As Nintendo Co and Microsoft Corp prepare to flood the video-game market with two new consoles that promise more lifelike graphics and better sound, anal-ysts have some advice for investors: Beware the transition.
The latest crop of souped-up devices eventually will result in higher sales as gamers upgrade their systems and sophisticated features woo new users, analysts say. Still, before any benefit, the sometimes-awkward shift from older systems can lead to plunging sales as customers put off purchases while waiting for new devices.
Investors, meantime, haven't been dissuaded. Instead, they've sent shares of game makers Electronic Arts Inc, Activision Inc and THQ Inc soaring in advance of the annual Electronic Entertainment Expo, or E3, which starts Wed-nesday in Los Angeles, on hopes that new systems will give sales a lift. Some analysts say that optimism is premature because game makers' new products still face plenty of hurdles, including a slowing economy.
"People will need to see something so spectacular and unanticipated at E3 to keep the stocks at these levels," said Felecia Rae Kantor, an analyst at Lehman Brothers.
Investors are already expecting to hear prices for Microsoft's Xbox and Nintendo's GameCube and the dates the devices will reach stores this year, Kantor said. Without additional blockbuster developments, many investors are likely to sell the stocks, Kantor said.
Nintendo and Microsoft also could reveal bad news, such as delays in putting their systems on sale, which would probably cause video-game stocks to fall.
Investors are choosing to look beyond the transition by focusing on analyst predictions that sales will rise about 25 percent annually from 2002 through 2004.
"There aren't many industries out there with that kind of visible growth potential," said Sam Nordberg, an analyst with Lord Abbett & Co.
Electronic Arts shares have risen 28 percent this year, while THQ has climbed 74 percent. Activision has increased 87 percent in the same period, compared with a 16 percent decline in the NASDAQ Composite Index.
Still, if history is any guide, the journey could have unforeseen setbacks. Game sales fell 21 percent in the last transition period, from 1993 to 1995, market researcher NPD Group said, as consumers rejected Sega Corp.'s Saturn system and Nintendo delayed its N64 console.
Sales started rising again in 1996 and more than doubled by 1999.
This time, game makers must cope with an economic slowdown that has prompted consumers to pare spending on computer-related products. Some video-game executives say sales will hold up regardless of the economy, because consumers stay home during a recession and need entertainment.
Software companies depend on console sales to create a customer base to buy their games. Industry insiders say most new consoles will sell at least 1.5 million to 2 million units without any problem because hobbyists -- known for lining up the night before systems go on sale -- typically buy every console they can.
To attract additional customers and generate growth, console makers need to target casual gamers, who may be more sensitive to swings in the economy. The new game systems aren't cheap: a PlayStation2, three games, a memory card, and an extra controller can cost more than US$500 altogether.
"This has been an industry that gets a lot of money from disposable income when times are good," said Peter Moore, president of Sega Corp's US unit. "Maybe a year ago two platforms purchased in the same period of time would have been OK, but not any more."
The state of the economy could be pivotal in the holiday shopping season of 2002, when consoles should be plentiful and available for more casual gamers.
There are other potential pitfalls. Competition could result in lower prices and better products, said Jeffrey Griffiths, a senior vice president for retailer Electronics Boutique Holdings Corp. Yet consumers will also face a tough choice among the three rival consoles.
Buy a system that eventually loses, and the investment will be wasted because not many games will be published for that console. As a result, some consumers may hold off until a winner emerges.
"The bad thing could be that they get so confused that they defer a purchase decision," Griffiths said.
Software companies such as THQ and Electronic Arts likewise have to make the right choices to increase profit. If they invest time and resources in developing tools and expertise for making games for a system that ultimately fails, the effort could be squandered.
Even doing everything right doesn't always pay off.
Electronic Arts planned for months on making games for PlayStation 2 and so far has garnered some 40 percent of software sales for the system with best-selling games such as snowboarding title "SSX." Because parts shortages last year caused Sony to ship fewer PlayStations then expected, Electronic Arts lost potential sales.
The company said its sales in the fiscal year ended March 31 fell 7 percent, the first annual decline for Electronic Arts since its initial public offering in 1989.
"You do have to make some bets," said Brian Farrell, chief executive of THQ. "Our job is to make those decisions."
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