies after December, once those early purchases have already been made. “I think that changing economic conditions apply more to the mass market consumers,” said Cai. “The early adopter market is partially [driven by] interest, [and] also partially [by] household income and disposable income.” Conceivably, some early adopters will have already saved up for this purchase, since the price is already very well known.

But those early adopters are gamers, Cai believes, for whom Blu-ray may be a bonus but not the deciding factor. After them comes an emerging segment of the market, for which Cai has coined a very clever term we just might have to keep: “a large percentage of what we call claimers always claim they have high interest in everything. If they don’t have disposable income, they will remain claimers; and those real early adopters who both have high interest and high disposable income, are less likely to be influenced [by changing economic conditions].” In other words, there is an emerging segment of the market whose claims to technological adoption are bigger than their actual investments.

What does that matter? Cai’s “claimers” comprise a segment of consumers emerging from the mass market, that are more sensitive to the economy. If they can’t afford to be among the first two million adopters, assuming Sony reaches its goals, then they’ll have to try to find a place among the six million – or less – that wait until the price starts coming down. Partly for this reason, Cai believes, “I think it’s easier [for Sony] to stick to the two million goal than the six million goal. Those early adopters who are eager for this platform, I’m pretty sure there will be at least two million of those. But moving from two million to six million, that’s going to depend on a lot more factors, including the availability of Blu-ray content, and including [the fact that] potentially Sony may be reducing the price in the near future.”

Even the early adopters, Cai reminded us, are having a difficult time deciphering the almost esoteric technical distinctions between the two high-definition formats. “Even for the technology-savvy folks who are more likely to be early adopters of PS3,” he said, “I think a bigger factor is, they are more likely to understand the value of having one box that plays both Blu-ray movies and next-generation PS games. So the $700 price tag is easier for them to justify, compared to the later adopters who are less likely to combine those two considerations.”

Chris Crotty from iSuppli sees a scenario that’s similar in some respects, though certainly not all: He projects Blu-ray will be a big bonus supporting Sony’s initial sales, helping it to reach that early two million goal. But as the mass market starts to approach the PS3, a single-format high-definition DVD player, in his opinion, will be less likely to be the deciding factor, especially if Sony drops its prices.

“I’m sure a certain percentage of the gamers will [want] a cheap Blu-ray drive, integrated into PS3… but I’m just not sure whether the mass market consumers will…”

Michael Cai, Parks Associates

“Sony has a built-in audience for people who want the PS3 as a game machine,” remarked Crotty, “and there’s a lot of those people, of course. [PS3] will expose a lot of people to the joy of high-definition video, and people will see this is a way for them to get into high-definition DVD at a relatively low cost, comparable to what Toshiba’s offering [with its HD-A1 HD DVD player].”

Crotty despises comparisons between today’s video market and the 1980s format war between VHS and Beta, during which he says consumers were not as well educated about consumer electronics. Consumers know, he feels, that dual-format high-def players are an eventual reality, despite what appears to be reluctance by some manufacturers – including LG and Samsung – to be the first ones out of the gate.

Movie studios will give in to competitive pressures, Crotty believes, eventually – and probably next year – releasing titles in both formats, with the possible exception of the Sony-controlled studios (which include Columbia Pictures, Tri-Star, and MGM). “The movie studios are a little scared right now about DVD sales,” Crotty told us, reminding us of a study frequently cited by studio representatives, estimating that VHS movie cassette sales peaked when VHS players reached 80% market penetration in North America. “Now, they’re saying that DVD penetration is around 80%, and that movie title sales on DVD have peaked. So they are desperate to find another way to get more revenue, to make sure they keep selling movies, and certainly high-definition gives them another way.”

As soon as studios realize they’re losing money by sticking with either format on its own, they’ll buckle and produce for both formats. That buckling, he feels, will trigger component manufacturers to produce dual-format players.

“My position is, there’s not going to be a winner in this format war,” states Crotty. “It’s going to be kind of a stalemate, almost a moot point in a few years, because I truly believe that in 18 months, you will see dual-format players on the market.”

Spoilers in the midst

Crotty foresees a long-term scenario that will eventually play out to the PS3’s advantage, even if Blu-ray doesn’t come out smelling like a rose. It begins with the notion that the format war itself is stalling market adoption for both sides. “Because HD DVD and Blu-ray are so busy battling each other,” he remarked, “they’re not looking over their shoulder at the common enemy, which is online delivery. And I say that to people, and they say, ‘Oh, Crotty, you’re nuts. Online delivery of a high-definition movie would take so much time to download!’ And I’m like, ‘Well, what else is your PC doing overnight?’ Look at the Netflix model and apply that to the online world.” He reminded us that Netflix is doing precisely that, and may come up with its own online distribution model later in the year.

“If there was a dual-format, high-definition DVD player out there, it’d be a hot product with zero risk…Then it wouldn’t matter – if somebody eventually did win the format war, who cares?”

Chris Crotty, iSuppli

“Five years from now, it may turn out it doesn’t matter whether it’s Blu-ray or HD DVD,” projected Crotty, “because nobody’s buying the discs any more.”

You’d think that would bode an ill portent for PS3. Not so, in Crotty’s view: “Because these guys are battling each other, the adoption rate is much slower than it would be. If there was no standards battle, these players would be flying off the shelf a lot faster…You’re delaying the adoption rate of one to two years of what it could be; meanwhile, that gives alternative delivery mechanisms one to two years to act.”

In other words, if next-generation DVD were indeed ready for prime time, the online delivery alternative would have to be “readier.” In such a case, having any high-def DVD player attached to a PS3 would seem like an anchor weighing against its own momentum. But as it stands, PS3 actually benefits by high-def DVD’s floundering, as long as the alternative continues to flounder as well.

“I think high-definition and online [are] still going to take five years,” Crotty predicted. Five years, just by coincidence, would be just about right, he added, because “that’s a typical cycle for the video game console market.” So right about the time online delivery got its act together, it’d be time for the “PS4” anyway.

Should there be a break in the action, however, there could be a few possible outcomes, following Crotty’s scenario to a conclusion: Conceivably, Sony could be the last to buckle, retrofitting later PS3 editions with dual-format players. But if all studios publish for both formats anyway, Sony might not even need to go that far. In a strange twist, with dual-format players becoming more common and single-format players less common, single-format players could become less expensive, enabling higher margins for Sony.

“Honestly, right now, if there was a dual-format, high-definition DVD player out there, it’d be a hot product with zero risk,” said Crotty. “Then it wouldn’t matter – if somebody eventually did win the format war, who cares?”

“As you move along the curve, it’s going to be harder and harder for the later adopters to accept that price tag.”

Michael Cai, Parks Associates

Michael Cai disagrees. For the later adopters in the mass market, the question won’t be, “Who cares?” but, “Where’s the value?” If a consumer has made the choice not to invest in a high-definition content library anyway, then having a Blu-ray player in the PS3 could be viewed as a waste of space and dollars. For that customer, he said, the bundle may not have any value. But if that customer is sold on high-def DVD, the bundle has a clear value. The problem is, it becomes up to the success of Blu-ray to make the case in favor of PS3, not the other way around as Sony had originally envisioned it. In that case, Blu-ray – particularly its perceived value over and above HD DVD – would have to matter.

“As you move along the curve,” remarked Cai, “it’s going to be harder and harder for the later adopters to accept that price tag.”

Sony faces a potential danger, Cai believes, if it goes down the road of continuing to integrate home entertainment features into its PlayStation line. That road led to a dead end once already, he reminded us. “For the past five or six years, we’ve been hearing the notion of next-generation consoles becoming media servers,” he said. “Instead of a dedicated gaming platform, it does all music, video, and all that. It’s becoming a tired notion. Sony actually tried that with PSX, which was a disaster even in Japan, considered one of the best early adopter markets. So the lesson is, there is a point where you bundle too much into the gaming platform. I don’t want to draw the conclusion that bundling Blu-ray is breaking that point, but there’s definitely a point where you need to stop bundling, and refocus on gaming.

“If you want to position the game console as a stand-alone media server,” Cai added, “then a lot of the gamers will be turned off because of the high price tag.” Microsoft doesn’t face this danger, he believes, since it has the unexpected virtue of relying on a completely different class of machine – the Media Center PC – to serve as its media center offering. And Nintendo doesn’t face this danger for a more direct reason: It doesn’t want to. Its upcoming Wii is essentially a game console, and Nintendo has made clear it will remain just that.

“Plan B” for PS3?

In a worst-case scenario, in which Blu-ray becomes a disastrous failure in the market, iSuppli’s Chris Crotty believes the PS3 has an escape clause. Like the Wii, he believes, PS3’s fundamental game console technology doesn’t need an entertainment media tie-in to be successful. “If a year from November, people express that they’re more interested in [PS3] as a game machine than a Blu-ray player, and for some reason Blu-ray died,” he remarked, “[Sony] could take it out. There’s other ways they could put something else in there.”

“If you want to position the game console as a stand-alone media server, then a lot of the gamers will be turned off because of the high price tag.”

Michael Cai, Parks Associates

Again, Parks’ Michael Cai disagrees, citing the lack of historical precedent for any CE device manufacturer to cut back on features in order to drive product adoption. “Obviously, [Sony’s] hope is driving the ecosystem for Blu-ray,” Cai remarked. “So they want to form a virtuous circle, but if it turns into a vicious circle, then that would be their biggest fear. If it does become a virtuous circle, then the equipment and component costs would become cheaper and cheaper for the PS3.”

When a manufacturer has an “ecosystem” ideal, its hopes are that the success of one segment of its product line is supported by another segment – for instance, Microsoft’s operating systems by Microsoft’s applications software, and vice versa. Sony’s belief appears to be that Blu-ray’s success could trigger eventual PS3 price drops, as component prices become cheaper and more mass produced. This would enable Sony by 2008 to slash PS3 prices the way it slashed PS2 prices earlier this year.

The problem is, as Cai sees it, PS3 is a component of the Blu-ray ecosystem. So for that price slash to remain feasible, Blu-ray has to succeed pretty strongly and pretty soon, which means that Sony will have to start slashing Blu-ray player prices first. With four-digit price tags characterizing the current Blu-ray models, there’s a lot of room to slash. Even if BD player prices end up being half what they are now – for instance, in the $600 – $750 price range – Cai believes they won’t reach a “bottom” that could trigger similar cuts in the PS3. BD player volume, you see, must reach a certain level before BD component manufacturers (ironically including Sony) will want to cut costs; and until they do that, Sony can’t turn around and cut PS3 prices.

“All these different factors will play together,” predicted Cai, “and I guess I wouldn’t go as far as saying Sony will definitely be doomed, but I would say we won’t see the market share they’ve had with the current generation.”

If Sony loses any market share at all, there will be some who proclaim that fact a defeat for Sony in and of itself. So it doesn’t help matters much that game developers are pulling back on their initial support for the PS3, as evidenced by a growing list of cancelled titles compiled by the enthusiast blog Technophilia, many of which we saw previewed just last May at E3. Is that list evidence that developers see a rough road ahead for PS3, precipitated by Blu-ray? No, says Chris Crotty.

“If nothing else, the PlayStation 3 is guaranteed a minimum of 33.3% market share for video game consoles,” stated Crotty. “That would be saying that the Wii, the Xbox 360, and the PS3 split the market perfectly, [although] that’s kind of unlikely. PlayStation historically has done better than their competitors, so if you’re a game developer – and this is a growing market – you want that one-third…What I’ve heard is that, the game developers are a little frustrated because developing for the PS3 is expensive and complicated because of the Cell [processor].”

“When it comes down to it, neither of these two technologies really offers anything distinctive and advantageous over the other. It’s really ridiculous that they couldn’t come to a common agreement.”

Chris Crotty, iSuppli

Developers with cancellations or postponements may be missing those early adopters, whose numbers Sony hopes meet or exceed two million. Will there be enough mass market adoption of the PS3 to ensure a market for these developers in 2007 or beyond? Crotty remains hopeful, especially with what he sees as an inevitable price drop. “Granted, you’re always going to have the early adopters who are going to spend more,” he said, “but the price is going to come down over time. And what you’re getting for that $599 is pretty impressive, right? You’re getting this very powerful game machine, and you’re getting a next-generation DVD player.”

Just last March, that seemed to be an unbeatable combo – two great tastes, to borrow a phrase, that taste great together. While expert opinion hasn’t entirely shifted to the dark side, there is indeed a shift in the wind – just enough to put PlayStation 3’s ardent supporters on the defensive. On the one hand is the belief that PS3 must survive first and foremost as a game console; on the other is the observation that Sony considers PS3 a critical component of the Blu-ray ecosystem. Historical precedent weighs in Sony’s favor in terms of game machines that have succeeded in their own right, and to Sony’s detriment with respect to game consoles that tried to masquerade as something else. As we’ve seen, the PS3’s future isn’t dependent entirely on Blu-ray’s success – in fact, there’s a scenario that, when played out, leaves PS3 hindered by such success, unable to drop its prices if stand-alone players aren’t slashed first.

If there’s any common ground among all sides in this dispute, it’s the observation that PS3 and Blu-ray are forces in themselves, which in this one incarnation are tied together. Their forward momentum must not only be significant but also the same direction if either is to gain ground in its respective market, and survive the otherwise uncertain future ahead.

See pictures of the PS3 and other Blu-ray Disc players …