C ase 10 PS3: Sony on the Run 1

Gun shots and sirens fill the air around him. Speeding through city streets, Sony C E O Sir Howard Stringer is on the run. Sir Stringer hooks a left; the cops keep up the frantic pace and are on his tail. Cant separate from these #@*%ing!!! bobbies, Sir Stringer grunted. In the heat of the moment, Sir Stringers mind wanders onto the recent turmoil at Sony. His strategy of cost-cutting and selling of non-core assets has brought short-term gains to the income statement. However, this has produced little confidence to a divided boardroom. As the situation becomes
more drastic so does Sir Stringers actions. The chase escalates with Sir Springer weaving

dangerously in and out of traffic. As Sir Stringers doomed fate begins to materialize, he reflects over the recent contentious Sony boardroom meeting that finished moments before the chase began.

Sony in the E arly Y ears It all began on May 7, 1946, in Tokyo right after the war. Tokyo Tsushin Kogyo (Totsuko), cofounded by Ibuka and Morita, was officially established. In Ibukas prospectus for the new company he wrote, that the purpose of incorporation was to establish of an ideal factory that stresses a spirit of freedom and open-mindedness, and where engineers with sincere motivation
1

This case was prepared by Deanna Chan, Gavin Simon, and Kenji Yonemoto of the University of

Hawaii at Manoa under the supervision of Professor Masaaki Kotabe for class discussion rather than to illustrate either effective or ineffective management of a situation described (2008).

can exercise their technological skills to the highest level, and to reconstruct Japan and to elevate the nation's culture through dynamic technological and manufacturing activities. From the very beginning the company that was to become Sony Corporation set out to change everyday life. Totsuko first went to work fixing radios after the war. People yearned for news around the world and demand grew. Ibuka also wanted to produce products for everyday life. Products that would help rebuild Japan after the war. The company with little more than the creativity, energy, and ambition of its employees set out to create new markets. The company in the early days was made up of young, passionate employees that worked hard and late into the night, often getting locked in the department store in which the company workshop was located. Totsuko next developed an electric rice cooker that unfortunately made mostly undercooked or overcooked rice. It was the first of many failures for the company. Totsukos next popular product was an electrically heated cushion. The cushion sold well during the time after the war where conveniences were scarce despite the fact it had no thermostat or fire retardant. Even though a cushion Ibuka gave as a gift burnt his friends pants and caught blankets on fire, the cushions earned much needed revenue for the young company. With these early failures, the core ideology of Sony was established. The founders of Sony believed they were creating revolutionary products. Failures may happen along the way, but innovation was key to advancement. Not all products would be a success, but it was more important to push and challenge standards. When at the forefront of creation, not everything is a success. The founders of Sony understood this and were willing to take the gamble. Central to Sonys success throughout its history is its ability to innovate and push the bar of acceptance toward a new standard.

Sometimes this led to non-acceptance such as the Betamax system in the early 1980s, but more often this led to world dominance such as the compact cassette in the late 1960s, the Walkman in 1979, 3.5 inch floppy disk in 1983, and the launch of the first PlayStation in 1994. This was the foundation of Sony, however, in recent times Sonys core has dramatically shifted.

Modern Sony The founders of Sony had a vision that the company would one day manufacture both hardware and software (content for products) and realize synergies on both sides. Sony believed that high quality content would greatly help and promote Sonys diverse electronics. In 1968 Sony came closer to this vision when it formed a joint venture with CBS, CBS/Sony Records Inc. By the end of the 1980s, rich from its electronics that enjoyed huge popularity and success, Sony acquired CBS records and Columbia Pictures Entertainment ($3.4 billion purchase). Through the 1990s Sonys huge investments in film and music began to have an impact on the company. Columbia TriStars instability is evidenced by high top-executive turnover. However, these acquisitions led to the next big step for Sony, gaming. Competencies combined when Sony Computer Entertainment Inc. was established to develop, market, and license video game consoles and game titles. The PlayStation combined hardware knowledge of Sony Corporation and the software knowledge of Sony Music Entertainment. Although Sony began setting up overseas manufacturing subsidiaries in the 1970s, during the 1990s the company began to be increasingly reliant on outsourcing. This was in large part due to cost pressures from manufacturers of low-priced products in South Korea, China and Taiwan. Not only was Sony forced to increase outsourcing, but also began spreading R&D outside of Japan at a time when consumers began to put an increasing emphasis on quality due to

the higher price relative to competitors. Sony found itself facing a string of problems unlike any the company had faced before. In 2006, 9.6 million faulty batteries were recalled costing Sony $436 million. With the advent of the iPod, Sony also lost its leadership role in portable music players. Sony was caught in a lose-lose situation: it needed to increase outsourcing to stay costcompetitive, but more outsourcing led to less quality control and innovation. By 2002, 62% of Sonys profits came from PlayStation 2 console and game software sales alone. As Sonys other divisions floundered, the PlayStation line kept the company alive. As the PlayStation 2 became the centerpiece of the company and the image of Sony success, a true and weaker image of Sony Corporation was hidden in the background. Sony had huge investments tied up in unprofitable film and music projects, was heavily reliant on outsourcing, lost much of its innovative capabilities, and clung to the PlayStation 2 as its only life preserver in the rough and competitive industry environment. With the upcoming launch of PlayStation 3, hopes for its dominance were high. Indeed it seemed to Sony as an imperative.

PlayStation 1 and 2 In 1988, Sony formed a partnership with Nintendo to create a Super Disk. The Super Disk would be a CD-ROM attachment for Nintendos Super NES gaming platform. The Super Disk format combined compressed audio, visual, and computer data that had been created in partnership with Philips. Sony and Nintendos agreement gave Sony sole licensing power. Sony also retained the rights to the audio chip, which was a crucial component of the Super NES system. The PlayStation was officially announced at the 1991 Consumer Electronics Show. The name came from developer Ken Kutaragis reasoning that if computers used for work were called work stations then similar technology used for play should be a play station. The PlayStation would

have a CD-ROM drive to play Sony disks as well as a port to play Super NES cartridges. A day after this announcement Nintendo announced it would work on the CD-ROM drive with Philips instead. Nintendo was concerned that Sony might eventually use its R&D department, licensing power, and audio chip to take over Nintendos business. Sonys management was furious at Nintendo. Rather than abandoning the PlayStation, it was redesigned to be a freestanding platform which played games on compact disks. The 32 bit compact disk format had the advantages of being cheaper to make and store more information. Adding additional disks allowed game designers and programmers the freedom to build more complex worlds. Sonys goal was to beat Nintendo at its own game. The revamped PlayStation was released in 1994. The PlayStation broadened the gaming market from children and teenagers to include young adults. PlayStation has sold over 50 million units since its release. The PlayStation 2 (PS2), released in 2,000, quickly became the fastest selling console in history. The PS2 played DVDs which, like the PS1, enabled better graphics and allowed owners to view movies on DVD. The success of the PS1 and PS2 gave Sony a dominant market share position in the video game market and helped carry Sony Corporation through its recent past.

In a muffled breath, Bloody wankers, what a m I not getting? He shakes that thought away. He refocuses, its all riding on the PS3. It is his and Sonys only hope for a dominant future. At one time the PS2 brought in more than half of Sonys profit and carried the company through some of its hardest times. The combination of the Blu-ray technology with the PS3 leaves Sony with all of their eggs in one basket. Damn, our blimy PS3 marketing strategy, Sir Stringer laments in his head. His internal rant continues, mismanagement of outsourcing, loss of price control, and lack of inimitability have %%@ @ up our positioning.

PlayStation 3 The PlayStation 3 (PS3) is a graphical powerhouse utilizing a Nvidia graphics chip and cuttingedge cell processor. The PS3 can also play high definition Blu-ray movies. The PS3 was envisioned as an entertainment hub for the whole family. Multiple added features made the PS3 more expensive than the Xbox 360. A 60GB PS3 currently sells for $200 more than a premium Xbox 360. The PS3 was also released much later than the Xbox360 because of a delay that stemmed from outsourcing coordination. Furthermore, the online media and commerce are not as developed as the Xbox 360. For these reasons, PS3s marketability has been seriously injured and is not Sonys panacea as expected.

T he V ideo G ame Industry The video game industry was once for hobbyists, children, and computer nerds. It is now a 27.5 billion dollar industry. Once a niche market, the industry has grown rapidly. The video game industry now reaches a broader market than ever before. In 2001, sales from video games surpassed the movie industrys annual box office earnings by $1 billion. This highly profitable industry is also highly concentrated. Microsoft, Sony, Nintendo, and Electronic Arts make up 65% of new product sales. Furthermore, the top 10 vendors make up 80% of new product sales. These key players continue to invest large amounts of capital in R&D to develop a next generation console. Because each new generation redefines the industry, the industry is highly cyclical with no entrenched leaders. Nintendos console dominated until the PlayStation was released. Sonys PlayStation was the clear industry leader until Nintendos Wii was released. If a next generation console is revolutionary enough, it can leap ahead of its competitors.

Nintendo W ii After losing to the PlayStation, Nintendo appeared to be out of the race. However, in 2006, Nintendo released the Wii. In contrast to the Xbox360 and the PS3, the Wii has attracted a whole new market of gamers. The Wii is the cheapest, least powerful contender in the console wars. While the lack of gaming depth has deterred some serious gamers, with the Wiis simplicity and innovation it has attracted both young children and grandparents alike. This has made the Wii the clearly dominant seller among the current generation consoles selling 27.42 million units worldwide. The Wii has been able to seize the holy-grail of the gaming industry, a broad target market. While the typical console adoption cycle initiates with harder-core gamers and spreads to more mainstream gamers, with the latest generation of consoles this trend has changed. The market has been split recently with the Wii attracting mainstream gamers and a broader market from the outset and the PS3 and Xbox360 in fierce competition over the hard-core gamers. As the Wii finds itself alone dominating a large and open market, the PS3 and Xbox360 are really battling in a separate segment. C ase E xhibit 10-1 shows the comparison among the PS3, the Xbox360, and the Wii.

C ase E xhibit 10-1: G ame Console Comparison PS3 Price Units Sold to Date $500-$600 13.26 Million X box360 $300 19.13 Million W ii $250 27.42 Million

(June 2008) Units Sold to 2007 C ustomer M ar ket C PU 3.2-GHz Xenon PowerPC Memory D V D media format 20-60 Gb Dual-layer DVD BluDVD ray Optional-20 Gb 512 Mb 3.25 Million Hard-Core Gamer 9.15 Million Hard-Core Gamer Broadway 3.2-GHz Cell 7.38 Million Mainstream Gamer

C ase E xhibit 10-2 plots total units sales for each console starting from each consoles launch. Note that because of PS3s delayed launching, the plot for PS3 does not extend out as far as the Xbox360. Case Exhibit 10-1 clearly illustrates the similar trend in sales that the PS3 and Xbox360 experience by the similar trajectory of the plots. The Wii, however, has sold dramatically better and experiences a completely different sales pattern, further reinforcing that the Wii sells in a separate, wide open market.

C ase E xhibit 10-2

Source: VG Chartz 2008.

Sony PS3 Vs. M icrosoft X box360 While Microsofts Xbox struggled, losing $4 billion in four years, the launch of the Xbox360, turned the table. The Xbox 360 was announced several days before Sony announced the PS3. The Xbox360 released in November 2005, one year before the PS3. Because of the direct competition of the two consoles, this gave the Xbox360 a clear advantage. The lower price of the Xbox360 has also helped its sales. The Xbox360 sold 19 million units worldwide, 10 million of those units in the United States. However, while the earlier introduction and lower price of the Xbox360 helped its sales initially, the PS3 and the Xbox360 are very similar as is shown in Case Exhibit 10-1. Both consoles are highly powerful processing machines similar to personal computers, which can serve as multi-media machines, playing both video, and music. The PS3 and the Xbox360 are both heavily reliant on third party support. Looking at a recent weeks sales, most of the top video games sold for each console are offered on the

competitors console. During the first week of June 2008, Dragon Ball Z, Burst Limit and Lego Indiana Jones, and The Original Adventures were top sellers and available on both the PS3 and the Xbox360. This lack of software differentiation between the two consoles increases the already extremely intense competition. Again this fierce competition is illustrated in Case Exhibit 10-2 with the close sales figures of the PS3 and the Xbox360. It is clear from the graph that as yet there is no clear winner between the two and there is a constant struggle to gain or maintain the lead.

Sir Stringers attention jolts back to the pursuit. He pulls out a quick U-turn and fires his mac-10

wildly into the fleet of police in hot pursuit. This does little to stop them but partly out of anger and partly out of fear Stringer pulls the same move again. Another quick U-turn, only this time he accidentally has lined himself up for a head-on collision with a speeding cop car. He returns to his internal monologue, What could I have done differently to avoid this travesty?

PS3 M ar keting Strategy Prior to its release, the Sonys PS3 was the predicted favorite of the next generation of video game consoles. This was due to the aforementioned dominance of the PS2 and the superior technological capabilities of the PS3. However, Sonys befuddled marketing strategy of the PS3 has caused a slow jump out of the gates. Issues with outsourcing, loss of pricing control, lack of differentiation, and misguided advertising have manifested themselves into poor positioning of the PS3. In order for the PS3 and Sony to succeed in the future a major adjustment of their marketing strategy is vital.

O utsourcing The PS3s excessive outsourcing strategy has been a major hindrance to its marketing strategy via price and availability. Due to the mismanagement of the PS3 supply chain, Sony abandoned its ability of price control and capability to meet delivery targets at the PS3 release dates. Sony is not a typical Japanese firm. Throughout the majority of its history the company has heavily used outsourcing as tool to combat high fixed costs, high risks, and distribution issues with in-house production. However, Sonys outsourcing benefits have also come with a steep cost. Its outsourcing strategy resulted in a lack of product innovation in the early 2000s that nearly caused the company to go out of business. As discussed earlier, in 2006 Sony had a major recall of laptop batteries that was extremely costly and largely a result of loss of quality control due to outsourcing. The PS3 is no stranger to the short-comings of outsourcing. The first mover strategy brought the PS2 great success in achieving its dominant market share. Initially Sony intended on using the same strategy for the PS3. However, issues in its outsourcing part of the supply-chain inhibited this strategy and even led to delays of the PS3 behind all other next generation consoles. The PS2 was released nearly a year ahead of the XBOX. The PS3 lagged its release date by only by a few months, but more importantly it lost the first mover advantage. Excessive outsourcing contributed to creating another hindrance for Sony and the PS3. Due to delays in the production of blue laser diodes, the PS3s release was delayed 6 months, with only 100,000 available for release in Japan, and 400,000 units for the American release. Sonys limited release is impeding its attempt to achieve the dominant 70% market share it once held with the PS and PS2. If I we're asked whether Sony's quality of manufacturing has declined, I would have to say 'yes,'" Mr. Kutaragi, the creator of PlayStation series including PS3, told reporters.

Pricing At $500-600 in the U.S. and 50,000-60,000 (or $425-510) in Japan, the PS3s pricing has targeted the dedicated hard-core gamer. The PS3 high pricing has resulted in incorrect positioning of the product. This error in elevated pricing was caused by several factors. First, Sony completely misjudged the markets price range. The company believed the average consumer would be willing to pay top dollar for a complete entertainment hub. Also, the inclusion of the Blu-ray technology greatly increased Sonys production cost. And last but not least, heavy outsourcing allowed Sony to lose price controls of its supply chain. Outsourcing was a major factor in Sony to lose its ability to control costing. The combination of the loss of price control and the inclusion of Blu-ray technology priced the PS3 at release beyond its intended target market.

Promotion Sony originally planned to market the PS3 as a home entertainment centre. Sony hoped the combination of its gaming capabilities, large hard drive, Blu-ray technology and broadband access would appeal to a broader target market. Our goal is to definitely widen our target base and not be so niche, said Kim Nguyen, PlayStation 3 manager. Contrasting to its publicly stated strategy, the PS3 marketing strategy has positioned itself toward the hard-core gamer.

The disturbing crying infant advertisement (see C ase E xhibit 10-3) was targeted to the hard-core gamer if anyone at all. Sometimes the PS3 is marketed as a subsidized Blu-ray player, other times it is a home super computer, or more recently it is a video game console. Consumers

have yet to be a given a consistent marketing campaign explaining the products main appeal and value. C ase E xhibit 10-3 The PS3 advertisement at release is described and pictured below:

An animated baby doll sits in a white room looking at a small black box. It coos with delight. It laughs with an adults demented cackle. Tears flow down its cheeksand back up again. And just for an instant, an image from the PS3 game Resistance: Fall of Man flashes in its eyes.

Sonys jumbled promotional strategy has only compounded the issue of a lack of differentiation between the PS3 and their direct competitor Microsofts XBOX 360. The major difference between the two competitors is a lower price for the XBOX 360 and more powerful hardware and Blu-ray capabilities for the PS3. Consumers, unaware of any differentiation, will more likely purchase the less expensive product.

Positioning

The PS3 may have the most sophisticated technology and the broadest entertainment capabilities, however Sonys positioning of its key strategic product leaves something to be desired. The PS3s positioning is described effectively by Yoichi Wada, President of Square Enix, a prominent video game developer, "Sony first unveiled the PS3 as a mighty home electronics product. Then, after some badgering from game companies, it shifted the position of the console closer to a game machine," he commented. "(The future of the PS3) would be tough if its marketing strategy is not straightened up."

Unable to dodge the oncoming police car, Sir Stringer drops the pedal to the metal. Violently accelerating into the fast approaching squad car, the impact thrusts his body through the windshield onto the hood of the cop car, where Sir Stringer is promptly busted by police with guns drawn. Furious, Sir Stringer heaves his PS3 controller shattering the Sony Bravia flat screen in his office. Usually a stress reliever, Grand Theft Auto 4 (GTA4) has left the Sony C E O even more livid than before he began the ga me.