Expert: gameusurper - 6/1/2008

Question
I am looking into going into this business and this question is really bothering me--
Why do video game providers chose to sell consoles at break even or even at a loss when it comes to prices, profiting instead from royalties charged to game publishers?  Is there any difference between the video industry and PC industry

Answer
Sorry for taking so long in answering.

Concerning the question of why video game console makers sell their wares at break even or at a loss. I suppose the idea is to get as many consoles out to the public as possible (known as 'install base' or 'user base') and recoup the costs through software sales. If the company loses a little or no money from a console sale, but doesn't profit from it, they can always recoup the cost on multiple software sales to any individual who owns a system.

First party support by the console manufacturer, in this case, is a very important business decision. If they don't have any first party titles to sell, there is no way to get the possible loss sustained from the console sales back in the form of software sales. Nintendo is well known for fully supporting, and in most cases, surpassing the support for their systems compared to most third party publishers that make games for their consoles. Coincidentally, Nintendo is also the only company this console generation that is making a profit off the sale of their hardware. Both Sony and Microsoft lose money on the sale of each of their consoles.

A company can not manufacture (i.e. make a sellable hard copy of the game) without being the manufacturer of the console for which that game is being made. (this began with Nintendo) The actual issue then, is of video game manufacturers (those that make the hard copies) 'profiting' from royalties charged to those that are financing the production of the game. (the publisher) The publisher does not manufacture the game, they merely provide funding and marketing for it.

Any company that manufactures a game for any system takes on what is called 'inventory risk'. This is the possibility that those copies of the game that the publisher pays to have printed won't sell to the consumer. To defray some of the costs of manufacture, companies charge a royalty to produce the hard copy to make up for that possible cost. Unlike most other industries, where the royalties are paid as the product sells, these are paid up front before production and also on all unsold product as well. If half the games the publisher ordered don't sell, guess what, they have to eat that cost.

If the manufacturer of the copies took on all the risk, guess what, they would have to eat the full costs instead. Admittedly, this does not make much financial sense. So to relieve some of those risks, the manufacturer charges the royalty for production of the software in question. This not only saves the manufacturer from major loss should the games not sell as well as hoped, but I guess in theory also helps to assist with the games quality in the end. If a publishing company is willing to pay to have all these copies made, one would think they stand behind the quality of the game and are willing to share the risks. So I wouldn't say it's so much as the manufacturer profiting per se, it's more like them covering their ass from a financial standpoint should the game flop.

Unfortunately, I am not familiar with the practices in the PC industry versus the videogame one. But a little internet research will probably answer this for you. You can start here:

http://en.wikipedia.org/wiki/Software_industry
http://en.wikipedia.org/wiki/Computer_software

http://en.wikipedia.org/wiki/Video_game_industry_practices

There are links on these pages to various other topics of relevance you can learn about.

Thanks for inquiring and hope you find this info useful.