TV and video game contracts could be the future

Electronics makers are taking inspiration from the mobile-phone business: offer cheap gadgets to lock customers into contracts.

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(Photo: Joe Kohen/Xbox)

Don Mattrick’s keynote address should be exciting, considering it features record-breaking news, international spy intrigue and an alien attack.

The head of Microsoft’s interactive entertainment division seems right at home onstage in front of a large audience of journalists and video-game developers at the Galen Center arena in Los Angeles, where thousands of insiders are gathered for the annual Electronic Entertainment Expo, or E3. He’s already played a thunderous trailer for Halo 4, the forthcoming instalment of Microsoft’s bestselling alien shoot-’em-up, and now dims the lights again for another preview, this time for Splinter Cell: Blacklist, the next title in the long-running super-spy series. The crowd whoops and cheers as crashing spaceships and terrorist hideouts explode across the screen.

Mattrick is polished and assured, in part because it’s the fourth year he’s given Microsoft’s keynote, but also because he has only good news to share.

This year, the Xbox 360 became the biggest game console worldwide, with more than 70 million units sold since its 2005 debut. The device has been besting rivals for nearly two years running, with continued momentum being driven by the Kinect motion-sensor add-on introduced in 2010 and online functionality that lets people rent digital movies and use services such as Netflix. Both have expanded the console’s lifespan and appeal beyond just core gamers to kids and families, Mattrick says.

But for all the big sales data—not to mention the alien firefights—onstage, Mattrick’s address feels like it’s on cruise control. Business is good; the new games are sequels to popular and profitable franchises. Mattrick says the best is yet to come, but he’s conspicuously silent about the thing that everyone at E3 wants to know about: the next-generation Xbox.

At seven years old, the Xbox 360 is geriatric in the world of electronics. Rival Nintendo will launch its next-generation Wii U console on Nov. 18 to replace its similarly aged Wii, while Sony is also doubtlessly working on a PlayStation 4.

Lounging backstage after his keynote, Mattrick wonders why anyone in his position would want to mess with such a good thing: “It’s an awesome business.” Still, with the wind at his back, the Vancouver native instead has the luxury of experimenting with even more ways to keep the momentum going. And his experiment could say a lot about the future of the entire electronics industry.

In May, Microsoft announced it was testing a new pricing model where, rather than selling the Xbox 360 outright for $250 or more, consumers could opt to buy it at a company-owned store in the U.S. for $99. The catch was, they had to agree to a two-year contract to the online Xbox Live service at $15 a month, complete with early-cancellation penalties. It was a play right out of the cellphone industry’s book.

Mattrick declines discussing numbers but insists the test is going well. Its expansion to U.S. Best Buy and GameStop stores shortly after E3 adds legitimacy to the claim.

How Microsoft sells its next-generation console will likely be contingent on this experiment, which may be why it’s too early to talk about the successor. Mattrick indeed hints that this contract model could be the way forward—not just for his business but the entire $1-trillion electronics industry. “We’re just giving consumers more choice and flexibility,” he says. “We’re always trying to bring in new ways to join our ecosystem for consumers and for partners.”

That “ecosystem” is the key to the whole scheme. In the same way cellphone companies long ago figured out that the devices they sell are only the delivery mechanisms for the real product—monthly wireless subscriptions—the Xbox maker is coming to understand where its future revenue lies.

Under the old paradigm, electronics makers—mostly based in Japan—could slap one or two new features onto their products every year and make a good return. That’s no longer the case, for two reasons: hardware has become commoditized, with high-volume, low-margin producers racing each other to the bottom; and features are increasingly coming from upgradeable software, which extends the life of devices.

“A lot of consumer electronics devices are going to come out of cereal boxes pretty soon, from an economic standpoint,” says Kaan Yigit, president of Toronto-based consumer tracking firm Solutions Research Group. “The whole business is becoming so commoditized that unless you have incredible scale, how are you going to sustain that business?”

In a recent survey, SRG found that consumer buying intent is growing in only three areas: smartphones, tablets and Xbox consoles. Everything else, from e-readers to cameras to laptops, is declining.

The result is what Yigit is calling “the Japanese bloodbath,” where the stalwarts of the electronics industry—Sony, Panasonic, Toshiba and the rest—are posting steep losses and talking mergers. Clearly, the old model of selling gadgets is due for an overhaul.

In a world of ever-cheaper commodity hardware, the real and sustainable income is going to come from the online services that sell games, movies, music, books and other content. It’s actually the return of a classic idea: give away the razor, make a killing on the blades.

There are several reasons why someone might want to sell something on a contract. One is that the business is looking to boost early uptake levels. By lowering the product’s upfront cost, more consumers are likely to buy it faster. The seller may also want to increase market share, so contracts can be a quick and easy way to get a leg up on competitors. Lastly, as in Microsoft’s case, the device itself may only be the delivery mechanism for the real product.

So what’s in it for the buyer? After all, don’t people hate contracts? Consumer watchdogs and Canada’s new cellphone companies, including Wind Mobile and Mobilicity, have been saying so for years. They’ve stressed that the long-term costs of cellphone plans outweigh the short-term savings. It’s better to pay for devices upfront and save over the long haul, they say, which is the common practice in Europe and Asia.

A number of provinces, including Quebec and Manitoba, have taken heed and moved to protect consumers from getting fleeced by instituting limits to the fees that can be charged when breaking a contract early.

The big three wireless carriers, however, firmly believe that consumers desire contracts. Rogers, Bell and Telus offer phones without them, but they find the vast majority of consumers still opt for the upfront discount. About 80% of Canadian cellphone subscribers are indeed in long-term agreements, according to the Seaboard Group telecommunications consultancy.

John Boynton, chief marketing officer at Rogers (which owns Canadian Business), says that with smartphones often ranging into the $600 and $700 range, customers would rather split their costs up over time than fork it all over at once.

There’s also a degree of risk mitigation happening. The average buyer doesn’t want to get into a big outlay when there’s a chance they won’t like their purchase, or that something more desirable is soon going to come along, which is more than likely in the fast-changing technology world. Many cellphone contracts allow customers to upgrade devices with limited penalties.

“The data is massively overwhelming regardless of the rhetoric. Consumers willingly choose hardware-service agreements over and over and over,” Boynton says. “This isn’t debatable anymore. We offer both, and that’s what happens.”

It’s easy, then, to see contracts working with other categories of electronics. Cameras could be sold with printing or cloud hosting services, e-readers with book subscriptions, GPS devices with traffic reports, and so on. The possibilities are limited only by manufacturers’ imaginations.

That doesn’t mean service contracts can work in every situation. A number of manufacturers and wireless carriers have tried to sell tablets—especially those running Google’s Android software—in the same way as smartphones, yet most estimates consider such efforts a big failure. One U.S. analyst, Chetan Sharma, figures the number of tablets sold with attached data plans to be as low as 10%.

The problem with tablets may not be the contracts themselves, but that they’ve been offered in the wrong context by the wrong sellers. So far, it’s been wireless carriers giving customers discounts on the devices in exchange for multiyear data-plan commitments, but with most people using their tablets at home and on the couch as a sort of second TV or computer screen, it might make more sense for television or Internet service providers to offer the contracts.

“Steve Jobs didn’t demo the iPad while walking around, he did it while sitting in a comfortable chair,” says Shawn DuBravac, chief economist for the Consumer Electronics Association. “That to me was very indicative of what the use-case scenario was.”

Some Canadian television providers may even have an advantage when it comes to selling tablets because of their hefty media holdings. The likes of Bell and Rogers certainly have room to offer discounts on tablets if they choose to leverage the content they own—or so the manufacturers hope.

A tablet is more like a TV than a phone, making it a good platform for selling ads, says Paul Brannen, vice-president at Samsung Canada. “Don’t use the phone model as a way to drive tablet sales, use content to drive tablet sales.”

Everyone seems to agree there’s one category of electronics that’s ripe for change: televisions. With sales growth falling off a cliff in the past two years, they’re becoming the most commoditized of hardware and the most responsible for the “bloodbath” losses mounting at Japanese manufacturers.

The elephant in the room is Apple. The company has, over the past decade, transformed itself from a humble maker of computers into the biggest and most important technology company on the planet, mostly by eschewing the gadget-only approach. Apple has excelled at giving people what DuBravac calls the “360 solution,” or devices designed from the ground up to work exceptionally well with the content also sold by the company.

Now, with chief executive Tim Cook saying that television is an area of “intense focus,” Apple is poised to enter a hyper-competitive market where the margins are razor thin. What could the company be thinking? (Apple declined to comment for this article.)

A newspaper report earlier this year suggested the company was talking to the likes of Bell and Rogers about partnerships. Such discussions, if they are happening, could be limited to content deals, but analysts say it’s likely to involve more, possibly even some sort of contract model. With most consumers having recently spent thousands on new flat-panel televisions, they won’t be interested in a new model any time soon—unless, of course, Apple and others can come up with an alluring enticement.

“I’ve long believed that anyone who thinks Apple’s TV project is just another screen with an Apple logo on it is out to lunch,” Yigit says. “If they wanted to just do a TV, they would have done that long ago.”

One possible permutation of the entire contract model is a shift toward renting. In the same way that content is migrating to the cloud where it can be accessed from any device, so too might the electronics themselves move to a similar paradigm. Apple or Microsoft could, for example, outright lease the consumer a television or video-game console in exchange for a monthly subscription to their services.

It’s working in other areas of technology—online services such as Netflix and Rdio are essentially rental operations—as well as in physical goods, where companies like Zipcar and RentTheRunway.com (which rents designer clothing) are proliferating.

In the grand scheme of the changing world of how electronics are sold, contracts could actually be just a way station to a new era in which consumers don’t actually own any of their gear. The market appears to be primed.

“Renting is the new owning,” DuBravac says. “Even real estate ownership isn’t the American dream it was. Consumers are more content to rent than ever before.”

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