How Apple TV Might Disrupt Microsoft and Sony

Beyond the fact most of us had nothing better to do in the 1980s, a big reason to own a gaming console was that they were a phenomenally good deal. In 1985 Nintendo introduced the Famicom to North America as the Nintendo Entertainment System for a mere $199, a remarkably low price considering the average PC cost around $2,400.1 While PC prices soon began to fall, the Playstation/Nintendo 64 generation was still nearly $1,500 cheaper than the average PC.

Over the last two generations of consoles, however, prices have actually risen, and today a Playstation 4 or Xbox One is nearly the same price as an average PC.

PC prices have plummeted while console prices have slowly risen
PC prices have plummeted while console prices have slowly risen

In some respects, this makes no sense: why hasn’t Moore’s law had the same impact on consoles as it has had on PCs? Moreover, when you consider that consoles now compete with a whole host of new time-wasters like phones, tablets, social networks, dramatically expanded TV offerings, the Internet, etc., it’s downright bizarre.

I think the answer lies in a specific part of disruption theory. Specifically, incumbents are driven by their best customers to add more and more features that drive up the price, causing the incumbents’ product to move further and further away from the average customer’s needs (needs which have actually been decreasing as more entertainment options become available):

High-end and low-end customer needs have diverged, and Microsoft and Sony have chased the high-end
High-end and low-end customer needs have diverged, and Microsoft and Sony have chased the high-end

It’s hard to imagine an industry where high-end customers are more vocal and demanding than the console business, and there is no better example of this phenomenon than the Xbox One. Just before last year’s E3, Microsoft formally introduced the Xbox One with a heavy emphasis on its built-in Kinect and entertainment features. While their presentation featured trailers for a few upcoming games, it was clear that Microsoft was finally making a major play for the living room. And, excuse my French, gamers went apeshit.

Beyond the perceived lack of focus on games, gamers objected to the Xbox One’s always-on capabilities (meant to facilitate Kinect voice commands), its DRM, its price ($100 more expensive than the Playstation 4), and, especially, its perceived sacrifices in performance. Sony pounced on gamers’ disgust, using their E3 presentation and launch runup to position themselves as the anti-Microsoft pro-gamer alternative, and successfully so. The Playstation 4 beat the Microsoft One out of the gate, and has only increased its lead since then.

Microsoft, meanwhile, has been backtracking furiously, completely remaking their DRM, making the essential Kinect optional, lowering the price, and this week at E3 focusing on “nothing but games”. From CNet’s coverage of Microsoft’s press conference:

“You are shaping the future of Xbox and we are better for it,” said Xbox head Phil Spencer, the first Microsoft executive to take the stage before the conference launched into its first demo, a gameplay showing of Call of Duty: Advanced Warfare. “We are dedicating our entire briefing to games,” he added to strong applause.

So began a press conference where barely a sliver of time was dedicated to even acknowledging the existence of the Kinect camera and motion sensor, which was unbundled from the Xbox One last month, or any of Microsoft’s original television programming or entertainment features.

Let me be very clear: this is a perfectly rational response by Microsoft, and a strategic disaster, all at the same time. The reason the Xbox existed in the first place was to give Microsoft a toe-hold in the living room. Over time the expectation was that the entertainment aspects of the console would make it appeal to not just gamers, but normal consumers as well. Instead, Microsoft has (understandably) been captured by gamers, and the only purpose their original strategic intent has served has been to make them less competitive with said gamers (the Xbox was more expensive and made different processing choices in order to accommodate the Kinect-centric entertainment focus). Meanwhile, no rational non-gamer will buy an Xbox One for $499 $399 in the face of sub-$100 alternatives like the Apple TV, Kindle Fire TV, or Roku.

Here’s the thing though: I’m not sure that Microsoft’s strategy was wrong, broadly speaking. As I wrote in Black Box Strategy, the TV is worth fighting for:

As I’ve written multiple times, the scarcest resource for consumer tech companies, especially ad-supported ones, is user attention. There are only so many minutes in the day, and their consumption is zero-sum: a moment spent doing activity A is not spent doing activity B, and then that moment is gone.

Meanwhile, TV continues to monopolize a significant amount of that user attention. Although digital products have overtaken the amount of time spent on TV, primarily due to the accretive time spent on smartphones, the absolute time spent on TV has remained stubbornly persistent at about four-and-a-half hours per day per U.S. adult (source).

What Microsoft messed up is the exact thing they seem to always mess up: timing.

Back in 2001, when Xbox launched, console hardware was still not “good enough” for most gamers. The Xbox was big and bulky, with remarkably dated graphics that don’t even stand up to modern smartphones. It made sense to follow the standard console pattern: produce hardware just at the edge of possible, sell it at a loss, and make up the difference through game licensing and bending the cost curve. However, once Microsoft was committed to that pattern, they were stuck with it. And so, it’s 13 years later, and Microsoft (along with Sony and Nintendo) has only launched three consoles.

Compare that to Apple (or Samsung or Nokia), which has launched 8 new iPhones in the last 7 years (plus 7 different iPads in the last 4). True, for most of that time all of those phones and iPads have cost more than a console, and even if Apple has fewer fragmentation issues, there is still tremendous efficiencies to be gained from developers writing for one specific platform.

However, the developer environment has changed as well. In particular, the move to HD graphics increased the cost of development significantly, leading most developers to focus on cross-platform engines that let them easily develop games that ran on Xbox, Playstation and PC. These high costs also began to squeeze out smaller developers and increased the focus on blockbusters – often sequels and formula-type games – that were sure to earn back their investment. Prices of games increased as well – $60 is standard for the current generation – further turning off average consumers.

The net result is that traditional consoles are about as far removed from average consumers as they could be. There is clearly a core gamer market, and Sony and Microsoft are fighting ferociously for it, but no one is growing the pie. I think there is an opening.

Imagine a new TV product, with two models:

  • $99 with a full set of entertainment options, but no gaming
  • $179 with a full set of entertainment options, plus gaming

This TV product would be on an annual release cycle; average consumers would only upgrade every few years (the core OS and most games would support 3 generations), while more serious gamers would upgrade every year providing a nice bit of recurring revenue (this would be much more feasible today, as developers have long since developed the expertise to make games available across multiple architectures). Video games would be delivered not as packaged goods, but rather through an app store. Prices would likely be significantly lower than traditional consoles, but the aforementioned serious gamers would support a higher-price tier for AAA titles and ambitious indies. This console would also integrate seamlessly with the devices carried by many of its potential customers: video and photos could easily be transferred wirelessly, and you could even share screens or use the TV for video calling.

Unlike the current console model, these TV boxes would be sold at a profit. I’ll stop the charade – I’m clearly talking about Apple – so that I can get specific about costs. According to iSuppli, a 16GB iPad Air has a bill of materials of $269. However, that cost includes the following components that would be unnecessary in an Apple TV:

  • $90 Display
  • $43 Touch screen
  • $ 9 Cameras
  • $10 User interface and sensors
  • $ 7 Power management
  • $19 Battery
  • $42 Mechanical/Electro-Mechanical

That leaves a mere $49 in costs! I do think a console needs a controller (in fact, that’s largely the point),2 so let’s add $15, and mechanical/electro-mechanical is obviously not zero (but it’s likely less given there is less need for miniaturization); let’s put that at $25, plus $10 for a power supply. That comes out to $99; add in another $20 for IP, and you’re still talking about a box with a 33% margin. It’s a new growth driver for a company that could use one; more importantly, it increases the value of iPhones and iPads.

I’ve gone back and forth on the Apple TV as a console; there is certainly a strategic incentive to own the TV, and the way to do that is by doing the jobs TV does. Still, though, the timing needs to be right, and now the tech is there, the APIs are there, and more importantly, I believe the market is there:

There is a big market in meeting the needs of lower-end consumers (of which there are many more)
There is a big market in meeting the needs of lower-end consumers (of which there are many more)

Meanwhile, Sony3 and Microsoft will be stuck with increasingly old consoles that are too expensive and, sooner rather than later, less capable than the continually upgraded Apple TV. At that point they will lose the high end gamers as well, and the textbook disruption will be complete.

Update: I wrote a big follow-up to this article in Friday’s Daily Update (members-only), including talk about Nintendo, Playstation TV, the archaic console business model, pricing, and whether or not this will actually happen. Check it out or sign up for a membership.

Update 2: I have changed my mind about the inevitable disruption of consoles. Read Gaming and Good Enough

  1. PC Prices from 1985 to 1995 are from this paper; prices from 1995 to 2005 were found by searching CNet’s archives; prices from 2005 to present from information provided to me by Charles Arthur. I’d also like to thank @typistX for helping me search for data 

  2. I’ve gone back-and-forth as well as to whether an iPhone will be the default controller; I think that hurts the value prop, so I’m leaning towards no 

  3. To be fair, Sony has released the Playstation TV for $99; although it has some flaws, I think it’s a very smart move that shows some impressive strategic agility. However, I question how much traction they will get: both their traditional retail channels and Sony itself are incentivized to push the PS4, not the Playstation TV