The first proclamation on setting straight these false truths, the mythological idea that consoles have always been sold below cost.

Contrary to popular mythology, the idea of selling a console at below cost
is a rather new phenomenon.  It it not an ancient practice handed down
through the ages.

To understand how this came to be thought, you have to step back to 1994.

Late in 1994, there were two videogame systems introduced unto the world.  The Sega Saturn and the Sony PlayStation...and these consoles were not cheap.  With the exchange rate at the time, both consoles were well over $500 US each.

When Sony had demoed the system a year before, the video game world stopped and drooled.  It was unlike anything they'd ever seen before.  Fully 3D texture mapped goodness at over 300,000 polygons a second.  The 3DO by comparison which was released a couple months prior clocked in at around 20,000.

Popular legend also has it that, when Sony unveiled the PlayStation, the president of Sega walked down to the R&D department of Sega where they were working on the forthcoming Saturn.  The Saturn was to be the ultimate 2D system.  He spoke not so softly.

"Why am I looking at that PlayStation and going 'god damn, that is so going
to kick our asses?'"

"Fear not, our leader, for we have designed the ultimate 2D system to crush
the scourge that is the 16-bit Nintendo and lay claim to all that we see!"

<BLAM!>

"I'll repeat the question!  Why do I see 3D prettiness over in Camp Sony and none in Camp Sega?"

"Well, our arcade division has those $20,000 arcade cabinets which are
better than the PlayStation!"

<BLAM!>

"Why do I not hear what I want to hear?  When next I return, I want 3D
prettiness!"

"Yes sir!"

"And Mr. Kim..."

"Yes?"

<BLAM!>

"I never liked you.  That's for bringing your GameBoy to work."

Anyway, the Saturn was basically the ultimate 2D machine that had 3D slapped on at the end of the development cycle, and it showed.  Poor development software, unstylish motherboard design, and all around 3D ugliness for it's launch games.

So there we were.  End of 1994, the PlayStation and Saturn were upon Japan at more than $500 each.

Curious note:  In Japan (with exchange rates at the time), minimum wage was $3000 US a month.  So while $500 seems like a lot, that's less than a weeks wage.

Flash forward to May 1995.  The E3 Expo was having it's first go, and
everyone showed up.  Nintendo was telling us to wait for the Ultra 64 as it
could do "real-time ray tracing" and was just so damn pretty they couldn't
show it to us as we weren't ready to handle it.  For if we saw it, we would
go insane!

At the show, Sega and Sony announced their launch plans.

Sega: "The Saturn will be $399US.... and it's out now!  We launched it
today!  Remember Pearl Harbor?  That's right!  Strike when don't expect it!  Take that Sony!  We are going to kill you and dance about on your grave!  You can't handle us!  We're Sega!"

Immediately following that press conference down the hall was the Sony press conference.  There was a big lead up to what the price point would be, and when it would be launched.  Finally, the president of Sony walked out slowly on stage and a silence fell upon the room.  We all awaited his words, and finally he spoke.

"Two hundred ninety-nine dollars."

Then he turned and walked away.

Back at the Sega conference room....

"Oh no!  This can't be happening!"

Everyone was in awe.  Sony was bringing the super console known as the
PlayStation to America for almost half the price it was selling for in Japan.

This brought force claims of dumping by Atari.  Atari swore that they would have the PlayStation stopped before it came out at that price "because it
was being sold below cost and that's dumping!"

The myth was born.

By the time the PlayStation came out in North America 4 months later, a lot
had changed during the year.  RAM had gone from $50US a megabyte to $20.  The Yen had gone from 80 yen per US dollar to 110.  And Sega had dropped the price of the Saturn to $299.  At this point the PlayStation was indeed profitable, and the Saturn was a minor money pit for Sega.

Sega was not only losing money on the Saturn, but asked retailers to expect the same.  A "modest $15 per console" loss to help Sega.  Well, you can
imagine what many retailers said...

The Saturn was the first console that was actively being marketed and the
company was losing money.  While Sony was building the PlayStation from parts they made themselves, Sega was paying a higher price and buying parts from others.

The Nintendo 64 came out the next year at $199 US.  Nintendo claims that
they were not losing money on units sold, which I have no doubt not to
believe.  Nintendo has better things to do than sell a console at a loss.

The Dreamcast was a money losing venture for Sega.  Sega went for broke in building the best console they could buy with the Dreamcast, and sold them at less than cost.  A lot less than cost.  The theory being that scale of economics would catch up to let them rebuild their once glorious market share and, that the margins on their own games would be good enough to justify a loss.

$800 million lost later, Sega cancelled the Dreamcast.

Xbox.  MS has decided to follow the Sega model.  Buy off the shelf parts,
have someone else build it, and take a loss in order to push units out the
door.  The Xbox was to have been a super console that could do 200 million polygons a second... and then 300 million!  Then 125  million.... then... well, tech demo's have it running at 60 million.

Anyway, Microsoft is losing money per console sold, not including what they are spending advertising and support.  Reports have it fall between $50 to $105 lost per console.  MS has only said that they are losing money, and
won't comment on how much.

Notice what isn't on that list?  The PS2.

Unlike Sega and MS, Sony is an R&D hardware company.  They make a lot of things.  In designing up the PS2, they spent a lot of cash.  Then they spent a hell of a lot more cash to build things like the chip foundries to
produce the chips for the PS2.

In the end, before the first PS2 rolled off the production line for
consumers, Sony had spent $2 billion!  TWO BILLION!

Then we look at Sony's stock report for Oct-Dec 2000, and there is an
interesting little blurb.  It said that had Sony been able to meet demand
with another 1 million PS2 units, they would have pocketed $175 million in
profits.  $175 million divided by one million consoles equals $175 per
console profit.

Now, that is a bit high.  This assumed that the average consumer continues to buy four games per console (so around $24 in royalties), and 2 accessories (about $30 in profit total).  That reduces the $175 to about $120.  Sony is making $120 profit per system.

Granted, they have to sell nearly 20 million PS2s to pay back the $2 billion
they already spent, but that shouldn't be a problem since they already
passed that.

At this point, it's free money.

Also not on the list is the GameCube.  I haven't got numbers from anyone
yet, but it would seem that at $199 it's a break-even for Nintendo.  And
since Nintendo is planning on being the top software producer on their
system, they could quite easily eat a huge loss per system if they really
wanted to.

Edit - 12/17/01 - Nick Maragos over at "Gaming Intelligence Agency"  sent me this link http://www.thegia.com/news/0108/n23r.php that has this in it:

In more general matters, Mr. Main admitted that the GameCube's pricing would not initially follow Nintendo's rule of turning a profit on every console sold. "We expect to incur a small loss on the GameCube hardware initially, and you're right that it hasn't been our habit in the past but we expect it to turn okay early next year."

So it appears that now Nintendo has joined the ranks of console manufacturers that outsource their machine production and takes losses.

So there we have it.  The myth that was "all consoles are sold below cost"
has been vanquished!  Go forth and spread the word of The Gord, and may the light of truth chase away the shadows of lies!

Follow-up: February 2003

It amuses me the amount of email I received from people claiming that I was wrong about the PS2 and profitability.  That somehow I misjudged numbers or was making things up.  After all, mythology never lies.

Apparently this article was just a little too much reading for some people who would rather conclude nothing was said than actually bother to learn how this industry works.  Fine, here's the short version:

It's not I saying that Sony has always made a unit profit on each PS2 sold, but Sony themselves claiming that.  In both the press conferences for follow-up questions pertaining to the 2000 and 2001 stock report for investors, which were available online in audio files on Sony's website for months after the publication of their annual report, Sony openly discussed how the PS2 is profitable on each unit sold.

End of short version.  Everything else beyond that is the how and why everything works the way it does.  Is Sony going to go out and make a press release about it? "Hey!  We're making $100 profit per console sold while MS loses $100 on each Xbox!"  Of course not.  People want their hardware as cheap as possible with the perception that it cost a lot.  Consumers want a deal. They want their perceived value.  It helps to justify why games are $50 brand new instead of the $19 they should be.  Others want to believe that companies like Sony made the PS2 because they love video games and profit from a console sale goes against everything they believe in.  A number of people are offended at the idea a console manufacturer would make a profit as they've lived the lie of every console is sold below cost for years.   Plus others will say "there must be a price drop coming!" and push off purchasing a console. 

Plus for us to accept that Sony is lying and that they are in fact losing money per console sold, that means we have to accept that hundreds of employees are all conspiring to cover the truth and risking their personal fortunes and possible jail time to cover a secret that would be discovered eventually. 

Let's keep our eyes on the ball people.  Sony has sold more than fifty million PS2s. Lets pretend Sony has been lying to us all along and that the PS2 is a money pit. Assuming a true cost/price different of $200 (from the originally claimed  cost of $100 below retail to $100 above retail) on fifty million units, that's ten billion dollars.  TEN BILLION.  People are going to notice ten billion dollars missing from the bank accounts.  Hell, let's say Sony isn't even losing any money at all but instead are selling at cost.  Ok, so it's only five billion dollars missing from the bank account.  Don't dare to try and claim that this number could possibly hidden as as a rounding error.

It's not like it's some great secret that Sony makes money hand over fist on the PS2.  While Nintendo, Sega, and Microsoft all outsource production, Sony makes everything themselves.  Outsourcing means that someone else is in the loop who has to make a profit.  No one works for free.

Don't blame the messenger if you are angry that I opened your eyes to the economic realities of this market.