Most expected 2001 to be a banner year for the video game business, but that was before a slowing economy piled on top of Sony's production problems and the effective demise of Sega's Dreamcast system. There's still reason to be upbeat about the sector long-term, but the picture waiting around the corner may not be as pretty.
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An interesting story has popped up in the high-stakes world of video game companies: Japanese hardware and software manufacturer Nintendo has apparently reacted strongly to some of Microsoft's (Nasdaq: MSFT) marketing materials for its new Xbox game console, scheduled for introduction later this year. While a little sniping between competitors is business as usual in any industry, the undertone is one of tension in an industry that had expected a joyous 2001. Nintendo executive Peter Main, it seems, sent a letter to retailers in February raising questions about some Microsoft point-of-purchase (POP) materials Nintendo felt encouraged shoppers to hold off on their purchases until the Xbox debuts later this year: "The curious question is... why retailers would join with a potential future industry participant," Main's letter said, "before his unspecified product actually arrives, to essentially sell against these current and continuing impulse sales." "I am suggesting that Nintendo," continued the letter, "with a 48% share of the existing video game market, along with your company, may have more concern about the interim health of the industry than a company with a current zero share of the business." Microsoft essentially laughed the accusation off in a discussion with a gaming website, saying all it was doing was providing information to interested gamers. And though Sony (NYSE: SNE) denies it, an informal survey by another website suggests that the company may have threatened to withhold further PlayStation 2 shipments from retailer Babbage's, owned by Barnes & Noble (NYSE: BKS), if it wouldn't remove Microsoft materials from stores. The PR back-and-forth is predictable enough, and secondary to the broader story in the industry. At this time a year ago, Sega's Dreamcast console was still the only 128-bit game in town, PlayStation 2 a glimmer in the holiday eye, and the upcoming Xbox and Nintendo GameCube were even farther down the line. The coming hardware transition, while not expected to be clean as a whistle, was at least still plottable on a regular office calculator, and the Nasdaq was still at remarkable highs with consumer confidence in fine shape. Today the landscape couldn't be more different. Sega, its longtime visionary chairman recently deceased, is moving out of the hardware business. While the console makers must be happy to hear that Sega's well-regarded games will now be available for their machines, it also means serious competition for entrenched software names such as Electronic Arts (Nasdaq: ERTS) and Activision (Nasdaq: ATVI). Meanwhile, the launch of PlayStation 2 was handled clumsily because of component shortages that hurt the entire sector -- gamers had held off purchases in anticipation of the machine's arrival last fall -- during the key holiday season. Microsoft is now forecasting delays for its Japanese Xbox debut because of insufficient software support; the company had hoped for a simultaneous global launch. And news of job cuts in some Electronic Arts departments has some hard-core gamers concerned about their favorite pipeline products. Taken in combination with a slowing economy that has hurt consumer confidence, it seems at times remarkable that shares of Electronic Arts and Activision have held up as well as they have over the past year. Investors have apparently moved into the sector's revenue leaders to ride out the storm. As the blinds continue to be drawn on second-half "visibility" by the nation's corporate leaders, one wonders whether the ill wind will shift to the packaged home entertainment sector soon. Anecdotally the business seems strong, with consoles still in high demand -- Nintendo's hot new Game Boy Advance handheld hit Japanese shelves this week -- and Disney (NYSE: DIS) reporting strong DVD sales. But the undercurrent, however, isn't so optimistic, at least for the near term. Dave Marino-Nachison is having trouble beating the last enemy in Final Fantasy 9. His stock holdings can be viewed online, as can the Fool's disclosure policy.
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