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Dec 2007

Video Game: Increased Supply and Demand for the Holiday Season


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According to the Entertainment Software Association, 67% of American households play computer and video games. The electronic gaming industry market is highly competitive and encompasses console video game unites, handheld video game systems, software, online gaming services, and cell phone and PDA applications. Supply and demand plays a significant role in determining what the value of a company or product line is. In recent years, the market has been seeing a shift in demand from board games to video games. With the holiday season underway, strong demand will prevail through the end of the year but retailers will face mixed supply as manufacturing lead times and supply chain constraints of certain systems limit manufacturers' ability to meet short term demand.

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SUPPLY

Research and development

Electronic gaming companies invest a substantial amount of time and resources in research and development. Whether developing systems or software, gaming companies spend years getting products to market. Gaming consoles can take five to seven years to develop. For example, development of the Nintendo Wii began in 2001; the system was released in 2006. Duration of software development varies widely, but it can take up to three years to release innovative games. This lengthy phase results in a decreased ability of gaming companies to adjust supply in reaction to changes in demand.

Manufacturing lead time

Gaming console manufacturers face a substantial investment in time to get new production facilities producing more units to meet demand. At Nintendo, all console manufacturing is outsourced, so bringing a new manufacturer on line is time consuming as the process to qualify it can take some time. When rushed, quality problems can ensue, like what happened to Microsoft in 2005. The firm rushed production so the product would be available for the 2005 holiday shopping season. This acceleration was pointed to by many analysts as the reason for $1 billion manufacturing defect recalls of the unit. Evidence of the impact this supply-side constraint can have on business is making headlines. Nintendo has announced they are at maximum production but acknowledge they will still not meet the demand of the holiday shopping season.

Component cost

When designing a console, electronic gaming companies must choose which components will go into the unit. For the PlayStation 3 (PS3), Sony chose to use the Blu-ray format rather than lower cost components. The result was that the PS3's initial production costs were estimated at $250 over retail price. The total of this loss contributed to the Sony gaming division loosing $1.9 billion in the fiscal year ending in 2007. Tight supplies of the Blu-ray diode and entrance costs of the new cell processor drove the high component costs. Recent component cost reduction has coincided with retail price drops. Microsoft's Xbox 360 originally ran at a loss of $125 per console though is now likely in the black per unit. Contrast this to the Wii, which at a retail price of $250, is far above the estimated $160 component cost. As the costs of these components are driven down, the market should see an increase in supply.

Supply chain

To increase supply, console manufacturers must secure a corresponding increase in supply from component suppliers. Without a commitment from all suppliers along the chain, the increased production cannot occur. The electronic gaming industry is highly dependent on the efficiency and flexibility of the component suppliers, which affects the ability of the manufacturers to react to increased demand.

Installed base

Companies distributing software for gaming consoles often wait to see where demand is before determining which systems it will sell a product for. Before making decisions, these companies will often wait for statistics on installed base, the number of units sold actually in use, to determine systems' popularity and, in turn, where the highest game sales are likely to follow.

DEMAND

Seasonal demand

The electronic gaming industry is highly seasonal. Sales of games and consoles are typically highest during the holiday buying season. If companies fail to deliver products to meet this seasonal demand, sales will suffer. Or, if platforms for which companies have developed products are delayed, sales will decrease.

Brand preferences

Electronic gaming companies set brand visions that define which customers choose to enter the gaming market via their console. Microsoft's Xbox 360 has set its brand as the adult gaming machine. The Nintendo Wii has continued its long standing brand of family gaming, with child friendly titles and a strong reliance on the Mario brand within a brand. Sony's PlayStation 3 (PS3) has set its brand as the platform on the bleeding edge of technology by incorporating Sony's Blu-ray optical disc drive, which may also be used for high definition video. The PS3 also has an Intel/Toshiba designed cell processor which makes it the most powerful next generation system. Buyers decide which brand they identify with the closest and drive demand to that system, in turn, telling the industry what they value.

Piracy

Consumer demand ebbs as ways are found to emulate, modify, and reverse engineer consoles and potential buyers turn to copying software rather than purchasing it. The Entertainment Software Association estimates that piracy costs the video game industry billions of dollars each year. The willingness of potential buyers to use pirated methods can and has affected demand across the entire industry dramatically.

Synergies

The synergies within the electronic gaming industry are widespread. Consider the mutual dependence between console and video game designers. Console designers drive to create systems that provide developers with new tools to utilize in game development. On the other hand, game developers and distributors can drive demand to a console by releasing a title only to certain units. Halo 3 has undoubtedly driven system sales for Xbox 360, while various "Mario" titles have driven sales of Nintendo gaming systems.

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