The Next Game Wars

With videogames, as with real life, you never get a second chance to make a first impression. That's especially true at the Electronic Entertainment Expo, the world's biggest videogame conference. And based on what attendees saw recently, it's clear that when it comes to the pitched battle for the living room, Sony Computer Entertainment chief Ken Kutaragi has an infinitely stronger understanding of the value of showmanship than does Microsoft's Bill Gates. Sony kicked off the show by announcing its new PlayStation 3, reeling off specs (two tera-flops of computing power), features (built-in Wi-Fi, Bluetooth and high-definition DVD playback) and mind-blowing game demonstrations (one showed the force of a boxer's punch rippling through the skin and muscle of his opponent's face). Two hours later, when Kutaragi held a mock-up of the device over his head, the guests had been shocked and awed into submission--right before they headed over to Microsoft's Xbox 360 event. By the time attendees exited the Redmond, Washington, giant's straining-to-be-cool press conference--punctuated by a painfully unfunny video clip starring Gates and CEO Steve Ballmer dressed as geeky "Star Wars" fans--there was just one word on everyone's lips: PS3.

The real battle, of course, won't be fought until Microsoft starts shipping the Xbox 360 toward the end of this year, followed by Sony's PS3 and Nintendo's Revolution in the first half of 2006. But this early gamesmanship matters when the spoils of a $25 billion industry and ownership of an increasingly digitized living room are at stake. During the analog era, when PCs and TVs coexisted peacefully, so did Sony and Microsoft. But as the line between the PC and the TV becomes ever more blurred, the former allies have become fierce competitors. (Nintendo, meanwhile, seems to be sidestepping this war by focusing on its core audience of kids and nostalgic adults.) After Sony's Kutaragi rebuffed two overtures from Gates in 1999 to use a Microsoft operating system, Gates decided to enter the videogame market directly.

The economics of the videogame industry--collecting royalties from the game software sold by publishers to offset one's initial investments in high-powered hardware that is initially sold at a loss--have made videogames a risky and potentially rewarding staging area for companies that want to own the living room. So far, Microsoft has seen more risk than reward; it's lost nearly $4 billion on sales of 20 million units worldwide, more than Nintendo's 18 million but far less than Sony's 89 million units. With Xbox 360, the company hopes for a fresh start. "The thing about transitions is that the deck gets reshuffled," says Brian Farrell, the CEO of U.S. game publisher THQ. With both broadband networking and high-definition televisions expected to achieve critical mass in the next five to seven years, this is a battle that neither Sony nor Microsoft can afford to lose.

True to form, each firm is pushing the strengths of its heritage. Sony is honoring its consumer-electronics roots by highlighting its market-leading support for high-definition television and high-performance game hardware, built around absurdly powerful components that it helped create. For the PS3, the company partnered with IBM and Toshiba on a radically advanced computer chip that integrates the CPU with eight co-processors to simultaneously handle massive amounts of data (dubbed CELL), along with a graphics chip from Nvidia (nicknamed the Reality Synthesizer). Hyperbolic nomenclature aside, the end result is widely expected to be the most powerful of the coming generation.

Microsoft executives insist that their chips are far better than Sony's at processing the vast majority of game code. But one independent publisher who's intimately familiar with both PS3 and Xbox 360 says that Sony's console will deliver one-and-a-half times the graphics and three times the CPU performance of Microsoft's--making it possible to re-create those hyperrealistic punches, among other effects. Another source says he also believes PS3 to be more capable, but stresses that it's too early to be certain. (Unlocking all of its capabilities will also put a lot of pressure on Sony and IBM to deliver software tools to a skeptical publishing community.) Sony's other wild card is high definition: unlike Xbox 360, PS3 will be able to display images at the highest HDTV standard, and Sony also plans to incorporate a player for Blu-Ray discs, which have five times the capacity of DVDs, so that users can also watch Hollywood movies in maximum high definition.

Microsoft's pc heritage, by contrast, has given it tremendous expertise in software development and networking. Executives say that the company's developer-friendly tools and its highly acclaimed Xbox Live online gaming service give it an advantage over Sony. "The analysts' reports say that there's billions of dollars in growth in online," says Xbox vice president James (J) Allard, "and we're going to drive it with hardware, software and services." Allard's boss, Robbie Bach, points to internal research showing that Live subscribers purchase two to three times as many games as nonsubscribers.

The closer Bach and Allard's vision remains to gaming--fostering competition with tournaments and prizes or connecting easily with friends--the more enthralling that vision will be to both gamers and publishers. "They have a better consumer proposition," says Electronic Arts senior vice president David Gardner. "Europe is not as addicted to the whole broadband experience, but if they get incredibly lucky with uniquely available content, it could help them push ahead." And as online gaming explodes in South Korea and China, that approach is increasingly appealing to Japanese publishers, who face plunging sales at home and declining market share in North America and Europe. Square Enix president Yoichi Wada snubbed the first Xbox. Now he cites Microsoft's service as one of the main reasons his company will make games for Xbox 360.

Sony isn't invulnerable, by any means. Its online infrastructure is seriously underdeveloped, its Blu-Ray format could lose out to Toshiba's competing HD-DVD technology, and Xbox 360 will beat PS3 to store shelves. Because Sony is the leader--it has more online users in North America than Microsoft has globally--the burden is on Microsoft to prove that it can knock off Sony's crown, or at least tarnish it. It's not clear that Microsoft has the right strategy to do so. For instance, Allard waxes enthusiastic about getting women to play casual games, or grandparents to use Xbox Live's spectator mode to watch their grandkids competing online. For anyone who's given up videogaming for several years, as many young women have, or barely dabbled in it, as is the case with most seniors, the real issue is the intimidating presence of a controller sporting nine buttons, two triggers and two analog sticks, like the one on the Xbox.

Sony also seems to understand better than Microsoft that alternative forms of gaming are a stronger lure to nongamers than online platforms. These days, non- extreme videogamers have more inviting options than Xbox 360: Web browser games, played with the familiar mouse and keyboard; games for mobile phones; Nintendo's Game Boy Advance, and even Sony's PSP. Sony has also had great success with its karaoke game Singstar in Europe and globally with its EyeToy Webcam, which lets users control games by gestures.

With six months to go before Microsoft's launch, the only sure thing is that Xbox 360 will have an advantage in being first to market. But that lead could be as little as four months; by comparison, the PS2 shipped 18 months earlier than the first Xbox, allowing Sony to blaze its way to 20 million units shipped before Microsoft had sold a single unit. Also, by introducing its new console after just four years, while the five-year-old PS2 is still going strong, Microsoft risks alienating consumers and publishers who have come to expect a five-year life span for videogame hardware. Fortunately for Microsoft, the only thing publishers like less than its forced exit strategy for the original Xbox is the thought of Sony's standing alone after the final bell. Because in videogames, as in real life, everyone wants to see competition.