Strategy: Outside the box

By David Becker
Staff Writer, CNET News.com
December 9, 2003, 4:00 AM PT

Instead, the Utah-based software engineer switches on his Microsoft game machine and fires up the Xbox Media Center, an unauthorized piece of software that he helped write and that allows a modified console to play most popular digital movie and audio formats.

"It's a convenience thing," said Phil, whose hacking hobbies discourage him from divulging his full name. "All of my movies are organized into categories, and it's very easy to navigate through the menus to find exactly what I want to watch. I have a PC in the basement of my house which stores all of my music and movies, and the Xbox makes it extremely convenient to use them."

For now, such crossmedia choice is restricted largely to those willing to outfit their game consoles with underground hardware and software. But such capabilities are increasingly being offered by console makers themselves, who believe they've finally found the right formula for "convergence"--the often-floated concept of combining diverse digital media and entertainment functions in a single box.

After years of big talk and false starts, the game industry is emerging as one of the leading contenders to create such a digital uberdevice. While consumers have yet to embrace the convergence idea fully, console makers recognize the trend's persistence and want to make sure they don't cede their spot in the living room to digital video recorders or other potential combo devices, none of which can boast a customer base near the tens of millions of home worldwide that are equipped with game consoles.

"There'll be other digital devices, like networked DVD players, pushing in the same direction," said Charlie Kim, vice president of consulting firm Bain & Co. "The best things the game consoles have going for them is that they're already there."

That domain has been guarded fiercely by games makers, which have traditionally resisted expanding the function of their devices for fear of diluting their primary business. But as their market has matured, many companies have come to believe that multifunctional devices are more likely to draw a new class of casual gamers to the market than to distract current customers.

Moreover, the industry has finally identified which digital activities should converge on its boxes. Early assumptions for convergence devices included Web surfing and e-mail, which Sony promoted through a partnership with America Online that has yet to bear fruit. But the idea of a games console with a keyboard seemed to make little sense.

"People have finally accepted that doing Web surfing on your TV set is a horrible experience," said Schelley Olhava, an analyst for research firm IDC. Rather than emulating PC-like informational tools, games companies are broadening the functionality of their devices by adding entertainment features such as music, video and broadcast technologies.

PSX--Sony's pioneer
Sony is expected to boost the game industry's momentum toward convergence with the PSX, a pricey device that will combine a digital video recorder, a satellite TV tuner and a PlayStation 2 video game machine. The device is set to go on sale in Japan late this year and arrive in North America in 2004.

"The PSX is kind of a guinea pig," said P.J. McNealy, an analyst for American Technology Research. "It's a big testing ground for Sony to see if they can get people interested in this concept. Changing consumer behavior does not take place overnight."

Sony is also promising multimedia functionality for the 40GB PS2 hard drive it plans to introduce next March, which can be loaded with software to manage video and music files, said Andrew House, executive vice president for Sony Computer Entertainment America. Sony expects to introduce downloadable media services for the PS2 shortly after the hard drive goes on sale.

Microsoft began adding its own nongaming functions last month with the Xbox Music Mixer, a karaoke kit that also allows people to store digital photos and watch TV slide shows. Most of those functions require a connection to a PC, an approach likely to be mirrored in future expansions to the gaming device.

The software company's idea of convergence is based on providing consistent media and entertainment experiences over a variety of networked devices, said Cameron Ferroni, general manager of Microsoft's Xbox Live online game service.

"One of the things you need to be careful of with the whole idea of convergence is not to tread into it for technology's sake, trying to shoehorn every experience into every piece of equipment," Ferroni said. "Where we look at it from is: How do we make sure we can integrate all these things, to put the entertainment experience people want in their living room?"

Today's tentative steps towards convergence are expected to reach a full sprint in two years, when Sony and Microsoft reveal the next generations of their games machines. Those consoles are expected to have a wide set of features that exploit broadband Internet connections, including support for streaming media content.

Sony has identified convergence of consumer electronics and games technology as a key element of its "Transformation 60" strategy for the future, and Microsoft is believed to be taking a parallel route from the computing side.

"In my mind, if you look at what Xbox 2 is going to have, you can almost be certain there are going to be multimedia features beyond gaming," said Jay Srivatsa, a senior analyst for research firm iSuppli. "It starts to act like an audio or video server."

The move toward all-in-one boxes represents a sea change for the gaming industry. Although consoles have been technologically capable of handling any number of nongaming tasks, as Phil and other hackers have demonstrated, companies have alternated between caution and disdain toward the prospect of all-in-one devices.

Games makers have long feared that multipurpose devices would undermine their business. Hardware manufacturers typically sell their consoles at a loss, in hopes of making up the difference in software sales from the games themselves.

Sony learned the pitfalls of convergence three years ago, when it launched PlayStation 2, which plays DVDs as well as games. PS2 promptly became the cheapest DVD player in Japan, bought by many consumers who used it mostly as a movie player.

"Sony lost of a lot of money on those initial customers, because they didn't buy many games," IDC's Olhava said. "If you give people reasons to buy a console besides games, that starts to destroy the whole business model."

Even making money from games-related activities can be tough. Sony recently began offering online gam,e playing for free with the PS2, charging only for a few premium subscription games. Microsoft charges $50 a year for access to Xbox Live, but that amount is believed to be considerably lower than the cost of operating the online service.

Music boxes?
As broadband and storage advances make it much easier to download content, however, console manufacturers may find new opportunities to charge for music, movies and other media. Sony, for example, could claim a chunk of revenue from any such services provided through the PS2. As House noted, Apple Computer's success with its iTunes music service shows that consumers are willing to pay for downloadable content.

"We've found the royalty-based model works for us now with game software, and we're looking at some iteration of that" for other media, he said.

Similarly, at Microsoft, Ferroni said Xbox Live could easily carry downloaded material and probably will do so at some point. "What we've done with Xbox Live is create a platform where we can sell things on the Xbox--movies, music, whatever," he said. "That could be a real moneymaker down the road."

Noticeably absent from the expansion trend is Nintendo. The Japanese game giant has shown negligible interest in convergence and uses a proprietary media format that prevents its GameCube console from even playing music or movie discs.

"Nintendo will continue to stick with what we do best: delivering the best and most creative interactive entertainment possible," said Anka Dolecki, public relations manager for Nintendo of America. "Without the need to help support other businesses, Nintendo will remain focused on maximizing technology for the sole purpose of creating the world's best video game play."

Outside the games industry, other hardware competitors are vying to become the central media device of the modern home. Leading candidates include digital video recorders such as TiVo and sleek PCs that run the Media Center edition of Microsoft's Windows XP operating system.

No competitor, however, has consumer loyalty anywhere near that of modern games consoles, which are found in tens of millions of homes worldwide. Games companies hope to use that advantage to jump ahead of other devices in the convergence evolution.

"I think the argument is that a different type of consumer will want these cool media players in their house, and now they've got this gaming capability that's new to them," said Peter Dille, senior vice president of global marketing for game maker THQ. "They're not necessarily going to be hard-core gamers, but they'll buy a few pieces of software and expand the market."

Conversely, the industry isn't worried that regular gamers will abandon their consoles if new features are built into them.

"They're not going to get very involved in distractions," said Jeff Brown, a vice president at leading game publisher Electronic Arts. "I have a cell phone, and I have a toaster. If they included a cell phone on my toaster, I probably wouldn't make any fewer calls because I was spending so much time eating toast."

Nevertheless, consumer demand for convergence devices remains uncertain. Kim of Bain & Co. noted that different members of a household often play video games and use other media simultaneously, making it impractical to have all functions in the same box.

"The research suggests we'll have discrete devices longer than might seem logical," Kim said. "It's a matter of habit; it's a matter of who's using the devices in the home."

Complicating matters further are the differing schedules for advances in gaming and other media technologies. Many technophiles are unlikely to be satisfied with a state-of-the-art video recorder combined with last year's games console, or vice-versa.

Cultural differences also enter the corporate strategies. In densely populated Japan, for instance, a prevailing taste for expensive consumer electronics and relatively tight living spaces combine to create a much more enthusiastic market for convergence devices than in the rest of the world.

Because that success may not translate immediately in other countries, including the United States, some consumers are pursuing their own, underground paths to multimedia bliss.

"I feel that we're adding the functionality that was definitely missing from the Xbox," Phil said. "I would hope that Microsoft has, if nothing else, learned from us what the Xbox can do for multimedia." 

"I think there are definitely opportunities with voice. That whole market is very much in its infancy, and the game consoles are getting people used to the concept," iSuppli analyst Jay Srivatsa said. "But once again, the question is: How do you pay for that? Voice applications take a lot of bandwidth."