Sony's Battle For Video Game Supremacy

07-046
Rev. December 8, 2011
Sony's Battle for Video Game Supremacy

John Sterman, Kahn Jekarl, Cate Reavis
As Sir Howard Stringer, CEO of Sony Corporation, settled in for his flight back to Japan from New
York, a number of pressing issues occupied his mind about Sony’s future. At the forefront, Sony’s
next generation video game console, the PlayStation 3 (PS3), was set to launch worldwide on
November 17, 2006, a mere week away. Despite PlayStation 2’s (PS2) dominance in the last
generation of gaming consoles, Stringer understood that past successes were no guarantee of future
success in the intensely competitive game industry.
Microsoft had launched the first volley in the last console war by releasing the Xbox 360 in the fall of
2005. Within one year, almost 4 million Xbox 360s had been sold worldwide, giving Microsoft a
significant head-start in the race for market dominance. Meanwhile, Nintendo, a competitor thought
to be dead due to the lackluster sales of its previous console, the Nintendo Gamecube, had generated
significant “buzz” around its new entry, the Nintendo Wii (pronounced “we”). Targeting more of a
mainstream audience than Sony and Microsoft, the Wii, scheduled to launch just two days after the
PS3, posed a serious threat to Sony’s market share, particularly due to its $249.99 retail price, half the
price of the PS3.
Stringer also knew that there was much more at stake than winning the console war. The next
generation of the DVD market was at stake as well. In addition to being a gaming console, the PS3
was a Blu-Ray disc player. Blu-Ray was a next-generation optical disc format that held more than
five times as much information as DVDs and allowed high-definition television (HDTV) owners to
watch movies with an unprecedented level of image quality. The PS3 was, in effect, the “Trojan-
horse” for the Blu-Ray format.
This case was prepared by Kahn Jekarl, MBA 2007, and Cate Reavis under the supervision of Professor John Sterman. Professor
Sterman is the Jay W. Forrester Professor of Management and Director, MIT System Dynamics Group.
Copyright © 2007, John Sterman. This work is licensed under the Creative Commons Attribution-Noncommercial-No Derivative Works 3.0
Unported License. To view a copy of this license visit http://creativecommons.org/licenses/by-nc-nd/3.0/ or send a letter to Creative
Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA.
SONY'S BATTLE FOR VIDEO GAME SUPREMACY
Sony found itself in an intense standards war with Toshiba, a well-established Japanese electronics
manufacturer, that, in partnership with Microsoft, had developed its own digital video standard, the
HD-DVD that retailed for $500. The battle lines were being drawn as companies including HBO,
New Line, Intel, and Sanyo aligned themselves with HD-DVD and Fox, Disney, MGM, Lionsgate,
Apple, Dell, Pioneer, Panasonic, Philips, HP, and Sharp sided with Blu-Ray. Warner Brothers and
Paramount were supporting both formats.1 F
While winning the digital video format war could prove to be extremely profitable for Sony, the
battle would be hard-fought. Sony, meanwhile, had had some disappointments in the past in
estalishing its own technology formats. In the mid 1970s, it launched the BetaMax, a home
videocassette tape recording format which was quickly outmarketed by JVC’s VHS format largely
due to the fact that VHS tapes held more taping capacity (two hours) compared to Betamax’s one
hour. In 2003, Sony attempted to establish its own music and movie playing format by introducing
the Universal Media Disc (UMD) for its portable gaming device the PlayStation Portable (PSP).
Initial PSP units were sold with the UMD version of Spider-Man to highlight the flexibility of the
device. But UMD never took hold, in large part due to the lack of UMD titles and the number of
other devices that played UMDs.
Stringer was well aware that replicating the PS2’s success would not be easy. The price of the PS3
would be a significant barrier to widespread penetration. At $599, the PS3 could no longer be
considered a toy and would not likely be an impulse purchase for the majority of consumers.
Although compared to stand-alone Blu-Ray players, which sold for $900-$1,000, the PS3 could be
considered a bargain since it could play games as well including some older generation PlayStation
games.
By all accounts, since entering the video game industry in 1994, Sony’s ability to capture the
attention spans of child and adult gamers had been impressive. However, as technology became more
varied and versatile, so did consumer tastes. Stringer knew it was critical that Sony kept consumer
appetites at one and the same time satiated and begging for more.
The Evolution of Home Video Games

0B
During the 30-year history of video games, the industry had experienced significant changes not only
in who played video games— the average computer and video game player in the United States was
33 years old while the average age of the most frequent video game purchaser was 40 years old—2 F
but in how they were conceived, developed, priced, and ultimately sold, all of which had significant
implications for Sony as it prepared for the launch of the PS3 and the competitive response that
would inevitably ensue. (Figure 1 breaks down video game players by age and gender.)
1
John Wenzel, “The Season’s Main Event: Battle of the Digital Decade,” Denver Post, September 26, 2006.
2
Entertainment Software Association, Essential Facts About the Computer and Video Game Industry 2006
Rev. December 8, 2011 2

Figure 1 Video Game Players by Age and Gender, 2005
70%
60%
50%
40%
30%
20%
10%
0%
Under 18 18-49 50+ Male Female
Source: Entertainment Software Association, Essential Facts About the Computer and Video Game Industry 2006.
Microsoft, Nintendo and Sony would all be launching their new generation of video game consoles at
a time when the industry was ripe for a new growth spurt. In 2005, the U.S. video game and PC
game retail industry—including the sales of portable and console hardware, software and accessories
and PC game software—generated nearly $10.5 billion in revenue in 2005, a 6% increase over 2004
(Figure 2). Of this amount, software sales totaled $7 billion (229 million units), a slight drop from
the $7.4 billion generated in 2004.3 F
Figure 2 Video Game Software Sales (in US$ and units)
8.0 300.0
6.0 250.0
4.0 200.0
2.0 150.0 Sales
millions of
0.0 100.0 Volume

US$
50.0
0.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Sales2.63.74.85.55.66.17.07.17.47.0
Volume 74.1 108.4 153.0 185.2 197.1 211.0 226.4 241.4 250.0 228.5
Source: Entertainment Software Association, Essential Facts About the Computer and Video Game Industry 2006.
3
The NPD Group.

The software sales decline was mostly due to the industry’s transition to the next generation of
gaming hardware. Those consumers interested in purchasing a gaming console were willing to hold
off a year until the next generation had arrived, while those with current generation consoles such as
the Xbox and PS2 were reluctant to purchase new software for a system that would soon be outdated.
Most industry forecasts, however, were very optimistic, with firms such as PricewaterhouseCoopers
estimating that the industry would grow to $46 billion by 2010 (11.4% CAGR).4 F
The industry had traveled leaps and bounds from the days when Atari was providing U.S. households
with the newest and greatest inventions in electronic entertainment.
The Rise and Fall of Atari

6B
In 1966, an engineer at Sanders Associates, a small New Hampshire-based electronics company,

developed Odyssey, the first home video game system. A ball-and-paddle game that could be played
on a TV set, the Odyssey achieved limited commercial success. Its successor Pong, however, did
extremely well in arcades and the home market. Nolan Bushnell, founder of Atari, oversaw the
development of Pong and introduced the home version in 1975. Atari sold 150,000 copies of Pong in
the first year.
Electronics manufacturers quickly saw the benefits of producing a console that could play multiple
games. In 1976, Fairchild, a U.S. electronics company, developed the first console of this kind
naming it the Fairchild Channel F. Atari quickly followed suit with its 2600 VCS (“video computer
system”). In late 1977, Atari released the VCS for $199 with a library of nine titles. Each cartridge
cost $5-$10 to manufacture and retailed for $25-$30.
By 1979, many other electronics and toy companies were entering the home console market including
Mattel, Coleco, RCA, and Philips Electronics. Despite the new entrants, Atari represented two-thirds
of the home console market in the United States. Home versions of hit arcade games such as Space
Invaders and Asteroids grew the game industry into a $3 billion business by 1982.5 F
By the end of 1983, however, the industry had collapsed. The market had been saturated with
multiple consoles and poor quality software, killing consumer appetite for games altogether. In one
notable example, Atari developed E.T., a game based on Steven Spielberg’s hit movie by the same
name. With only one month to deliver a game in time for the holiday season, the development team
created an extremely poor title. Atari took such an enormous loss on E.T. due to unsold inventory
and a large licensing fee that it ended up dumping five million of copies into a landfill in New
Mexico.6 In 1983, Atari posted a $536 million loss and the company was sold at a substantial
F
4
PricewaterhouseCoopers, Global Entertainment and Media Outlook: 2006-2010
5
Mark Mayfield, “What Your Kids Want,” USA Today, December 2, 1988.
6
Ronald Grover and Cliff Edwards, “Game Wars,” Business Week, February 28, 2005.

discount in 1984. The video game market was moribund for several years after the collapse until
Nintendo came and took the U.S. market by storm.
The Rise of Nintendo

7B
Kyoto, Japan-based Nintendo began as a playing-card manufacturing company. After diversifying

into various kinds of electronics in the 1970s, Nintendo entered the home video game market in Japan
in 1983 with its Famicom system. In an effort to avoid the quality issues that had plagued other game
consoles, Nintendo focused on producing fewer, but higher quality games. The Famicom could
display 52 colors at a resolution of 256x240 pixels, superior to the competition of the day. Launched
at 24,000Y ($100), the Famicom cost 50% less than the closest competitor.
All games that were produced for the Famicom (known as the Nintendo Entertainment System in the
United States) had to go through Nintendo’s approval process in order to receive the Nintendo “Seal
of Quality.” A security chip was installed into every console to ensure that only Nintendo-approved
games could be played on the system. Manufacturing of the Famicom was subcontracted out to
numerous companies. Wary of giving any one manufacturer too much information about the overall
production process, Nintendo used up to 30 different suppliers and completed final assembly of the
system at its own production facility.
Due to its popularity, Nintendo licensed out the development of games. Nintendo charged licensees
20% of the 6,000Y ($30) wholesale price for every game sold. In addition, licensees had to pay the
manufacturing costs of the system in advance, with a 10,000 unit minimum order. Once Nintendo
entered the U.S. market, in 1985, the minimum order was raised to 30,000 units. Nintendo also added
an exclusivity clause that prevented licensees from producing games on competing consoles for two
years. Companies such as Namco, one of the first licensees, complained that Nintendo’s monopoly
over the market was hurting the industry, but eventually backed down and agreed to Nintendo’s
terms.
Nintendo had a tight grip on retailers as well, requiring them to place orders, take delivery, and pay in
a matter of months, as opposed to the year time-frame they were used to. The company also
exercised strict inventory management, quickly removing games that were not selling well and, at
times, restricting supply to maintain the appearance of scarcity. Atari filed a number of lawsuits
against Nintendo contending the company used monopolistic practices to shut out competitors
including withholding merchandise from retailers that sold competitors’ products or attempted to
discount the price of the system.7 F
By 1990, with hit titles such as Super Mario Bros. and The Legend of Zelda, Nintendo represented
more than 90% of the U.S. home console market. Approximately 30 million NES units had been
sold, about one for every three American households.
7
“Atari Video System to Battle Nintendo,” Houston Chronicle, November 22, 1989.

Nintendo’s next system, the Super Nintendo launched in September 1991, did not capture the market
like its predecessor. Super Nintendo’s lack of backwards-compatibility prevented Nintendo from
taking full advantage of its existing catalog of games. Meanwhile, Sega, another Japanese home
console manufacturer, had successfully entered the U.S. market two years earlier with the Sega
Genesis console and effectively fought Nintendo to a draw. Strong internal game development at
Sega coupled with relatively favorable terms for software licensees (in comparison to Nintendo)
paved the way for an extremely competitive library of titles for the Sega Genesis.
By the mid-1990s, Sega was the least of Nintendo’s worries as Sony entered the video game market
with a bang.
Sony Enters the Arena

8B
Believing that a three-dimensional (3D) game could provide a more immersive experience than a
traditional two-dimensional (2D) game, the Sony PlayStation, launched in 1994, was designed as a
fully three-dimensional machine. Ken Kutaragi, the lead architect for the PlayStation, believed game
players were eager to navigate 3D environments that were more life-like than 2D, side-scrolling
games such as Super Mario Brothers. Ready for the jump in complexity, gamers rushed to purchase
the PlayStation. Within two years of launch, PlayStation revenues reached $700 million with profits
of $70 million.8 F
Sony opted for the compact-disc format instead of the traditional cartridge format that Nintendo
historically utilized. CDs held up to 20 times more information than a standard cartridge and allowed
game developers to create the more intricate characters and environments required for a 3D
experience. The potential downside of the CD format was the “seek time” needed for information to
be read from the disc, making CDs 50 times slower than a cartridge.9 Advanced data formatting, F
however, minimized disruptions to the game-play experience. CDs were also attractive to Sony and
its licensed developers because their production costs were falling below costs for cartridges. By the
late 1990s, the manufacturing cost for a CD game was about $1.50 per unit compared to $12.00 for a
cartridge game.10 F
When it came to the library of games that were available for the PlayStation, Sony took a much
different approach than Nintendo and was less restrictive about the number of games that were
released for the PlayStation. Sony recognized that competing with Nintendo on a game-to-game
basis would be difficult. Nintendo had the very best game developers in the world. Sony believed
that a greater selection of titles for the consumer would be the best chance to topple Nintendo. While
still maintaining a detailed approval process for game developers, Sony succeeded in creating a robust
8
Robert Le Franco, “Take That, Nintendo,” Forbes, June 3, 1996, p. 96.
9
Peter J. Coughlan, “Note on Home Video Game Technology and Industry Structure,” HBS Case No. 700-107, June 13, 2001.
10
Ibid.

library of titles. Retailers such as GameStop and Electronics Boutique soon had entire walls
dedicated to PlayStation titles.
With the PlayStation, Sony succeeded in capturing 60% of the U.S. market by 1999, dwarfing
Nintendo’s 30% share and Sega’s 5%.11 Kutaragi, now president and CEO of Sony Computer
F F
Entertainment Interactive, was charged with improving on the PlayStation’s success with its
successor, the PlayStation 2 (PS2). With powerful graphics and a loyal following of experienced
game development studios, the PS2, launched in October 2000, was again a resounding success. One
of the main features responsible for the PS2’s success was the additional functionality the console
provided for consumers. The first PlayStation’s ability to play audio CDs was considered a minor
feature as many people already had CD players. But the PS2 had the ability to play DVDs.
Launched in 1996, DVD players had yet to become a mainstream device and at the end of 1999 could
be found in just 11% of U.S. homes.12 At $299, a price on par with DVD players, the PS2 gave users
F F
access to this new technology at a reasonable price. The PS2 enabled consumers to upgrade their
movie-watching experience while getting a cutting-edge video game console.
By early 2006, Sony’s PS2 dominated the video console market with a 55% market share, followed
by Microsoft’s Xbox with 24%, Nintendo Game Cube with 15%, and the newest entry, Microsoft’s
Xbox 360 with 6%.13 Meanwhile, eight of the top 10 selling video games in 2005 were for the PS2
F F
(Figure 3).
Figure 3 Top Selling Video Games, 2005
Rank Title Platform Publisher

1 Madden NFL ‘06 PS2 Electronic Arts
2 Pokemon Emerald Nintendo GBA
3 Gran Turismo 4 PS2 Sony
4 Madden NFL ‘06 Xbox Electronic Arts
5 NCAA Football ‘06 PS2 Electronic Arts
6 Star Wars: Battlefront 2 PS2 Lucasarts
7 MVP Baseball PS2 Electronic Arts
8 Star Wars Episode 3: Revenge of the Sith PS2 Lucasarts
9 NBA Live ‘06 PS2 Electronic Arts
10 Lego Star Wars PS2 Eidos
Source: NPD Group.
11
“Sega’s New Player Fails to Scare Competitors,” The Associated Press, May 14, 1999.
12
“DVD Video to Outstrip VHS,” Inside Multimedia, September 27, 1999.
13
Dean Takahashi, “Dean and Nooch on Gaming,” San Jose Mercury News, January 13, 2006.

Game Development and Publishing

1B
Gaming manufacturers made their money not from the sales of consoles—in fact most consoles were
priced below cost— but rather from software. It was widely believed that Microsoft’s Xbox console,
launched in 2001, was sold at a $100 loss per unit14 and estimates indicated that each Xbox 360,
F F
launched in 2005, lost close to $130 per unit.15 A number of industry analysts believed Sony’s PS3,
F F
even at $599 for the premium version, would sell at a loss of $250 per unit. (In 2006, Sony earned
about $8 on each PS2 sold.16) F F
Acting as gatekeepers for developing and selling games on their respective systems, gaming
manufacturers typically received between $5 and $7 for every unit of software sold for their particular
console.17 On average, video games sold between 200,000 to 300,000 units; a blockbuster was any
F F
title that sold over 5 million units.
Over the 30-year history of the video game industry, the role of game developers and publishers had
evolved to the point where companies like Microsoft were paying large sums of money to bring the
talent in-house.
Fragmentation and Consolidation

9B
When Atari introduced its 2600 VCS in 1977, all games were developed in-house by Atari engineers.
Despite Atari’s rapid success in the late 1970s, the company did not adequately compensate its
engineers. In 1979, four of Atari’s top engineers left to form a new company called Activision, which
became the first independent developer for the Atari 2600.
The formation of Activition marked the industry’s first move towards specialization, whereby
independent companies focused solely on software development. The model became increasingly
popular during Nintendo’s rise in the 1980s. While many of the top titles were developed by
Nintendo, independent titles such as Konami’s Castlevania and Capcom’s Mega Man played a
significant role in securing Nintendo’s grip on the market. As Nintendo sold more consoles, more
independent game companies entered the market while established developers increased staff to
handle multiple projects at once.
In time, independent game companies sought greater control and began to self-publish their titles.
They funded projects, developed and tested games, built up marketing departments, and negotiated
terms with retailers. Independent publishers, including Capcom and Tecmo, which published games
for mulitple platforms came to be known as 3 rd-party publishers, whereas console manufacturers that
published games for their own platform were 1st-party publishers.
14
Matt Richtel, “Xbox Fails to Win Gaming Dominance,” The New York Times, February 13, 2003.
15
Paul Sweeting and George T. Chronis, “PlayStation 3 Delay Possible,” Video Business, February 27, 2006.
16
Kenji Hall, “The PlayStation 2 Still Rocks,” BusinessWeek Online, December 29, 2006.
International Development Group. In reality, royalties are based on a sales schedule. As the number of units sold passes certain milestones, the
17
manufacturer’s royalty is lowered.

When publishers released a game that struck a chord in the market, they often seized the opportunity
to build a franchise around the game. Capcom’s Street Fighter, released in 1989, was one such
example. While Street Fighter was a moderate success, over the next eight years, Capcom released a
series of spinoffs including Street Fighter II, Street Fighter II Champion’s Edition, Street Fighter II
Turbo, Super Street Fighter II, Street Fighter Alpha, Street Fighter EX, and Street Fighter III. The
entire series sold 500,000 coin-operated units and 24 million console games were sold worldwide,
generating over $1 billion in revenues for Capcom.18 F F
Lucrative franchises like Street Fighter certainly made publishers very happy, but the engineers and
staff that produced the titles tired of incremental improvements to existing titles. Many developers
entered the industry because they had game concepts of their own to develop, not to spend years
making minor changes to an existing product. Teams of developers began to leave publishers to form
their own independent development studios. Starting a new company was risky, but talented teams
placed a high value on creative freedom and recognized the financial reward that high-quality
innovative titles could bring.
By the early to mid-1990s, the software video game industry was largely fragmented. While only a
few console manufacturers existed at any one time, there were dozens of 3rd-party publishers and
three to four times as many independent game developers. New business models were emerging to
reflect the movement of creative resources. Third-party publishers were no longer solely funding
internal projects, but were also entering into contracts with independent developers. For the
developers, publishers typically funded development (which normally took 12-18 months), obtained
approvals from manufacturers to release the game on their console, and handled the sales and
marketing of the title. In return, publishers received all revenues of the title upon release (less the
retail markup) until the cost of development had been recouped. Once the break-even point was
reached, developers received a small royalty per unit sold. The royalty would normally increase as
agreed-upon sales milestones were met.
Publishers also insisted on owning the game’s brand, or the intellectual property (IP). Owning the IP
could be another major source of revenue as a game’s brand spread to other markets such as comic
books, action figures, and feature films.
18
Capcom Corporate Background: http://www.capcom.com/corporate/

By 2001, sales of video games topped $6 billion in the United States.19 While the retail cost of games F F
had stayed the same, development budgets were increasing, schedules were lengthening, and
production values were at their highest level. On average, 20 to 30 people worked for 18 months to
develop a game for the PS2 and each game cost upwards of $5 million to develop.20 The industry was F F
becoming a blockbuster-driven market. The top three selling games in 2001 (Grand Theft Auto 3,
Madden NFL 2002, and Metal Gear Solid 2) totaled over $240 million in sales.21 F F
As more hit titles were created by independent developers, publishers found themselves paying
royalty fees that ranged from 10% to 40% of the retail price of software once development costs were
recouped.22 In an effort to avoid paying royalties, publishers began acquiring talented development
F F
studios. In 2001, UbiSoft, acquired Red Storm Entertainment, the developer of Tom Clancy’s
Rainbow Six games, for $43 million and a year later Microsoft purchased Rare Ltd, known for its
James Bond titles, for a sizable $375 million. As publishers’ pockets got deeper, acquisitions became
more commonplace (Figure 3). In time, purchasing talented development studios became a defensive
measure for publishers to prevent competitors from acquiring top talent. By 2006, the largest
publishers owned several studios including Activision (11 studios) and THQ (14 studios).
Figure 3
Game Developer Acquisitions 1991-2004

(2003 data reflects Jan-Mar)
16
14
12
10
8
6
4
2
0
Source: Dan Lee Rogers, “The End Game: How Top Developers Sold Their Studios, Part 1,”
http://gamasutra.com/features/20040303/rogers_o1.shtml
19
Susan Stellin, “Brisk Sales for Video Games,” The New York Times, November 25, 2002.
20
Felix Vikhman, “Back from the Brink,” National Post, September 1, 2002.
21
International Development Group
22
Peter J. Coughlan, “Note on Home Video Game Technology and Industry Structure,” HBS Case No. 700-107, June 13, 2001.

Console Wars Re-Ignite

2B
The launch of the Xbox 360 in November 2005 marked the beginning of the first console war in
which Internet connectivity was a core component of all the major hardware manufacturers’
strategies. Prior to Internet gaming, a major reason to purchase the most popular console was that it
made it easier to trade games with friends. Internet gaming created the opportunity for a much deeper
experience among owners of the same console. Users could now play together online, create groups
of friends with whom they enjoyed playing, and monitor friends’ progress through various games.
Social networks on game consoles had never been stronger.
Although PC gamers could play multiplayer games online throughout the 1990s, console gamers did
not have an opportunity to play with each other online until the year 2000 when Sega released
Phantasy Star Online, the first “massively multiplayer” online game for consoles. One year earlier
Sega had launched the Sega Dreamcast with a built-in modem. This marked the first time thousands
of console gamers could meet online, chat, and complete game objectives with each other.
Sega also made a play into one of the most popular video game genres, releasing NFL 2K1, the first
football title with online play. NFL 2K1 featured real players and teams licensed from the National
Football League. Despite Sega’s best attempts to highlight connectivity as the reason for gamers to
choose Dreamcast, hardware sales lagged as a mediocre software library and the impending release of
the PS2 in 2000 dissuaded gamers from switching. By early 2001, Sega announced that it would be
exiting the hardware business, Dreamcast production would stop, and the company would focus
purely on software development.
Sony and Nintendo made efforts to establish online play on their respective consoles, the PS2 and
GameCube, but moved hesitantly due to limited broadband penetration in key markets such as the
United States where it was about 24% in 2001.23 Broadband Internet connectivity was the obvious
F F
choice for game companies as it allowed developers to reliably transmit more information across the
network in comparison to dial-up connections. Dependable data transmission reduced the likelihood
of lag or disruptions to gameplay caused when game machines needed to synchronize game data, a
key attribute particularly for games involving sports or a lot of physical movement. A Nintendo
executive stated in 2001 that the company was more focused on providing a good gaming experience
and reaching a broad audience than being first to offer a state of the art online experience: “We still
see online as a small number (of gamers). There’s still lots of questions about online. For kids who
are 13, 14, 15, are their parents ready to set up a broadband or modem connection? There are costs
and hurdles involved.”24 F
For PS2 owners, Sony released a network adapter, sold separately for $39.95, which allowed users to
connect via dial-up or broadband. It was then up to individual game developers to provide a seamless
23
“Digital Cable Rollout to Slow in U.S.,” Total Telecom, December 18, 2001.
24
Omar Gallaga, “Mano a Mano, Xbox a Xbox,” Austin American-Statesman, November 21, 2002.

online experience for players despite significant variation in connection speeds. Sony gave
developers enormous freedom in shaping the online experience as they saw fit. Developers could
integrate online play as much, or as little, as they wanted and could implement their own pricing
models (although few charged users for online play). However, with great freedom came great
responsibility, and for many developers designing the online components of their game was just one
more substantial task that needed to be accomplished in order to complete the title.
Microsoft, which released the Xbox in the fall of 2001, adopted a much different approach. The
company wanted to unify the online experience for developers and players alike by providing a
consistent experience with the service Microsoft named Xbox Live. Microsoft actively encouraged
developers to incorporate online features into games to show off the features of Xbox Live.
Microsoft distributed code libraries to developers, hosted online games on its own servers, and
created a uniform online interface that focused on allowing users to easily build a community of
“friends.” Two highlights of Xbox Live were the microphone headset that enabled real-time voice
communication among gamers and the ability for friends to contact one another even if they were
playing different Live-enabled games. The headset was part of the retail Xbox Live package that sold
for $49.99 and gave gamers a one-year subscription to the service.
In addition to providing a unified online experience, Microsoft made the controversial decision to
require broadband connectivity for the Xbox. While this decision improved online play for those
with broadband Internet service, it also severely limited the number of potential users for Xbox Live.
The commonly held belief, however, was that Xbox was part of Microsoft’s long-term strategy to
gain significant knowledge about the game industry.
Xbox Live introduced new revenue streams for Microsoft and its partner companies. While some
content could be downloaded for free, including demonstrations of new games, and stored on the
Xbox hard drive, premium content such as extra levels and characters for games could be purchased
for $5 to $15. A set of new multiplayer maps for Call of Duty 2, a World War II title, was priced at
$15 and was one of the most popular downloads on Xbox Live in 2005.
Companies such as Cadillac took advantage of the marketing opportunities that the Xbox Live
Marketplace provided. In an effort to target the male 25-35 year old demographic, the company
developed video game versions of its cars for the hit racing game, Project Gotham Racing 3. The site
included a message that read: “If you’re a fan of Cadillac and Project Gotham Racing 3, it’s time to
break out of your dancing shoes to celebrate the arrival of the new Cadillac V-Series downloadable
content.”
In an attempt to appeal to more casual game players, Microsoft created Xbox Live Arcade, an area of
the Marketplace where simpler games such as Pac-Man and Uno could be downloaded and played.

Adopting a popular model from the PC casual game industry,25 demos of Xbox Live Arcade games F F
could be downloaded for free with the full version available if purchased. In addition to nostalgic
titles such as Frogger and Galaxian, new titles such as Geometry Wars were very popular as well.
The game development community praised Arcade and were hopeful that it would hearken a return to
the days of innovative, smaller, and less financially risky games. Microsoft, however, was very
selective and restrictive in releasing games on Arcade, so it was unlikely that many developers could
be sustained by the Xbox Live Arcade alone.
Nintendo, with its new Wii console, looked forward to launching the first Nintendo console with
well-integrated online functionality that, among other things, provided Wii owners with weather
updates and email and web browsing services. Named the Virtual Console, the online service’s most
compelling feature was access to the enormous library of high-quality Nintendo titles dating back to
1984. Classic games for the original Nintendo, the Super Nintendo, the Nintendo 64, and the
GameCube would be available for download at prices ranging from $4 to $8. Nintendo hoped that
the pull of nostalgia would bring older gamers back to Nintendo.
Sony would be entering the online video game arena with the PlayStation Network Platform,
described as an “ecosystem” comparable to Microsoft’s Xbox live which would be launched
simultaneously with the PS3. The platform would allow players to connect to the Internet so that they
could play against each other online as well as communicate through email and live voice chat.26 PS3 F F
owners would also be able to purchase games although it was not known if the back catalog of
PlayStation and PS2 games would be available for download. Unlike the Xbox 360, the PlayStation
Network Platform would allow licensees to connect their own game servers to the network.27 As one F F
analyst opined, “Sony sees online as more of a loyalty builder for their audience rather than a money
making strategy. Microsoft sees it as both.”28 F
Many industry analysts speculated that the new generation of video game consoles— the Xbox 360,
the Nintendo Wii, and the Sony PS3—would overshadow the role of the PC in many homes. As one
technology analyst pointed out, the games console was becoming the focus of breakthrough
technology: “It suggests the platform of growth (in home computing) is shifting away from the PC to
the games machine.”29 As the CFO of video game publisher Electronic Arts put it, “The stakes for
F F
next generation hardware leadership are enormous. It’s about owning the set-top box that may
ultimately connect the living room to the Internet.”30 F F
25
The term casual game refers to a category of electronic or computer games targeted at a mass audience. They typically have very simple rules or play
techniques making them easy to learn and play. They require no long-term time commitment or special skills to play, and there are comparatively low
production and distribution costs for the producer.
26
Daniel Terdiman, “Sony’s PlayStation 3 Race,” CNET News.com, March 22, 2006.
27
Hirohiko Niizumi and Tor Thorsen, “PlayStation Network Platform Detaile,” GameSpot, March 15, 2006.
28
Kim Peterson, “Sony Online Gaming to Debut with PS3,” The Seattle Time, March 23, 2006.
29
Chris Nuttall and Richard Waters, “All to Play For: Microsoft and Sony Take the Video Game Battle to the Next Level,” The Financial Times¸May 11, 2005.
30
Ibid.

Different Strategies for Different Audiences

3B
Up until the 1990s, video games were thought to be toys primarily for children and teenagers and the
goal for console manufacturers was simple: target children. Eventually the popularity of games grew
to the point where entire generations were labeled the Atari or Nintendo generation. But by the late
1990s, the first generation of video game players was graduating from university, entering the
workforce, and spending its income on video games. Sony owed much of the PlayStation’s success
to an effective campaign that targeted maturing gamers looking for edgier, more sophisticated games
that tested their gaming skills. As Sony claimed industry dominance, a new mantra spread over the
industry: target the core gamers – males in their 20s. The strategy worked extremely well for Sony
which sold over 100 million of its PS2 units worldwide. This would continue to be the strategy for
Sony and Microsoft as both heavyweights rolled out powerful hardware in 2005 and 2006.
Meanwhile, Nintendo had not kept up with shifting consumer tastes and its games were viewed as too
“kiddy” for older gamers. In 2001, Nintendo’s Game Cube accounted for 18% of the console market
in the United States, behind Microsoft’s Xbox with 24% and Sony’s PS2 with 55%.31 Nintendo found F F
itself in a difficult position as the company wanted to continue to create fun, simple, kid-friendly
games, but saw older gamers moving on to different types of games. Many wondered if Nintendo’s
time had passed and questioned its ability to compete against companies like Sony and Microsoft.
But when asked if Nintendo would leave the hardware business, the company’s CEO responded,
“When we withdraw from the home game console, that’s when we withdraw from the video game
business.”32 F
As GameCube sales leveled off just two years after the system’s launch, Nintendo began to
reformulate its strategy. Willing to let Sony and Microsoft battle it out for the core gamer
demographic, Nintendo adopted a strategy to expand the market believing that simple, fun games
with intuitive control schemes would appeal to people of all ages and genders. Nintendo first
attempted this strategy with its portable gaming device, the Nintendo DS (Dual-Screen), which was
launched in 2004. The DS had a clamshell design with two screens, one on top of the other. The
bottom screen was touch-sensitive and could be pressed by either finger or stylus. The first breakout
title for the DS, Nintendogs, proved Nintendo’s intuition about the market correct, and was a runaway
success. Nintendogs was a game where owners could care for a virtual puppy by using touch-screen
controls or voice commands. By fall of 2006, Nintendo had sold over 4 million copies of Nintendogs
in the United States.
Confident that its strategy was sound, Nintendo moved forward in developing its next home console,
the Nintendo Wii, bringing to market a new type of controller that could detect three-dimensional
motion and acceleration. In a tennis game, for example, players no longer pushed a button to swing
the racquet, but swung the controller like a real racquet to hit the ball. Consumer anticipation was
31
“Wii: Power Rests in the Palm of Your Hand,” TWICE, January 8, 2007.
32
Yuka Obayashi and Keiko Kanai, “Nintendo Eyes Next Generation Console Launch,” Reuters News, January 23, 2003.

very high as the Wii’s launch date approached. What was thought to be a two-company battle
between Sony and Microsoft was shaping up to be a hard-fought three-way struggle for the hearts and
wallets of gamers the world over.
Public Backlash
4B
In addition to competing head-on with Nintendo and Microsoft, Sony, as did all video game
manufacturers, faced a public relations challenge that, although not new, was not showing signs of
subsiding any time soon. The issue was violence.
As gaming hardware became more sophisticated, so did video game characters and their surrounding
environments. By the mid-1990s, game players were navigating characters through three-
dimensional worlds with a true sense of depth. Game developers strove to create the most immersive,
realistic experience possible. Environments were becoming more detailed, the play between light and
shadow more subtle, and character animations increasingly life-like.
Violence in early video games was often quite comical as players had to use their imaginations to
figure out how a particular attack actually caused damage to an enemy. But as game environments
became more real with the help of 3D technology, characters’ attacks became more life-like.
Eventually, gamers were taking careful aim with sniper rifles at the heads of Nazi soldiers and using
piano-wire to strangle uncooperative mobsters. Bestseller Grand Auto Theft 3 involved stealing cars,
killing cops, and beating up prostitutes.
Certain groups, particularly politicians and parents of gamers, began to raise questions about violence
in video games: Did playing violent video games desensitize children to real-world violence? Did
children become more violent after playing violent video games? Were comparisons to violence in
movies inappropriate since game players were participants in violence instead of spectators to it?
The furor over video games peaked after it was discovered that the 1999 Columbine High School
shootings, which took the lives of 12 students and 1 teacher, were carried out by two students who
were frequent players of Doom and Wolfenstein 3D, first-person shooting games. Some argued that
constant exposure to violent imagery in these games desensitized the shooters to violence. Families
of victims filed a lawsuit against game makers stating that “absent the combination of extremely
violent video games...and the boys’ basic personalities, these murders and this massacre would not
have occurred.”33 U.S. District Judge Lewis Babcock said that there was no way the makers of
F F
violent games (including Doom) could have reasonably foreseen that their products would cause the
Columbine shooting or any other violent acts.34 The lawsuit was dismissed.
F F
33
Mark Ward, “Columbine families sue computer game makers,” http://news.bbc.co.uk/2/hi/science/nature/1295920.stm
34
“Columbine lawsuit against makers of video games, movies thrown out,” Associated Press,
http://www.freedomforum.org/templates/document.asp?documentID=15820

Still, many felt that games had become too violent and laws should be passed to ban the sale of
violent video games. To preempt federal regulation, the Entertainment Software Ratings Board
(ESRB) was established in 1994 to assign ratings to inform consumers about the content in games.
Similar to the Motion Picture Association of America, which rated films, the ESRB described itself as
an independent, self-regulatory body whose goal was to help consumers make educated decisions
about purchasing games. Funded by game makers, the ESRB had slowly but steadily gained
momentum; sales associates at game retailers such as GameStop and Electronics Boutique were well-
versed with the ratings system and quick to educate consumers about the system.35 F
Yet the ESRB had its critics. Confidence in the rating system was undermined when it was
discovered that a sex mini-game (nicknamed “Hot Coffee”) was uncovered in Rockstar Games’
Grand Theft Auto: San Andreas. Although special hardware was needed to access the game for the
console versions, the mini-game highlighted the ease with which unrated content could be published.
The “Mature 17+” title was re-assigned an “Adults Only” rating until Rockstar Games removed the
content.
Dr. Kimberly Thompson of Harvard University’s School of Public Health was a vocal critic of the
ESRB’s rating process.36 In 2004 Thompson published the results of a study she had conducted
F F
analyzing the reationship between game conent and ESRB content desriptors. She discovered that
ESRB raters did not actually play the games they were rating. Instead, game publishers sent video
clips of the game and ESRB raters determined rating and content description based on those brief
excerpts. Thompson’s assessments based on actual game play indicated games in the initial E, E-10+,
and T categories were much more violent than the ratings suggested, with an average of one death per
minute in T-rated games.37 The study concluded that “a significant amount of content in T-rated
F F
video games that might surprise adolescent players and their parents given the presence of this
content in games without ESRB content descriptors.”38 Thompson pushed the ESRB to require that
F F
raters play the games they rated in an effort to improve rating accuracy. The ESRB had taken some
of Dr. Thompson’s recommendations into account. In 2005, the ESRB introduced the “Everyone
10+” rating to fill the gap between children and teen-rated titles.39 F
A number of states had attempted to introduce laws that banned the sale of violent video games.
Michigan claimed that the interactive nature of video games made them less entitled to First
Amendment protection. Illinois attempted to fine stores that did not add warning labels to mature-
rated games (despite already having ESRB ratings on the box). However, all attempts had been
deemed violations of the First Amendment.
35
Interviews with sales associates at GameStop, Electronics Boutique, and Wal-Mart.
36
Dr. Thompson’s testimony on the ESRB to the U.S. House of Representatives can be found at:
http://energycommerce.house.gov/108/Hearings/06142006hearing1921/Thompson.pdf
37
Thompson KM. Kids and Media: Learning Happens. http://doctor.medscape.com/viewarticle/505766
38
“Kevin Haninger and Kimberly M. Thompson, Content and Ratings of Teen-Rated Video Games, The Journal of the American Medical Association,
February 18, 2004.
39
ESRB website, http://www.esrb.org/about/chronology.jsp

At the federal level, Senators Hillary Rodham Clinton and Joseph Lieberman introduced the Family
Entertainment Protection Act in November 2005. The bill sought to prohibit the selling of “Mature”
or “Adults Only”-rated games to anyone under 17. Retailers would be fined for violations. The bill
would also allow private citizens to file complaints against the ESRB if ratings or content
descriptions failed to accurately describe a game’s content. The bill was in the first stages of the
legislation process and would likely undergo significant changes in subsequent legislative sessions.40 F
Reason for Optimism?

5B
As the launch date approached, Stringer recognized that the holiday season of 2006 would be critical
to PS3’s success. He hoped that the enormous popularity of the PS2 would help the PS3 in its early
days.
Some industry analysts belived the PS3 would put Sony on top of the video game market for the
forseeable future. In-Stat, a communications services research and analyst firm, predicted that through
2010, the Sony PS3 would account for just over 50% of the installed base of next-generation
consoles, while the Microsoft Xbox 360 would have 28.6%, and the Nintendo Wii, 21.2%.41 F F
But getting there would not necessarily be easy. As one industry analyst opined, “Microsoft has
driven a stake in the ground. They will have 10 million units by the time Sony ships the PS3. Sony is
going to have to respond in a big way.”42 F F
In October, just one one month before the public unveiling of the PS3, 235,000 PS2s were sold in the
United States compared to 217,000 Xbox 360s.
40
To check the status of the Family Entertainment Protection Act, please visit http://www.govtrack.us/congress/bill.xpd?bill=s109-2126
41
Sumner Lemon, “Will PlayStation 3 Outsell Xbox 360,” PCWorld, March 22, 2006.
42
Ryan Kim, “Keeping Players in the Game,” The San Francisco Chronicle, May 8, 2006.

Exhibit 1a Sony Corporation Operating Performance by Business Segment 2005-2006
USD in millions
Percent
Sales and operating revenue 2005 2006 change
Electronics 43,306 44,021 1.7%
Game 6,238 8,193 31.4%
Pictures 6,271 6,375 1.7%
Financial Services 4,791 6,352 32.6%
All other 3,931 3,495 -11.1%
Elimination (3,343) (4,544)
Consolidated 61,194 63,893 4.4%
Operating income (loss)
Electronics (293) (264)
Game 369 74 -79.7%
Pictures 546 234 -57.1%
Financial Services 474 1,609 239.4%
All other 36 138 286.4%
Sub-Total 1,132 1,792 58.3%
Elimination and unallocated
corporate expenses (159) (158)
Consolidated 974 1,634 67.9%
Source: Sony Annual Report 2006. http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html.
Exhibit 1b Sony Corporation Operating Revenue by Business Segment
Sony Corporation: Share of sales and

operating revenue by business segment
9.3% 5.1%
9.3%
Electronics Game
Pictures
12.0% Financial Services

64.3% All Other
Source: Sony Annual Report 2006. http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html.

Exhibit 1c Sony Corporation Game Business Operating Performance 2004-2006
USD in millions 2004 2005 2006
Sales $6,668.4 $6,237.6 $8,193.2

Operating Income $577.8 $369.2 $74.4
Operating Margin $74.4 $50.4 $7.7
Assets $5,847.9 $4,119.7 $4,447.9
Source: Sony Annual Report 2006. http://www.sony.net/SonyInfo/IR/financial/ar/2006/qfhh7c00000aksvu-

att/qfhh7c00000aksx9.pdf.
Exhibit 2 Nintendo Income Statement, 2001-2006 (in US$ millions)
2006 2005 2004 2003 2002 2001
Net Sales $4,349 $4,813 $4,899 $4,798 $4,169 $3,475

Cost of Sales $2,511 $2,781 $2,923 $2,935 $2,513 $2,091
Gross Margin $1,834 $2,031 $1,977 $1,863 $1,656 $1,384
SG&A $1,058 $971 $927 $908 $757 $746
Operating Income $780 $1,060 $1,050 $955 $899 $638
Other income $643 $299 ($546) $124 $477 $630

Income before tax and
minority interests $1,423 $1,359 $504 $1,079 $1,376 $1,268
Total income taxes $582 $542 $188 $438 $577 $544
Minority interests ($0) $0 $1 $1 ($2) ($2)
Net income $841 $817 $316 $640 $800 $726
Cash dividends per share $3 $3 $1 $1 $1 $1
Source: Nintendo Annual Financial Report. http://www.nintendo.com/corp/annual_report.jsp.

H

Exhibit 3a Microsoft Home and Entertainment Division

Revenues and Operating Losses, 2002-2006 (includes Xbox division)
(In millions) 2006 2005 2004 2003 2002

Revenues $4,256 $3,140 $2,737 $2,748 $2,453
Operating Losses ($1,262) ($485) ($1,337) ($1,191) ($1,135)
Exhibit 3b Microsoft Revenue and Income Statement by Business Division, FY 2006
For the quarter ended For the quarter ended

Fiscal
June March Dec.Sept. Fiscal June March Dec.Sept.
Year30, 31, 31, 30, Year 30, 31, 31, 30,
(In millions)2006200620062005200520052005200520042004
Segments
Client $13,209 $3,376 $3,187 $3,459 $3,187 $12,151 $3,014 $2,964 $3,193 $2,980
Server and Tools 9,653 2,690 2,398 2,438 2,127 8,370 2,245 2,058 2,161 1,906
Online Services Business
2,299 580 561 594 564 2,344 598 581 606 559
Microsoft Business
Division 14,488 3,908 3,608 3,689 3,283 13,520 3,637 3,384 3,413 3,086
Entertainmentand Devices
Total revenue 4,6331,2501,1461,6575803,4036676331,445658
$44,282 $11,804 $10,900 $11,837 $9,741 $39,788 $10,161 $9,620 $10,818 $9,189
For the quarter ended For the quarter ended

Fiscal
June March Dec.Sept. Fiscal June March Dec.Sept.
Year
30, 31, 31,30, Year 30, 31, 31,30,
(In millions)2006200620062005200520052005200520042004
Segments
Client $10,182 $2,504 $2,471 $2,638 $2,569 $9,403 $2,172 $2,331 $2,513 $2,387
Server and Tools 3,017 903 746 762 606 2,109 479 515 660 455
Online BusinessServices
Microsoft Division
Entertainment (77)(190)(26)5881 411101101130 79
Business
9,6752,5442,4142,4662,2519,1162,2852,3162,3552,160
and
Devices (1,337) (437) (422) (296) (182) (607) (235) (198) 28 (202)
Corporate-Level
Activity (4,988) (1,443) (1,295) (971) (1,279) (5,871) (1,813) (1,736) (937) (1,385)
Total operating
income $16,472 $3,881 $3,888 $4,657 $4,046 $14,561 $2,989 $3,329 $4,749 $3,494
Source: Microsoft Corporation Annual Report 2006.

Exhibit 4a Developer Acquisitions (1991 - 2003)
DATE COMPANY PRODUCTS ACQUIRER TERMS

4D Boxing, Hardball, Test Electronic
1991 Distinctive Drive Arts $11 million ($785K in cash)*
Electronic
1992 Origin Wing Commander, Ultima Arts $35 million stock (estimate)*
1992 Westwood Kyrandia Virgin $5 million value (estimate)*
1994 SONY PLAYSTATION LAUNCHES
1995 Iguana Turok Acclaim $5 million cash + undisclosed stock
Sculptured Star Wars, Mortal Kombat,
Oct 95 Software Jack Nicklaus Golf Acclaim $30 million in stock
Die Hard, Back to the
Oct 95 Probe Future, X Men Acclaim $30 million in stock (estimate)*
1995 Papyrus NASCAR Sierra $40 million stock (approx.)*
Ceasar II, Lords of the
1995 Impressions Realm Sierra $8 million stock (approx.)*
Populous, Syndicate, Magic Electronic
1995 Bullfrog Carpet Arts $25 million (estimate)*
1996 NINTENDO N64 LAUNCHES
Apr 96 Headgate PGA Championship Golf Sierra $8-10 million stock*
$1,674,478 cash, 182,923 stock (value
Sep-96 Mission Studios Jet Fighter Take Two $440,000). Promissory note value
GT
Jun-96 Formgen Duke Nukem Interactive 1,030,000 shares GT stock
GT
Jul-96 Humongous Freddie Fish, Putt Putt Interactive 3,458,000 shares GT stock
Dec-96 DMA Lemmings Gremlin £4.2 million
Apr-97 Berkley Systems You Don't Know Jack Sierra $25 million stock (approx.)
Electronic
Jul-97 Maxis Sim City Arts $125 million value stock
Sep-97 Raven Soldier of Fortune Activision Value $13 million, 1,040,000 shares
GT
Sep-97 Odd World Abe's Oddysee Interactive $7 million (TCI portion) (estimate)
JetMoto, Twisted Metal, $5.4 million in cash and 700,000 shares
Twisted Metal II and GT of stock valued at $7.2 million, (total
Oct-97 SingleTrac WarHawk Interactive value of $12.6M)
Command and Conquer, Electronic
Aug-98 Westwood Lands of Lore Arts $122.6 million (majority to Westwood)
Sep-98 Crystal Dynamics Gex, Soul Reaver Eidos $47.5 million US (Â£28.4)
1,033,336 shares (accounted as a
Dec-98 Talonsoft Battleground, Art of War Take Two pooling of interest
GT
Dec-98 Reflections Driver, Destruction Derby Interactive 2.28 million shares of common stock
Dec-98 FASA MechWarrior Microsoft Undisclosed

1999 SEGA DREAMCAST LAUNCHES

GT
Jan-99 Legend Mission Critical, Death Gate Interactive $13.5 million stock
Grand Theft Auto, Realms
Mar-99 Gremlin of the Haunting, Loaded Infogames $36.8 million cash
DMA (Owned by Grand Theft Auto, Realms
Sep-99 Infogames) of the Haunting, Loaded Take Two $11 million cash (assumed DMA debt)
Apr-99 Access Software Links Microsoft Undisclosed
Pacific Coast &
May 99 Power Activision THQ $10M in stock (estimate)
AMDK, Tony Hawk Pro
Oct-99 Neversoft Skater Activision 700,000 shares stock (est. value 10M)
Nov-99 Bungie Myth Take Two $5 million cash for 19%
2000 SONY PS2 LAUNCHES
Est. value $20-$40 million (based on
Take Two sale of 19% @ 5M cash, 5.8
Jun-00 Bungie Oni, Myth, Halo Microsoft sale of Bungie assets)*
Jul-00 Pop Top Railroad Tycoon II, Tropico Take Two 559,100 shares (est. value $5.8M)
Â£300K for 30%, 9.5% bond, remaining
Startup with multiplayer 70% purchased 9-2001 for a nominal
Jul-00 LTStudios concepts Argonaut sum
890,100 shares common stock +
109,900 shares common (options)+
500K debt assumed (est value
Aug-00 Volition Freespace, Red Faction THQ $21.25M)
Â£200,000 cash and 400,000 stock plus

Oct-00 Just Add Monsters Kung Fu Chaos Argonaut a deferred Â£210,000 in Loan Notes
Dec-00 Digital Anvil Freelancer Microsoft Undisclosed
2001 MICROSOFT XBOX LAUNCHES
Jan-01 Red Zone NFL Gameday Sony Undisclosed
Crash Bandicoot, Jak and
Jan-01 Naughty Dog Daxter Sony Undisclosed
Feb-01 Blue Byte The Settlers Ubi Soft Value 13 million Euros ($8.2 M US)
926,077 shares common stock (est.
May-01 Ensemble Studios Age of Empires Microsoft value $83M)
Jul-01 Red Storm Rainbow Six Ubi Soft $43 million value
Â£2.4 million in total plus 3.5M in
Jan-01 Particle Systems Powerdrome, SubWar 2050 Argonaut Argonaut shares
Return to Castle
Jan-02 Gray Matter Wofenstein Activision $3.2 million in stock
Total value est. $44.6M (1,287,000
Motocross Madness, shares of stock plus performance
Jan-02 Rainbow Studios Splashdown THQ incentives)
Value Â£400,000 (in Warthog shares),
father 700K shares based on
Apr-02 42-Bit Rally Championship 7 Warthog performance
Wipeout, Big Hurt Baseball, 387,932 shares of common stock. Value
Mar-07 Shaba Games Magic: The Gathering Activision $7.4 million

$47 million (31M cash, 16.2 promissory

Apr-02 Shiny MDK, Matrix Infogames notes)
May-02 Outrage Decent PC THQ Undisclosed
$12.5 million in cash and 373,385
shares of stock. Total value $20.9
May-02 Z-Axis Dave Mirra Freestyle BMX Activision million
NHL Hits, Need for Speed, Electronic
Jun-02 Black Box Sega Soccer Arts 14M rumored value*
Global Operations,
Homeworld: Cataclysm, $3 million cash, 242,450 shares
Aug-02 Barking Dog Treasure Planet Take Two restricted stock (total est. value $9M)
Total $375 million cash, $100m of which
Sep-02 Rare StarFox, Donkey Kong Microsoft to Nintendo
True Crime, Vigilante,
Oct-02 Luxoflux Streets of LA Activision $9 million cash
Treyarch 1,228,442 shares common stock. Total
Oct-02 Invention Tony Hawk, Spider-Man Activision value $18.2 million
Massive Vivendi
Oct-02 Entertainment Ground Control Universal Undisclosed
Jan-03 Infinity Ward Call of Duty Activision Undisclosed
Smuggler's Run, Midnight
Club, Red Dead Revolver, $28 million cash, 235,679 shares
Nov-02 Angel Studios Transworld Surf Take Two restricted stock (total est. value $38M)
Â£1.5 Million over 3 years, contingent
Dec-02 Zed Two Pillage Warthog on performance*
Starlancer (former Digital
2003 Fever Pitch Avil developers) Warthog Value $ 300,000 Warthog shares
Value Â£2.4 million (Sci already owned
Sep-03 Pivotal Games Conflict Desert Storm SCi 10%)*
Exhibit 4b Developer Acquisitions (2003 - 2005)
ACQUIRING
DATE DEVELOPER PRODUCTS COMPANY TERMS
Shadowbane -
3/1/2004 Wolfpack MMO Ubisoft Undisclosed
$4.5 million, of which $3.6 million was paid in
cash, $920K due in March 2005. T2 recognized
Max Payne GBA, identifiable intangibles of $960K (non-competition
High Heat agreements) and goodwill of 4.6 million. $2
3/1/2004 Mobius Baseball GBA Take Two million more based on delivery of products.
£36 million ($68 million) in cash and stock, along
IO Freedom with a payment of up to £5 million linked to the
3/4/2004 Interactive Fighters, Hitman Eidos four-year performance of the studio.
Surreal All-stock transaction: 540,317 common shares

3/9/2004 Software The Suffering Midway with an additional 137,199 restricted shares

issued to key employees.
Homeworld,
Warhammer: $6 million in cash and $4 million over the next
4/29/2004 Relic Dawn Of War THQ two years.
According to a 10-Q form filed with the SEC,
Burnout, Electronic Electronic Arts spent somewhere in the range of
8/9/2004 Criterion Renderware Arts $48 million to buy Criterion Studios.
871,312 common shares of which 55,607 are
being held in escrow for a period of up to one
year. Under the terms of the escrow agreement,
the principal shareholder of ARUSH is entitled to
Hunting Hip purchase the escrowed shares from Hip at a price
8/9/2004 ARUSH Unlimited Interactive of $1.50 per share.
Tron 2.0, No
One Lives
Forever, Aliens Warner
8/11/2004 Monolith vs. Predator 2 Brothers Undisclosed
The Hobbit,
Defender, All-stock transaction: 218,421 common shares
Tribes: Aerial with an additional 152,824 restricted shares
8/26/2004 Inevitable Assault Midway issued to key employees.
$1.2 million in cash, recording identifiable
9/1/2004 Venom Rocky Boxing Take Two intangibles of $750K and goodwill of $620K
EA now controls approximately 67.3% of DICE,
Digital Electronic and all the 2,329,102 outstanding company
11/16/2004 Illusions Battlefield 1942 Arts warrants.
Mortal Kombat, All-stock transaction: 333,334 Midway common
Backyard shares, with 261,906 restricted shares issued by
12/1/2004 Paradox Wrestling Midway key employees.
Microsoft's $18.5 million in cash, recording $5.8 million in
former sports identifiable intangible assets, $11.5 million of
team, Top Spin, goodwill, $280K of fixed assets, and $820K of
12/4/2005 Indie Built Links, Amped Take Two accounts receivable.
Vicarious Shrek 2, Spider-
1/20/2005 Visions Man 2 DS, PSP Activision Undisclosed
Visual $24 million in cash with rights to all intellectual
Concepts / property associated with the sports titles, as wells
1/25/2005 Kush Games ESPN 2K sports Take Two as rights to the 2K brand.
Source: Dan Lee Rogers. The End Game: 2005 Acquisition Activity Update. http://www.gamasutra.com/features/20050225/r.

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07-046

Rev. December 8, 2011

The Evolution of Home Video Games

Rev. December 8, 2011 2

Figure 1 Video Game Players by Age and Gender, 2005

Figure 2 Video Game Software Sales (in US$ and units)

0.0 100.0 Volume

Rev. December 8, 2011 3

The Rise and Fall of Atari

In 1966, an engineer at Sanders Associates, a small New Hampshire-based electronics company,

Rev. December 8, 2011 4

The Rise of Nintendo

Kyoto, Japan-based Nintendo began as a playing-card manufacturing company. After diversifying

Rev. December 8, 2011 5

Sony Enters the Arena

Rev. December 8, 2011 6

Figure 3 Top Selling Video Games, 2005

Rank Title Platform Publisher

Rev. December 8, 2011 7

Game Development and Publishing

title that sold over 5 million units.

Fragmentation and Consolidation

manufacturer’s royalty is lowered.

Rev. December 8, 2011 8

Rev. December 8, 2011 9

Game Developer Acquisitions 1991-2004

Rev. December 8, 2011 1

Console Wars Re-Ignite

Rev. December 8, 2011 1

Rev. December 8, 2011 1

Rev. December 8, 2011 1

Different Strategies for Different Audiences

Rev. December 8, 2011 1

Rev. December 8, 2011 1

Rev. December 8, 2011 1

Reason for Optimism?

Rev. December 8, 2011 1

Exhibit 1a Sony Corporation Operating Performance by Business Segment 2005-2006

Source: Sony Annual Report 2006. http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html.

Exhibit 1b Sony Corporation Operating Revenue by Business Segment

Sony Corporation: Share of sales and

12.0% Financial Services

Source: Sony Annual Report 2006. http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html.

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Exhibit 1c Sony Corporation Game Business Operating Performance 2004-2006

USD in millions 2004 2005 2006

Sales $6,668.4 $6,237.6 $8,193.2

Source: Sony Annual Report 2006. http://www.sony.net/SonyInfo/IR/financial/ar/2006/qfhh7c00000aksvu-

Exhibit 2 Nintendo Income Statement, 2001-2006 (in US$ millions)

2006 2005 2004 2003 2002 2001

Net Sales $4,349 $4,813 $4,899 $4,798 $4,169 $3,475

Other income $643 $299 ($546) $124 $477 $630

Total income taxes $582 $542 $188 $438 $577 $544

Minority interests ($0) $0 $1 $1 ($2) ($2)

Net income $841 $817 $316 $640 $800 $726

Cash dividends per share $3 $3 $1 $1 $1 $1

Source: Nintendo Annual Financial Report. http://www.nintendo.com/corp/annual_report.jsp.

Rev. December 8, 2011 1