Gamer's Outpost LLC

by Mark Milian

There’s a far more entertaining video game competition happening right now than anything streaming on Twitch. It’s the shootout between Microsoft and Sony as they try to one-up each other in game-console sales.

For those following along at home, Microsoft’s Xbox One pulled ahead in sales during the holiday-shopping season in the U.S., the company said, citing data from market researcher NPD Group. That was the Xbox One’s first lead over the PlayStation 4 since its brief victory in December 2013, when Sony was struggling to produce enough of its hardware.

Several factors determine which system comes out on top in any given month: exclusive game releases, new online multiplayer features, and available apps. (On the latter, PlayStation 4 just got Spotify on Wednesday, Jan 28.) With the latest PlayStation and Xbox each having Blu-ray players, subscription game networks, and a similar roster of games, however, the lines between the two have never been blurrier. That leaves one big wild card: price.

The PlayStation 4 came out in the U.S. on Nov. 15, 2013—a week before the Xbox One—at $100 less. It took Microsoft seven months to match the $399 price. The company finally undercut Sony in November with a “special, limited-time promotional offer.” You can see what happened next in the chart below, which relies on data from the industry website VGChartz, because NPD declined to release its data.

The $50 discount ended on Jan. 3 as promised, but then Microsoft did something unusual. On Jan. 16, the Xbox One was back at $349. In a press release, Microsoft called it a “special price”—whatever that means. In an e-mail, Microsoft says it “saw a great response” to the holiday promotion and decided to bring it back. “We are not going into depth on the life of the price promotion at this time, but we will share more details soon,” Microsoft says.

The pricing strategy has been good for moving products off the shelf, although not so good for Microsoft’s profit margins. That can even out later as the company collects royalties on game sales and pushes add-ons, such as annual subscriptions to Xbox Live and downloadable content. It’s the reason many console makers are willing to take a loss on the hardware, which Microsoft and Sony are both doing, according to researcher IHS.

Game systems are a somewhat unusual breed among consumer electronics. Apple doesn’t sell the same iPhone for eight years, and you won’t find a six-year-old Lenovo PC on display at Best Buy. While there isn’t a precise formula for the economics of game-console pricing, bargain hunters can look for certain signals to determine when to buy a new system. The price is highest at launch, when hardcore gamers are willing to wait in line and supplies are low as hardware makers struggle to churn enough off assembly lines. Price drops tend to happen more frequently in the first couple of years with each new generation of consoles. And if you see an Xbox go down in price, you can expect the PlayStation won’t be far behind.

Lowering the price isn’t generally the preferred option, says Julia Miller, a former marketing executive at Microsoft and Sega. “Price is always one of your marketing levers, but the ramifications of that are pretty widespread, because you have the physical cost of goods to create the hardware,” says Miller, who now runs a digital-marketing agency called Digipowers where Sony’s PlayStation is a client. “You can only get to a certain point of dropping price to be successful.”

When Miller helped launch the original Xbox at Microsoft, things were simpler in the console price wars. As you can see from the chart below, price drops were formulaic: One company announces a reduction, and the other follows almost immediately. Microsoft was just getting a feel for the console market, and Sony could rely on a loyal fan base it amassed with its first PlayStation. (Nintendo’s GameCube was a distant third.)

At that time, the companies relied more heavily on other factors besides price to differentiate. Microsoft introduced Xbox Live in 2002 with an emphasis on voice chat, which was new to the living room, and an exclusive shooter called Halo that was an instant hit. Sony had a two-year window starting in 2001 when it had the only game system that played the mobster breakout Grand Theft Auto III.

These exclusive games introduced a different way to sell systems. Hardware makers cut deals with game publishers to bundle popular games with consoles, a move that increased demand each time a new release in the series came out. Microsoft and Sony liked doing this because it delayed the need for a permanent price drop, and publishers liked it because they sold more games. “Bundling allowed you to satisfy a consumer demand for value,” Miller says. “Bundles help sell consoles.”

In the next generation of consoles, price was used more aggressively. The Xbox 360 not only had a one-year head start on the PlayStation 3, but it was $100 cheaper. During the new PlayStation’s first year on the market, Microsoft cut the price of its cheapest Xbox 360 by $20 and then by another $80 the next year. The Xbox 360 won this round. (Well, really the Nintendo Wii did, but its simpler, motion-based games appealed to a different audience.) There were major differences between the two systems from Sony and Microsoft. For one, the PlayStation 3 had a Blu-ray player, and the Xbox 360 didn’t. But Microsoft created another big franchise in 2006 with Gears of War, which helped it sell more consoles.

That brings us to today. Must-have games are now generally available for both the PlayStation 4 and Xbox One. None of the 10 top-selling games last year were exclusive to either system. (Nintendo’s Wii U had one: Super Smash Bros.) Microsoft and Sony have brokered for exclusive access to certain levels or weapons in some games, which they’ll bundle with their consoles, but those distinctions can be harder for gamers to make.

So price is becoming an even more important lever. Sony, which didn’t respond to a request for comment, can’t afford to take as big a loss as Microsoft in the game business. The Japanese company, which is in the middle of cutting thousands of jobs, has $14.1 billion in cash and equivalents, according to data compiled by Bloomberg. Microsoft has more than six times that amount, which means it can afford to eat an extra $50 per console for quite a long time.