It's all about risk management
Posted by aogThursday, 16 November 2006 at 14:17 TrackBack Ping URL

Deep Black asks one of the importants questions of our time, which is — why do game console manufacturers not charge a premium for the first units? Given the wait people endure to get one and the grey market in flipping the consoles by first purchasers, presumably the original equipment manufacturer (OEM) could charge more and is therefore leaving money on the table. Why would the OEM do that?

Game consoles are not something that are easy to churn out. They, like new airplane models, take a large amount of design effort. Unlike personal computers, a design must remain fixed for a much longer amount of time, so the costs of getting it wrong are much larger. Predicting when the design of the console itself and the manufacturing will be ready is challenging. OEMs face the additional constraint that the purchase of their product is strongly seasonal, so a slip in schedule can be devastating.

Therefore the entire production cycle is planned long before the consoles appear on the market. Part of that planning is pricing. This makes pricing much less flexible for several reasons.

  • The price point is announced up to a year before the consoles hit the market. This sets expectations will are difficult to change later, so it’s best to pick a reasonable price and stick with it than to try to ride the initial release spike.
  • Distributers and retailers want guarantees about supply and pricing long before the release as well.
  • There is the public relations issue of appearing to be gouging.
  • It’s hard to predict the size of the spike and it’s not good to have to be noticeably dropping the unit price shortly after a release. Stable prices matter in the customer community.

In effect, it is similar to other producers purchasing options to avoid risk. By fixing the price and supply, in cooperation with retailers, the manufacturer buys a “put”, decreasing risk while sacrificing spot market / grey market profits.

Comments — Formatting by Textile
cjm Saturday, 18 November 2006 at 01:31

the real money is in the game cartridges. i used to work at atari in the halcyon days, and can provide humorous anecdotes if anyone cares to hear them.

David Cohen Saturday, 18 November 2006 at 21:50

I’d love to hear them.

David Cohen Saturday, 18 November 2006 at 21:57

However, “the money is in the game cartridges” doesn’t really answer the question, and might even point in the opposite direction. The point about the money being in the game cartridges would seem to be that you want to get the consoles out there, even at little or no profit, so that the cartridges will sell. Therefore, anything that deters system sales is bad. But that’s what’s so special about announcement time. The product is hot and the supplies are limited. As a result the price is too low by the exact definition of too low; the price being charged is not the market clearing price but is lower than the market clearing price, resulting in scarcity, lines and a grey market. In other words, we see all the classic signs of artificially low pricing. We can understand, if bemoan, when Jimmy Carter sets the price of gasoline too low and causes the 1973 shortage. But why would Sony do it. Not only would raising the price increase revenue at no additional cost but it would enforce an orderly market, not reduce the number of consoles and ensure that consoles are bought at retailers, where cartridges are sold, rather than on ebay.

Annoying Old Guy Saturday, 18 November 2006 at 22:02

What about earnings smoothing?

cjm Monday, 20 November 2006 at 09:32

the point about cartridge sales, is that the platform is a loss leader. so your point about getting a new platform out there is valid, being balanced against not wanting to taint the new system by releasing faulty equipment. they want to build interest, and not have potential customers start ignoring pr about th enew platform because of some predatory initial pricing. there is already a lot of controversey about the ps3 pricing.

to me the real question is why anyone would put themselves out to have an early model, when they know the thing will be easily available within a short time. it bespeaks a terrible emptiness within an individual, that something like a new game platform gets them to line up like lemmings.

atari had a boom-bust-boom kind of history. when i started there, nolan bushnell had already left and the current ceo was a somewhat flamboyant egyptian fellow (whose previous expereince was in the linen industry). so the top three game designers arranged for a meeting with the ceo, and requested that their names be mentioned on the games (and there might have been some financial participation involved, too). the ceo type was dismisive, telling the designers that “anyone can do what you do” and that they were nothing more than “towel designers”. fast forward about 12 months, and the three game designers have left to form activision, and have taken away 30% of atari’s monopoly on cartrdige sales. the company’s response to this was classic corporate…

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