PS3 and Backwards Compatibility: The Analysts are Missing It

My friend Rob and I talk a lot about gaming in general, and gaming analysts in particular. Frequently, we can't quite understand how they approach problems or arrive at conclusions, probably because they are mired in cranking out reports and not spending enough time thinking about the big picture. And this was never more clear than in an article that ran in today's GameDailyBIZ concerning the issue of the PS3s lack of backwards compatibility. The analysts conclusion: since much has been made over the PS3s high price point, and since stripping out this functionality saves between $30-$50 per unit, a cost reduction is clearly more important than offering this feature. Voila! Instant Wall Street group-think.

In short, my pal and I believe this thinking is, well, quite stoned, and evidence of thinking deep, deep inside the box and neither looking at the facts nor Sony's true economic motivation. But hey, this is only the view of a couple of stupid non-gaming analysts.

First, some excerpts from the article:

So the question must be asked: Considering the pure dominance of the PS2 and the millions of gamers who may want the ability to play PS2 games on the PS3 should they ever purchase the console when it comes down in price, is Sony shooting itself in the foot?

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"Cost is hard to gauge, probably $30 - $50 per unit," Wedbush Morgan Securities' Michael Pachter said. "I thought lack of backward compatibility would hurt the Xbox [360], but it really didn't. My guess is that Sony has addressed the concerns of those who care about backward compatibility with all of the boxes sold to date, and that they will continue to offer the 80GB model if anybody feels that they need backward compatibility. So it's not fatal."

It's not an ideal solution, but something had to be done. "It's about cost reduction, but also getting people to focus on PS3 games. End of the day, they need to do something, and this was probably a compromise between costs and price cuts," UBS analyst Ben Schachter said.

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For Cole, the bigger issue for Sony and its consumers remains the price barrier and the losses piling up in Sony's gaming division. "For me the big problem with the PS3 is high price. The problem is bringing the price down means bleeding a lot of money per unit. You lower the price $100 and you are losing $100 million for every million units sold. To me I just can't imagine many consumers stumbling over backwards compatibility. But I can imagine a whole bunch stumbling over price," he said.

Colin Sebastian, an analyst at Lazard Capital Markets, agrees wholeheartedly. "It appears that pricing is becoming more of a priority, which makes sense given where the PS3 is selling in terms of market share. I don't believe removing backwards compatibility is a huge deal, considering that most people who want to play PS2 games will continue to do so on their PS2s," he said.

So, a question arises, say, like why Sony wouldn't make the PS3 backwards compatible. There has been tons of talk about the PS3 being priced too high. "Let's see, it costs money to make the PS3 backwards compatible, the price of the console is too high...I've got it, they're going to strip out the functionality and reduce the price. That's surely the answer." There is only one answer for such narrow-minded thinking: the recency effect.

The recency effect, in psychology, is a cognitive bias that results from disproportionate salience of recent stimuli or observations. People tend to recall items that were at the end on a list rather than items that were in the middle on a list. For example, if a driver sees an equal total number of red cars as blue cars during a long journey, but there happens to be a glut of red cars at the end of the journey, he or she is likely to conclude that there were more red cars than blue cars throughout the drive.

Right. Since high price is the proximate problem, any action Sony takes will be perceived as trying to address this issue. My view: WRONG.  Consider this explanation. PS2 is kicking PS3s ass, both in terms of hardware and software sales. And not by a narrow margin, mind you. Consider these figures from VGChartz:

                                                       PS2                                PS3

Hardware (13 wks)                        746,341                        502,730

Weekly avg                                        57k                                39k

Software (13 wks)                         3,969,654                2,721,050

So, if I'm Sony, am I worried about people focusing on the PS3, or not cannibalizing my far more profitable cash cow, the PS2?   Come on, guys. The answer is right in front of you. Sony is actually being economically rational for a change. The last thing they want is for PS2 console sales to slow to a trickle, sales that attract a far greater margin than PS3. Further, they are selling many more PS2 titles than PS3. And Sony is enjoying that nice license stream off of PS2 games. So bottom line, they are using PS2s profits to subsidize PS3s losses to offset a slower-then-expected adoption cycle. And they are making the bet that the PS3 has the technology and will have the game library to overtake Xbox 360 and the Wii over the long haul, ergo their 10 year console life cycle positioning.

It all makes perfect sense, doesn't it? But again, my pal and I aren't Wall Street analysts. And just maybe that's a good thing.

Comments

[Rob]

I think the curious thing in Backward Compatibility is that Sony switched from hardware emulation to software emulation in July. Software costs nothing to include in the console outside the original development costs vs the cost of including the emotion chip. The PS3 does PSOne software emulation but Sony has said nothing about PS2 game support. I find this strange. From Gamspot via Cnet UK

http://news.cnet.co.uk/gamesgear/0,39029682,49293240,00.htm

"When asked about PSOne games, Sony told CNET.co.uk's sister site, GameSpot, "the backwards compatibility of PSOne titles is achieved through software and the vast majority of PSOne titles are backwards compatible with the new PS3". Sony did not return calls to comment by press time on why PlayStation 2 compatibility -- which has always been handled with software in European PS3s -- could not be achieved with the new model as well."

So why gimp the thing? Perhaps it has to do with the high development costs on PS3 and wanting to let developers still make a living off of PS2. A quick scan of forth quarter releases by platform shows that publishers are still developing more games for the PS2 than the PS3. Check Gamespy in my 10 minute 'blink' analysis -- I count 61 PS2 titles vs. 46 PS3 titles from October 15 till December 18 (Wii & DS are over 100). Sony may believe that PS2 is the only 'real' offering they have to Wii in the low cost development area and they are keeping it around to stop developers from breaking away. Developing for the PS3, right now, isn't making anyone money. If they can pull it off -- I think it is a good tactical move -- but long term they need developers to embrace the PS3.

[David]

Roger,

You keep hammering Sony about the PS3, but what about the recent surge that the PSP has seen especially in Japan? With the introduction of the new model and the new Final Fantasy game, it is at least temporarily outselling the DS according to vgchartz. Also there has been a rather large decline in Wii sales in the Japanese market. You wrote an article earlier about the importance of the Japanese market and now you seem to ignore it since Nintendo hasn't been doing as well there. I'll admit "as well" is relative and they are still dominating the market. I think you are spot on about Microsoft, but are underestimating Sony. While the PS3 gets the most attention, they are outperforming with their other two systems.

[Roger]

Sorry to disagree, Phil, but I think my use is contextually correct. In fact, I think my use of the term is quite powerful and drives home exactly the point I intended to make. So there.

[phil]

i laugh my face when i see analysts apply psychological concepts that they really dont understand in orderto try and explain some tortured model of the woprld. the studies that led to terms like recency or representativeness or loss aversion were complex and subtle and if u do not fully understand them dont use them....

[Richard Gaywood]

This also accounts for the puzzling decision to introduce a 40Gb PS3 in Europe with no backwards compatability at all -- not even the software-based layer used on the 80Gb US PS3s. This confused me; clearly, the software is already written and the 40Gb and 80Gb models have no BC hardware, so I couldn't see how there was any cost reduction as part of this move.

But your suggestion that it is to protect the PS2 does make sense to me. Interesting viewpoint!

[warmwaterpenguin]

This was my assumption too, Roger; nice to see someone else who sees it.

How effective do you think this will be? I'm a bit concerned about potential backlash. If they take steps to make the lack of backwards compatibility crystal clear, they risk making it into a bigger issue for users than it is, but if they do anything less (say quietly remove the feature from the list on the box), I expect a lot of angry customers.

If the customer perception is that they have been misled, whatever the reality, that damages the reputation of an already faltering brand, and this is the sort of thing I don't believe the consumer community lets go.