Open Vs Closed: The Future of Console Gaming
Closed platforms have dominated the entire history of (console) gaming. Despite some innovations on monetization, gaming's business model has hardly changed since the 1970s: consumers buy hardware that gives them access to a library of software. If the right network effect ensues, the platform can become profitable by attracting third-party developers and consumers. For the last 40 years, buying a console effectively locked you in the platform in question with little room to operate: "I was Nintendo/Sega kid!". Even inter-generational consoles from the same company seldom communicated well with each other, dividing player bases and rendering old technology obsolete faster.
The debate over backward compatibility is not particularly new. In 1991, during the launch of the SNES (Super Nintendo), parents were demonstrably upset that Nintendo didn't create a system that allowed their children to play their older cartridges.
Many people rightly associate the Xbox One's 2013 announcement debacle with their DRM messaging. Still, I would argue that by failing to launch with backward compatibility, Microsoft ceded a critical competitive advantage.
To be fair to console manufacturers, attaining backward compatibility is hard and requires difficult choices. In the past, those choices were primarily hardware-centric. The original PlayStation 3 was notoriously massive and costly partly in an attempt to have the necessary components to load PlayStation 2 games. Nintendo had a similar conundrum with both the Wii and the DS for the Gamecube and the GameBoy. Those additional components are never zero-marginal-costs decisions: $7 worth of "Gameboy" parts in the DS could quickly balloon to $600 million in additional costs in the lifetime of the portable console that famously sold more than 150 million units. That's precisely the reason why budget-slim consoles that get released in the middle of a generation cycle are usually stripped down of additional hardware features, i.e., the PlayStation 3 Slim, the DS Lite, and the Wii mini could not play PS2, GameBoy, and Gamecube games respectively.
Sony's PlayStation 5 announcement this week was fascinating on many levels, including the bold look of its new console and an impressive showcase of exclusive software. Most importantly, the Japanese firm had a clear message on its approach to nextgen: PlayStation 5 will have games that will only be playable on the new platform, a bright contrast to Microsoft's consumer-friendly strategy with Smart Delivery.
Sony Intertainment's CEO Jim Ryan recently laid out Sony's philosophy in a gameindustrybiz interview:
We have always said that we believe in generations. We believe that when you go to all the trouble of creating a next-gen console, that it should include features and benefits that the previous generation does not include. And that, in our view, people should make games that can make the most of those features… We do believe in generations, and whether it's the DualSense controller, whether it's the 3D audio, whether it's the multiple ways that the SSD can be used... we are thinking that it is time to give the PlayStation community something new, something different, that can really only be enjoyed on PS5.
Sony will be doubling down on the old paradigm of closed consoles. I doubt they’ll allow forward compatibility, which means that PS4 players will most likely have to purchase an additional copy of The Last of Us Part 2 when they eventually upgrade to PS5.
Microsoft's Strategy
Microsoft was fast to respond; not only will their console be backward compatible (3 generations back!!) they will also provide forward compatibility for free:
Although Greenberg's tweet only notes Microsoft's first-party games, this option will be available for any third-party games publisher that wishes to opt-in the Smart Delivery system. As someone who's been gaming for more than twenty years, I can't stress how big of a competitive advantage Smart Delivery is. Forward compatibility is a more prominent feature than backward compatibility, especially at the inception of a new generation since most of the latest games' release in the next 30 months will be available on both generations.
It's what happened from 2013 to 2015 when multiple publishers released same-day cross-generational versions of their games such as Tomb Raider, Assasin's Creed Black Flag, Metal Gear Solid V, and the various sports franchises (FIFA, 2K, etc.). This list doesn't even include games that started on the previous generation that eventually got "ultimate" editions in the new generations years later, like GTA 5, Saints Row, and the Metro franchise.
Forward compatibility is simply a radical pro-consumer approach that demonstrates Microsoft's ambitions:
They want to develop a new console business model that is not solely focused on traditional hardware-software network effect sales combination. Microsoft intends to become our end-to-end gaming service provider by offering a bundle of products with recurring revenue: Xbox's Game Pass, Xbox Live, and eventually xCloud. They’re even toying with new payment models for consumers that mirror the telecommunications industry through their Xbox All Access subscription.
Microsoft wants to become the top player in gaming. They're not just looking at Sony or Nintendo; my bet is Phil Spencer's team is paying close attention to other innovators in the game such as Epic Games and Valve.
Those services mentioned above, coupled with consumer-friendly policies on cross-platform flexibility, will make Microsoft's Xbox Series X the best console ecosystem on the market. It's quite admirable that Microsoft is fighting back so hard after the evident failure of Xbox One. For context, the Nintendo Switch has outsold the Xbox One despite releasing a full four years later. The PS4 has in all accounts outsold the Xbox One by a margin of 3:1. Microsoft could have easily tempered its ambitions in the console space and focused on its profitable services line (Live).
Instead, under Spencer's leadership, Xbox has routinely introduced the best innovations in console gaming space: backward compatibility and Games Pass. It should be noted that PC gamers have enjoyed the benefits of a relatively "open" ecosystem for the last two decades. It's infuriating that Smart Delivery is considered a radical innovation in 2020 when every other consumer application has made the transition to a device-agnostic future (see Apple's App Store, for example).
To be clear, Microsoft could have gone a step further by offering a stripped-down version of Live free of charge to all of its customers. A "Basic" live would allow players to still play games online without any "premium" features (voice-chat, free games, cross-platform support, etc.). It's not like Microsoft can't do this, and it would be a zero-marginal-cost alternative.
They won't do it though; Live has over 70 Million active-monthly-users as of June 2019, which means they generate over $3 billion in revenue from the service. Microsoft doesn't break down the costs of the service, but there is no way they're spending more than a billion dollars on this service on maintenance, updates, promotions, and free games with gold. Live as we know it is untouchable. The service is just too profitable in its current form. It's not surprising that Xbox is anchoring its Game Pass Bundle to Live, given the service's favorable economics.
One last point on Microsoft: having the best gaming ecosystem is not enough to succeed as a platform. Brand equity and exclusive-software matter tremendously in this war. The truth is Microsoft lacks both.
Xbox will never be able to generate the amount of affection Nintendo commands when they release a new Zelda game. The same can be said for Sony as well, to a lesser extent. I'm generally skeptical that Sony's exclusive games (Spiderman aside) moved the needle so much on consoles sales to justify a 3:1 lead. They certainly don't have the incremental effect games like Zelda, Mario Kart, Super Mario, Pokemon or Animal Crossing have for Nintendo. The data bears this out too: 1 out 3 Nintendo Switch players own one of the five best selling games, that number is closer to 1 out 10 for Sony's exclusives.
But even as a skeptic of the "Sony's exclusives are the reason why they're winning" theory, I must confess that what Sony's been able to achieve with its first and second party studio relationship is nothing short of sensational. They've released a series of fantastic games across their portfolio. Xbox does not have one exclusive game that is as good as God of War, Days Gone, Ratchet & Clank, or Spiderman. Sony earned the right to be the number one destination for gamers even though its platform is slightly regressive.
Microsoft has been in acquisition mode over the last few years to beef up its internal studios. None of their acquisitions have been revolutionary, and to be honest, I'm surprised Spencer's team didn't push for an Insomniac acquisition a few years before Sony closed the deal last summer. Perhaps they didn't have that option given Sony's deep tie with the American studio, and to be fair, Insomniac's games have not gained mainstream success if you remove Sony's IPs (Spiderman and Ratchet & Clank). If the deal was contractually possible, I can't help but feel a studio that's capable of producing games like Spiderman and Sunset Overdrive would have injected Microsoft the AAA talent they desperately need to diversify their library.
Game Theory: a Game of Chickens
We've now had a close look into nextgen platforms. We know what the boxes look like, we know they'll both be coming out around November, and we have an idea what the launch titles will look like. We're still missing an essential piece of the puzzle: pricing. I plan on covering pricing strategy in a longer article over later this summer. Nevertheless, I figured now would be a good time to touch on a few interesting strategic implications.
I suspect the prices for nextgen consoles will be high. Console manufacturers are aware of this and doing everything they can to keep costs under control. Microsoft is planning to launch a cheaper less-powerful-all-digital SKU on the market codenamed Lockhart. This week. Sony confirmed there would be two versions of the new PS5: one with a disc drive and the other without. If Sony or Microsoft could legitimately sell their hardware at a slight loss (or breakeven) for $400-450, I'm confident they'd announce it out of the gate and earn some positive share of mind with consumers. The truth is they can't.
This doesn't necessarily mean that the new consoles will cost upwards of $600. Sony tried selling a console for $600, and it resulted in the company's only tough patch during its time in the gaming industry. Microsoft made a similar mistake in 2013 when they bundled Kinnect to their box, bringing the One's tag price to $500. They're still paying for that strategic mistake today. The marketers at Microsoft and Sony know they can't exceed that mark for a successful launch. The better question is how much money can they afford to lose on each box? More crucially, if their acceptable $-loss-per-box range is wide, can they undercut their rival on price?
You can't undercut your competitor if you don't know their price. Moreover, unless your pricing is extremely low, there is no real advantage at announcing your price first. The economic shocks from the global pandemic make this decision even more delicate. Sony and Microsoft's decision on pricing is a classic example of game theory - a sequential pricing game to be more specific.
Sony has been the undisputed king of the video games industry for 25 years now, and they're very well set up to continue their dominance. It's up to Microsoft to blow us away and make Sony defend on pricing. Pricing alone will not make them win, the same way having the best gaming platform has not moved the needle in terms of sales. But it is a start, and I'm excited to see how Microsoft decides to approach this.