As a result of problems related to the mass production of a key component of its Blu-ray DVD player, Sony (SNE) will delay the European launch of its next generation video game console, the PlayStation 3 (PS3). Sony will also reduce the number of PS3 units immediately available in both the U.S. and Japan.

In the U.S., the PS3 will launch on November 17th, with approximately 400,000 consoles available for sale. The U.S. launch will come almost a week after the Japanese launch which will consist of merely 100,000 units.

Sony's PlayStation 3 is the successor to the PlayStation 2, the world's most popular (and as recently as July, the world's best selling) video game console.

The Number That Really Matters

The fact that there will only be 400,000 PS3 units available for sale in the United States on November 17th is totally unimportant. The launch date itself is unimportant. What matters is how many units will be available for sale in mid to late December.

Sony claims it will have 1 million to 1.2 million consoles available for sale by December 31st. So, let's assume there will be at least a million PS3 consoles available for sale in the U.S. by Christmas.

Will that be enough to put a PlayStation in the living room of every household that wants one?

No. There will almost certainly be many people who have to go without a PS3 for Christmas, despite being willing to pay the very high price Sony is asking. But, that's nothing new. Other consoles (including the Xbox 360) have been launched without an adequate number of units immediately available for sale.

A delay is much worse than a mere shortage. There's a promise (and a tangible product) behind a console that has already launched. So, very few people in the U.S. or Japan who planned to buy a PS3 are likely to change their minds because of a Christmas shortage – no matter how severe.

The Things That Really Matter

The success of any gaming platform is largely based on five factors:

Available Titles

Relative Launch Date

Price

Predecessor's Installed Base

Technology

Of these five, technology is by far the least important factor. The four most important factors (available titles, relative launch date, price, and predecessor's installed base) are difficult to separate. Clearly, having a predecessor with a large installed base (such as the PS2) can be tremendously beneficial, if you get satisfactory marks in the other three areas (titles, launch date, and price).

Predecessor's Installed Base

The PlayStation 3 dominates when it comes to having a predecessor with a large installed base. So, how does it score in the other three areas?

In terms of available titles, the PS3 scores as well as any of its competitors, if not better. However, none of the three consoles (Xbox 360, PS3, or Wii) does very well in this regard. Unfortunately, the titles are likely to be somewhat segregated by console. There will be quality games on each system; but, almost no one will buy all three. Simply put, there will be some games exclusive to each console that a lot of people would really love to play – but can't.

Relative Launch Date

Returning to the list of factors that determine a console's success, let's consider the launch date issue. Sony clearly has a bit of a problem in Europe, because it will have one less Christmas season than both the Xbox 360 and the Wii. Some analysts think Sony will lose no more than a few hundred thousand console sales to substitutions. If that's true, lost revenue might be in the hundreds of millions rather than the billions.

Three Separate Markets

The U.S., Japan, and Europe are really three very different markets. It's quite possible you could have a console that is very successful in one market and yet unable to get any real momentum in another.

Before this delay, I felt strongly that Europe was the market where the PS3 could come closest to duplicating the performance of the PS2 in terms of market share. There's a long-term danger that Microsoft will gain market share in the U.S. and Nintendo will gain market share in both the U.S. and Japan.

Obviously, Europe isn't as well defined a market as either the U.S. or Japan. So, it's much harder to predict how a certain type of console or a certain type of game will go over there. The U.S. and Japan are very clearly defined game markets, largely because they have very clearly defined consumer cultures in general and entertainment cultures in particular.

So, what does the PS3 delay mean for Sony's future in Europe? It's hard to say. I'm more interested in seeing what the installed base of each next generation console will look like in the American and Japanese markets after Christmas 2007, when we'll have the first real chance to predict how this round of the console wars will play out.

Although I do think Sony is doing serious harm to its PlayStation line by insisting upon including Blu-ray and charging a ridiculous price, I don't think any amount of managerial ineptitude is likely to cause the catastrophic failure of a successor to such a dominant console as the PS2.

Price

If price isn't the elephant in the room, it should be. Most of the articles I read about the recently announced PS3 delay / production scale-down didn't say much about the pricing of the PS3. That's a mistake – especially, because several articles mentioned the laptop battery recall, which has nothing to do with the PS3 and very little to do with Sony (it has everything to do with lithium-ion batteries irrespective of their manufacturer).

The PS3's price is a big problem. One that might have manifested itself in poor Christmas sales, if the number of units available for sale had approached the expected demand. For now, Sony is planning on having so few units available in the U.S. by Christmas that the launch will go well even if the PS3 is ultimately a failure. Sony claims it will have 6 million units by the end of its fiscal year. A few analysts are skeptical, but Sony is sticking to that line.

In the weeks ahead, expect Sony to make a big deal about the fact that it will actually make more PS3 units available by the end of December than the number of Xbox 360s Microsoft had made available by the same time the year before. It's a valid point. But, it omits two key facts. The PS3 is launching after the Xbox 360 and there are more PS2 owners out there who will want to trade up for the new system.

Since the PS3 is launching after the Xbox 360, no one is waiting around to see what the alternative will look like. They already know what the Xbox 360 is, what it can do, and what (some of) the games available for it are. As soon as the PS3 launches, the comparisons can begin. That wasn't possible when the Xbox 360 launched and everybody knew the PS3 was on its way.

The second reason why no parallel exists between the demand for Xbox 360s at launch and the demand for PS3s at launch is simply that there are more PS2s out there. As a result, Sony having as many units available by Christmas as Microsoft had the year before would be a lot like Gillette having as many new razors available as Schick had produced the year before. The difference in market share obliterates any possible comparison.

So, even though I think the PS3 is far too expensive going into the Christmas season, I'm quite sure that fact won't be evident in the sales numbers, because there will be a severe PS3 shortage throughout 2006. Even if the PlayStation 3 is too expensive, it will look like it's selling well, because there simply won't be enough of them produced in 2006.

Why am I so convinced the PS3 is priced too high?

The PS3 is too expensive to be a Christmas gift. Around Christmas, a lot of these consoles are bought by parents as gifts for their kids. Parents are willing to pay a lot for them, because they're a huge one-time item for the kid (and the parents have been hearing about it since well before the launch). But, the prices likely to be charged in 2006 for the PS3 are simply beyond what parents are willing to spend.

It's not an issue of how much consumers have to spend versus the value they're getting. It's an issue of being psychologically unprepared for paying this kind of price for any gift.

It may be a price older gamers are willing to pay to get a PS3 for themselves. But, it's not a price parents will be willing to spend on their kids.

Copyright 2006 Geoff Gannon

Geoff Gannon writes a daily value investing blog and produces a twice weekly (half hour) value investing podcast at: http://www.gannononinvesting.com

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