Sofa Analytics # 237. Playstation 5 scarcity – why it’s inevitable

Hey.

In Russia, pre-orders for the Sony Playstation 5 began, and it quickly became clear that the quotas allocated to retail players had ended. Someone connected this with the successful launch of a new generation of game consoles, someone habitually complained that the bulk goes to the home market and the United States. And for us this is a great opportunity to discuss why a shortage of consoles is inevitable and part of the business model that Sony has. Moreover, the deficit is observed not only in Russia, you can look at what is happening in America and realize that the situation there is no better. Buyers scour different stores in search of where to leave their money and be one of the first to wait for the console.

Sofa Analytics # 237. Playstation 5 shortage - why it's inevitable

Let’s try to figure out together why a deficit is inevitable in the existing model, and how sales are distributed across different countries, what factors affect production.

Anyone more or less interested in the topic of games knows that the manufacturers of game consoles do not make money on them. The business model is such that the set-top box is sold at almost zero or with a minimum subsidy, it all depends on what expenses you take into account in its cost. But games are sold with a higher mark-up to compensate for what they could not earn on hardware. This idea is probably familiar to many and does not cause rejection. The buyer receives powerful hardware for relatively little money, the life cycle of the set-top box is 4-5 years, which pays off all investments in it. Consoles have taken a place between gaming and conventional computers, the former are expensive and not available to everyone. While the console is a mass product, it is easy to use and gives a good gaming experience.

In the fourth quarter of 2013, the Playstation 4 appeared on the market, during that time the company shipped 4.5 million set-top boxes, in the first quarter of 2014 – another 3 million units. Conventionally, the first two quarters can be called peak demand, when the novelty was hunted, and the launch in 2013 was limited to North America and Europe, in addition to the home market.

The game console market is split between Sony and Microsoft today, with Sony’s sales being higher. At the end of 2020, both companies are offering their products at about the same time, which creates the illusion of a collision on a collision course. The illusion lies in the fact that Sony’s loyal audience will patiently wait for the set-top box, even if they cannot buy it in the early days. A small number of users have both XBox and Playstation at the same time. Most people buy one set-top box and also games for it. And this library of games becomes the main anchor that keeps it on a particular platform. You can also remember the subscription to gaming services, established teams and friends that play on the same consoles. Therefore, it is difficult to drag a user from an XBox to a Playstation, as well as to move in the opposite direction. Only those who buy the first console can be taken into account, and here the presence of certain games that you want to play comes to the fore. The struggle between Playstation and Xbox, of course, exists, but it goes for games, for attracting new audiences, but almost never occurs in the field of dragging the existing users of each system.

Why can’t Sony produce so many PlayStations at the same time that there is no shortage and everyone can buy this set-top box? The answer to this question requires a detailed study of how production works and what pitfalls are present.

To begin with, any production has assembly lines, they are not universal for a product such as set-top boxes. That is, it is impossible today to produce set-top boxes on such a conveyor, and then start churning out TVs, smartphones or tablets. Production is created for a specific product and has clearly defined parameters. Let’s say that you have all the money in the world and finances are not a limitation, you want to produce 10 million Playstation per month at your factory. The bottleneck is the capacity of your conveyors and your ability to expand them. In theory, you can buy more lines and then you will cope with this task, build new workshops. But in a couple of months you will need to produce not 10 million pieces, but a smaller number, say, 5 million. And what to do with the purchased equipment? Throwing away? It costs far from a penny and will be included in the cost of the set-top boxes you produce.

The first period of production for a new and potentially popular product can be called “swinging”. You need to ship your product to as many countries as possible at the same time to get it on store shelves. But you are not ready to expand production. For this, there has long been a tactic that avoids the bottleneck. You start production in advance in order to accumulate the required number of the same set-top boxes and so that the logistics can cope with their delivery around the world. Just like on a conveyor belt, you have a limit on the number of trucks, airplanes and other means of delivering goods to the shelves. Playing with time allows you to prepare for the start of sales.

The popularity of production in China is not least due to the fact that the plant can work in three shifts, 24 to 7. In other countries, problems often arise with this, in China, production can stamp a product non-stop, and there is no huge overpayment. for such a work schedule. As you can imagine, this is an additional opportunity to increase the output of the desired product in a short time.

Production planning directly depends on sales forecasts, they have several options. Initially, the manufacturer discusses the sales volumes with their representative offices in each country, makes rough plans and realizes how much product needs to be produced. I will not dwell on this issue in detail, since it is not fundamental for us. Good sales planning helps to avoid overstocking of shelves, and bad planning leads to production stoppages. But it is also bad planning when the demand for a product exceeds its availability at times. The product becomes a bestseller, but it is impossible to meet demand in a short time, since there are no components for production, production already works 24/7.

But for game consoles, another important point interferes with planning – the cost of the console. For the Playstation 5, the cost of the BOM sheet is estimated at $ 450. For comparison, in 2013, the cost of the PS4 in America was $ 399, and today the PS4 Pro is offered for a price of $ 399 minus various discounts, it can be bought in the region of $ 300-320. The PS4 cost $ 381 in components (IHS Markit estimate). It is easy to calculate that there is also a retail player’s margin, it averages about 18% of the retail value. It turns out that the subsidy from Sony is at least 20% of the price, in fact it is higher when you take into account the cost of development, logistics and marketing.

By releasing the Playstation, Sony is losing money from each set-top box, since the hardware is subsidized. This makes the game consoles market very different from any other where the price of the goods is not subsidized by the manufacturer. Let’s do some arithmetic that will show us this model in numbers. For example, let’s say Sony produces a different number of set-top boxes per month. Let’s take as a starting point that on each Sony Playstation 5 the subsidy is $ 100 (the accuracy of the figure is not at all important here, we are not looking at specific indicators).

With a production volume of a million units per month, Sony gets a minus of $ 100 million. Increasing the volume? For example, with a production volume of 5 million units, this will already be $ 500 million. A trifle? I don’t think so.

The company must purchase components, plan the next stages of production, spend money on marketing. Costs are cosmic, and there are a small number of tricks that can reduce them.

The first and easiest way is to sell goods for “real” money, when the shipment takes place without a delay in payment. Sony instantly gets the money and can put it back into production. We remember that this is less money than the company spends on the production of a set-top box. But the scheme itself helps to narrow the financial gap. Further, retail players can also charge the full price for pre-ordering the set-top box (this is already happening in Russia). At Sony, they see the volume of orders in retail, receive new orders from partners and, most importantly, receive money. As a result, the quota for a particular country increases. This process looks like a push-and-pull, sales are in steps. But there is no gap in this scheme, as losses simply multiply.

It’s time to remember about games, as they allow the company to make money. But the problem here is that together with the start of sales of the console it is impossible to present hundreds of new games, their number is limited. This is also justified from a marketing point of view, when a small number of new products are promoted, the emphasis is on them. Hardware reimbursements are stretched over time, and it is assumed that the Playstation user will buy games as they play through the old ones. There is no point in buying a dozen games at once, you simply cannot play them. The fact that games have become online, multiplayer, increases their lifespan, you can play the same game for years and not try to watch something else. My son’s example shows that he buys new toys for the collection, goes through them and forgets for a while. But this is absolutely atypical behavior for most console owners, they buy several games during the entire time they use the console. Statistics confirm this, for example, Sony at CES2019 announced that it sold 91.6 million PS4 consoles, and the number of games sold was 876 million. It is easy to calculate that on average 9.5 games were played on the console.

But here we get to the next pitfall, which will explain to us how quotas are set for individual countries when selling consoles. Sales of games per console vary from country to country. Somewhere buyers are active, somewhere they buy one game and torture it endlessly. It is important for Sony to cover losses from subsidies for iron, which means that first of all it is necessary to saturate those markets where the largest number of games are sold per player. Historically, this is the American market, and it is also one of the largest and most significant. Hence the highest priority for sales in the USA, plus it is competition with the XBox, the reason is not one at all, there is a whole set of them.

Does this mean that there is no need to supply the console to countries where few games are bought? Not at all. For example, if you compare Russia and the United States, you get the impression that sales on the Russian market will be small, the number of games purchased per person is quite low. But if we leave the estimate of the average temperature in the hospital, then we get that there are different strata of players, both those who buy a lot and those who buy very little. There are more of the latter in Russia, but the former are more active. And they certainly need to be given a product, as this increases the profit for the company from the sale of games. I will not consider a subscription to Sony services, this point also needs to be taken into account in the calculations, it is important.

The audience of game consoles buyers is loyal to consoles, and they also have no special alternatives. They can buy a gaming computer, but that would be a different cost level. The increase in the manufacturer’s costs for subsidies automatically leads to the fact that these costs need to be compensated for by the cost of games, it should grow. This is exactly what we see in the example of Sony.

Playstation 5 games range from $ 50 to $ 70, for example, Lucid Games / XDEV’s Destruction All Stars costs $ 70 (€ 80). The previous jump in prices for games for consoles happened at the time of the release of the Playstation 3 and Xbox 360, then the prices went from $ 50 to $ 60. And that was about 15 years ago. Today, the price increase is also due to the fact that game development costs have increased, so Sony gives more to the studios, but the proportion of revenue sharing remains more or less the same compared to previous periods.

In Russia, the rise in prices for games is not as noticeable as in other countries, for example, the same Destruction All Stars will cost 5 rubles. This is actually the cost of playing in the US. This pricing is due to the fact that Sony wants to sell as many games as possible, and a sharp rise in cost will put a big cross on this desire.

Game sales are stretched over time and can be superimposed on the console lifecycle. At the same time, the established level of prices for games implies that it will be possible to carry out certain marketing campaigns with them, to give discounts in future periods. At the initial stage, the cost is formed as the maximum offer for the market.

What I like about the game console market is the unusual business scheme. You need to successfully sell iron, find a middle ground in terms of cost, not get into a big minus on subsidies. And then for several years you need to balance on sales of hardware and games for it, as well as subscriptions. And only by increasing momentum, you can create a positive cash flow. But it cannot be said that these are super profits, since there are a lot of operating expenses. I figured very roughly that with a console lifespan of 5 years, the payback for the manufacturer comes on the condition that six games are sold per console. For every console sold in the world. Not so much at first glance, but on a national scale, this is a difficult task.

Let’s go back to where we started our journey. The shortage for game consoles is a necessity for the manufacturer, since it cannot meet the demand instantly. The cost of meeting this demand will overshadow all future gaming and subscription revenues. There is nothing wrong with scarcity (well, except that someone doesn’t get a prefix when they want it), it’s embedded in this business model. If the planning was correct, then the deficit will remain moderate and will quickly be covered by subsequent sales, as it happened in previous years. But if, for some reason, people rush for a new generation of game consoles, the audience will increase, this will create a long-term scarcity. The business model itself does not imply that it can be satisfied quickly, since subsidies burn up significant funds, and even corporations like Sony or Microsoft cannot afford them in this amount. Sometimes I hear that this is the reluctance of companies to meet the needs of a particular market, favoritism in favor of individual countries, but this is not at all the case. There is almost always business logic behind such decisions, some of the processes are described above, it gives an understanding of what companies are guided by and why it works like this. I hope that these processes have become a little clearer for you as well.

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