Fun 'n Games in the New Economy

IN A TRADEMARK POLITICALLY incorrect episode of South Park parodying Pokemon, Japanese corporate baddies mastermind the takeover of the US using mind-controlling "Chin-Poko" toys and games.

Hyperbole aside, while Japan may be behind the US in high technology, videogames is one area where Japanese firms dominate. But wireless and broadband are now changing the dynamics of the serious business of electronic games, forcing both hardware and software makers to review their business models.

The generation of 128-bit home videogame consoles are becoming more like PCs, with super-powerful processors, DVD drives, and network capability. Game machine makers are hoping that the console will become the hearth of a complete digital home entertainment system.

One-third of the Japanese population are already plugged in to home videogame systems, much to the dismay of video arcade operators, who are looking for ways to pull people away from their home game consoles, which rival the graphics of the larger arcade machines. The value of the video arcades is becoming the consumer research they offer the home-use market.

WIRELESS GAMES
In another area where Japan leads, mobile phones provide a new platform for game creators. Current cell phone game offerings make Pong look like virtual reality. But as newer handsets are souped up with Java, game developers will be better able to flaunt their skills.

Sixty to 70 percent of NTT DoCoMo's (9437) i-mode users subscribe to fee-based sites charging ´yen;100 to ´yen;300 a month, including 30 percent who subscribe to fee-based game and character content services. Mobile phone users represent a new market for game content, and unlike many free information services this content commands subscription revenue collected by the cell phone operators. Technologically less sophisticated than arcade or home videogames, wireless games provide higher profit margins.

NETWORK GAMES
The Net and broadband in particular offer natural extensions to the home videogame platform by offering multiplayer network games. However, while mobile phones have become a fact of life in Japan, the promises of broadband have yet to be fulfilled.

The commercial success of network games for either game consoles or PCs will hinge on inexpensive Internet access. As long as NTT has its way, local telephone charges won't be significantly reduced, leaving alternatives such as ADSL (asymmetric digital subscriber lines) and cable. ADSL operators, who must install equipment at local telephone exchanges, not surprisingly face an uncooperative attitude from NTT, and thus service launch delays. Cable operators are thinly dispersed and do not offer universal coverage, even within major metropolitan areas like Tokyo. In addition, most apartment landlords are unwilling to fork out the money to equip buildings with cable Internet services for even those buildings already equipped with cable TV.

Whereas narrowband wireless games are relatively cheap to produce and cheap to access, it remains to be seen whether home videogame players will be willing to increase their spending budget for broadband network games.

Competition will heat up even more when Microsoft (Nasdaq: MSFT) joins the fray, making it the big four. In spring 2001, Microsoft plans to launch its own game system called X-Box, fitted with hard drive, DVD drive, and Ethernet card. Microsoft is already talking with Japanese game software houses about developing titles for X-Box.

Sony (6758 or SNE)
Sony Computer Entertainment (SCE), a wholly owned subsidiary of Sony, was late in the game in introducing its PlayStation but sideswiped Sega and Nintendo to become the market leader in the home videogame platform.

Sony's 128-bit PlayStation2, first launched in Japan with much fanfare in March, heralded a new era in which the game console is anticipated to converge with the Internet and other forms of digital entertainment. A bit ahead of its time, PlayStation2 sports a number of ports left unutilized until Sony introduces its hard drive and Ethernet expansion unit and mobile cable later this year for Internet and cell phone connectivity. PlayStation2's processor is so powerful that the Japanese government imposed export controls for fear of it being used for military purposes.

PlayStation2 is also the first game console to include a DVD drive. Although the retail price of ´yen;39,800 is considered expensive for a game console, it may not be considered expensive if it is seen as a DVD player too. In fact, Sony's own surveys found that PlayStation2 attracted buyers in their 30s and 40s rather than teenagers because of the DVD player.

PlayStation2 is at the core of Sony's Internet strategy. Sony is placing its bets on broadband and has tied up with Tokyu Cable Television to develop a high-speed network for its entertainment offerings. Sony has also launched its online videogame, movie, and music portal site PlayStation.com as a key link within this network.

While Sony's main focus is on the high-quality graphics that its military-strength PlayStation2 -- coupled with fat bandwidth -- can offer, perhaps it is also hedging itself on the mobile side. Sony introduced the portable PSone, which it will be marketing in place of the old PlayStation. The quirky PSone is not fully portable, however, as it cannot run on batteries and remains tethered to its AC adapter.

Sony has also agreed with NTT DoCoMo to jointly develop network games for PlayStation linked to Internet-ready i-mode phones.

Sega (7964 or SEGNY)
Although CSK Corporation group company Sega Enterprises created the first 128-bit game machine, Dreamcast, in 1998, its sales have remained flat due to a lack of good software titles, the absence of a DVD drive, and expectations for Sony's PlayStation2. Sega appears to still be fishing for a strategy to turn around its three-year streak of net losses.

Sega will steer away from video arcade operations and turn more toward the Internet. Dreamcast, which has a built-in 33.6-Kbps modem, has already attracted over 1 million Internet subscribers worldwide among Dreamcast users. About 31.5 percent of Japanese users and 26 percent of users worldwide subscribe to Internet services either through Sega's free ISP SegaNet (in Japan and Europe) or through their own ISPs using Dreamcast machines (in the US).

Similar to Sony, it has partnered with cable companies to offer broadband network games and is selling an adapter to connect Dreamcast machines to cable modems to replace the standard dial-up modem.

But rather than merely compete head to head with Sony, Sega will focus on mobile phones as the next major platform. Sega is teaming up with US-based Motorola to develop an API (application programming interface) for cell phone games, compatible with Java and based on Sega's videogame image-processing technology. Sega hopes to generate revenue from licensing fees for the API as well as from game software sales.

Nintendo enjoys a 90 percent market share of handheld game machines in Japan and 99 percent in the US and Europe with its Game Boy, Nintendo's profit center. As such, Nintendo's strength is not in awe-inspiring cinematic graphics, which the company claims can bankrupt game developers, but in portability and fun characters like its Pocket Monsters. Nintendo's target users represent a younger group than those of Sony or Sega.

For Nintendo, mobile phones represent both a threat and an opportunity. In order to make the new wireless platform work for rather than against Nintendo, the company is focusing on Internet enabling its machines via cell phone to allow for multiplayer online games and character exchange. Later this year it will sell a mobile phone adapter for Game Boy, although the new 32-bit Game Boy Advance will have this adapter built in.

Nintendo formed a joint venture with Konami called Mobile21 Co. to develop multiplayer games for the handheld Game Boy Advance and software to link mobile phones with the Dolphin game console.

Nintendo has also created a joint venture with advertising agency Dentsu called NDCube to develop non-traditional games geared toward mobile phones connected to Game Boy and Game Boy Advance.

Because of its expertise with handheld game machines, Nintendo is espousing wireless narrowband rather than broadband.

THE GAME CONTENT KINGS
Even with the most powerful hardware, a box is still just a box without good software content. The success of the game platforms depends largely on the quality and quantity of game software titles available.

One of the characteristics of the packaged game software industry is that while investment in terms of time and money are high, sales cycles are short. Revenues fluctuate and depend greatly on make-or-break game titles. Both wireless phone games and broadband network games lend themselves to business models with steadier profits.

Square (9620)
Creator of the blockbuster Final Fantasy series, Square is switching its strategy from packaged game software toward network game services.

Its Play Online network game service for game consoles and PCs is scheduled to start in March 2001 through NTT Communication's OCN Internet access service. Play Online's mainstay, role-playing game Final Fantasy XI, will become online-only from autumn 2001. Square plans to charge a monthly basic membership fee of ´yen;500 and a monthly game usage fee of ´yen;1,000 plus additional fees for other ecommerce areas. Square targets 2 million Play Online users, drawing from over 3 million Final Fantasy purchasers in Japan and 7 million worldwide.

Capcom (9697)
Game developer for the Nintendo and Sega consoles and NEC PCs, Capcom is well known for titles such as Street Fighter, Dino Crisis, and Bio Hazard. Capcom is aggressively expanding into both network games and mobile phone games.

In March, Capcom began its Marvel vs. Capcom 2 network game for Dreamcast consoles through long-distance carrier KDD's (9431) lines and Capcom's own servers. Revenues from network games come in the form of software sales and per-minute charges. Capcom also plans to offer role-playing games on the Internet with automatic translation in five languages (Japanese, Chinese, English, French, and German).

For the wireless platform, Capcom intends to introduce 10 titles for i-mode, including characters from Street Fighter, by spring 2001. Recognizing that cell phone use has boomed throughout Asia, Capcom has partnered with telcos in other Asian countries to distribute games and character content for the small screen. It has started offering its game characters via cell phones in Hong Kong through a tie-up with Cable & Wireless HKT (NYSE: HKT) and plans to do the same in other Asian countries such as Singapore, Taiwan, and the Philippines.

Capcom is also upgrading its "chaku-mero" (cell phone ring melodies) download terminals to "Town Server AZ Navi" multimedia terminals, in conjunction with Kyocera (6971 or KYO) and DDI Pocket, in order to offer games, characters, music, photo stickers, and information services for mobile phones, game consoles, and PCs.

Konami (9766)
Game software maker for all console platforms, Konami is the creator of popular titles such as Dance Dance Revolution. One of parent Konami's software houses, Konami Computer Entertainment Osaka (4729) specializes in sports titles, with licensing from ESPN. Konami plans to offer over 10 titles in the next business year for Sony's PlayStation2. It is also engaged in a joint venture with Sony rival Nintendo to create multiplayer games for Game Boy Advance and the future GameCube.

Konami operates an i-mode pay site called "Konami Net" offering horoscopes and a "Tokimeki Memorial" dating simulation game. To exploit synergies between the electronic game and toy businesses, Konami is to take a majority 22.8 percent stake in beleaguered toymaker Takara (7969).

Enix (9684)
Game developer for Sony's PlayStation and Nintendo's Game Boy (and diversified in publishing and toys as well), Enix is unique in that it has no in-house development team and depends solely on subcontractors.

Enix's profits rely heavily on its popular Dragon Quest series, a role-playing game competing with Square's Final Fantasy series.

Namco (9752)
A major operator of amusement centers, Namco has been shutting down unprofitable ones in Japan, although amusement centers overseas remain strong.

Its home videogame division has seen declining revenues due to fewer new titles, diminishing demand for older generation games, and lack of a big hit. Namco has formed a videogame software development subsidiary to produce role-playing games, with emphasis on the PlayStation2 platform. Namco also operates an i-mode pay site called "Namco Station" with a "Lvlovers!" poker game and slot machine game.

Koei (9654)
PC and videogame software maker Koei is well known for its historical simulation titles, such as Kessen, the first title for PlayStation2.

Koei is launching a Web site for online games and is to start a service to provide game software to IDO Corp.'s cdmaOne mobile phone users.

Bandai (7967 or BNDCY)
Japan's largest toy maker Bandai is particularly strong in the character merchandising business. Ninety percent of its toy products are character-based, 70 percent of which is based on licensed characters such as Nintendo's Pokemon and 30 percent on original characters such as Digimon.

It is no wonder that Bandai's fee-charging character download service "Charappa" has become one of i-mode's well-known success stories. The company also operates the "Bandai Channel" site, which provides Internet games with virtual friends.

With no big hit since the tamagotchi virtual pet, Bandai is moving toward digital content development for mobile phones and its own handheld game machine, Wonder Swan. Square is to provide game titles for the black-and-white LCD Wonder Swan. Bandai will also offer connectors to link to mobile phones, the Internet, and even Sony's PlayStation.

INVESTING IN GAMES
The launch of PlayStation2 in the US and Europe this autumn will likely stimulate investor interest in the electronic game sector again. With the potentials of wireless and broadband added to the deck and Microsoft's X-Box as the wild card, investors will be curious to see who become the winners and the losers in the shuffle.