Video game consoles’ dominance is crumbling

At the video game industry’s first Electronic Entertainment Expo 16 years ago, Sony Corp.’s PlayStation and Sega’s Saturn dazzled attendees and defined the cutting edge of coolness with their CD drives and three-dimensional graphics.

This week, as the industry gathers in downtown Los Angeles for its annual E3 extravaganza, some experts are questioning how significant those boxes of electronics really are in a rapidly changing video game business.

After dominating the market for decades and making their way into 1 out of every 2 U.S. homes, consoles are beginning to face serious competition as teenagers and adults increasingly play games designed for smartphones, tablets and online social networks.

“Consoles are now only a segment of the video game industry,” said Kevin Bachus, a former Microsoft Corp. executive who helped launch the original Xbox and is now chief product officer for social network Bebo. “The rest of the industry is growing faster and outpacing consoles.”

A recent report from Deutsche Bank Securities Inc. projected that through 2014, spending on “social games” on networks like Facebook would grow 46% annually, other online games 23%, and mobile games 19%.

Meanwhile, spending on console-game discs is projected to drop 6% a year.

Overall game sales in the U.S. are expected to mushroom to nearly $30 billion over that time period from about $20 billion last year.

The trend is already evident in the market for portable consoles made to play on the go. Nintendo Co. once ruled the roost with its Game Boy, selling more than 100 million units since 1989. But the company recently acknowledged that sales of its new 3DS device were “not what we had expected.”

Many in the industry attribute the Nintendo 3DS’ disappointing launch to the popularity of iPhones and Android phones. Although most consumers buy smartphones to talk and email, they discover they can also use the phones to play games that typically cost less than $5, as opposed to $40 for 3DS titles.

Consoles are far from dead, however. Nintendo’s announcement next Tuesday debuting its next console, code named Project Cafe, is expected to generate headlines around the world. And through Internet connections, consoles such as the one Nintendo is slated to unveil will share in some of the growth in online gaming.

But if current trends continue, consoles may become niche products for hard-core gamers, digital media hubs for which games are just one function, or historical curios like Pong arcade machines.

“It used to be that if you wanted to play an interactive game, you could only do it with a console made by one of the big three manufacturers,” said J.T. Taylor, an analyst and managing partner with Arcadia Investment Corp. “The traditional video game guys have lost market share, wallet share, eyeball share and coolness share.”

The video game console business began in the 1970s, first gaining prominence with Atari’s 2600 system. But it wasn’t until the Nintendo Entertainment System hit the U.S. in 1985 that consoles became the industry’s driving force. They have since been updated every five to seven years with new generations of competing devices that offer jumps in processing power.

Nintendo has remained a mainstay of the industry since the mid-’80s, while former rivals such as Atari and Sega have faded and been replaced by Sony and Microsoft.

Over the last two generations, launching a new console has required an investment of more than $1 billion in research and development, manufacturing, marketing and developer support. The makers earned that money back, however, because they once had a lock on the video game industry and collected royalties on every title sold.

Today the market is more diffuse. More than 85,000 games are available for Apple Inc.’s iPhone and iPad alone. And although their production values aren’t nearly as good as those of top console titles like Halo, many players find that they’re good enough.

“In the past few years a whole new area of gaming has opened up in which the power of consoles really doesn’t matter,” said Feargus Urquhart, chief executive of Irvine game developer Obsidian Entertainment Inc.

There’s still a segment of the video game market, of course, for whom only the best will do. The avid gamers who bought more than 20 million copies of last November’s Call of Duty: Black Ops are unlikely to abandon their favorite military shooter game for an iPad app.

“Fortunately, we still have a very concentrated audience for our games,” said Ted Price, CEO of Insomniac Games Inc., a big-budget console game developer in Burbank.

But if consoles cater only to young male devotees of action games, they may alienate a broad demographic of potential customers. Women accounted for 46% of all game purchases last year, according to the Entertainment Software Assn., the trade group that stages E3. However, most Xbox 360 and PlayStation 3 owners are men.

At a minimum, it’s widely believed that the discs that are inserted into consoles to play games will disappear soon. “I don’t think we need disc drives anymore, and my hope is the next generation of consoles won’t have them,” said Mark Rein, vice president of North Carolina developer Epic Games Inc.

Once discs go the way of the dodo, it’s possible that people could use other Internet-connected devices in the living room to play video games.

“Imagine if you could download games onto a television like apps on an iPhone,” said Chris Ulm, CEO of Appy Entertainment Inc. in San Diego. “Then a lot of people would have to think whether a console is still worth it.”

OnLive Inc., a start-up run by veteran technology entrepreneur Steve Perlman, is hoping to take the industry one step further by making downloads irrelevant. The company is testing a service that runs video games on servers and streams them through a broadband connection the way Netflix streams movies.

Electronic Arts Inc. — which grew into one of the nation’s largest video game publishers with blockbuster console franchises such as Madden Football — is seeking to refashion itself for an era in which “200 million console players have become 1.5 billion consumers gaming on multiple devices,” as Chief Executive John Riccitiello said on a recent call with investors.

EA’s reconstruction of its FIFA soccer video game franchise is one indication of how consumers could be buying and playing games in the future. Once available only on discs, FIFA now is served up on the iPad and iPhone, on Facebook as a social game and online as a marketplace where players can assume the role of a team owner.

“Three or four years ago, we’d build the game, launch it and go take a break on the beach,” said Peter Moore, who used to run the Xbox business for Microsoft and is now president of EA’s sports games unit. “Today, it’s a 24-hour live operation with commerce, competitions and events. We think of our games less as a product and more as an ongoing service.” The result is that last year, EA’s FIFA franchise rang up $100 million, or more than 10% of its overall revenue, from online and mobile sources.

With billions of dollars at stake, console manufacturers are not accepting that the future could very well pass them by. Sony executives have already said they are developing a PlayStation 4, and Microsoft is widely believed to have a new Xbox in the works. Both companies have been candid about their intentions to turn their devices into digital entertainment hubs that deliver movies, music and TV shows on demand.

“Our aspiration is to be the all-in-one device for all the home entertainment you would ever want,” said David Dennis, director of program management for Xbox.

Already, the 30 million users of the Xbox Live online service spend more than $900 million a year downloading games, renting movies or buying TV shows. Netflix streaming has also become popular on living room game consoles.

“The console is no longer just the disc and the hardware,” said Mark Long, co-CEO of Zombie Studios in Seattle. “The collection of services behind the box are now more important than what’s in the box.”

For now, consoles still command a significant chunk of the business, accounting for 64% of the spending on games last year, according to Deutsche Bank.

“The world evolves at a certain pace,” said OnLive’s Perlman. “Habits will keep people attached to their consoles for a while.”

Michael Gallagher, president of the Entertainment Software Assn., said that as long as people keep playing games, it will be good for his industry. “It’s not an either-or proposition,” he noted. “It’s both. And that means growth.”

The trade group invited companies like Facebook Inc. and social games developer Zynga Inc. to present at E3 this week, but they declined, meaning the show will still focus primarily on traditional console games rather than the broadening industry.

Also notably absent will be Apple, which is putting on its Worldwide Developers Conference in San Francisco at the same time.

Appy’s Ulm said he and his developers would skip E3 this year to attend the Apple event.

“E3 is not as important to the industry as it was in the 1990s,” he said, “because consoles are not as important.”

alex.pham@latimes.com

ben.fritz@latimes.com