Way back in the 20th century, 1994 to be exact, a price war was raging between the Daily News and the New York Post for the price of New York’s Daily Tabloid Newspaper. The lessons of this exercise in game theory provides insight into the ongoing console wars between Microsoft, Sony, and Nintendo. In addition,  Sony’s CES announcement that it will not be launching PS4 at the 2012 E3 conference (E3 is the video game industry’s largest conference) is one of the best illustrations of game theory seen in recent years.

(Disclosure: I am employed by Microsoft. I neither work on Xbox nor have insight into their product marketing, product strategy or product roadmap. This blog reflects my personal opinions as a practitioner of business strategy.)

Game Theory and The Newsstand Price War of 1994

When applied to business, game theory provides a set of tactics to change the players, values, rules, perceptions, and scope of a given industry. In the case of the 1994 newsstand price war, the price war began with The Daily News, and Rupert Murdoch’s New York Post priced at 40 cents a paper. (The following case study is adapted from Harvard Business Review’s The Right Game: Use Game Theory to Shape Strategy)

At the time, the newspaper industry was quite familiar with newsstand price increases. For example, In 1992, when the Chicago Tribune increased its price to 50 cents, the Sun-Times remained at 35 cents and gained substantial share. Much as Pepsi and Coca-Cola mirror each other’s price increases, in the newspaper industry when one competitor raises prices it is a signal to others to do the same.

In 1994 newspaper operators were facing costs for newsprint that jumped as much as 37% in a single year, accounting for up to a third of operational expenses (David Lieberman, Newsprint Costs Roll Up: Newspapers Raise. Prices, Pare Stuff, USA Today, Dec. 5, 1994, at 1B). To respond newspapers laid off staff (evidence that it is not a new phenomenon of the internet age) and increased newsstand prices across the nation. However, in the summer of ’94, the NY Daily News was not in a spirit to comply. When Murdoch’s New York Post raised its newsstand price to 50 cents earlier that year, the Daily News did not follow suit.

With the Daily News priced at 40 cents and the Post priced at 50 cent, the Post was losing subscribers and ad revenue to the Daily News. Whereas Murdoch saw an untenable situation with increasing expenses and a lower readership, the Daily News, with its increasing readership and advertising base, did not see the same problem.

Price War or Profits: Lifting the Fog

To convey the implications of their actions- Murdoch announced his intention to drastically lower the price of the Post to 25 cents. An unsustainable price for all involved. The Daily News, doubting the Post’s resolve and believing they were gaining readership because of their superior paper- ignored Murdoch’s threat.

When Murdoch lowered the newsstand price to 25 cents as a test limited to Staten Island, The Daily News saw its sales plummet. As Newsday reported in 1994 (Nov. 17, 2994):

During the recent six-month reporting period, The Times and Daily News each raised their newsstand prices in the metropolitan area by a dime and Newsday increased the cost of home delivery. The Post, on the other hand, boosted its Staten Island circulation by halving the newsstand price in that borough to 25 cents.

Seeing the implications of a price war, and the possibility for mutual profits at a price of 50 cents; the Daily News raised its price to 50 cents and equilibrium was restored.

Sony Lift’s the Fog

So what does this have to do with Sony’s CES announcement? In 1994, the New York Post lifted the ‘fog’  surrounding the video game console industry by announcing a price decrease and demonstrating its resolve. In the case of the newspaper price war, lifting the ‘fog’ communicated to the other players that there were profits to be had at 50 cents a paper and losses to be had at all lower price points.

In turn, Sony President Kazuo Hirai’s comment during a Consumer Electronics Show round table, demonstrated Sony’s resolve; announcing Sony will not be discussing PlayStation 4 at E3 this year:

“Andy is absolutely right in that we are not making any announcements at E3,” said Hirai. “I’ve always said a 10-year life cycle for PS3, and there is no reason to go away from that.”

This single statement lifted the fog that encompassed the video game industry by communicating to Microsoft specifically, that Microsoft will not be under competitive pressure to announce its next generation console this year. In general, the big threat all companies in the video game console industry face, is being late to or missing a hardware upgrade cycle. Xbox lost big when when it launched in 2001 late to the upgrade cycle and the PS3 was late in 2006 and has been playing catch up, with some success, since.

Why Sony’s Strategy Makes Sense

By communicating to the entire industry that Sony’s stance is that 2012 is not the year for ‘next generation discussions’- Sony hopes to convince Microsoft to extend, at least for another year, the profits of the current generation hardware. As every hardware refresh traditionally brings uncertainty, intense competition, and red ink for the first few years. Sony believes it is likely to succeed with this gambit for two reasons:

• Both Sony and Microsoft have taken particularly heavy losses in this generation’s console wars. Sony having subsidized the purchase of its high cost of goods console, due to the addition of a blu-ray player; and Microsoft having written off $1B in loses associated with it’s console’s high failure rates in the early years of release.
• In addition, because Microsoft is leading Sony in profits and with Kinect breathing new life into the console, it does not have the same competitive need to announce a next generation console before its competitors- as it did with the Xbox 360.

Sony’s Tactic: Beautifully, Common Cents

With more to lose than gain, by starting the next round of console wars, Sony beautifully executed a common cents strategy to reduce needless ambiguity for consumers, industry trade press, and most of all its competitive environment. Depending on how Microsoft responds this should enable Sony to recuperate more of its PS3 investments.