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Sega exits the console business: Durlacher Comment
Jan 2001
Sega's decision to reconsider its
role within the games console hardware business will come as no surprise to those within the games industry. The company has struggled to emulate, let alone build upon, the retail success it experienced in the early
90s with its MegaDrive console. The Company has made repeated mistakes with ill-advised attempts to upgrade the MegaDrive with the 32X and MegaCD and got not only the hardware strategy but also the marketing and
publisher partnerships wrong with Saturn. This, I would argue, was more damaging to Sega than the more recent failure of Dreamcast at retail.
Hardware manufacturers have a symbiotic relationship with game
publishers which leaves them with the catch-22 problem of needing to convince publishers to commit resources to developing high quality titles for a platform whose growth is entirely dependent on the release of high
quality titles. Publishers, being more sales than strategy-driven beasts, will only commit resources to developing games for platforms with either a large addressable market (e.g. PlayStation at its apex in 1999) or
platforms with the broad expectation of large addressable markets (e.g. PlayStation 2).
Thus Sega, weakened both financially but more importantly in the eyes of the games market by the failure of Saturn, 32X
an MegaCD, launched Dreamcast with few expecting it to seriously challenge its principal rival Sony in the longer run. With little serious support from publishers as a result, the self-fulfilling prophecy of its
demise as a retail product was more or less complete before it started. Sega has now finally realised that its image as a hardware manufacturer is too tarnished for it to play any further role in a retail market
made even more crowded by Microsoft's imminent arrival and that its balance sheet cannot take any further weight (it is over $170m in debt and expected to lose the same amount this financial year). This, though,
does not necessarily spell the end for Dreamcast.
As predicted by Durlacher over a year ago, whilst the retail channel has proven too difficult for Sega it has, wisely, turned to a new and potentially more
effective distribution channel: the set-top box wholesale market. By tying up with Pace Micro, Sega has paved the way for a longevity and addressable market for Dreamcast that it could not have achieved at retail.
Should one of Pace's many partners place an order for, say, 6m Dreamcast-compatible set-top boxes, not only would the Dreamcast market double overnight but such set top box installations would likely stay in homes
for longer than the retail product would.
Most importantly, however, such a move will introduce broadband to the console and with it the dream of publishers and console manufacturers everywhere: seamless
electronic distribution and high-speed multiplayer interactivity. Furthermore, Pace's plans to incorporate the Dreamcast platform into its hard-drive enabled set-top boxes will allow the electronically distributed
interactive content to be stored locally thus broadening the scope of future Dreamcast games designs and pitching it head to head with Microsoft's similarly equipped Xbox.
Despite the precarious nature of its
financial position, Sega's strategy should, though, prove in the longer term to be its panacea. The early pain it will experience exiting this market will be mitigated by its ability to concentrate on its true asset
base: its software. For the first time it will be able to exploit the far broader addressable markets offered by the aggregate of its former competitors' markets and indeed by a Dreamcast market which could expand
considerably should Pace secure a high volume of set-top box orders. Thus where Sega might have sold 2m units of Sonic for the retail version of Dreamcast, it could easily have sold 3 or 4 times that amount if it
was released on PlayStation, PlayStation 2 etc…
Short of the Sega making some catastrophic management errors, it would be surprising if Sega did not therefore stage a dramatic return to profitability within
the next 2 years, if not sooner. With over 100 titles in development and a huge number of highly successful games franchises established (e.g. Sonic, Virtua Fighter, Daytona, Shenmue etc…), Sega is now poised to
become one of the largest independent games publishers in the world.
Nick Gibson
Senior Internet and Games Analyst
Durlacher Research Ltd.
Durlacher Corporation PLC Durlacher has a long history
of research, consulting and investment activity in the games industry and has become a widely quoted authority on the industry's evolution.
Please contact us for further information on research, consulting, or corporate finance services. www.durlacher.com
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