Global Economics

Sony's Plan to Cut PS3 Costs


By letting Toshiba make the game console's chip, Sony can focus on core operations—and boosting PlayStation sales

In the video-game industry, it's the oldest trick in the book. To keep a console from collecting dust on store shelves, game console makers will periodically cut prices and watch as buyers flock. Since the PlayStation 3's global launch last November, Sony (SNE) has already dropped the price of its two models, originally $599 and $499, by $100 apiece. But with PS3 sales growing at a slower-than-expected pace and trailing Microsoft's (MSFT) Xbox 360 and Nintendo's Wii, Sony could be mulling over another price reduction in the coming weeks. Some observers think an announcement might come as soon as this week's Tokyo Game Show.

How can Sony afford such deep discounts? After all, the Tokyo technology giant takes a hit on every PS3 it sells, to the tune of hundreds of dollars a console. Analysts say it will take time to whittle away at production costs, and don't expect Sony's gaming division to break even for another year and a half.

But Sony appears to have a plan. The company is now in talks with Toshiba (TOSBF) to sell the factory in Nagasaki where the high-performance Cell chip that powers the PS3 is made, according to a Sept. 15 report in the Japanese financial daily Nikkei. (Sony's senior vice-president, Naofumi Hara, says no decision about the factory had been made.) The high-powered, multimedia chip sports a new design that crams speedy numbers-crunching and communications technology onto a single slab of silicon.

Restoring Video Games to Profitability

The sale could bring Sony an estimated windfall of $870 million. In the best-case scenario, Sony would gain another benefit: With Toshiba's expertise in production efficiency, Sony could get a cheaper price on chips that would lower the PS3's costs. Sony now spends about $89 on each Cell chip, or about a tenth of the overall cost per console, market researcher iSuppli estimated in a teardown analysis last November. "The point is this would have the effect of driving down costs for Sony's gaming division," says Macquarie Securities analyst David Gibson.

That would be a huge help for gaming boss Kazuo Hirai, who took over in June. He needs to show that he's the right guy for the job by restoring video games to profitability after a massive $2 billion operating loss last year.

The potential downside is that Sony would have to rely on a competitor for a key PS3 part. And as Sony rushes to develop the Cell for other gizmos, such as flat TVs, laptops, and cell phones, it puts a promising technology in a rival's hands. Sony would also be giving up on microprocessors for video cameras and older generations of gaming consoles.

Similar Arrangement with Samsung

That's not as bad an idea as it sounds. For starters, Toshiba isn't just any rival. Toshiba and Sony have been partners in semiconductors since 1999, and they recently announced a hook-up in next-generation chip technology. Toshiba's engineers were also part of the tech trio—with Sony and IBM (IBM)—that spent five years developing the Cell, from 2001. "[Sony] already produces certain chips jointly with Toshiba, and we think the procurement risk is thus limited," NikkoCitigroup's Kota Ezawa wrote in a recent note to investors.

The Nikkei said Toshiba would gain control of Sony's plant and then lease it to a joint venture owned by both companies. For Toshiba the advantage would be an instant expansion of its chip business and a huge buyer that's willing to split the gargantuan costs of running a chip factory.

The arrangement bears a striking resemblance to Sony's joint venture with Samsung Electronics to make liquid-crystal-display panels for flat-screen TVs. That venture, which was formed in 2004 and became profitable a year and a half later, is one reason Sony has clawed its way to the top of the LCD-TV market, after getting a late start. In the April-June quarter, Sony ranked second worldwide, with a 13% share, according to DisplaySearch.

Buying Time to Delay Another PS3 Cut

For Sony, the fact that a decision about semiconductors can improve its gaming business is a big plus. Combined, the two account for more than 20% of Sony's overall $70 billion in revenues, but were a big liability last year. Semiconductors lost about $500 million, the division's third consecutive year in the red.

In semiconductors, Executive Deputy President Yutaka Nakagawa wants to turn things around with an "asset-lite" strategy. That involves jettisoning noncore operations to focus on Sony's imaging chips for digital cameras, video cameras, and cell phones, an area where it's No. 1 in the world. Nakagawa knows that he won't succeed if he keeps throwing billions of dollars at new advances that would squeeze more tiny transistors onto a single chip. (Sony's startup costs for the Nagasaki plant: $1.7 billion.)

Hirai, president and chief operating officer of Sony Computer Entertainment, faces a similar budget crunch. He needs to restore video games to profitability after a massive $2 billion operating loss last year. This year won't be as bad, but Hirai may need to double his marketing efforts to drive PS3 sales. The more consoles he sells, the faster game software should sell and the more Sony will make off of licensing fees.

Meanwhile he's eager to close the gap between production costs and retail prices as quickly as possible. When the PS3 went on sale, market researcher iSuppli estimated that Sony was losing $306 on the lower-priced 20GB model and $241 on the pricier 60GB version. Outsourcing the Cell chip in-house may buy Hirai time to delay another PS3 price cut.


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