Sega Gets Hip to Reality

Sega's decision to get out of the game-machine business, like IBM's decision to get out of the retail desktop PC business, is being met with a significant amount of chest-beating and hair-tearing. The coverage reads like an obituary: solemn, with an emphasis on the company's historical highlights and commentary about how the end was sad but inevitable. Competitors make charitable eulogistic remarks. Consumers weep for a scrappy underdog platform. Rest in peace.

But Sega's decision to quit making consoles, far from being a death, is the first step the company has taken toward life in 10 years. Sega's brand has always stood for two things. One of them is fumbled consumer hardware. The adjective "ill-fated" describes most of the consumer electronics this company has released, from Genesis hard-disk and processing add-ons to the hand-held Game Gear platform to the disastrous Sega Saturn. Dreamcast is just the latest in a long line of devices that illustrate Sega's genetic inability to produce successful consumer boxes.

Fortunately, the other thing Sega stands for is great software. From Sonic to Shenmue, Sega's programmers have produced some of the most engaging experiences in the history of interactive media. Sega's profitable arcade division, responsible for blockbusters like Virtua Cop and House of the Dead, is alive and well and continues to hoover money from the pockets of teenage boys. Unshackled by a struggling console platform, this platoon of world-class software developers can do what they do best for any machine on the market, from the PC to PlayStation 2 to X-Box, without compromising the company. That, in turn, amplifies the value of Sega's brands, which means more revenue from a panoply of Sonic merchandise.

NO DIRTY HANDS

Essentially, Sega is migrating from a capital-intensive, low-margin manufacturing business to a high-margin business based purely on information. On the heels of its console news, Sega announced an agreement to license its technology for a set-top personal video recorder manufactured by Pace Micro Technology. Good-bye inventory, hello licensing revenue. Let someone else sink hundreds of millions of dollars into a state-of-the-art factory that will be obsolete in five years. If you can make money furnishing design to the people who get their hands dirty, that's called moving up the value chain.

And yes, this is a forced migration-Sega failed as a razor company. But no-one makes money on razors in the videogame business. The cash is in the blades-the revenues that platform companies like Sony and Nintendo derive from every unit of software sold. Having abandoned its ambitions to manufacture razors, Sega is now exclusively a blade business, which is where its competence has always been. All of the company's value resides in its intellectual capital: its software and its brands-the spark that remains after the mortal coil of its hardware business has been shed.

Dreamcast is dead. Long live Sega.

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