Sony’s PS4 'Blue Light of Death' Hardware Failures Could Be Foxconn’s Fault

Sony's (SNE +3.03%) eagerly anticipated eighth-generation home console, the Playstation 4, got off to a great start last weekend, selling more than 1 million units in North America within the first 24 hours of sales. Those results easily topped the initial sales figures for the 2006 release of its previous console, the Playstation 3, and gave it a slight head start over Microsoft's (MSFT +0.66%) Xbox One, which will be released on Nov. 22.

Source: Company website.

Poor quality control leaves a lasting impression

Yet immediately following that robust launch, reports emerged that some PS4 units had malfunctioned, displaying a "blue light of death" similar to the dreaded "red ring of death" that tarnished the reputation of Microsoft's Xbox 360 in 2008.

Although Sony declared that the events were "isolated incidents," the number of one-star reviews has been piling up on Amazon.com, with nearly 600 one-star ratings (out of over 2,100) for the console at the time of this writing. There were only roughly 1,300 five-star reviews -- not a great first impression for one of the most eagerly anticipated products of the holiday season.

Sony wasn't the first company to botch a major product release -- last November, Nintendo's (NTDOY +1.32%) Wii U required a firmware update out of the box, which the company warned could damage the console during the update progress if the power supply was interrupted.

Consumers might have noticed a trend in declining quality control in home electronics -- cell phones, computers, and video game consoles have become more rich in features, but also more cheaply built.

Therefore, we should dig into Sony's pricing strategies and supply chain issues to get to the root of this problem.

Is Sony's pricing strategy desperate or clever?

The Playstation 4 is actually Sony's cheapest console ever manufactured, after costs and launch prices are adjusted for inflation. It is also one of the cheapest consoles ever produced in video game history.

Source: Ign.com

The low price of the PS4 is a clear attempt to undercut the Xbox One, which will launch for $100 more. However, the PS4 will initially sell at a loss, on Sony's traditional razor to razor blades model, with software sales eventually making up for the initial losses.

Nintendo, by comparison, sold the original Wii at a profit from day one, but is now selling its poorly performing Wii U at a loss. Microsoft intends to sell the Xbox One at either a break-even price or a profit from day one.

But just how much of a loss has Sony been willing to take on each new console?

Sources: iSuppli, Gamespot, Eurogamer, author's calculations.

Although these numbers are based on analyst estimates and not official figures (which have never been released), the trend of narrowing losses is interesting. Even though the Playstation 4 is the cheapest console so far, it is also the least costly one to manufacture. In fact, the Playstation 4 could actually be sold at a profit if it simply matched the Xbox One's launch price of $499.99.

On paper, Sony's plan looked solid -- it would simply undercut the Xbox One's price at launch, driving sales of more consoles, then post higher profits from software sales later on.

Unfortunately, Sony either overlooked or ignored some glaring problems with its production partner, Foxconn.

All eyes on Foxconn

Immediately after the technical problems about the PS4 surfaced, all eyes turned to Foxconn, the Taiwanese contracts manufacturing giant that has been repeatedly accused of worker abuses in China and poor quality control.

A Foxconn intern claimed that the PS4 was intentionally sabotaged during the manufacturing process to protest the poor working conditions at its plants. That damaging accusation, although unverified by Sony or Foxconn, highlights a key question that Sony and other multinational tech giants have been asking themselves over the past few years -- is it wise to rely on Foxconn's plants to manufacture such major products, which also include the iPhone, iPad, Kindle, and Wii U, for the sake of higher margins?

In October, university students in Xi'an were sent to Foxconn on a mandatory "internship" to help manufacture the Playstation 4 for two months to receive their diplomas. The students were paid $263 per month, the same rate as the local factory workers -- in a region where the average monthly salary is $570. Last April, the company was accused of using student interns -- some as young as 16 -- to assemble Apple (AAPL +1.18%) products.

Therefore, it's not hard to see why unhappy Foxconn interns, being paid less than half the average local wage, would sabotage Sony's crown jewel in a bid to embarrass the company.

Foxconn workers. Source: Guardian.com.

Apple has expressed concerns about Foxconn on multiple occasions, auditing the company twice, in 2007 and 2012, to investigate claims of poor working conditions.

In China, 18 Foxconn employees attempted suicide in 2010, resulting in 14 deaths, and in Mexico, disgruntled employees set fire to a factory that same year. In April, Apple rejected nearly 8 million iPhones from Foxconn, due to quality control problems.

It's easy to pin the problems on Foxconn, but the company is being squeezed on both ends by rising demand for cheaper consumer electronics and the rising costs of living in China, where it operates 13 factories in nine cities.

Last quarter, Foxconn's gross margin fell 6.1% year-over-year to 7.07% -- indicating that protests over labor and quality control problems might continue for the foreseeable future.

A final thought

In conclusion, I doubt that Sony's recent blunder will dampen consumer appetite for the Playstation 4, but it has left a nasty blemish on an otherwise robust product launch. It will be interesting to see if Microsoft, which had Foxconn manufacture 10% of the Xbox One consoles, will run into similar problems when it launches later this week.

If so, then it might be time for these companies to rethink their relationship with Foxconn, and decide if slightly higher margins are worth tarnished reputations and costly recalls.