Sega vs. EA Sports

Take your pick: Advanced Micro Devices (NYSE: AMD  ) vs. Intel (Nasdaq: INTC  ) , Apple (Nasdaq: AAPL  ) vs. Microsoft (Nasdaq: MSFT  ) , Sega (Pink Sheets: SEGNY) vs. Nintendo, and Sega Dreamcast vs. the Sony (NYSE: SNE  ) PlayStation. What these classic battles have in common is that they all feature an underdog, with an arguably better product, pitted against the longtime market dominator with other considerable competitive advantages, namely powerful brands, friends, and resources.

Today's matchup features the top two players in the video game sports-simulation arena: Sega's ESPN line and Electronic Arts (Nasdaq: ERTS  ) . Everybody seems to be talking about it. Over the past few years, Sega has brought football, basketball, baseball, and hockey games to the table under the ESPN brand that rivaled -- if not surpassed -- the quality of EA's best-selling sports games. Yet year after year, EA has continued to blow away Sega on the sales front in every category.

But this year, as we've noted before, Sega has taken a drastic measure to give the rivalry a new jolt. Via its new co-distribution partnership with Take-Two Interactive (Nasdaq: TTWO  ) , the companies have begun to sell Sega's major sports properties at a mere $20 a pop. Following the release of ESPN NHL 2K5 earlier this month, ESPN NBA 2K5 last week became the third game in Sega's sports lineup to be released at the $20 value price point.

Should EA be worried?
At the beginning of this discussion, I mentioned the old gaming hardware battles between Sega and Nintendo, and Sega Dreamcast and Sony PlayStation. The reason I mentioned that is because Sega lost every single one of those battles, and it even lost the last one despite having a platform that was a whole generation ahead of its competitor.

But things are a little bit different this time. On a pure product level, what should be understood is that EA Sports is the sports-simulation brand that the video game industry has grown up with. EA's Madden NFL has ranked among the top-selling video games every single year it has been released, period. What's more, EA's NHL and NBA Live brands are the longest-running franchises in their respective competitive markets, and the company's latest baseball franchise was a major success this year (see EA's New MVP).

And despite Sega cutting Madden's football lead down to roughly 3-to-2 on a unit basis, I don't think that football is the area EA is particularly worried about. This year, Madden was still the best-selling video game of them all for the month of August, and it still managed to show growth, even at the regular $50 price per copy. What's more, in an even greater display of brand strength, the company's special edition for the PS2 sold well, even at $60!

EA's NHL and NBA brands are vulnerable
On the flip side, I believe that EA's NHL and NBA brands are particularly vulnerable to Sega's pricing pressures. To illustrate, EA's NHL '94 for the Sega Genesis was the game that turned me onto hockey, and I've long felt that NHL 2000 on the PC was the most enjoyable hockey simulation I've played. The problem, as I see it, is that EA has strayed from the old simulation style by adding more bells, whistles, and bigger, arcade-like hits every year to appeal to a mainstream audience and, thus, turning off real hockey fans. As a result, EA left the door for Sega's ESPN hockey games to step in and become the simulation that hockey fans felt EA was supposed to make.

EA's NBA Live has similarly suffered, with Sega's ESPN NBA often the game of choice in college dorm rooms across the country.

EA has taken notice and taken action. In response to Sega's price cuts, EA released NBA Live 2005 last week at only $40 per copy. Further cutting into margins, the company is also now offering a "buy two, get one free" mail-in rebate on its 2005 sports lineup.

Sega/Take-Two's strategy
It's still early in the game, but several things are apparent. First, Sega won't sell the games at $20 forever. As we saw in this past quarter's earnings report from Take-Two (see Game On for Take-Two), the company saw a considerable revenue boost from the addition of Sega's ESPN NFL 2K5, accounting for 13% of revenues. However, that addition came with little to no benefit to the bottom line. That said, for the Sega/Take-Two combo to sell the ESPN-branded games for $20 forever would be to rob both Sega/Take-Two and EA of profits.

Second, that's not the plan anyway. Sega/Take-Two's strategy seems to be to build market share at near breakeven, acquire brand loyalty with its highly competitive products, and eventually raise prices and profit later. As Hidden Gems subscribers might recognize, this is similar to the strategy that upstart online retailer Overstock.com is using to take its own profitable share from Amazon.com, the difference being that Overstock.com intends to profit from scale rather than pricing power.

Lastly, having Take-Two as a sensible partner is really what makes Sega's case different this time. Sega has what Take-Two didn't have in high-quality sports franchises with recognizable brands. Meanwhile, Take-Two has the financial means to make this strategy feasible.

EA is still the game
In the short run, EA stands to lose some profits due to Sega and Take-Two's price cuts in the football, hockey, and basketball franchises. And if Sega and Take-Two are successful -- and I think they will be -- the two partners also stand to share a piece of EA's long-run profits as well.

Having said all that, EA isn't really at risk of giving up its sports dominance, just merely a portion of its long-run profits. Madden still carries the brand power and the national tournaments, and EA still has Microsoft as an ally in a worldwide video game football (soccer) tournament (see Microsoft, EA Team Up for World Cup). In addition, EA is still running away with its other highly profitable sports franchises, including Tiger Woods golf franchise and FIFA soccer.

And one last thing: Sega and Take-Two may have the product quality, but as long as they compete on value without pricing power, Sega/Take-Two will never be able to fashion itself as a legitimate challenger to EA's throne, and EA will always be the game.

Amazon and EA have been featured in theMotley Fool Stock Advisor, a newsletter that is invaluable in helping the individual investor find equities that will beat the market over time. Check it out by signing up for six months, risk-free.

Fool contributor Jeff Hwang owns shares of EA and Overstock.com. The Fool has a disclosure policy.


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