How Sony Got Game?

By Daren Fonda

Correction Appended: November 21, 2006 Burning batteries are two words that Sony CEO Sir Howard Stringer would never like to hear again. Before reports surfaced in August that Sony-made lithium-ion batteries had an occasional tendency to fry Apple, Dell and other laptops, the boss of the sprawling Japanese media conglomerate was having a great year. For four quarters, Sony had beaten financial expectations (though it wasn't always profitable). The firm was leaner, following more than 10,000 job cuts and the closure of nine factories. The consumer-electronics division was back in the black. And the movie studio was riding high, led by The Da Vinci Code. Meanwhile, investors had sent the stock up more than 8% through July. It was a nice vote of confidence for Stringer, Sony's first non-Japanese boss, who has probably acquired permanent jet lag traveling between Tokyo, New York City and his family home in London.

Yet after a massive voluntary recall of laptop batteries, Stringer turned opportunist, using the smoking cells as cover to clear out the vestiges of Sony's change-resistant culture. In Stringervision, the new Sony is led by software and linked horizontally across its vast product line. No more will the folks in the camera group not know what the TV-set guys are doing, he vows. He named a new boss of the consumer-electronics unit, Katsumi Ihara, to see to that. Software design is getting an overhaul too, so movies, MP3 players, TVs and cameras aren't strangers. The shining example is PlayStation 3, the fully loaded game machine that debuted in the North American market last week. "We've put a young guy in charge of the technology group to develop core software and media technologies, which we have not been good at," Stringer told TIME. Likewise, the components and semiconductor divisions have a new boss. And a global product-safety officer will make sure a battery fiasco doesn't recur. Out of this crisis, Stringer promised, "we're going to come out stronger and better organized."

Although not immediately more profitable. In mid-October Sony revised forecasts for its 2007 fiscal year, which ends in March, predicting a 38% decline in net income, to about $435 million. The losses are partly owing to charges for the battery recall and delays in launching the highly complex PS3. For fiscal 2008, Stringer is still predicting a profit margin of 5%, though he admits he's not sure how he'll achieve it. "But I am not altering the profit target."

The big question is whether the PS3 is the herald of Stringer's revitalized company, or a techno-turkey. The machine is off to a rocky start. Sony plans to ship just 2 million units this year, about half its initial projections. Customers queuing to buy one braved a shooting incident outside a store in Connecticut last week. And the lucky few who do snag one may be disappointed, since the PS3 can't play some older games without software upgrades that Sony is promising. (For a full review, go to TIME.com).

Long term, the idea isn't just to sell the machine to gamers. Sony envisions PS3 as an entertainment command center that will appeal to a mass market. The box features a ferociously fast computer chip, the Cell, a high-definition Blu-ray disc player, a hard drive and Web browser. In Sony's view, you'll use the PS3 to play games, watch movies and surf the Web. You'll be so dazzled by the hi-def images that you'll want to upgrade your TV with a new Bravia set that can display full 1080p resolution. Says Stringer of the PS3: "It's designed for the future as much as it is today."

It may be priced for the future too. In the U.S., Sony is charging $500 for the 20-gigabyte edition and $600 for the 60-GB box. (By comparison, the Xbox 360 costs $300 for a basic version and $400 for one with a hard drive; the Nintendo Wii console costs $250.) Throw in a few PS3 games, at $60 a pop, and you're out $900--a sum that may scare off consumers. And PS3 already frightens stock analysts. "We do not believe the machine provides incentives for buyers to buy a new machine ... except some game maniacs," Merrill Lynch analyst Hitoshi Kuriyama wrote in a recent report.

Sony is also launching a Ferrari when a Porsche (the 360) or Mazda (the Wii) may work fine for many families. Games such as Brain Age and Guitar Hero, which attract the mainstream audience, often don't require the most advanced hardware--it's their novelty, storytelling and fun factor that count. Moreover, game publishers are increasingly going to multiplatform strategies for big titles, as production costs have soared. That means fewer exclusive games for one console system, an ominous sign for Sony with the priciest box on the shelves.

At retail, Sony may soon find itself in a price war with Microsoft. Given its year head start, Microsoft could afford to cut prices on the 360 by up to $100 this spring. Xbox Live, the online service, has proved popular with gamers--and Microsoft recently announced HD movie and TV-show downloads for it, a possible killer app. Sony has similar aspirations for its online offering, which is getting a major upgrade with the PS3, though for now it's playing catch-up.

Ironically, analysts who once criticized Sony for falling behind the technological curve are faulting it for being too advanced with the PS3. Blu-ray discs can show game graphics and movies in gorgeous detail, for instance, but few households currently have TVs that can display the full resolution of the format. That will change as prices for those TV sets decline. But consumers may also be reluctant to invest in the PS3 given that Sony and Toshiba are waging a format war over next-generation DVDs--no one wants to be saddled with another Betamax. "A lot of the technology in the machine will not drive the market until the end of the PS3's life cycle," says Yankee Group analyst Mike Goodman.

Sony execs point out that similar barbs were hurled at the PS2 when it launched in 2000. Yet the PS2 became a monster hit, and still outsells even the 360. The Cell processor, moreover, isn't just going into the PS3. It will find a home in hundreds of products--horizontal, remember? As for Blu-ray, at worst it loses to Toshiba as a movie format but lives on in the gaming world as a top-notch platform.

Nonetheless, investors won't see a payoff for years. Sony will probably lose $1.7 billion selling PS3s in its 2007 fiscal year. Analysts for the Yankee Group estimate Sony spends $700 to $800 to make each PS3, creating a loss on every sale. The games division won't return to profitability until several million units have been sold, as component prices fall and revenues from higher-margin software kick in. Said Stringer: Sony will "have to generate some excitement and profits from elsewhere in the company."

And that won't be easy. Sony faces relentless competition in its core consumer electronics business. In the TV category, Sony is just now beginning to break even, partly because it was so late to switch to production of flat-screen TVs. In typical Sony fashion, the engineers weren't convinced that existing LCD technology was up to Sony standards and wasn't worth investing in. Wrong. Sony was forced initially to buy flat panels from rivals like Sharp. In digital cameras, though, Sony has been far more successful.

The uneven results have critics wondering if Stringer should break up the company. "It's time Sony takes a hard look at where their non-electronics divisions fit in the larger picture," says Yasunori Tateishi, author of Sony Inside Story. "The company talks about synergy, but it's never been realized."

This criticism drives Stringer nuts. In a world where everything is connected, he says, why disband a brand that can fulfill a consumer's every entertainment wish? He says the plan to get sprawling divisions to work together more closely is succeeding. "I just came back from China and the word Sony United is being stamped across every office there," he says. "People want to bring the company together." Slogans are one thing, though, and even Stringer acknowledges, "We still have a ways to go." Game on.

The original version of this story gave the incorrect price for the Xbox 360 video game system as $400 for the basic version and $500 for one with a hard drive. In fact, the two versions of the Xbox cost $300 and $400 respectively.

With reporting by Toko Sekiguchi, Bryan Walsh/Tokyo