WILL VIDEOGAME MACHINES BREAK MICROSOFT'S MONOPOLY?

While the Justice Department and Microsoft were busy debating the finer points of antitrust law, we were roaming the aisles of the huge Electronic Entertainment Expo in Atlanta, checking for a credible alternative to the Windows-Intel hegemony. The E3 show is one of the events where videogame technology is taken seriously, and we saw some intriguing signs that companies like Sony, Nintendo and Sega just might become serious players in the home computing market.

In some ways, of course, these machines already compete quite successfully for consumer dollars. Worldwide videogame sales are reported to be worth some $15 billion a year; 40% of U.S. households currently own some type of videogame device. And it took the Sony PlayStation--currently the best-selling platform--less than three years to reach a worldwide installed base of 30 million machines.

One reason for this explosive growth is that videogame machines are amazingly cheap--$149 for a PlayStation console. Often, these devices show up as a second machine in households that already own a more expensive PC. But technology is also an important factor: The new videogame machines now support full 3D rendering, decent sound quality, full-motion video, and a much richer graphical environment than earlier-generation game devices. No videogame machine is as versatile or sophisticated as the latest multimedia PCs, but the technology gap is definitely closing.

The more interesting question is whether videogame machines can move beyond their high-twitch, death-to-aliens roots. Without keyboards or disk drives, these machines aren't going to displace full-featured PCs or even NCs. But there's arguably a broader market in edutainment (where keyboards aren't essential) and, with some inexpensive enhancements, perhaps in e-mail and Internet access applications. In fact, a few publishers at E3 were already testing the waters with educational titles for younger kids, and we suspect this is a segment that could grow explosively as early as this coming Christmas season.

The E3 show is also a powerful reminder of the sheer distribution muscle that the big videogame companies can deploy. PC software and hardware vendors still rely heavily on computer and business-to-business channels that don't always attract mainstream consumers; the videogame companies dominate mass merchant chains, toy stores, consumer electronics outlets, and other stores that reach broader demographic segments. In addition, the videogame companies have a better grasp of the leverage points of consumer marketing--branding, television, in-store promotions--than their PC counterparts. Half of U.S. households don't yet own any kind of computing device, and it's conceivable that many of these consumers will end up with Sony PlayStations rather than Windows boxes.

Moreover, videogame hardware manufacturers usually have a stake in the revenues of third-party software developers (who have to buy cartridges or CDs from the hardware vendor), so videogame companies tend to put their marketing dollars behind independent software titles. Since videogame companies only grant licenses to developers with strong products, moreover, the marketplace is relatively uncrowded and orderly; the entire PlayStation platform supports only about 350 software titles. As a result, it's common for videogame titles to sell in excess of 100,000 units each.

It's this software-centric business model that makes the videogame platform a tough challenge for Microsoft. Although Sega has announced that its next-generation DreamCast machines will run a variant of Windows CE, it's unlikely that Sony or Nintendo will ever buy a generic operating system from anyone--and it's hard to believe that Microsoft will be willing to sell Windows cheaply enough to run on a machine that retails for less than $200. The videogame business is a universe where hardware companies compete on genuine differences in technology, where good software developers are courted and rewarded, and--judging from E3--where the Microsoft booth at a major show is mostly deserted.

Will the videogame and Wintel universes ever compete head-to-head in one home computing marketplace? That's a tough call. But it's worth remembering that Detroit's monopoly of the auto industry was finally broken by companies like Honda and Toyota that got their start by building motors for lawn mowers and motorcycles. It could happen again.