Sony Could Be About to Completely Revolutionize the Video Game Industry

PlayStation Now, Sony's (SONY -2.01%) on-demand, cloud-gaming service, will get its public debut next month. Owners of Sony's latest video game console, the PlayStation 4, will soon be able to stream games over the Internet, directly to their TVs.

In practice, this gives Sony's console a degree of backward compatibility -- even though the PlayStation 4 cannot play older PlayStation titles natively, these games will be accessible through the PlayStation Now service. Its chief competitor, the Xbox One, cannot currently play Xbox 360 titles.

But it's bigger than that. Sony's management has championed PlayStation Now as the future of the brand -- and if it succeeds, it could have immense effects on the entire industry, weighing on dedicated retailers like GameStop (GME -6.59%).

Games as a service
When the open beta begins next month, investors will have a better sense of PlayStation Now's viability. Other companies, including OnLive and GameStop, have tried and mostly failed to popularize game streaming, leaving many skeptical. Sony is a massive entertainment and gaming conglomerate, with far more resources at its disposal, but there are still significant hurdles.

Specifically, lag. Video games are not like movies -- data must be sent both ways constantly, and a split-second delay can render a game unplayable. Certain kinds of games, particularly competitive fighters, are unlikely to succeed. In terms of response, some of these games are so demanding that they are difficult, if not impossible, to play on particular, high-end HDTV models (a millisecond delay in rendering the image on the screen can be the difference between winning and losing).

But most games are not so unforgiving. Those that have played with Sony's service have generally come away impressed. Polygon called the technology "striking" and described it as perfectly workable. IGN said it observed "zero lag or latency issues."

PlayStation Now's true potential
Giving PlayStation 4 owners the ability to access older titles is a welcome perk, but the true potential of PlayStation Now will likely unfold over several years. Sony has said that it plans to bring PlayStation Now to its handheld PlayStation Vita and old PlayStation 3 system, and eventually, its Bravia TVs, smartphones, and tablets.

The potential sea change in the industry is difficult to overstate. Video game consoles are expensive -- the PlayStation 4 and Microsoft's Xbox One currently retail for $399. Before a player can buy a single game they must pay an enormous upfront fee. Consequently, the market for video game consoles have largely been limited to countries with developed economies -- Japan, the United States and Western Europe. Even in the U.S., most households can only afford to purchase one console every few years.

But if Sony could remove that barrier, it would open up its games to a much wider audience. With an installed base of just over 80 million consoles, the most any particular PlayStation 3 title could sell is 80 million copies; with streaming, virtually anyone with compatible device and a reliable Internet connection is a potential customer.

Revolutionizing the distribution model
Of course, this also stands to demolish the traditional model of video game distribution built around physical plastic discs sold and resold at retailers. GameStop, a company largely dependent on the sale of new and used video games, is exposed to a shift in the industry.

Last quarter, about half of GameStop's revenue, and more than 70% of its profit, came from the sale of video game software. The growing popularity digital downloads has long been seen as a major threat to GameStop's brick-and-mortar business, but cloud-based streaming is far more dangerous.

When games are streamed, they are not physically owned -- instead of buying discs, gamers pay for bits of data. A third-party retailer like GameStop is simply unnecessary. Moreover, the resale of used games, a business that generates almost half of GameStop's earnings, would be impossible, as games would not be owned in the first place.

Bigger than the PlayStation 4
Last year's launch, and subsequent record sales, of the PlayStation 4 has been commonly seen as most significant driver of Sony's gaming business.

In reality, PlayStation Now could be several times more substantial. If it succeeds, Sony will revolutionize the video game industry by eliminating the need to have a powerful, dedicated console, and opening the hobby up to millions more potential players.