After I wrote it, I noticed that Sony shows up in a few places throughout, but does not claim any defining event for itself (in my view, natch). I wonder if that's because Sony's contributions are so diffuse that it's difficult to point to any one and say "There! That's it!" or if it's my personal perspective.
Feel free to note events you think I missed or corrections in the comments.
Update (19:47): There was about a 30 minute discussion of the list on the Game Theory podcast today.
Come on friend, no love for the first PS? It brought real 3D to the consumer at an affordable level? The first ‘intelligent use of CD ROM and CD based software. PS also totally changed the way games were manufactured, distributed and sold in Japan. The use of CD also had an effect many consumer forget about…Sony made $50 games possible again.
[Let me trot out my Trojan horse…]
Revolutionaries at Sony: The Making of the Sony Playstation and The Visionaries Who Conquered The World of Video Games (Hardcover)
by Reiji Asakura
Chapter 4: Distribution Revolution: The "Breakout" Strategy
"What we wanted to do with the PlayStation,'' reveals Vice President Akira Sato of SCEI, "was to promote a concept that was clearly differentiated from anyone else's. In other words, we wanted to compete in a different arena altogether.'' Sony believed that, being late to market with the PlayStation, it should stake out a new battleground instead of copying its predecessors and so cause distributors, software houses, and subsequently end users to switch to Sony's approach. The primary secret to Sony's victory with the PlayStation lay in its technological superiority, which clearly impressed third-party suppliers. But that alone could not have produced such outstanding success. This is obvious from Sato's words: "When we thought about entering this business, we wondered how we could retain our own identity. Because we had no previous experience in the market, we resolved to impress users by creating something that would make them think, "Wow, Sony is a cut above its competitors!''' It was this attitude that carried the day.
If Sony had followed a traditional business model in the game market, it could not have dreamed of such remarkable success. Sato proclaims: "As intruders, we could operate freely without being restricted by industry conventions. From the industry's perspective, competition arose from an unexpected sources."
MASK ROM DISRUPTS THE DISTRIBUTION CHANNEL
Why did Sato feel that he had to start a distribution revolution? His resolve was partly based on bitter personal experience. Some time previously he had bought Super Famicom software from a store near his home. He couldn't find on display the popular title he sought, so he told the owner of the store what he was looking f or. The owner went off to the back of the store and shortly returned with the title, treating it like something precious and saying, "This is what you want, isn't it?"
Sato took the software home and connected the Famicom to the TV, only to find that there was something wrong; to his disgust, points scored by a previous player were displayed on the screen. Although it looked brand new, the software was unmistakably used. And he had paid the full price! He rushed back to the store to complain, and the storekeeper apologized meekly: "I'm sorry. You're right. It's definitely a used product."
Such practices were commonplace in the game market before the arrival of the PlayStation Says Sato: "Dissatisfaction will mount if users are treated that way; they were clearly being cheated. There's no doubt that people in the game business don't respect users. This experience made me determined to change the trading practices in the computer game market."
At that time Sato was merely another Super Famicom user, but complaints about the method of distribution were increasing sharply among software makers as well. Says Managing Director Kitagami of Konami: "We were losing our patience with the Shoshinkai, the Nintendo wholesaler organization. They wouldn't replace faulty products, they traded without regard for proper channels, they even copied software. They behaved so unethically, it was beyond belief. How could they get away with it?"
The game industry's distribution structure was complex and mysterious to outsiders. The conventional channel was from Shoshinkai wholesaler to retail store, but secondary wholesalers and cash wholesalers often operated between the two. Practices such as retailers returning products purchased from wholesalers and wholesalers diverting the products to a different store were commonplace. Selling a used product as a new one, a practice that Sato experienced, was only the tip of the iceberg. One example of a more insidious practice is "dummy rental." A retailer sells a new software product for $50, which is below the store's cost. Users will be attracted to the deal because the price is so low. The retailer then buys back the software from the same customers at an even lower price and sells it again for $50. Let's assume that the profit on the sale is $10. By repeating the buying and selling process ten times, the retailer earns a profit of $100. The more times the retailer turns over the some product, the greater the profit.
THE LIMITATIONS OF A MEDIUM
UNSUITED TO REPEAT PRODUCTION
Famicom software was distributed in a unique way. A Shoshinkai wholesaler would conclude a contract with a software company for bulk purchase of a title. The purchase would be for large quantities-say, 5,000 or 10,000 units. This is fine if the title is a hit, but otherwise the wholesaler will end up with a large inventory of unsold stock. And in reality, only a few titles are popular enough to sell in such high quantities.
Sellers exhibited a certain type of behavior under this kind of distribution structure. Wholesalers fear inventory buildup and make an effort to off-load the software they have purchased as quickly as possible. If the software is a sure seller, however, they are reluctant to sell and hang on to it for as long as possible, waiting for prices to rise.
Where the Famicom was concerned, the cause of this behavior lay in the characteristics of mask ROM (semiconductor memory packaged in an oblong cartridge) as a medium. The advantage of mask ROM is its quick data access, a feature much appreciated by users. From the manufacturer's point of view, however, mask ROM has the critical flaw of being time- consuming to produce. Manufacturers place additional orders in a panic if a hit product sells out, but mask ROM is a semiconductor product with a long manufacturing lead time- more than two months. Timing is crucial in the game business; sales opportunities will not wait. Software houses frequently suffered the experience of ending up with unsold inventory of a product because it took two months to replenish the stock, by which time its popularity had waned.
This was an inevitable problem for a medium whose physical characteristics were so removed from their content requirements. Mask ROM takes a long time to manufacture, so in practice repeat production is impossible. Fearing the loss of sales opportunities, game manufacturers will produce large quantities of the same title. Wholesalers, however, cannot hold all the stock and so dispose of part of their inventory by selling it to other wholesalers or cash wholesalers. This led to the many problems described above. The situation was truly a vicious circle.
"Although I was tricked into buying a used item," says Sato, "that business model is the right one for mask ROM. Since repeat production is impossible, a receptacle must be provided somewhere in the distribution system. If mask ROM had been adopted for the PlayStation, we would have used a distribution strategy similar to Nintendo's. There's no other option."
Temporary demand for mask ROM products arises easily. A retail store wants to buy a large supply of a title that is selling well, but because no single wholesaler can obtain a sufficient quantity, the store contacts other wholesalers. Several wholesalers receive an identical order and the total demand appears to be enormous. A large portion of this, however, is fictitious demand.
Only a few companies carried out precise market research and measured and understood software sales trends. Namco was one of them. Says Senior Managing Director Nakamura: "To ensure that mask ROM products would be on store shelves on the release date, we had to deliver the master copy to Nintendo three months in advance. Taking end-of-year demand into account, production had to start in August. But how you predict end-of-year demand accurately in August? If you forecast sales of 300,000 units and actual demand was for 400,000, you've lost the opportunity to sell 100,000 copies. Or in the opposite case, you end up with surplus stock of 100,000. When we made Nintendo games, we had to sneak out late at night to dispose of excess inventory on several occasions. You have to be a genius to predict mask ROM production and sales."
To avoid missing business opportunities, Namco tried to find ways to turn market trends to its advantage, even with mask ROM products. The company even attempted to explore the possibility of repeat orders. Sato was surprised when he heard this story: Namco was the rare exception. In the game industry, it was customary for manufacturers to build in a "risk insurance" component (usually $5) when calculating cost. With mask ROM the inventory risk was so great that nervous managers at software houses required compensating security.
CD-ROM: THE ONLY SOLUTION
The use of mask ROM brought serious problems to retail stores, users, and the management ranks of game manufacturers. The major disadvantage of mask ROM for retailers and software developers was the impossibility of making accurate sales forecasts. It was an exceedingly high-risk, high-return business for game manufacturers, because the developer would suffer shortages if a product sold well, but would end up with huge inventories if sales were disappointing. A decision on production volume could not be made without forecasting market trends three months ahead, which in reality is an impossible task. Therefore, decision making was extremely difficult.
Retail stores wanted to know the maximum sales potential for a product, but demand for hit products outpaced supply, whereas poor sellers resulted in excess inventory.
There were problems for users, as well. First of all, the software was expensive. This is primarily due to the high manufacturing cost of mask ROM. Software houses had to pay Nintendo an OEM manufacturing fee of $30 per copy, and after development cost, margin, risk insurance, and distribution costs were factored in, the final retail price approached $100.
The second problem was Nintendo's pricing strategy. Says Kutaragi, who worked with Nintendo for a long time: "Nintendo's idea over time. Instead of releasing software at an affordable price, it would restrict software to a small, high-quality selection and push up the price every time the format moved into a new generation. Back then, they believed in driving up software prices."
Software prices for the 8-bit Famicom were around $40, and almost $100 for the Super Famicom as a result of Nintendo's insistence on keeping software prices high. "It's ridiculous from an end user's point of view," Kutaragi comments. "It's very annoying for parents when software prices go up every year in late December and early January, and for kids too, because they can afford to buy only a limited number of titles with their limited spending money. Kids then begin to demonstrate a form of self-defense by playing the game as quickly as possible and taking it to a used-software outlet while it still has a high resale value. Soon it became commonplace for elementary school pupils to trade used software for thousands of yen, so they introduced a rule that youngsters had to bring a consent form signed by their parents before they could sell software. I knew that such a crazy situation could not last indefinitely.''
Against the backdrop of the game industry's retail and distribution system, which bordered on the anarchic, Sony began to see the correct distribution strategy for PlayStation. If Sony was to bring a new product onto the market, its software had to be something that satisfied all three market participants: software producers, retailers, and end users. Moreover, it had to allow management to formulate less risky selling strategies, enable retailers to make accurate sales forecasts, and be priced so that users could afford to buy it, even children spending their pocket money.
There was only one solution: to use CD-ROM as the medium. Kutaragi had first considered using CD-ROM when he was struggling to persuade Nintendo to adopt Sony's technology. Nintendo was experiencing a sense of crisis amid rumors that Sega was working on a 16-bit system and NEC planned to enter the market. Sony and Nintendo agreed to organize a summer business camp to discuss the next-generation Famicom at a Sony resort in Mikkabi, Shizuoka Prefecture, halfway between Tokyo and Kyoto. Lively debate ensued over three days and two nights starting on June 16, 1987.
Even at this early stage, Kutaragi proposed to Nintendo that they should use CD-ROM instead of mask ROM. It is clear that Kutaragi had favored the CD-ROM as a medium for many years. However, Nintendo's view was that mask ROM capacity would increase in the future, and they did not make any immediate decision. In 1989, when development of Nintendo's Super Famicom had reached the final stage, Kutaragi suggested again to Nintendo that it use CD-ROM. Nintendo, however, remained negative about CD-ROM, mindful of the poor sales performance of the Famicom disk adapter, and eventually asked Sony to work on it alone. Sony, therefore, began to develop in earnest a CD-ROM system compatible with the Super Famicom. The following year, the presidents of Sony and Nintendo signed anoint development agreement for the CD-ROM system. On June 2, 1991, Nintendo and Philips announced at the CES that they were to develop a CD-ROM system that would not be compatible with Sony's.
REVOLUTIONIZING THE DISTRIBUTION SYSTEM
Why did Kutaragi back CD-ROM? First, it was far cheaper and had greater storage capacity than mask ROM. It also offered multimedia benefits, since it combined image, sound, and digital data. Moreover, it was highly strategic as a software supply medium. Kutaragi's team not only focused on the medium's basic characteristics, such as low price and large capacity, but also analyzed CD-ROM from various perspectives and took full advantage of its rich strategic attributes. Clearly, their goal was to revolutionize the distribution system with CD-ROM.
CD-ROM had been used since 1990 as a game medium- Sega's Mega CD and NEC'S PC Engine are prime examples but no company had ever adopted CD-ROM as a medium with the intention of reforming the distribution system. CD-ROM was sold only in a limited market, distributed through the existing mask ROM product channels.
With the PlayStation, however, Sony made a deliberate attempt to emphasize the advantages of CD-ROM and use it to ignite a distribution revolution. First, Kutaragi's team stressed the attractive price of CD-ROM. They believed that the lower software prices made possible by using CD-ROM were a benefit that would not only satisfy users' needs, but would become the driving force behind distribution reform. Sony knew that the lower prices would be a powerful weapon to compete against the established format.
One indication of this was the used-software market, which in those days was essential to end users. Top-selling software would sell out immediately, with the less popular titles remaining on retailers' shelves. Thus, the only way people could obtain popular titles was through used-software dealers who bought these titles on the secondhand market.
Just when Kutaragi had decided that there was something very wrong with the situation, Sato had an inspiration. "This is the biggest weakness of the mask ROM business model," he said. "We can defeat the established manufacturers if we create a situation in which consumers can buy hit titles new, and whenever they want, at a price lower than that of used cartridges."
His thinking went like this: Super Famicom software retailing for $100 is sold to a used-software dealer for $50. The dealer adds a $20 margin and resells it for $70. If new PlayStation games could retail for less than $70, it should be possible for Sony to defeat its competitors. Furthermore, if the titles that had been circulating in the used-software market could be replaced by new ones, the profit from the secondhand market could be redirected to sales of new products.
The Sony team had discovered an inviting market opportunity by calmly analyzing the market's status quo. Kutaragi explains: "That's why we set the retail price of most PlayStation software at $58. The way to solve the problems with the old order was to offer new software at low prices. This was a deliberate, strategic move. The price was about half that of a mask ROM cartridge and in the same range as the early Famicom software."
Before the release of the PlayStation, mask ROM software prices were on the increase. Twenty-four of the Super Famicom titles released between October 1993 and September 1994 were priced above $100, more than double the number of the previous year. "With mask ROM, the developer builds the profit to be made in the used-software market into tile retail price, so the price of new products is high,? says Sato. "We used CD-ROM to change this absurd situation."
THE MEANS TO APPEAL TO SOFTWARE HOUSES
The appeal of CD-ROM for software producers would be reduced in proportion to the decrease in profits. Thus, it was essential to develop a business model that enabled software producers to make a reasonable profit even if the retail price of the software was slashed by 50 percent.
One way of looking at the PlayStation is as a series of cleverly contrived attractions. The attraction for software creators were 3-D computer graphics and the library, whereas the attraction for management was the business advantages of using CD-ROM as the software supply medium. First, CDROM has a far lower manufacturing cost than mask ROM-a cost advantage that Sony could use as an enticement to executives of software houses who were thinking of participating in the PlayStation platform: "We can make the software inexpensive. And you'll make a good profit."
Low cost means a low investment. Consider the following example: In the case of mask ROM, the OEM price is $30 per copy: $300,000 for 10,000 units, $1,800,000 for 60,000 units. There is a time lag between the actual sale and when the software producer receives the proceeds, so the company must have enough working capital to operate during this period. In the case of the PlayStation, however, the manufacturing cost of a CD-ROM is $9 per copy, or $540,000 for 60,000 units. This cost advantage would be appreciated by software makers who ha d creative ability but lacked capital.
Once the initial outlay has been calculated, the next step is to work out the profit. The retail price of a Super Famicom title is $100, compared with $58 for a PlayStation title. Sony guaranteed that its distribution system would maintain and even increase gross margins for software houses in spite of the software's lower prices. And the general framework of the distribution system would remain in line with industry conventions. This was the clever aspect of the PlayStation project: Although Sony the innovator had surpassed the existing technology, media, and marketing models, it would remain faithful to Nintendo's practices with respect to manufacturing structure and royalty concept.
Nintendo's royalty system worked as follows: The platform developer produced all the software under an OEM agreement (that is, under the software producers? brand name), and the software house paid the platform maker an OEM production fee and royalties. Says Sato, "We used Nintendo's basic royalty business formula unchanged. It was a perfectly good system, so there was no need for us to change it. Royalties are like a tax you pay on developing for the format."
Although the overall structure of Sony's arrangement with software developers was the some as Nintendo's, the details were far more favorable to software producers, whose main gripe had been the high royalties and OEM production fees. Sony realized that this weakness in Nintendo's system should be exploited. The physical manufacturing cost of CD-ROM is a tenth that of mask ROM. Sony thought that a new OEM production fee and royalty schedule that took maximum advantage of the low manufacturing cost would be attractive to software houses, many of whom had told Sony that smaller profits for them would not be acceptable.
The following is a profit-and-loss calculation model assumes mask ROM sales of 100,000 units and software development cost of $1 million. The Super Famicom platform's OEM price is $30 per unit, which includes the mask ROM cost of $15 per unit. In other words, the software houses pay Nintendo a royalty of $15 per unit for manufacturing the title.
The software houses include development cost an equipment amortization of $10 per unit. To this they add a profit of $10 per unit, an advertising cost of $6 per unit, and the $5 risk insurance (security against the risks associated with mask ROM, which is not suited to repeat production). The above factors total $61, which is the price to the wholesaler. The wholesaler's profit is $12 and the retailer's profit is $25, which brings the final retail price to $98.
By contrast, PlayStation software is suited to repeat production, so the $5 risk insurance does not apply. Software houses pay Sony a $9 OEM production fee, which includes the royalty and CD-ROM manufacturing cost. Add to this $10 in software development and equipment-amortization cost, the software producers' profit of $10, and advertising cost of $6; the total of $35 is the price to wholesalers. This is $26 less than the price of Super Famicom software. The wholesaler (in the case of SCEI) takes a profit of $6 and the retailer's margin is $17, bringing the final total to $58.
Thus, although the retail price was lower than for Super Famicom software, software house profit was the same $10, which meant there was no reason for them to object. This royalty system provided a strong incentive when Sony was inviting soft- ware producers to join the PlayStation camp. Most software houses agreed with Namco director Haraguchi, who says: "We thought the OEM price was reasonable. The $9 OEM fee [this has now been changed to a percentage rate] covered SCEI'S hardware development costs, support, and format promotion costs, so it was a fair figure."
Giant comment aside, I have to agree with monkeyking. The original PS really made gaming more popular with the mainstream, and it's my belief that had the PS not been as successful in this as it was, Microsoft wouldn't have bothered entering the market.
Dunno if that qualifies as a "defining event", however. Maybe more of a "legacy".