We attended the 2011 Electronic Entertainment Expo (E3) in Los Angeles from June 7 to 9, as well as all the vendor and publisher events on June 6. In our experience, the press events and demos at E3 inform and influence the North American market and, to a lesser extent, the European and Japanese markets in the near to mid-term.

Hardware launches tend to grab the biggest headlines, but ultimately E3 is about software. Large publishers including Electronic Arts, Activision Blizzard, Warner Bros. Interactive Entertainment, Take-Two Interactive Software and Disney Interactive Studios demoed high quality software ranging from triple A games that cost tens of millions and aiming for sales of well over a million units to smaller and less expensive (but still high quality) games targeted at niche audiences in both the hardcore gamer market and the mainstream market. As at previous E3 expos, franchise sequels and games based on licenses from comics, films, television, sports and music dominated the software mix, and most games will be published as packaged goods for use on dedicated consoles and handhelds.

Several publishers, including EA and Ubisoft, featured games for convergent platforms such as PC, smartphones and tablets. Publishers announced plans to use delivery and business models outside traditional brick-and-mortar and online retail of boxed games, adding more digital distribution systems and such divergent business models as paid download games, and pay to play as well as free to play (aka “freemium”) games with revenue driven by in-game purchases, subscriptions and in-game advertising. EA and Ubisoft presentations featured proprietary customer entitlement systems to deliver games as a service in addition to the ongoing packaged goods business. Electronic Arts, branding its online games services with a legacy franchise as “Origin, powered by EA”, specifically stressed this model as both transformative and indicative of future growth. EA’s and Ubisoft’s online strategies were more similar than different to other publishers’ in what M2 Research sees as a validation of on device access to Internet-connected software management and markets such as Valve’s Steam, Microsoft’s Xbox LIVE, Sony Computer Entertainment’s PlayStation Network and Apple’s App Store.

Nintendo Fortifies 3DS With Top Shelf IP and Launches the Next Generation With Wii U
Nintendo’s press event listed showcased anticipated high value franchises for 3DS for 2011 to 2012 including Zelda remake Ocarina of Time, a new Mario Kart game, a new Super Mario 3D platformer, Luigi’s Mansion 2, Star Fox 64 3D (featuring video communications for multiplayer) and Kid Icarus (featuring unique local and network based multiplayer modes). We believe upcoming releases of these games will drive increased momentum for 3DS hardware well into 2012.

Nintendo’s E3 presentation also revealed Wii U, positioned as a high definition technologically advanced console targeting hardcore gamers as well as mass market consumers. With Wii U, Nintendo means to catch up to the performance capabilities of Microsoft Xbox 360 and Sony PlayStation 3 and dig in to a new installed base in advance of competitors’ next generation hardware. Nintendo exhibited simulated high definition game style experiences to demonstrate Wii U’s graphics capabilities and the alternative gameplay mechanics made possible by use of the new controller incorporating a 6.2″ touch screen and gyroscopic and accelerometer sensors for motion control.

Nintendo did not announce pricing or release dates for Wii U, nor did the company share detailed processing specifications beyond the integration of “Watson” class IBM silicon for CPU and AMD design for GPU. Until these details are available, projecting Wii U performance remains a speculative exercise. Still, Wii U should play out well for Nintendo at launch in a window between April and December of 2012 (a Q4 2012 release is likely). Until Wii U is available, the new console’s short term impact will be negative on the market, particularly on Nintendo’s share. Wii hardware uptake has been slowing in the U.S. for over a year, and sales will now drag even lower with the announcement of a new system. New high value Wii titles such as Legend of Zelda: Skyward Sword are likely to improve Wii software sales, but third party Wii title performance remains sluggish.

Microsoft Selling Kinect as Hardcore Controller, We’re Not Buying. Yet.
Microsoft’s press event took victory laps for Xbox 360’s sustained and continuing momentum, in contrast with Nintendo Wii’s dramatically slowing sales and Sony PS3’s only recently growing performance after a lengthy slow post launch uptake. Much of Microsoft’s game industry momentum is attributable to strong Kinect uptake (10M units through March 2011), which defied the expectations of many market prognosticators (M2 Research was among those unsurprised by Kinect’s performance). Sell-in of new Xbox 360 consoles has also been vigorous to date and is in many cases discrete from Kinect, but we must highlight mitigating factors including a higher replacement and upgrade cycle rate (by a factor of at least 15%) and a recent successful cross-promotion where college students buying Windows 7-powered laptops get free Xbox 360 consoles with their purchase.

As expected, Microsoft showcased first party software and exclusive differentiated third party software features for Xbox 360 and Kinect hardware to make a case for extended market share growth. From Kinect’s launch at E3 2009 onward, Microsoft marketed Kinect as a gateway device for the mainstream consumer, particularly for children, groups and families. At E3 2011 Microsoft shifted target demographics, attempting to re-position Kinect as a viable alternative interface for hardcore gameplay mechanics, including first and third person shooters.

However, we remain unconvinced that Kinect can offer a smooth hardcore gaming experience, as Kinect gestural and motion control remains loose and interpretive, lacking the precision necessary for shooters and other enthusiast gameplay. There are notable exceptions, including Dance Central, which crosses over between mainstream and enthusiast sectors and Kinect Star Wars,with similar crossover prospects albeit for a younger demographic. Kinect motion control for Xbox 360 may provide depth of play for a younger audience (i.e. with Star Wars) but will continue to be only for simple or “dumbed down” gameplay and for flashy menu and multimedia control on the Xbox 360. Microsoft will have to alter Kinect’s Xbox 360 integration to allow for enhanced simultaneous input from the traditional game controller in conjunction with augmentative Kinect motion and gesture control to make Kinect part of the hardcore gaming experience.

Sony is Sorry for PSN Outages, Delivers With PS Vita, Promises With 3D, Falters (or Not) with AT&T
Sony Computer Entertainment (SCE) had a broad agenda for its E3 presentation, which was for the most part very successful. SCEA President Jack Tretton kicked off the event with sincere apologies for the recent extended PlayStation Network service outages due to hacker attacks and followed up with gratitude for the patience and support shown by PSN’s users. Tretton’s statements highlight Sony’s acknowledgement of the serious nature of the loss of privacy and services to customers and its increased commitment to more reliable service going forward.

Kaz Hirai, Representative CEO of Sony Corporation, revealed the important details regarding the company’s new dedicated handheld system. Its name is PlayStation Vita (PS Vita), its price is USD $249.99 for WiFi only version and $299.99 for WiFi plus 3G version and its release window is by end of 2011 in a region “to be specified.” These details, particularly the pricing, are very promising, and got an enthusiastic response from the crowd. Kaz Hirai’s enthusiasm for AT&T as the default carrier for the 3G PS Vita and the crowd’s negative response were in our view equally overstated, but we were not surprised SCEA chose AT&T, as the carrier has been aggressively rolling out wireless Internet coverage in many public locations and shares cross-promotion with Nintendo as well.

Tretton and a host of first and third party developers and Sony Computer Entertainment execs then showcased exclusive games and features for PS3, with a particular focus on 3D play. The audience had been supplied polarized 3D glasses to wear and remove as directed, as many games were shown in 3D. Later Sony further demonstrated a commitment to 3D, announcing a bundle with a 24″ 3D display monitor capable of 2 player discrete view mode, Resistance 3 game, 3D (active shutter-type) glasses and HDMI cable for $499.99. Sony’s fervor for 3D as a PS3 differentiator parallels the company’s previous bet on Blu Ray with the launch of PS3, and the company stands to gain by strong 3D uptake along with competitive display monitor vendors such as Samsung and Panasonic.

M2 Research believes that Sony is among those ahead of a yet to be proven market for 3D displays. Tethering to specialized glasses is a significant issue, but a scarcity of compelling content is another barrier to 3D TV uptake along with consumer spending constraints. Many of SCE’s games, notably Uncharted 3 and Gran Turismo 5, have impressive graphics in 2D but are more immersive and engaging in 3D and make a strong case for the display technology. In contrast, the television and film industries have been slow to produce a sufficient quantity of similarly compelling 3D viewing experiences. Sony rightly believes that getting gamers onboard with 3D will seed the technology among influencers. We remain skeptical that Sony can sell enough gamers on 3D quickly enough to boost 3D uptake in the near term.

What it All Means and Why You Should Care
The takeaways from E3 2011 point toward year over year revenue growth in the traditional retail market despite significant slowdowns to date this calendar year. The catalyst for that growth would be stronger hardware sales driven by the availability of quality software for that hardware.

We believe upcoming releases of highly anticipated Nintendo franchises including Mario Kart and Super Mario, Legend of Zelda and Starfox for 3DS will spur aggressive hardware uptake. 3DS hardware and software growth alone would be positive but could lack sufficient impact to push 2011 U.S. revenue from loss to growth, but we also expect strong first and third party software will drive increased momentum for PS3 hardware and to a somewhat lesser extent Xbox 360 and Kinect, which may be slow but will be mitigated by replacements, upgrades and the laptop cross-promotion giveaways continuing through early August 2011. PS3 and Xbox 360 software should remain strong through the mid term. We expect Wii hardware performance to continue to slow due to Nintendo’s announcement of a successor system and to a shift in quality software to 3DS in the near term and to Wii U in the long term, although, again, Legend of Zelda: Skyward Sword will boost Wii software sales.

There are other factors that will spur growth in the traditional packaged goods sector, including multiple triple A titles we believe will sell multiple millions mostly in fourth quarter 2011 and increased activity in the secondary market of pre-owned software and hardware which will be bought sold and traded in, predominantly at GameStop. PS Vita is the remaining wild card; when and where Sony plays it will disrupt regional performance. Historical patterns presuppose PS Vita release in Japan rather than North America, but Sony is being coy with details on which region will lead. Whichever region gets the new Sony handheld first will see revenue boosted by sell through of 500K to 1.5M units.Although US release would have strong positive impact, we believe Japan will get first PS Vita shipments as the Japanese market would support an economical diminished and slower production rollout for Sony, and possible negatives due to shortages would be constrained. Dollar strength relative to yen could also play a factor in where PS Vita is first released.

Online Games Are Way More Important Than You Think, Really.
Growth in revenue for online subscriptions, services, in-game purchases, game-associated advertising and digitally distributed standalone and add-on game software, mostly for convergent platforms such as PC, smartphones and tablets will likely continue to be viewed as a migration of hardcore gamers from the traditional packaged goods sector. This recent, corrective view represents a foxhole conversion-style recognition of changes in enthusiast gamer consumption patterns, and the long view is that digital distribution will overtake revenue from sales of game software as physical, packaged goods. There are truths and deceptions embedded in this perception, including the sustained and persistent under-representation of a mainstream audience for casual games outside the hardcore market. Other emerging digital distribution models including in-cloud processing game delivery as offered by OnLive and Gaikai will have impact on the enthusiast and mainstream markets. M2 Research will continue to explore these topics and other important game industry issues in greater detail in future briefs and reports.

Billy Pudgeon

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: