In case you haven't heard, they've begun another game platform war. The recent E3 show was chock full of important announcements concerning the new 32- and 64- bit gaming platforms. Just prior to E3, Nintendo announced they would delay the rollout of the Ultra 64 until spring of 1996, missing the all-important 1995 holiday season. Sega announced the very next week that they had begun shipping their 32-bit Saturn system. Sony followed suit by promising to have the PlayStation on retailers shelves by early autumn. Sega and Sony claimed a first mover's advantage (vis-à-vis Nintendo) in the new gaming market.

Since these events, many general business and trade publications have commented on the new systems; some have even attempted to analyze the platform war. These articles inevitably conclude that Nintendo has committed a huge blunder. These conclusions, however, are never supported by empirical evidence or systematic reasoning. Furthermore, they tend to ignore entirely the most important issue consumer acceptance of these new platforms.

Let's go out on a limb and look at this platform war from a different perspective that suggests that Nintendo may not have sold the farm after all. Instead of relying on anecdotal information or conventional wisdom to deduce that Sega, Sony, Nintendo, 3DO or whoever will come out of this thing a winner, we will rely on the principles of game theory to analyze the strategies of the participants. This is only fitting, since we are dealing with game platforms. As an added bonus, we'll include consumer acceptance of the new platforms as a in this analysis.

Game Theory and Business Strategy

Game theory is a branch of economics that enables one to examine sets of choices and the resulting outcomes systematically, and determine optimal strategies. You and an opponent are playing a game, let's call it "nuclear escalation." Both you and your opponent have two choices either build up your nuclear stockpile or disarm. While it is better for everybody if both opponents disarm, if only one disarms she is at a disadvantage. Game theory involves examining and determining if or an equilibrium exists. When a competitor examines the results of the available options versus her opponents, she may find that choosing one particular strategy will always make her better off regardless of what her opponent does. This is a called a dominant strategy. In "nuclear escalation" you will always be better off if you escalate than if you disarm, even though if both opponents would be better off if they both disarm. Since the dominated strategy of disarming would not be used, the equilibrium of this game is for both opponents to escalate.

The steps in a game theoretical analysis are:

Examine your available strategies and their outcomes.

Examine your opponent's available strategies and their outcomes.

Eliminate dominated strategies, determine the strategy your opponent will choose.

Given the strategy your opponent will choose, pick the strategy available to you that will maximize your payoff (or minimize your loss).

Payoffs in the Real World

The point about the various possibilities for other player's "moves" and the several choices available to Nintendo is that there are outcomes in the real world that have a payoff value. To use a "game theory" model to describe Nintendo's position, we need estimates of what those payoffs might be.

There are three players in this game Sega, Nintendo and Sony. Each player has two choices or strategies rollout the platform in time for the 1995 holiday season, or wait until 1996. (Atari Jaguar and 3DO, while important participants, are not considered in this game as they do not have the choice to enter or wait they are already in the market.)

For this analysis, we use a simple revenue model based on two possible market conditions for this year's peak holiday selling season a good market and a weak market. In the good market case (based on survey research by Alexander & Associates), consumers react favorably to the new introductions and 1.5 million units from all manufacturers sell. In the weaker market consumers are less favorable and only 500,000 units of all platforms sell. (Keep in mind that no game system has penetrated the mass market at a price of more than $150 to $175, and these systems are priced at $250 to $450.)

Clearly, there are many opportunities to expand on these market scenarios; one of the benefits of game theory analysis, however, is that we don't need the world's best market forecasts for an initial assessment of likely outcomes and strategic alternatives.

We divide up the total units sold equally among all participants in the holiday market but of course, that depends on who's playing. If there are three players in the good market, then we divide up the market three ways for a figure of 500 thousand units apiece; if there are two players in the weaker market, our figure would be 250,000 units for each platform. The dollar value of these payoffs is calculated at the hardware selling price times the number of units plus two software titles in the new format times their selling price. Since our focus is the companies, we use wholesale selling prices, not retail.

What about the 16-bit market? We make two basic assumptions concerning the existing base of over 20 million SNES and Genesis systems. First, Sega and Nintendo will receive payoffs from this market regardless of their new platform strategy (Sony will receive no payoff from this market as they have no 16-bit platform). Committing to the new market involves shifting resources from the 16-bit market and receiving a lower overall payoff (by 50 percent) for that market if your opponent does not commit to the new market.

If both Sega and Nintendo commit, or both do not commit, they split the 16-bit market 50-50. The second basic assumption is that if consumer acceptance for the new systems is unfavorable, the 16-bit market will be $2 billion versus $1 billion if consumer acceptance of the new platforms is favorable. (In either case, the 16-bit market in 1995 will be substantially less than it was in '94).