Price war looms for gaming systems: Silver lining: price cuts could spur demand for semis

Electronic News, Nov 26, 2001 by Peter Brown

The game-console market is revving up with the recent release of Microsoft's Xbox and Nintendo's Gamecube systems, but a budding 2002 price war could mean the real winners are the semiconductor vendors.

In fact, this could be exactly the stimulus package the market has been looking for. As the volumes for both consoles begin to push into the millions of units sometime next year, chipmakers are readying themselves to reap the benefits. These chips will be new manufactured chips and not the backlogged inventory that has plagued the semiconductor market for the past year.

"If video games are getting a lot of attention and selling millions of consoles, that is good news for the semi guys," said Peter Glaskowsky, senior analyst at Cahners In-Stat/MDR. "The more game consoles these vendors sell, the more new chips that need to be made. And that is certainly good for the ailing semiconductor market."

Beyond that, industry observers believe that sometime in 2002 a price war will erupt, with Sony and its Playstation 2 (PS2) being the first likely candidate to commit to a price break as it attempts to woo people away from buying the Xbox. This, in turn, could further spark demand for the consoles, meaning hundreds of thousands more chips being manufactured.

Makers of passive components and other suppliers to the game makers also will benefit.

Nvidia Corp., which has two chips inside the Xbox--a GPU and media processor--sees a huge opportunity for itself in the game-console market--and an even bigger opportunity if shipments increase substantially. Already the San Jose-based company has shipped about 1 million units to Microsoft, and it is shipping more chips to the software giant on a monthly basis, according to a spokesman for the company.

"Say the Xbox sells 5 million units. That's 10 million chips Nvidia is shipping. That represents a tremendous growth position for Nvidia," the spokesman said. "We predict that the Xbox will represent 10 percent of our overall revenue in 2002."

For a product that will be slightly more than one year old by the end of 2002, that would translate into impressive growth for the Not-so-small-anymore graphics chip company.

"Margins will come down, but I really believe that the Xbox and PS2 will hold their value a little longer than other boxes because of the [DVD, on-line gaming and graphics] content," the Nvidia spokesman said.

Meanwhile, Intel Corp. is focusing on many means of driving volumes of semiconductors into the market. The chip giant believes the game-console market presents "very good opportunities" for driving volumes of products, a spokesman said. However, the company said the Pentium 4 is its flagship product and will continue to be so even though a 733MHz Pentium III is integrated into the Xbox. The spokesman said a price war would certainly drive demand, but it would not impact Intel all that much.

Even if a price war hits all gaming boxes, it will take more than one product or market to stimulate the growth needed for an economic turnaround in the semiconductor market. But, as Glaskowsky says, "Every bit helps."

The Problems with Price Cuts

One of the biggest mitigating factors in future price cuts is that the margins on the game consoles are already slim. Driving down system prices further compounds that problem. Depending on what analyst firm is asked, Microsoft and Sony already are suffering losses on each console they sell. Both companies are said to be losing anywhere from just a few dollars to $100 to $150 on every box being manufactured.

"The prime motivation in these boxes is not necessarily to make money but to get market share," said Brian O'Rouke, senior analyst with Cahners InStat/MDR, which is owned by Cahners Business Information, the parent company of Electronic News. "Really it comes down to a profit versus market share battle. But if Sony feels the pressure in the market share arena, you can guarantee they will cut the price."

With Sony also wanting to push its hard drive and networking add-ons to the PS2, the company may have an even harder time cutting the box price, said Danielle Levitas, program director for consumer devices at International Data Corp. The reason: Sony won't make any money on these add-ons, either.

"Can [Sony] afford to drop the box price if they are already losing money and will lose money on their add-ons?" she asked. "However, can they afford not to drop the price with the Xbox out in the market and being the fresher machine? These are interesting questions that can't be answered yet."

The Near Term

As far as the near term, opinions about how the console boxes--and electronics in general--will do during the holidays are not encouraging. Referring to the state of consumer confidence, Risto Puhakka, VP of VLSI Research, said that "Christmas will decide some things this year." Puhakka said he expects to see the consumer electronics market moving nicely during the holidays with deep discounts, but adds that no one will be making money on the products.

Recent events have changed consumer thinking, according to George Penis, president of Sierra Marketing Group, Rocklin, Calif. "Ever since Sept. 11, a lot of changes in consumer attitudes have occurred. Their spending will be own, and they will be buying things that last longer and are more practical, which will hurt sales of games and a lot of other consumer products."