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Sony's still on track despite tough figures

Sony's still on track despite tough figures

Fri 16 May 2014 7:00am GMT / 3:00am EDT / 12:00am PDT
Business

Restructuring the consumer electronics giant was always going to be hard, but there's light at the end of the tunnel

It was the best of times, it was the worst of times; while I hesitate to apply Dickens' immortal words to something as fleetingly temporal as Sony's financial woes, it's a quote I couldn't quite shake as I digested this week's results statement. Here is a company that has just launched one of its most important products in years, the PlayStation 4, to almost universal fanfare and massive sales; whose reputation has risen remarkably in its core markets and whose overseas sales are, finally, being buoyed once more by a sensibly-priced Yen. The best of times! And yet; here is a company whose computer entertainment division can't turn a profit, a company posting huge losses against all expectations, a company whose already-interminable restructuring is set to last another year. The worst of times.

Sony lost over $1.2 billion last year. Revenues were up, though; over $75 billion poured through the company during the year, a 14.3% increase on the previous year. That's important context for the scale of the loss, but it doesn't make the loss itself any smaller. Market analysts expected a small profit. Instead, they got not only a loss overall, but a loss in the videogames division specifically, whose seemingly stellar performance recently could not plug the $78 million gap in its finances.

To add to the company's woes, its new CFO - the commendably straight-talking Yoshida Kenichiro - says that next year will be another loss. There's more restructuring ahead, he told analysts at a briefing this week, and it's going to hit the company's balance sheet hard in the next 12 months. Yoshida simultaneously promises light at the end of the tunnel, and a rocky road ahead; a travel-related mixed metaphor that probably doesn't fill any veteran Sony-watchers with confidence.

"the more units PS4 sold in its launch period, the more money Sony would lose - but this lost money is really more of an investment, since the firm is betting on getting it back in software sales down the line"

It's worth digging a little deeper into Sony's results to try and understand what's actually happening here. For all that it has trimmed its operations over the past decade, Sony remains a pretty enormous sprawl of a company, with interests that extend far beyond the consumer electronics for which western consumers recognise the firm. Sony Music and Sony Pictures, of course, are major parts of the business; Sony Computer Entertainment we all know and love; cameras and TVs we understand; but how about Sony's life insurance businesses, or its banking efforts? How about its semiconductor operations, or its sidelines in making camera components for other firms' smartphones? How about its fabrication plants for CDs, DVDs and Blu-Ray discs, responsible for a huge proportion of the discs on sale around the world today?

The challenge in interpreting Sony results lies in trying to understand the full scale of those business interests and then in trying to figure out where negative results really stem from. We know, for instance, that Sony is taking on major costs in winding down disc fabrication plants in some parts of the world. We know that the television division has been in trouble for years thanks to competition (some of it state-backed) from Asian rivals, and will finally be spun off and left to sink or swim in a major swathe of restructuring this year. That won't be without its own costs, of course. Other costs or profits may be harder to discern. Clients for component businesses are generally somewhat anonymous; it's considered an open secret that Sony provides the camera for recent iPhones, but few component contracts are quite so well-known, and thus, their bottom line impact is harder to discern.

What I'm saying is that Sony (and to an even greater extent, its rival Microsoft) is a bloody hard business to read and understand on the basis of financial reports. Companies like Nintendo, Electronic Arts and Activision Blizzard really just do videogames, so when their results are poor, it's easy to discern what's going on. We know their products, we know their markets and we can usually quite easily discern the weaknesses causing difficulties (although seeing the difficulty and suggesting an effective prescription are two very different talents). Sony, however, is big, complex and obfuscated to no small degree. We get broad outlines; a big loss is a big loss; but the fine detail is hard to get a grasp upon.

None of which is to say we shouldn't try. Sony is one of the most important companies in the games business; with the success of the PS4 over the past six months, it's arguably the most important company in the business right now. Hence, yes, it's a concern that it's making big losses. It's doubly concerning that some of those losses are coming out of the seemingly successful computer entertainment division, but we can make some educated guesses at what's happening here. Firstly, the extremely high sales of the PS4 in its early months are actually a short-term negative to the company's figures. Sony's console business is a razor-and-razorblades model, selling hardware at a loss initially but recouping this money through software sales and, ultimately, through more profitable hardware sales down the line when manufacturing costs have fallen. Thus, the more units PS4 sold in its launch period, the more money Sony would lose - but this lost money is really more of an investment, since the firm is betting on getting it back in software sales down the line.

High early sales also contribute to losses in other ways. Sony's launch plans for PS4 were hugely ambitious in terms of the number of units shipped to each territory; the company did end up somewhat supply-constrained, but it aimed to avoid such constraints where possible with enormous shipments and rapid resupply of inventory. This strategy may have been partially aimed at capitalising on Microsoft's launch weakness before strategic changes could be made to the Xbox One's product or pricing, but I'm sure that a wider goal was also in mind. Rapid sales of a new home console would silence some critics expecting tablets and smartphones to destroy this market sector entirely; such rapid sales would require a good supply chain, and those don't come cheap. The exceptional ramp-up of Sony's PS4 manufacturing capabilities won't have been cheap, an expense compounded by the loss the firm will have registered on manufacturing every PS4 shipped to date.

In the short term, that means a loss for SCE; but CFO Yoshida seemed pretty blase about that, and rightly so. In the medium term, it's a good investment. Sony has a great track record of strong attach rates for its consoles, meaning it will get its money back with interest. Moreover, it has a truly fantastic track record of cost-cutting on console manufacture, even managing to get the tricky Cell-based PS3 into a vastly smaller and cheaper casing in the end. The faster the installed base grows, the faster the bulk discounts to manufacturing costs can be realised; with PS4 selling far faster than PS3 or Xbox 360 did before it, Sony can expect its new console to be in the black well ahead of schedule.

As for the rest of the company; I reiterate my position that Kaz Hirai's job is not an enviable one. It was said of John Riccitiello's tenure at EA that he faced the task of trying to explain to shareholders why his company was in the fifth year of a three-year restructuring that was going to take seven years. Hirai's task is even more tricky, in some regards. He's only been in the top job for two years, so if his ambitious restructuring can truly be completed by next year (as Yoshida claims, with some authority) then it will actually have been a rather fast turnaround. However, Sony is already restructure-weary; seven years of turmoil under former CEO Howard Stringer left the company and its commentators skeptical of any claims regarding light at the end of the restructuring tunnel. Stringer did many good things and helped to move Sony's culture to a point where Hirai's ideas could find fertile soil, but he also permitted (or felt that he could not fight) all manner of poor strategy in core divisions, most notably television, where Sony has stumbled from disastrous strategy to doubly disastrous strategy on a near-annual basis for the past decade.

"Even if another year of pain does loom for Sony, the end might finally be in sight; in 12 months time we can hope to hear of a leaner, tighter and more focused Sony, with black ink finally starting to crop up on its accounts"

Hirai, at least, appears to have the confidence and the clout to make his plans work where Stringer's did not. Separating the almost certainly doomed TV business from the rest of Sony is a good plan, but one that required extraordinary political capital within the firm. Having the respected Yoshida as CFO is also a good move, since it's given Hirai the cover he needs to bring all of the financial pain of his restructuring plans into the current year and the following year. The temptation would have been to spread things out, but the markets seem to respect Hirai and Yoshida's honesty in front-loading the costs, anticipating a return to profitability in two years' time.

That, perhaps, is the big difference between Sony and Nintendo - two companies that have been compared heavily in discussion over their recent financial results. Both have some very profitable divisions (3DS does well for Nintendo, while movies and finance, in particular, are solid performers for Sony), but both have just recorded financial results well below expectations and triggered alarm among market commentators. Nintendo, though, can only suggest vague directions it might take to exit its current situation; it will take a major new product announcement to see whether the company can get back on track, and that's not likely for a couple of years. Until then, Nintendo's financial health is largely a matter of faith.

Sony, on the other hand, has a plan. It's a tough plan, but a solid one; the divestment of loss-making businesses, the refocus on core pillars that actually make money, and more specifically to our industry, the tried-and-tested approach to bringing the PS4 into profitability as rapidly as possible. A CFO like Yoshida can speak plainly about how Sony is going to change, what it's going to cost and when it's going to start making money; Nintendo, relying on products still under wraps to give it a relevant future, lacks the ability to be so blunt and straightforward about how it will build future success.

Even the rather tolerant Japanese stock market and its very patient institutional investors have limits, and Sony could yet reach those limits. The company's restructuring to date would try the patience of even someone playing a very long game; but Yoshida is a credible figure, Hirai seemingly retains the ability to carry out the reforms he plans, and the company's generally profitable divisions, including games, are still in good shape. Even if another year of pain does loom for Sony, the end might finally be in sight; in 12 months time we can hope to hear of a leaner, tighter and more focused Sony, with black ink finally starting to crop up on its accounts.

5 Comments

Alfonso Sexto
Lead Tester

813 643 0.8
If I have to make a rough comparison; if EA found a way to start recovering after 4-5 years of looses, I'm sure Sony will be able to do the same.

Posted:4 months ago

#1

Christian Keichel
Journalist

682 925 1.4
Thus, the more units PS4 sold in its launch period, the more money Sony would lose - but this lost money is really more of an investment, since the firm is betting on getting it back in software sales down the line.
Sony's software revenues were up 30% in the last fiscal year, so I don't see what kind of software sales improvement you expect for the company to make money again. On a side note, has anybody seen any software unit sales for the Playstation consoles? Until 2013 Sony reported unit sales, but in the new financial report I didn't found any note on unit sales any more, only revenues, which makes the numbers hard to compare.

Edited 1 times. Last edit by Christian Keichel on 16th May 2014 9:54am

Posted:4 months ago

#2

Nick Wofford
Hobbyist

180 190 1.1
@Christian
Yeah, my initial guess would be that software sales are going to go down over the next year or so, not up, because more and more PS3's will stop being played. But while that number drops, I highly doubt tens of millions of PS4's will compensate for that, so it'll probably be rough on software sales (for the X1 as well, for the same reason).

Posted:4 months ago

#3
Christian: I'm not predicting a software sales improvement, and I don't think anyone reasonably expects PS4's tie ratio to be any better than PS3's (possibly more units sold but at lower ASPs).

Rather, the point is that selling PS4s now at a loss builds an installed base which will enable Sony to continue profiting from software. In a few quarters' time, perhaps sooner, PS4 will be sold at break-even or better, and the units being sold at a loss now will have recouped that loss in software sales. That's how the business works; a platform holder is to be expected to lose money at launch, and must look to a much wider picture (a 5 year or longer lifespan) when considering the viability of a platform business.

Anyone surprised that the Sony Computer Entertainment division lost money in the launch year of a next-gen console hasn't been paying attention to how this business works. In fact, I suspect that the knowledge that PS4's launch would undermine SCE's figures may account for Sony's decision to shove so many exceptional loss items into this year rather than spreading them out over the coming years; better to get all the bad news out of the way at once, and give the world a real "turnaround" story next year when PS4 switches into profit and the restructuring is nearing its goal.

Posted:4 months ago

#4

Christian Keichel
Journalist

682 925 1.4
Rather, the point is that selling PS4s now at a loss builds an installed base which will enable Sony to continue profiting from software. In a few quarters' time, perhaps sooner, PS4 will be sold at break-even or better, and the units being sold at a loss now will have recouped that loss in software sales. That's how the business works; a platform holder is to be expected to lose money at launch, and must look to a much wider picture (a 5 year or longer lifespan) when considering the viability of a platform business.
This is exactly what Sony tried with the PS3, it didn't work. Now that they are selling more PS3 games then ever, they still loose money. They don't only loose money since they released the PS4, if you summarise the losses of SCE from 2007-2013, you can easily see, that the profits never even nearly made up the losses. The same goes for Microsoft since 2001. You say this is "how this business works", it's more this is how the business isn't working any more.
And it has never been working in the first place, the losses Sony took on the PS1 and PS2 hardware were not nearly comparable with the losses they took on the PS3 and obviously now on every PS4.
When Sony doesn't earn money despite a 30% increase in software revenues, it's pretty much clear, that Sony isn't in the black with every PS4 whenever they sell a game. The loss is much higher then this. Additionally the Playstation sold around 1 billion games, the Playstation 2 sold 1.24 billion games within 7 years, the Playstation 3 stood in 2012 at 595 million games. The days of software sales like on the PS1 and PS2 won't come back, simply because not enough games will be published for consoles any more. To sell your console at a loss like in previous days hasn't worked anymore in the last generation, I don't see how it can work in this generation.

Edited 4 times. Last edit by Christian Keichel on 18th May 2014 1:04pm

Posted:4 months ago

#5

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