Sony's new console will end up costing the company even more than it does the consumer, according to iSuppli analysts

Hopes are riding high that the PlayStation 3 can eventually bail troubled Japanese electronics and entertainment giant Sony out of the ever deepening waters it finds itself in.

On Nov. 17, Sony (SNE) is slated to release the new game console in the U.S. A successful PS3 launch will go a long way toward closing a year during which Sony has seen nothing but trouble: The biggest notebook battery recall in PC industry history, huge layoffs, and declining profits overall (see BusinessWeek.com, 10/26/06, "Sony's Singed Reputation").

And that was before the snags preceding the unveiling of the PS3. On Nov. 11, a scarcity of PS3s created chaos among key retail chains for the debut of the next-gen game console in Japan (see BusinessWeek.com, 11/12/06, "PS3: The Sound and Fury"). Then, a few days later, Sony confirmed a report that in spite of earlier assurances to the contrary, not all of the games designed for the PlayStation 2 are compatible with the new machine.

On top of that, Sony can't count on the new game machine being a quick fix for its financial woes. Sales of the PS3 itself aren't going to make Sony any money, at least not right away, according to a teardown analysis of the game console by market research firm iSuppli. In fact, Sony will be taking a bath on every unit sold, to the tune of $306 for the lower-priced 20GB model and $241 for the more expensive 60GB model.

Cheaper Chips

iSuppli estimates that the 60GB version of the PS3, which sells for $599, actually costs Sony $840 to build, not including the controller and packaging. The $499, 20GB model costs $805 to build. iSuppli analyzes manufacturing costs, not marketing expenses, which could send Sony's per-box loss even further skyward.

Sony's plan is much like that of rival Microsoft (MSFT): Take a loss on the console and make it back on the games. And that's exactly what Microsoft did when it launched the Xbox 360 a year ago (see BusinessWeek.com, 11/22/05, "Microsoft's Red-Ink Game"). At the time, the $399 Xbox 360 cost the software giant $470 to make, leaving a loss of $71 for each one sold.

But times change, and the prices of chips come down. A new iSuppli analysis of the Xbox 360 and the price of the components used in it reveals that Microsoft may be close to hitting the breakeven point on the Xbox 360. The console now costs Microsoft $323 to manufacture, leaving a gross profit of $76 per unit.

Out of the Ordinary

That puts a new spin on the second phase of the Microsoft-Sony battle: Sony is stepping back into the fight with a money-losing product just as the tide of profitability is turning for Microsoft. Microsoft's latest earnings report for the quarter ended Sept. 30 tells the tale: The software giant's entertainment business unit lost $96 million on sales of $1.03 billion, with sales up by more than $400 million and losses down by $77 million over the year-ago period (see BusinessWeek.com, 10/27/06, "Microsoft Waiting for Vista, Zune").

And so far, 6 million Xbox 360s have been sold. "If Microsoft can hit the 10 million mark by the end of the calendar year, it will be selling a lot more software, and so will be on target to be profitable sometime in [calendar] 2007," says analyst Matt Rosof with Directions on Microsoft, a Redmond (Wash.) consultancy. "They originally said they would do it in fiscal year 2007," he adds.

So why is the PS3 so expensive anyway? Because nothing about it is ordinary, says iSuppli analyst Andrew Rassweiler, from its specially designed core microprocessor to the memory chips it uses and the Blu-ray DVD drive it contains. "There's certainly nothing cheap about its design," Rassweiler says. "It's essentially a custom-made supercomputer sold at an affordable price. When we first looked at the motherboard, it looked like something built for high-end piece of telecom equipment, like a switch or a router."

Improved Memory

The most expensive component inside the PS3 is the Reality Synthesizer graphics chip from Nvidia (NVDA), which adds about $129 to the manufacturing cost. Behind that is Sony's own Blu-ray drive, which goes for $125, then the Cell processor, which Sony designed in partnership with IBM (IBM) and Toshiba (TOSBF), at $89 a chip.

Another notable component is a new type of memory chip from Samsung known as XDR DRAM, which is based on a design by Rambus (RMBS) for high-performance applications. It's a radical step up from conventional DRAM. Rassweiler says the four XDR chips used in the PS3 add $48 to the cost. "It's very cutting-edge memory technology, and it's the first time we've seen it used anywhere," he says.

Other suppliers include International Rectifier (IRF), which provides power-management chips to all three major gaming systems, including the forthcoming Nintendo Wii; Marvell Technology (MRVL), which supplied a Wi-Fi chipset; chipmaker Analog Devices (ADI); and hard-drive maker Seagate (STX).

Looking Ahead

With its price set some $100 to $200 higher than the Xbox 360, the PS3 will be at a disadvantage among consumers on a tight budget. But PS3 games will be priced at about $60 apiece, roughly the same as Xbox 360 titles. The problem there, says Rosoff of Directions on Microsoft, is that Sony will have to sell more games to make a per-machine profit. "Microsoft is selling on average five games per box, but I'm not sure how many it needs to sell per box to be profitable," he says. "It looks like Sony will have to sell more to reach that point."

Over time, Sony will reap the same benefits as Microsoft—the cost of chips will come down and some chips will be combined. One candidate for elimination in a future revision of the PS3, says iSuppli's Rassweiler, is a $27 Toshiba graphics chip designed to facilitate compatibility with older games from the PS2. "I've heard that Sony wants to put in some kind of software-emulator technology in the future, and so someday Sony could get rid of that chip." So over the long term, the PS3 could yet be a big profit-maker.