Sony's PlayStation 3 in race against time

By Kiyoshi Takenaka

TOKYO (Reuters) - After a slow start, the outlook for Sony's PlayStation 3 is getting brighter as growing appetite for high-definition TV fuels the game console's sales and production costs come down.

But Sony's window of opportunity is closing quickly if it hopes to catch up with rivals Microsoft Corp. and Nintendo Co. Ltd. and keep the support of game developers so vital to a console's success, analysts said.

Sony Corp. and other console makers typically lose money on the hardware and generate profit from royalties on software. So the key to making money is to establish a large installed base of consoles and encourage developers to put out a lot of games.

"It's a race against time," said Hiroshi Kamide, an analyst at KBC Securities who covers the $30 billion video game industry. "They must increase their users or it won't be commercially worthwhile for software makers to support it."

The success of the PlayStation 3 is critical for Sony's fledging earnings recovery and a point of pride for the electronics conglomerate, which has already lost the lead in other key products such as portable music players.

Dogged by the belated finalisation of the copy protection technology standard for a disc drive, Sony was several months behind schedule when it launched the PS3 in November 2006. That gave Microsoft's Xbox 360 a full year's head start.

Sony packed the PS3 with advanced technology including a Blu-ray disc player for high-definition movies and the powerful "Cell" microchip to drive the life-like graphics needed to satisfy hard core game fans.

At first glance, that strategy seems to have backfired.

High production costs pushed Sony's game division to a likely loss of more than $1.7 billion in the past business year.

Nintendo, meanwhile, sold more than twice as many Wii consoles in Japan and the United States in February as Sony's PS3 by attracting a wider audience with easy-to-play games, and because it sells for half the price of the PS3.

But growing demand for high-definition TVs could give game players a good reason to choose the PS3 over the Xbox 360 and Wii, which do not come equipped with a next-generation disc player as the PS3 does.

The penetration rate of full high-definition TVs in North America jumped to 5.1 percent in the third quarter of 2006 from 0.7 percent a year ago, according to research firm DisplaySearch.

"That will give the PS3 an advantage over the Wii in the living room," Morgan Stanley analyst Masahiro Ono said. "In the United States... people are buying full high-definition TVs at a premium although TV broadcasting has not really turned full HD yet."

The United States is the world's largest video game market, accounting for 40 percent of the global demand.

HISTORY AS GUIDE

The game business is seen as the greatest threat to Sony's recovery under Chief Executive Howard Stringer now that restructuring efforts and strong sales of flat TVs seem to have put the mainstay electronics division back on track.

At the time of the PS3 launch last November, research firm iSuppli estimated the total cost of the basic version of the PS3 at $806 per console, 60 percent higher than its retail price.

To cut costs, Sony is shifting production of the Cell chips to 65-nanometre circuitry from 90 nanometres. A narrower circuity makes a chip smaller and reduces per-chip production costs.

Moreover, Sony said in February it would cut back on microchip spending and might not produce cutting-edge semiconductors in-house in the future, potentially opening a door for its game unit to procure key semiconductors from outside at lower costs.

Morgan Stanley's Ono also said the softer memory chip market was helping Sony cut manufacturing costs for the PS3, which should allow it to cut console prices to spur demand, as it did many times with the highly successful predecessor PS2.

If the development of the PS2 is any guide, the PS3's current problems should not necessarily be reason for despair.

Despite initial setbacks, sales of the PS2 eventually picked up pace and have exceeded 100 million units, matching the accomplishment of the original PlayStation and giving Sony a decade-long dominance in the global videogame market.

"Back in 2000, Japanese developers complained the PS2 was complex and too difficult to develop for. There weren't good titles available for the PS2 in Japan," Macquarie analyst David Gibson said. "In fact, Japan sales in the first year disappointed people. This all sounds familiar," he said.

To be sure competition is harder in this round of the game console war. Microsoft's online gaming function has proved a hit while Nintendo has been able to attract women and the elderly with casual games played with a wand-like controller.

Cutting the PS3's price and having a strong stable of games will be key for Sony to regain the lead, analysts said.

KBC's Kamide said he was watching to see if Sony would launch a new version of its popular in-house racing game software "Gran Turismo" in Japan by the end of the year. "If they can manage it, then it will be a real boost," he said.

Satoshi Fukuoka, a spokesman at Sony Computer Entertainment (SCE), the game unit of Sony, said SCE has no plans at the moment to cut PS3 prices, and the launch timing for the next version of "Gran Turismo" has yet to be decided.