case W88C82

February 17, 2011

Pricing Games: Sony PlayStation and Microsoft Xbox

The home video game industry can be traced back to May 1972 in the United States with the release
of the Magnavox Odyssey, the first home television game console, which sold for $100. Though the game
had no sound and no color, console sales grew from 100,000 in the first year to 350,000 units by 1975.1
Competitors soon entered the marketplace, and within two years there were at least eleven major video game
manufacturers, including Atari, Coleco, Magnavox, and National Semiconductor.2

Atari released the Atari VCS/Atari 2600 in 1977, featuring its soon to be world-renowned game, Pong.
Because of its full-color output, sound, and cartridge-based games, the Atari 2600 soon became the market
leader in home consoles. In 1982, Coleco entered the market with its graphically superior Colecovision. Atari then
introduced the Atari 5200, with enhanced graphics, for $269, and retailers began discounting the 2600 model.3

The promise of success in this market attracted a flood of imitators, with many distinct manufacturers
each promoting their own systems. An inevitable industry shake-out occurred in 1983.4 Nevertheless,
prospects for renewed strength in the market came with the release of the Nintendo Entertainment System
in 1985.5 At $199, the basic console was bundled with one of the most popular video games of all time, Super
Mario Brothers. Once again, success attracted more competition, and the following year Sega Enterprises
introduced the Sega Master System, which soon became a serious challenger to Nintendo.

Some generations of technology later, the industry’s first CD-based console was introduced by Sega
in 1995. Sales of Sega’s 3-D graphical Saturn, however, totaled only 1.4 million units in the U.S. over the
product’s life. This was attributed mainly to two factors: (1) the complex multiprocessor made it difficult to
design games for the system, and (2) the $399 price was perceived as too high for many consumers. That
September, Sony’s CD-based PlayStation was unveiled at $100 less than the Saturn. It became an instant hit,
selling about 1.5 million units within 14 months.6 In its traditional second-mover style, Nintendo released
its Nintendo 64 console a year after, pricing it at $199. Though it maintained its cartridge-based format,
rather than moving to CD-based technology, Nintendo sold more consoles on the launch date than Sony had
sold within 13 weeks of PlayStation’s release.7 Sega eventually ceased console production in 2001.

Published by WDI Publishing, a division of the William Davidson Institute (WDI) at the University of Michigan.
©2011 William Davidson Institute. This case was written by Research Associate Nilima Achwal under the supervision of Valerie Suslow,
Professor of Business Economics and Public Policy, and Francine Lafontaine, William Davidson Professor of Business Economics and
Public Policy, at the University of Michigan’s Ross School of Business. Acknowledgements go to Sergei Kolomeitsev, for his contribution
to the initial research for this case.

This document is authorized for use only in Dr Garima Chaklader's Applied Managerial Economics C5 at Masters' Union from Mar 2025 to Sep 2025.
 Pricing Games: Sony PlayStation and Microsoft Xbox W88C82

The early 2000s again brought an influx of new-age consoles. Sony’s PlayStation 2, released in 2000 at
a price of $299, became the best-selling game console in history.i The following year, Microsoft’s $299 Xbox
beat Nintendo’s GameCube to the market by three days. Neither the Xbox nor the GameCube fared well, with
fewer games available for their systems, as well as service and support issues for the Xbox. Microsoft spent
several years redesigning its console and released the much-anticipated Xbox 360 in late 2005. For its part,
Sony introduced the PlayStation 3 (PS3) in November 2006.8 This was the start of a period of heightened
price competition between Sony and Microsoft, which continued throughout the remainder of the decade.

Pricing Decisions

Sony positioned the PS3 as its top video game system, based on its Blu-Ray disc player and powerful
processor. There were two versions of the PS3 console. In 2006, the basic model was priced at $499 and
the premium model sold for $599.9 Microsoft also had a low-end Xbox 360, priced at $299, and a high-end
version, dubbed the Xbox 360 Elite, priced at $479.10 Nintendo launched the Wii in late 2006, priced at
$249.11

In the second half of 2007, things began to heat up. In August 2007, Microsoft reduced the price of the
Xbox 360 Elite to $450.12 Two months later, Sony reacted to a loss in market share by reducing the price of
each of its two PS3 consoles by $100.13 In September 2008, Sony cut the price of its high-end model again,
to $399.14 In the same month, Microsoft also cut the price of the Xbox 360 Elite to $399.15 Nintendo did not
change its prices.

These price levels held steady for a year. But by August 2009, as the holiday season approached and with
the economy still mired in a major recession, gaming blog speculators and analysts at the Wall Street Journal
debated whether one or both of the companies would cut prices in the near future.ii If so, they expected
console price cuts of about $100, and they speculated about the resulting sales levels. Exhibit 1 summarizes
the expectations about likely sales levels for different pricing scenarios. Exhibits 2 and 3 present the cost
schedules for Sony and Microsoft. The “overhead” expenses in these exhibits represent the allocation of
management and other fixed costs to the console division in each company. The “distribution” costs are
negotiated with retailers on a per-unit basis. The lower distribution costs at higher levels of production
reflect negotiated reductions in retailer margins available at higher sales volumes.iii

Questions

1. Given the information in Exhibits 1, 2, and 3, would you predict that Sony and/or Microsoft will
want to reduce console prices by $100? Use a 2-by-2 one-shot simultaneous game to analyze this
short-run situation. You can assume Nintendo monitors its competitors’ actions, but has no plans
to change its price.
2. Assume that demand curves are all linear. Calculate the own-price point elasticities of demand
implied by the data at prices of $299 and $399 for both Sony and Microsoft. Are your answers
consistent with your understanding of short-run profit maximization for firms with market power?
3. Can you think of reasons why these firms would be particularly aggressive in pricing their consoles?

This document is authorized for use only in Dr Garima Chaklader's Applied Managerial Economics C5 at Masters' Union from Mar 2025 to Sep 2025.
 Pricing Games: Sony PlayStation and Microsoft Xbox W88C82

Exhibit 1
Prices and Projected Annual Sales Volumes for Sony PlayStation 3
and Microsoft Xbox 360 Elite

PS3 Price Xbox 360 Price PS3 Xbox 360

Projected Number of Projected Number of
Units Sold (millions) Units Sold (millions)
$299 $299 11.25 11.5
$299 $399 11.75 7.0
$399 $299 8.25 12.5
$399 $399 8.75 8.0

This document is authorized for use only in Dr Garima Chaklader's Applied Managerial Economics C5 at Masters' Union from Mar 2025 to Sep 2025.
This document is authorized for use only in Dr Garima Chaklader's Applied Managerial Economics C5 at Masters' Union from Mar 2025 to Sep 2025.

Exhibit 2

Pricing Games: Sony PlayStation and Microsoft Xbox

Sony PlayStation 3 Production Costs per Unit (US dollars)

Units Produced
8.25 8.75 9.25 9.75 10.25 10.75 11.25 11.75 12.25 12.75
(in millions)
Production Labor 98 80 67 55 45 38 32 28 26 28
Materials & Parts 168 161 155 145 143 141 140 140 141 142
Overhead 66.67 62.86 59.46 56.41 53.66 51.16 48.89 46.81 44.90 43.14
Distribution 40 40 40 40 40 40 40 30 30 30
Per Unit Total Cost $372.67 $343.86 $321.46 $296.41 $281.66 $270.16 $260.89 $244.81 $241.90 $243.14

Exhibit 3
Microsoft Xbox 360 Elite Production Costs per Unit (US dollars)

Units Produced
7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50 12.00 12.50
(in millions)
4

Production Labor 78 69 62 56 52 48 46 45 44 44 44 44
Materials & Parts 180 172 167 161 156 153 149 147 146 145 144 144
Overhead 64.29 60.00 56.25 52.94 50.00 47.37 45.00 42.86 40.91 39.13 37.50 36.00
Distribution 50 50 50 40 40 40 40 40 40 30 30 30
Per Unit Total Cost $372.29 $351.00 $335.25 $309.94 $298.00 $288.37 $280.00 $274.86 $270.91 $258.13 $255.50 $254.00

W88C82
 Guidelines for Submitting this Case Study: Individual Assignment
Deadline: April 21th, EOD

Kindly review the case study titled "Pricing Games: Sony PlayStation and Microsoft Xbox"
and respond to the provided questions. It's important to emphasize that, despite prior in-class
discussions, you are expected to address and submit responses to all the questions. Please
ensure that your answers are adequately explained. You are also required to submit PDF files
and not a google link.

The questions are:

Q1) Given the information in Exhibits 1, 2, and 3, predict whether Sony and/or Microsoft
would want to reduce console prices by $100? Use a 2-by-2 one-shot simultaneous game to
analyze this short-run situation. You can assume Nintendo monitors its competitors’ actions
but has no plans to change its price.

Q2) Assume that demand curves are all linear. Calculate the own-price point elasticities of
demand implied by the data at prices of $299 and $399 for both Sony and Microsoft. Are
your answers consistent with your understanding of short-run profit maximization for
firms with market power?

Q3) Can you think of reasons why these firms would be particularly aggressive in pricing
their gaming consoles?

Q4) Since we studied calculating own-price elasticity in class, use the concepts learnt to solve
the following questions:

(i) Calculate cross-price elasticity for both Sony and Microsoft.

(Hint: ESony, Microsoft =? And EMicrosoft, Sony = ?)

(ii) Are they substitutes or complements?

(Hint: Use Lecture 02 PPT to answer this question in case you need a revision)
(iii) Notice from part (i), that cross-price elasticities are not symmetrical. Meaning if
Microsoft cuts prices by 1%, Sony’s quantity sold will fall by _____ % whereas if
Sony cuts prices by 1%, Microsoft’s quantity sold. Using this information, can
you comment on brand loyalty for Sony’s and Microsoft’s gaming consoles?
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