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The Kindest Cut

Microsoft fires the first shot in the next-gen price war - but why now?

This week is something of a landmark in the lives of the next-generation consoles - with Microsoft's slashing of Xbox 360 prices in Europe on Friday representing the first straightforward price cut of the generation.

Certainly, there have been price movements before now - but for the most part, they have been obfuscated by the introduction of new hardware bundles to disguise the drops. Microsoft's prior cuts have been minor and largely unheralded, while Sony's big drop shortly after the launch of the PS3 was covered up with a major new hardware bundle and, subsequently, with the launch of the 40GB model - sans backward compatibility, much to the annoyance of many vociferous consumers.

Only Nintendo hasn't budged an inch on price since the launch of the Wii - but even taking into account the various shifts and adjustments we've seen in the SKU plans and associated prices of the next-gen machines, prices have stayed remarkably stable thus far in the generation. It's fair, then, to make the assertion that this week's cut is the first straight out shaving of pounds and Euros off the price point of a next-gen machine.

Cutting Back

The psychology behind price cuts in general is fairly straightforward. By knocking money off the asking price, consoles open up new segments of the market - consumers who wouldn't have previously considered investing in the hardware, but who will now be enticed by a combination of lower prices and a more mature line-up of software. Indeed, the inevitability of console price cuts has created a whole group of savvy consumers who recognise that the best value for money won't be had until a couple of years into a console's lifespan, and are willing to wait for the price drops before handing over their money.

As such, price cuts inevitably bring about a spike in sales - something Microsoft will certainly be hoping for after a somewhat slow start to the year. Looking back at historical chart data, it's obvious that well-timed price drops tap into a pent-up demand in the market, leading to weeks of high sales from consumers who had been holding off on their purchase until the cut.

This effect, when timed especially well, can lead to a somewhat longer term snowball effect that drives console sales for some months. It's for this reason that Sony has traditionally cut its hardware prices around September - the flood of "Now Only...", "Reduced To..." and "Save..." tags on its stock at retail, just as the Christmas shopping season starts to rumble into gear, has unquestionably helped consoles like the PS2 to achieve their record holiday sales.

March, by comparison, is a bit of an off season - but that's not to say that a similar reasoning doesn't underlie Microsoft's decision. Certainly, the company will be feeling that it needs to open up new consumer demographics for the console in order to prevent any slowdown in sales - that's not in question, and it's the main motivation behind these cuts. Putting an SKU (the Arcade console) onto the market that undercuts Nintendo's Wii is also a canny move, although it's probably optimistic to expect that it's going to eat seriously into Nintendo's market, especially with peerless mass-market products like Wii Fit on the horizon.

However, the timing of Microsoft's decision may well be a consequence of a looming battle - namely the release of GTA IV next month, which is widely seen as a key battleground between the Xbox 360 and the PS3. Building the installed base of Xbox 360 ahead of the launch is important, as is putting clear water between the price points of the PS3 and the 360. Having retailers putting Xbox 360 price-drop signs on their GTA IV displays won't hurt, either. This may not be the key motivation for the price drop, but it's certainly going to be in the back of Microsoft's minds.

Docking the Long Tail

It's in the long term, however, that console price cuts really make a difference. Microsoft had an early, if somewhat unpleasant, experience with the power of the price cut, when the original Xbox had to have its price slashed before sales could take off. It has avoided that admirably this time around (that fate, instead, arguably fell to the PS3), but it also knows that a timely price cut can have a vital effect on the curve of the installed base graph - with the immediate spike effect being, in the final analysis, far less important than the long tail.

In what is turning out to be the most competitive console battle for over a decade, Microsoft will be betting heavily on that long tail. Positioning its main SKUs at GBP 159 and GBP 199 leaves the company with little room to manoeuvre in 2008 - no further drops are likely this year, with hardware bundles being the main option left on the table if Microsoft wants to change the value proposition. As such, the firm is betting that its new prices will remain attractive - and keep pulling in new consumers - right through to Christmas.

It may well be right. Nintendo, still selling Wii units almost as quickly as it can build them, isn't going to want to drop its price any time soon - and even if it does seen the Arcade starting to eat up Wii sales, it's most likely that it'll price-match Microsoft, rather than undercutting. Sony, meanwhile, remains stuck at the top of the price scale with a console that's a lot more competitive than it was at launch, but which is still expensive enough to risk being positioned as an aspirational product at a time when the market is more focused on affordability than aspiration.

Sony can, of course, play its price cut cards - and I'd be hugely surprised if the PS3 didn't see a cut in the next six months. However, I'd be even more surprised if that cut brought the console in line with Microsoft's prices. With its cheapest SKU presently priced at GBP 300, a cut to GBP 200 would be incredibly tough for the company to justify. It's much more likely that we'll see a GBP 239 or GBP 249 console - leaving Microsoft with the edge on pricing as we approach Christmas 2008.

One thing is certain, however; Microsoft's price cut represents a very late, but very welcome, start to the next-gen price war. Thus far this has been something of a phoney war, with cuts being passed through as nebulous "changes to the value proposition". As of this week, the gloves are off.

For Microsoft, that means an immediate spike in sales as it hoovers up pent up demand and fence-sitters, followed by a consistently stronger sales over a period of many months - and, potentially, a major boost in sales of the 360 SKU of GTA IV. As for Sony - well, the ball is now in Sony's court. It may need to respond more aggressively than it had planned if it's going to retain the strong footing it has been building up in Europe in the past year.

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Rob Fahey avatar
Rob Fahey: Rob Fahey is a former editor of who spent several years living in Japan and probably still has a mint condition Dreamcast Samba de Amigo set.