MAY 22, 2007 • DFC Intelligence believes that dedicated portable game systems are likely here to stay for the foreseeable future and should only increase in popularity. As it stands now, there are three major portable systems that have quality backing from today’s top developers and publishers: the Nintendo DS, the Sony PSP, and the Nintendo Game Boy Advance (as an established system and able to play on the DS). On top of this there are literally hundreds of millions of other devices already in consumer hands that have the ability to play games. However, only Nintendo and Sony have been successful at building a stable base that can be consistently profitable for game developers. Time will only tell if the marketplace, for the first time in its more than 25 year old history can sustain more than one successful handheld.

Nintendo has more than held its own thus far with the DS. In 2005 the DS started to pull far ahead of the PSP in Japan as the DS went past the 10 million user mark. With the release of the DS Lite and innovative games, the Nintendo DS started to significantly outsell the PSP in North America and Europe in the second half of 2006. By the end of 2006 North America and Europe had DS sales of nearly 10 million units each and clearly the momentum was with the DS over the PSP. The DS is clearly a success in all major markets and by 2007 was the hottest game platform in the world. In January 2007, Nintendo released the DS Lite in South Korea, and soon China – neither of which historically has had a traditional video game market.

It is clear that the Nintendo DS is helping expand the market, especially in Japan. However, the issue with this expansion is that these new users may not be active buyers of software. Or at least not the traditional software for game developers. As discussed in the game genre section, many of the DS titles fall into the simulation, strategy and casual puzzle genres. However, many of the products are not even games at all. This is especially true in Japan where products like English Training and a portable cook book have become popular. If the DS is increasingly purchased for those type of applications than the tie rate for purchase of actual games will be low. Thus game publishers need to be very careful when looking at just the raw sales numbers.

Many companies have been rumored to be possible entrants into the portable game market including Microsoft, Apple and cell phone manufacturers like Nokia, Motorola and others. However, it is likely that the strategy of these companies will be to focus on added game functionality to another portable device such as a cell phone or music player. It should be stressed that such a device IS NOT considered a portable game device for purposes of this report. To highlight this point we would use the example of Nokia’s N-Gage. The original N-Gage, released in 2003, was a game device that offered other features, most notably a cell phone. In 2007, Nokia is re-releasing the N-Gage brand as a game playing feature on many different cell phones. The original N-Gage would be included as a dedicated game platform. The new N-Gage cell phones are not considered to be phones, not game systems and thus not included in this report.

With the PSP the issue is a little different. There is no doubt the PSP is a portable game device, despite the system’s powerful movie and audio functions. Although the ratio of UMD movies to games published for the PSP was in favor of the former early on, motion picture studios have backed off supporting the system as UMD sales have fallen off. PSP owners discovered it was far easier and cheaper copying a movie from DVD to a Memory Stick for PSP playback, than buying UMDs for the system.

As for games on the PSP, thanks to superior graphics compared to average handheld devices, the focus has been on bringing over portable versions of what consumers like on console systems. The problem is that in terms of graphics and play control a portable system can never compete with a high-end console system that is connected to a large screen display. The display is simply smaller and the controls by nature need to be simplified. Sony is asking consumers to pay full price for what amounts to watered down versions of what they are getting on the console systems. What seems to work best on portable systems are games that are more strategic in nature and/or use more simplified controls. It is unclear whether the bulk of consumers really desire a portable system that mimics what they are already playing on their console systems.

Yet in just its first year on the market, third party publishers have had greater success on the PSP than they had on the Nintendo systems. Take Two Interactive’s game Grand Theft Auto: Liberty City Stories generated over $100 million in revenue in the first year of the PSP’s life. Other third-party titles have not had anywhere the success of the GTA games but have still generated some solid revenue. Electronic Arts, with its popular sports games and franchises was able to generate $252 million in revenue from the PSP in fiscal 2006. This was more than twice the revenue EA had ever generated from the well established Nintendo portable platforms.

By comparison, third-party publishers have struggled to make a profit from the successful Nintendo portable platforms. In part this is because Nintendo is successful with its own software that it overshadows the potential of software from third-party publishers. Nintendo regularly generates over $1 billion a year from its own published software. Another reason for the difficulty faced by third-party publishers for the Nintendo portable platforms is the high cost of goods that varies based on the amount of memory required for the game. The low margins mean publishers have been leery about sinking too many development resources into portable games. This becomes a Catch-22 because a limited budget means a mediocre game and a mediocre game usually results in mediocre sales.

Still, the PSP has become a problematic platform for publishers. The platform has been overcrowded with software. Consumers seem to be getting leery of publishers porting their popular graphic-intensive action titles from the console over to the PSP. With a limited installed base, average unit sales are weak, about what they would be for a Nintendo portable platform. Furthermore, development for the PSP, with its more sophisticated graphics capability, is significantly more expensive than for the Nintendo DS or Game Boy Advance. A DS title can still be developed for $500,000 to $1 million. On the other hand, even a mediocre PSP title can cost over $2 million.

In the end, the DS, PSP, and even possibly the GBA, present strong potential profit opportunities for third party publishers. However, to take advantage of this opportunity will probably require a significant investment in creating a product that takes advantage of the unique attributes of a portable game system. In short, developing a high quality hit tile for either the DS or PSP could easily take an investment in development of $5 million or more. Without that type of investment it will be very hard for a portable game title to break the 500,000 unit sales level. Publishers have preferred to invest those resources into console games where the margins are higher and the success rate a little better.

Another factor impacting third-party publishers is that Sony has been slow in reducing the price and retooling the system by introducing a new form factor. With the PlayStation 3 and Blu-ray introduction Sony is in a major struggle to build several new platforms. Thus, there is a major question mark of how much bandwidth Sony has to focus on the PSP going forward.

Expectation: Best Case Scenario Nintendo DS
With current market conditions we feel that the Nintendo Best Case Scenario is the most likely to occur. The Nintendo DS has extremely strong momentum in the market in early 2007. That’s’ not say that there isn’t a Best Case forecast for Sony, only that is dependent on a retooling of the PSP, including the release of a new PSP form factor. As of spring 2007, Sony has given no indication that they will release a new PSP form factor. Should that retooling occur, then we the Sony Best Case Scenario below would be more likely.

Under both scenarios there are projections for “other” portable systems. This would be for unannounced systems from a third party manufacturer, not a new system from Nintendo or Sony. So far there is no formal announcements on such a system and most everything revolves around conjuncture and rumors. Therefore we stress that all forecasts for “other” systems need to be taken with a grain of salt. We have modeled what we think such a system would look like but have no details to make a solid case.

Finally it should be noted that we have been very cautious in our long-term forecasts. This is because of the uncertainty over new portable platforms and also the competition between other devices such as cell phones and music devices. We do not think game sales for these systems will come anywhere close to that of the dedicated portable game systems, but they could have some negative impact on sales for dedicated systems. The market could be substantially greater than what we have forecasted but with such uncertainty we caution that prudence is probably the best strategy.

Nintendo Best Case Scenario for the DS
• This scenario assumes that the Nintendo DS maintains its momentum for several more years. This is considered the most likely scenario based on current market

• The Nintendo DS is the worldwide market leader with a cumulative installed base of nearly 115 million units worldwide. This puts the system on track to be the best-selling interactive entertainment system ever, including console systems.

• The Nintendo DS is strong in all major markets around the world. Sales in Japan exceed 30 million units and sales in North America and Europe/rest of the world exceed 40 million units each.

• Worldwide DS software sales peak at $3.3 billion in 2008. By 2011, DS software sales have declined to $1.7 billion.

• The Sony PSP is able to establish a solid installed base of 45 million units worldwide. The system is strongest in North America with sales of nearly 18 million.

• PSP worldwide software sales peak in 2007 at $1.9 billion. By 2011 PSP software sales have declined to about $557 million.

• Under this scenario, two competing portable systems are released on the market in 2009. By 2011, these systems have solid penetration in the market with combined sales of over 24 million units worldwide. Worldwide software sales for these new systems reach $1.4 billion in 2011.

• Overall sales of portable software peaks in 2007 at $5.8 billion and decline to $3.7 billion by 2011. However, it should be emphasized that this is not an indication of decline in the overall market. The decline is more an indication of slowing for older game systems and conservative estimates for new systems. There is also expected to be slightly increased competition from other mobile devices

Sony Best Case Scenario for the PSP
• This scenario assumes that Sony puts a new emphasis on the PSP, including a releasing a new version (form factor) for the system by the end of 2008

• The Nintendo DS is still the worldwide market leader, but its cumulative installed base is only 93 million units. This still makes the DS one of the best selling portable game systems ever and overall sales are greater than with the Game Boy Advance. The GBA has cumulative worldwide sales of 82 million by 2011.

• Worldwide DS software sales peak at $2.9 billion in 2007. By 2011, DS software sales have declined to $1.2 billion

• The Sony PSP is able to establish a very successful installed base of 71 million units worldwide. The system is strongest in North America with sales of 28 million units putting it very close to the Nintendo DS at 34 million.

• PSP worldwide software sales peak in 2008 at $2.3 billion. By 2011 PSP software sales have declined to about $1.4 billion

• Under this scenario, two competing portable systems are released on the market in 2009. By 2011, these systems have solid penetration in the market with combined sales of over 25 million units worldwide. Worldwide software sales for these new systems reach $1.5 billion in 2011

• Overall sales of portable software peaks in 2007 at $5.7 billion and decline to $4.1 billion by 2011. However, it should be emphasized that this is not an indication of decline in the overall market. The decline is more an indication of slowing for older game systems and conservative estimates for new systems. There is also expected to be slightly increased competition from other mobile devices.

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