Porter’s five forces analysis to understand the attractiveness of the Industry – “Highly Attractive.

”
The threat of new entrants (LOW)

• Requirement of software: The console developers needed to connect with the 3rd party software
developers like Sega, Electronics Art, etc. for the console games. Software accounted for 70 percent of the
gaming industry revenues, and formal exclusive franchises was a common scenario, increasing the
premium for the developers and creating additional loyalty for the console. Such exclusivity contracts were
a major barrier.
• Customer switching costs: The switching cost for the customers was considerably high as new console
would cost around $299. As a result, consumers would be hesitant to switch to new options.
• Capital Requirements: Capital requirements are considerably high in the industry. For example, Microsoft
spent $2 billion on the development costs.
• Brand Loyalty: Existing firms fought very hard to maintain brand loyalty with Microsoft spending $500
million and Sony spending around $750 million towards the marketing campaign to maintain brand loyalty.
Thus, it will be very difficult and expensive to overcome existing consumer preferences.
Competitive Rivalry (LOW)

• Consolidated Market: There are just two major players in the current industry; Nintendo and Sony,
combined 70% of total industry revenue, which opens the $18.7 billion industry for more players.
• Dimensions of competition(Product Differentiation): Each participant tried to get an edge over the other
through either pricing or product features as a measure of differentiation e.g. Xbox had an Ethernet port
for broadband internet access and 8gb build in hard drive whereas Nintendo priced its product at $100
lower than the others and included 3rd party games, Sony’s PS2 let users to not only play games but also
watch DVD’s and listen to audio CDs.
• High industry growth rate: The industry is projected to grow from $270 million in 2001 to $4.6 billion in
2005, which gives enough room for other players.
Power of suppliers (Moderate)

• Software suppliers: The 3rd party software developers had significant leverage in the industry as software
accounted for 70% of the gaming industry revenues and console makers profited from loss leader strategy.
Also, each console maker sought exclusive titles with each of the software providers to attract more
consumers, thus increasing the bargaining power of the software suppliers.
• Backward Integration: Backward integration was possible in this case, as the present players Nintendo and
Sony in the Console market made their own in-house games. However, it was not enough to provide
diversity and varied games that gamers desired. Hence, supplier power was moderate
• Number of suppliers: For only a few players in the market, there is a large number of software publishers
present such as Nintendo, EA, Infogrames, Activision, etc. (refer exhibit 2). As a result, the bargaining
power of the suppliers reduces.
• Chip Suppliers: There were very few internal chips suppliers such as Intel, IBM, Toshiba in the industry;
hence, their bargaining power was high.
Power of Buyers – Wholesalers (LOW), Consumers (LOW)

• Backward Integration: Even though there are no patents or technical hurdles for backward integration,
there is a low threat - as there is a high entry cost to the tune of $2 billion acting as entry barriers.
• Fewer Substitutes: PC and portable games are the only available substitutes for the consumers which fail
short in the features offered by the console games like PC online games can be played only on PC, unlike
consoles which could be played on televisions.
• Low Purchasing Volume (Consumers): Product lifecycle is long; hence, consumers will buy once in 5 years,
which reduces the volume per consumer, thus reducing bargaining power.
• High Switching Costs (Consumers): Each console costs about $199-$299; thus, there is a high switching
cost, which decreases consumer bargaining power.
Threat of the Substitutes (LOW to MODERATE)

• Low Number of Substitutes: The console industry has two substitutes: PC and portable games. However,
the present sales of consoles are increasing at a greater rate compared to the substitutes and is predicted
to be an $18.7 billion industry in 2001. Hence the substitutes in 2001 didn’t have a concerning threat

Business Model of Microsoft Xbox:

Target Market: Microsoft decided to position the Xbox to attract older gamers age 18 to 34. This was to
compete for head to head with PS2
Customer Value Proposition: Provide customers access to online gaming through the Xbox console. Also,
provide a hard drive that would allow users to store music and save personalized games scenarios
Value Chain Analysis:
Product Differentiation Strategy:
• To leverage the online gaming community, Xbox had a dedicated ethernet port for broadband internet
access and an 8GB built in hard drive. Both were not present in Sony PS2, and Nintendo GameCube.
Broadband access would enhance the interactive capability of the XBOX by increasing gamer
interaction, allowing users to play online games, and download game enhancements. The hard-drive
empowered users to store music digitally, leverage personalized game scenarios, improve loading time
of the detailed graphics and help in addition of other applications in future.
Developer/Publisher/Distributor Retailers
• Xbox team abandoned Microsoft usual hard- • Price- Despite being a better product, the
nosed tactics with the developers console was priced as $299 (same as PS2). This
• Consulted industry gained developers for was to ensure the retailer didn’t have any
nearly a year before beginning the design incentive to go to PS2
work- so that they can have the system they
needed to make the great teams

VRIO Analysis: (Possibility of Sustaining Competitive Advantage)

Using existing Windows environment: Microsoft planned to use the existing Windows/Intel environment to
develop its console.
 o Valuable: This is valuable to Microsoft as it could shorten lengthy and expensive OS development
process and give the developers a “PC-like” familiarity.
o Rare: The Windows-based tools would draw in PC game developers who had never created or
ported games to consoles before.
o Inimitable: As the OS used will be a Windows based no other console manufacturer would be able
to use it.
o Organization: The Windows/Intel capability would be easily put into development as a modified
Intel 733 MHz Pentium 3 chip guaranteed that the system would run on a stripped-down version of
Windows.

Evaluation of Profitability Excel output is attached in the appendix

Although the profit margin of Microsoft Xbox is negative, the market share and subscriber conversion
percentage to break-even is surprisingly low when compared to industry average. The calculation and the
analysis for the same is explained in the stepwise manner below: (Number in the line item 1,2,3,6,7,8,9 have
been taken from Exhibit 17- “Xbox Financial data”)
• Line Item 4 and 5:
o Margin per Unit (Hardware)= Wholesale Price – Cost per Unit
o Profit = Margin per Unit * Console Sales
• Line Item 10: Margin per Unit (Games) = Retail Price – Cost per Unit
• Line Item 11 and 12
o Total Profit Year 1: Margin per Unit * Attach Rate for Year 1
o Total Profit Year 2: Margin per Unit * Attach Rate for Year 2
• Line Item 14:Cumulative profit considering all years include Console and Game profits
• Line Item 15:Addition of Users per Year(Assuming linear addition of users per year): Assuming
contribution made per customer is same between 2001 and 2005, we can estimate the number of
users for each year between 2001 and 2005.
• Line Item 16: Total number of online gamers - Number of online users in first year is given as 35.1M
(Exhibit 15) and 141.25M users are added every year as per line Item 15.
• Line Item 17: Paying Subscriber/year -Given only 10% of online gamers like to pay the subscription
fees, and assuming this number won’t change over the next four years (10% of Line Item 16)
• Line Item 18: Subscribers Needed to Breakeven- Using Exhibit 6, average willingness to pay as per
current market is indicated as $120 per year ($10 per month). Thus to breakeven, we divide line Item
14 by $120 to get annual subscribers in Millions
• Line Item 19: Market Share to Breakeven- Line Item 18/Line Item 17
• Line Item 20: Subscriber Conversion % to Breakeven- Line Item 18/Line Item 1. This is starting at an
enormous 86% in the first year but reduces to mere 3% by FY2005. Since there is already a high
broadband coverage in the target market and the ethernet port is already built in to the console, thus
achieving a 3% conversion doesn’t look very difficult.

Conclusion
As per the above analysis, we can see that the industry is extremely attractive as most of the forces are low.
Microsoft’s strategy of adding the ethernet port into the Xbox will help in tapping into the growing online
gaming market. The profitability calculations clearly show that Microsoft has made a good decision to get into
the video game console market if they keep their online gaming strategy aggressive
APPENDIX

Porter 5 Forces:
Excel Output to back up the calculations of profitability analysis: