On Jan. 31, 2001, Sega announced it would cease production of its Dreamcast console. The Dreamcast was far from a dud, having sold 10.6 million systems. Yet, Sega was losing hundreds of millions of dollars a year selling the Dreamcast, and the company knew it could no longer compete in a high-stakes battle known as "the console wars." On one side of the battle was Sega -- lined up against them were Nintendo (NASDAQOTH: NTDOY), Sony (NYSE:SNE), and Microsoft (NASDAQ:MSFT).
The console wars have long been the equivalent of corporate high-stakes poker. Launching a new game system can cost billions of dollars, and market share shifts dramatically in the four to five years between each generation of systems. Yesterday's winner can fade rapidly if it's priced too high, its launch games are limited, or any number of other possible missteps.
In Sega's case, the company had battled Nintendo to a near draw in the early '90s, with its Genesis console (40 million units) trailing the Super Nintendo (49 million) by a respectable margin. Yet, between March 1998 and March 2001, Sega lost nearly $1.5 billion trying to create momentum for the Dreamcast. It no longer could afford the "table stakes" of supporting a money-losing system, and was forced to bow out. Microsoft filled the void with its Xbox console, and wasn't shy about losing money. Over its first six years, the division that developed the Xbox would lose over $6 billion as the company spent lavishly to compete with Sony and Nintendo.
Today, the era of expensive "console wars" is seeing a challenge from a new direction. Multiple reports have Amazon.com (NASDAQ:AMZN), Google (NASDAQ:GOOGL), and Apple (NASDAQ:AAPL) all developing devices for the living room. While these companies have the resources to spend billions on a traditional video game system -- Apple alone has $159 billion in cash on its balance sheet -- they're looking in a new direction. Each company is hoping to move the mobile operating systems that currently power smartphones and tablets into the living room by selling devices that play music, stream films, and yes -- feature a robust selection of video games.
A new age of video games looks set to begin. Within a decade, the very idea of "console wars" could be a relic of the past.
Ouya: Mobile gaming moves into the living room
The idea of moving mobile operating systems like Android into the living room is far more than conceptual. In 2012, a small company named Ouya unveiled its concept for the future -- a 3-inch cube, slated to cost $99, that would come with a controller and run on a modified version of Android. The creators took to crowdfunding site Kickstarter and quickly raised $8.6 million, the second largest amount ever raised for a project on the site.
The launch of Ouya was a landmark event, but not because of its sales. It proved that launching video game consoles no longer required billion-dollar investments, and demonstrated the opportunities and challenges of moving games designed for mobile devices into the living room. Cheap processors and components developed for mobile devices allowed Ouya to be built at a fraction of the price of new gaming systems like PlayStation 4 ($400) or Xbox One ($500).
As a product, Ouya was rough around the edges and has been far from a commercial breakout. But it showed what could be expected from more refined products released by companies such as Google, Apple, and Amazon. Are these companies interested in the space?
Last year, reports surfaced that Amazon was looking to creating a home entertainment system that focused heavily on video games. Industry website Gamasutra noted Amazon was aggressively hiring game developers. The Wall Street Journal reported Amazon was gearing up for a holiday season release. After apparent delays that moved the launch of Amazon's system into 2014, reports started springing up again in the past week. Video game website VG24/7 quoted publishers from the industry who had seen a design of Amazon's new unit and met with the company.
Why the interest in the video game space?
There is little reason to believe any of these companies are interested in the traditional video game model. Launching a new system every half decade is expensive, risky, and a distraction for companies whose core businesses are elsewhere. Likewise, most leaks from insiders report Google, Amazon, and Apple have focused on video games as one component of TV devices with broader ambitions.
The living room is the next logical frontier for these companies to expand their investments in mobile. All three have built tremendous foundations in not only app stores, but media storefronts and even streaming services. All those areas help lock users into their broader "ecosystem," and encourage future upgrades of smartphones or tablets.
The television is especially lucrative right now because growth is fizzling in other areas of mobile. Smartphone growth, while strong globally, is well past its prime in areas like the United States and Europe. Last quarter, AT&T saw smartphone sales off 23% versus last year. Overall, 77% of its subscribers on contracts already have smartphones. Global tablet sales saw a 28% jump in the fourth quarter compared to last year, according to IDC, but the researcher lamented that markets like the U.S. are becoming "saturated."
While the mobile growth story fades in the world's richer countries, the television is almost entirely upside. According to Nielsen, 96.7% of American households own a television. Compared to a market like smartphones or tablets where Apple's iOS and Android dominate the market, the companies currently have devices connected to just a fraction of televisions.
How big is the video game industry?
The rationale as to why Apple, Amazon, and Google would be interested in expanding into the living room is clear. What's less clear is how successful they'll be.
Looking at a narrow measure of market size, Gartner estimates the console hardware business will hit $22.7 billion by 2015. Including the value of games and accessories, the total console market that year is projected at $49.3 billion.
With a presence in the living room, app stores have already become a key growth engine in the game industry. In 2013, Apple reported it crossed $10 billion in App Store sales. Third-party researcher Distimo estimated that 79% of those sales were for video games, implying the App Store has $7.9 billion worth of gaming revenue. Gartner estimates that worldwide mobile game revenue was $13.2 billion in 2013, but will rise to $22 billion by 2015; a heady projected growth rate of 67% over two years.
Regardless of whether mobile games make the jump into the living room, the market is expected to be about 45% the size of the console business by the end of next year. So, with most Americans already owning a smartphone and tablets hitting saturation, would consumers want to play a mobile game on their television instead of on existing tablets and smartphones? What's the appeal for a consumer to buy an extra device that plugs into their TV?
Clues on a future Android or iOS living room strategy
There are some clues as to what Amazon, Google, and Apple are planning on this front. Amazon has a range of jobs open for its Amazon Game Studios unit, and the company's begun creating its own original television shows for its Prime Instant television streaming service. It wouldn't be hard to imagine adapting that model and creating games that could be exclusive.
Providing a glimpse of how a future version of Apple TV could place a greater emphasis on video games, the company standardized video game controllers with the release of iOS 7 last September. With controllers being the popular form of input on consoles -- rather than touch input -- that could be a clue to Apple's ambitions.
An interesting approach for any of these companies would be to create a specific "Game App" that features games optimized for the television. With Apple selling 2 million units of Apple TV in a quarter while labeling the product a "hobby," developers wouldn't need much convincing that any expanded Apple home entertainment device would quickly build a large fanbase. Also, games on televisions might be welcomed by game designers. Consumers are conditioned to paying more for video games played on televisions than mobile devices, so they could charge more than the current going rate for mobile games.
There are no indications that systems from Amazon, Google, or Apple would challenge the raw processing power of new systems like Xbox One or PlayStation 4, or even Nintendo's Wii U. Instead, reports have the companies tapping into their app stores' existing wide selection of casual games while potentially offering a smaller selection of games created to be played on a television.
A focus on casual gaming has seen recent success outside mobile video games. Last generation, Nintendo's Wii outsold Microsoft and Sony by appealing to the casual market and launching at a lower price point. The Wii is a unique product that makes any comparison less than apples-to-apples, but its success does show a level of potential.
Studies show only about 40%-50% of American households have gaming systems. Offerings from Amazon, Google, and Apple could use broader entertainment offerings to appeal to the other half of Americans without gaming systems, while also looking to find traction in households who currently own a system.
Nearing the end of the console wars?
Meanwhile, the console makers aren't sitting idly by. As Amazon, Google, and Apple are increasingly interested in encroaching in the video game space, incumbents like Microsoft and Sony are shifting their focus into becoming all-in-one entertainment systems. Both sides are eyeing the dream of becoming a single entertainment hub that connects to the television.
Xbox One ads have focused on features like live television, a built-in Xbox Music platform, Skype, and integration with Windows smartphones. While Apple's iOS and Google's Android would have larger install bases to connect to future living room devices, video game companies are fighting to fend off challenges from new entertainment devices.
If Android or iOS devices start gaining traction in the living room, the industry's attention will shift to pricing. Eight years after release, high-end models of the Xbox 360 still cost $299. The new Xbox One, released last November, costs $499. But that's certainly not all profit. Consoles come packed with powerful processors and components meant to stay current with technology for a half decade or more, so the companies generally lose money on each system. They make that money back by taking a cut of game sales, service subscriptions, and other downloaded content.
Yet, the VG24/7 report stated Amazon's system will sell for less than $300. Google sells its Chromecast device for $35 and has a history of undercutting the price of other hardware companies when it enters a new space. If Amazon follows the same strategy it uses selling tablets, it could release a new system on an annual basis. If that model proved successful -- for Amazon, Google, or Apple -- it could place traditional video game companies in a bind. While they seek to be general entertainment platforms, the need for top-end hardware to power the most advanced games leaves them in a higher price bracket. If the companies tried going too low-end to cater to the mass market, they risk alienating their core gaming audience.
The success -- or lack of success -- of new devices in the living room will determine whether the strategy of releasing gaming systems in long intervals -- the console wars -- still makes sense when video game systems aspire to also be general entertainment devices. There's also the question of whether expensive gaming hardware of any kind will be necessary a decade from now. At the Consumer Electronics Show, Sony showed off its new PlayStation Now service. Instead of needing a video game console hooked up to a television, the service will stream games from remote servers. Conceptually, the service allows people to play games on televisions, tablets, or smartphones, with no expensive gaming system needed. All the processing is done in "the cloud."
There are plenty of challenges Sony needs to overcome before PlayStation Now can be dubbed the future of gaming. It hasn't been commercially launched yet. But it remains an impressive technology with major implications on the next decade of video games.
The winners of the next decade's battle for the living room are far from determined. The status quo could win out and the same players might be battling a decade from now. But with so many cash-rich technology companies deeply interested in the same space, the stakes have never been higher.
Just ask Sega, a company now developing games for both next-generation systems like the Wii U and smartphones and tablets. The console wars of today look nothing like the old ones.
Eric Bleeker, CFA has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.