Sony - “Wii Are In Trouble”

Note: this post was carried today on Wallstrip

Overview

When I think of what Sony used to mean to me, the following adjectives come to mind: Innovative, High Quality, Close to the Customer, Smart, Long-term Focused. When I think of what Sony means to me today, and the sentiment that is reflected across the Internet, most of these adjectives are not currently in play. While Sony is certainly capable of innovation, a new adjective set might include Customer Unfriendly, Not So Smart, and Short-term Focused. Needless to say, none of this bodes well for the stock price, which has encountered a roller-coaster ride from $34 up to $52 and back down to the current $40. Clearly not a ringing endorsement of current management or their strategic direction. Sony is, in fact, living out the plot of one of its horror movies, “The Grudge”:

The normal façade of a modest house in Tokyo belies the hidden terror within. It is possessed by a violent plague that destroys the lives of everyone who enters. Known as The Grudge, this curse causes its victims to die in the grip of a powerful rage. Those who are fatally afflicted by the curse die and a new curse is born–passed like a virus to all those who enter the house in an endless, growing chain of horror.

Sounds kind of like what is going on at Sony these days. Sad to say, all is not well, much to the chagrin of those long SNE. Read on.

ISSUE #1: Customer Awareness as a Historic Asset? See Asset Destruction in Process

Exhibit 1: The Sony Rootkit Fiasco

From BoingBoing

Mark Russinovich, a security researcher, discovers that Sony has been sneakily installing “rootkit”-based DRM on their customers’ computers. Rootkits are black-hat hacker tools used to disguise the workings of their malicious software. Removing Sony’s rootkit nukes your Windows installation.

And a little history and perspective from Sony Management, via an interview with Thomas Hesse from Sony BMG’s on NPR

In an interview with NPR late last week, Sony BMG’s Global Digital Business President Thomas Hesse downplayed the recent DRM fiasco saying he objected to terms such as malware, spyware and rootkit. “Most people, I think, don’t even know what a rootkit is, so why should they care about it?” he said.

Hesse acknowledged that the controversial First 4 Internet technology that installs and “cloaks” the DRM software without a user’s permission shipped on about 20 CDs. But “no information ever gets gathered about the user behavior,” he claimed. “This is purely about restricting the ability to burn MP3 files in an unprotected manner.”

Pure genius? Not. And it gets even worse - when (now Governor-elect) Elliott Spitzer got involved:

“It is unacceptable that more than three weeks after this serious vulnerability was revealed, these same CDs are still on shelves, during the busiest shopping days of the year,” Spitzer said in a written statement. “I strongly urge all retailers to heed the warnings issued about these products, pull them from distribution immediately, and ship them back to Sony.”

Punch line: Sony put a rootkit on some CDs to stop the ripping and burning of MP3s, in order to essentially manage music rights. Why? Could it be because of Apple’s dominance of the portable digital music business? Was Sony testing a way to slow their progress and regain ground? Who knows, except that their actions spawned a PR nightmare among the smartest and most influential members of their user base - the tech-savvy users and bloggers. Not a segment of your customer base that you should be pissing off.

ISSUE #2: The Battery Melt-down: Crisis Management Required

Who can forget the recent history of Dell and the exploding laptop battery. What started out as a little video clip on the Internet (showing a laptop bursting into flames) became the Web 2.0 version of the J&J Tylenol scare.

Exhibit 1: Dell laptop explodes at Japanese conference   

From The Inquirer.net 6/21/2006

AN INQUIRER READER attending a conference in Japan was sat just feet away from a laptop computer that suddenly exploded into flames, in what could have been a deadly accident.

Gaston, our astonished reader reports: “The damn thing was on fire and produced several explosions for more than five minutes”.

This story with the accompanying photos spread like “wildfire” (yes, we over at IA are witty) on the Internet. Action was taken by Dell, the maker of the offending laptop, two months later when more incidents began to appear on the Internet. Trivia question: Which company was the principal battery supplier to Dell? You guessed it - Sony. But wait - it gets even better.

From InfoWorld August 2006:

Dell, Sony discussed battery problem 10 months ago

Dell and Sony knew about and discussed manufacturing problems with Sony-made Lithium-Ion batteries as long as ten months ago, but held off on issuing a recall until those flaws were clearly linked to catastrophic failures causing those batteries to catch fire, a Sony Electronics spokesman said Friday.

Spokesman Rick Clancy said the companies had conversations in October 2005 and again in February 2006. Discussions were about the problem of small metal particles that had contaminated Lithium-Ion battery cells manufactured by Sony, causing batteries to fail and, in some cases, overheat.

As a result of those conversations, Sony made changes to its manufacturing process to minimize the presence and size of the particles in its batteries. However, the company did not recall batteries that it thought might contain the particles because it wasn’t clear that they were dangerous, Clancy said.

“We didn’t have confirmation of incidents [involving fires] until relatively recently. We received reports, but didn’t know if there were environmental situations not related to the systems themselves,” he said. “Different measures were taken in February and in October [2005] to further ensure that there were as few of these particles as possible and that they were as small as possible.”

You have got to be kidding me. Did these guys learn anything from the Rootkit PR debacle? As I’ve discussed in previous posts, there are tried and true ways of getting out in front of serious PR problems, acknowledging them early, dealing with them openly and honestly and protecting the safety of your customers. Sony Management’s reading of their customers likely response to he Rootkit strategy backfired in 2005, and they repeated the same mistake with the battery problems in late 2005/early 2006. It didn’t need to happen this way. 4.1 million batteries were going to be recalled in any event, so why not use the problem as a PR opportunity to do the right thing and regain the confidence of your key constituency, your customers? Because Sony Management doesn’t get it, that’s why. This is not the customer-focused company I remember from the Walkman days. Something has happened to Sony’s DNA - and it’s not good.

ISSUE #3: Why are we feeling so Blu when Wii should be feeling happy? Supply-chain and Strategic Hell

Sony has been losing ground for years in Home Entertainment. The long-time edge in portable music - gone. The game-changing Walkman is a name scarcely known by today’s young influencers. Apple is the new King. In the face of stiff competition, Sony has been concentrating its hopes on its next generation gaming consoles. Sad to say (but no surprise), things did not go exactly as planned. Microsoft was able to beat Sony to market for Christmas 2005 with their next generation console. Microsoft has been waiting a year for Sony’s new entrant - PS3. With Sony’s hand forced by delays, PS3 shipped this November 17 with an eye towards going head-to-head with Xbox 360. Without question, Sony needed an edge, so they chose to go way, way up market to try and bring the coolest high-tech gaming engine to market. This relied upon Blu-ray technology. Unfortunately, this go-for-broke strategy with an immature technology has raised two unintended consequences: (1) supply-chain problems; and (2) a potential paradigm shift.

1. Supply-chain problems

In order to make Blu-ray players you need these things called Blue Laser Diodes. And if you want to make high-end consumer Blu-ray players/recorders you also need these things called Blue Laser Diodes. And if the supply of Blu-ray diodes is limited you have an issues of scarcity and production allocations that need to be addressed. Ergo, in Sony’s case two different divisions were competing for the same scare component to achieve their strategic objectives. This is a story that just can’t end well, and, in fact, because of this “crowding out” Europe will essentially miss PS3 for Christmas. You have to read the stuff below to believe it.

In EE Times on October 24, less than a month before PS3 launch

Sony delays Blu-ray Disc player again

In news coming out of Japan this week, Sony has apparently delayed again the release of its stand-alone BDP-S1 Blu-ray Disc player to December or possibly not till 2007. The player was scheduled to due to arrive on retailers shelves this week. Originally, the BDP-S1 was due out in July, but was postponed until August, then to October 25.

Apparently, the delay seems to have been a strategic decision that is based on availability of blue laser diode supplies rather than any trouble with the player - unlike the problems that Samsung has recently encountered. As early as a year ago, it was speculated by several journalists and industry insiders that Sony would have problems delivering both PS3 and a stand-alone Blu-ray Disc player. Not surprisingly, the Blu-ray diode used in the BDP-S1 is the same one used in Sony’s PlayStation 3 game console, which is set for release on November 17. According to experts and analysts in Consumer Electronics, there simply doesn’t seem to be enough parts to go around.

Who’s driving the bus here, folks? One team, right? Wrong.

2. Paradigm shift? Nintendo and the Wii

Is Nintendo Changing the Game?: An Innovator’s Dilemma (thanks, Clay). Sony and Microsoft have been battling it out in a classic “feature war,” replete with ever-higher levels of graphics quality and more and more realistic polygon images. That is where they believe games are going. On the other hand Nintendo, an earlier winner of the game wars, has concentrated on a revolutionary controller that allows motions to be captured as part of playing the game. With Sony’s delay problems we have the opportunity to witness the juxtaposition of two new product launches with different fundamentally gaming approaches. On the one hand, Sony is going straight for the hard-core gaming market against Microsoft, with an expensive $500 - $600 machine that has roughly the same resolution as Xbox 360. On the other hand, Nintendo is offering a $250 machine with fewer high-tech graphics but with clear emphasis on a revolutionary controller that seeks to make the gaming experience active, fun, and more accessible to wider audience. Nintendo has worked to make natural hand movements displayed and reflected both on the screen and in the game, creating a much, much flatter learning curve. In short, fun and success are much closer at hand than in the high-end games of Sony and Microsoft.

Sony appears to be going after the existing market while Nintendo is looking to expand the market, opening it up to people who have either never played or are causal players intimidated by the high-end games. From Dr. Christensen (The Innovator’s Dilemma) himself:

“Consistently, established firms attempt to push the technology into their established markets, while successful entrants find a new market that values the technology.”

Nintendo just seems so smart and thinking outside-the-box, while Sony seems so slow and hamstrung by convention. Add to this the fact that the Wii has garnered lots of buzz, has far lower development costs than for the PS3 and Xbox 360 ($5-$8 million vs. $15-$20 million) and has laid the foundation for lots more game titles than the higher-end consoles (and rapid and prolific third-party development is the lifeblood of success for a gaming platform), it would appear that Sony’s technical tour de force may not win the war of economics in the end.

And this is not just our view of the Wii. Check out these articles:

Nintendo’s Wii Is A Revolution - Forbes.com November 13th

Question of the Week: Are Games Industry Professionals buying a PS3 or a Wii? - Gamasutra.com November 17th

Game makers say Wii a bargain - Yahoo! News November 16th

Wii Launch NYC: 5,000 Wiis in Times Square - Gizmodo.com November 18th

Conclusion

Sony, the once-dominant home entertainment giant is a shadow of its former self. Loss of customer focus, lack of out-of-the-box thinking and crushing internal and external competition is laying it low. It is hard to see a near-term scenario that results in a rosy picture for SNE’s shares. And in light of the Yahoo! Peanut Butter Manifesto, it seems that Sony could benefit from such a wake-up call.

Thanks to Rob Passarella for his assistance with this post
The author does not currently own securities of Sony.

Comments

[Yaser Anwar]

While you've mentioned some good points I think they are overly concentrated on Nintendo's Wii (which personally I think is not half as good as a PS3, but one gets what they pay for).

The aforementioned problems, except Wii have led to: Poor financial performance. SNE’s net sales decreased 4.3% to $63.89 billion in 05 due to a decline in its Electronic segment and Picture segment sales. Net profit decreased 30.8% to $1.05 billion in 05.

SNE's likely to further delay the launch of PS3, in all territories before the end of the year, would result in missing out on the Christmas sales season which could harm its financials (My PS3 is going to arrive at the end of Feb., ridiculous!).

Investors need to ask what is management planning to do?

Restructuring plans for future growth. In a step towards boosting efficiency and reduce costs, SNE unveiled a sweeping restructuring plan to cut 10K jobs, about 7.0% of its global work force, by March 08. Alongside closing several plants, selling non-core assets, and changing the organizational structure.

What else? In order to make up for the falling revenues from the electronics and picture segments, SNE finalized its plans to establish a joint venture with NEC for optical disk drives. This venture started its operations in April 06 and is expected to control about 1/5th of the market, with annual sales estimates of about $1.9 billion.

As a result of this restructuring, SNE expects a reasonable growth in revenues and net income for full FY06.

Granted these restructuring efforts should help SNE but management needs to be more clear as to where it expects majority of the growth to come from & whether we will see anymore additional taxes! (Japanese tax authorities have ordered SNE to pay an estimated $243.00 million in additional taxes, related to its game console and other operations in the US after finding fault with previous tax filings.) After all, restructuring can only take you so far.....

Unfortunately for shareholders of SNE PS3 lacks earnings power as gaming business is roughly 13-15% of total earnings.