June 27, 2019
Joel Hruska

Sony, Nintendo, Microsoft: Don’t Whack Consoles With 25 Percent Tariff

The big three console manufacturers in the United States collectively sent the Trump Administration a letter this week, asking not to be targeted with retaliatory tariffs as part of the ongoing price war between the Chinese and American governments. The letter claims that the 25 percent tariffs contemplated by the government would injure consumers, game developers, retailers, and manufacturers. It would also potentially risk US jobs and, according to the companies in question at least, stifle innovation.

The letter then steps through some interesting stats on games and game development. The US video game industry generated $36B in revenue in 2017 and $43.4B in 2018, and there are video game developers in all 50 states. 96 percent of the video game consoles in the United States were built in China in 2018, which says something about how exposed the major manufacturers are to this problem. The companies write:

[W]e sell [consoles] under very tight margin situations, meaning that we price video game consoles at—or slightly above—cost to make them as affordable as possible, and look to the sale of video games and services, which are much lower priced, to drive economic returns. Console purchasers are extremely price sensitive.

According to the supplementary materials provided, 66 percent of console owners indicated price was among the top five considerations when picking a game. The problem of price sensitivity has been a genuine one, however. Sony absolutely crushed Microsoft in this current console generation, partly because the PS4SEEAMAZON_ET_135 See Amazon ET commerce came in $100 under the Xbox One. It would be inaccurate to imply this was the only reason — Microsoft’s Xbox OneSEEAMAZON_ET_135 See Amazon ET commerce unveil and its initial message for the console was unappealing and confusing — but it certainly played a role. No matter where you lay blame for these problems, however, nobody wants to see a 1.25x price increase slapped on their next-generation consoles.

And the impact wouldn’t just be felt at Sony, Microsoft, and Nintendo. Fewer console sales mean fewer video game sales, which means retailers and video game developers are both going to be impacted. Worst-case, this could whack the entire industry. Game developers gearing up to support next-generation titles may not be willing to take the same degree of risk to do so, or to commit to ramping up hiring for major projects the same way if sales on next-generation platforms are higher due to passed-on costs.

Interestingly enough, the console manufacturers apparently aren’t all that worried about IP theft or related problems. Video games and consoles are not targeted as part of the Made in China 2025 initiative, and because production margins are so tight, the incentive to steal IP for counterfeit console production is reportedly quite low.

In trade news more broadly, the US President criticized Vietnam today. A number of companies have moved production to Vietnam to escape the Chinese tariff issue. Mexico and Vietnam have both gained nearly half a point of market share from October through March.

TradeChart

The President, however, is also unhappy with the Vietnam situation, saying: “Well, a lot of companies are moving to Vietnam, but Vietnam takes advantage of us even worse than China.” When asked if the US intended to pursue tariffs against Vietnam, the President responded: “Well, we’re in discussions with Vietnam. Vietnam is almost the single worst – much smaller than China, much, but it’s almost the single worst abuser of everybody.”

Regarding the ongoing discussion with China, President Trump stated he’d be happy to raise tariffs if talks with Chinese President Xi Jinping fell through, but implied that he might use a lower rate than the 25 percent that’s been the target up until now. “My Plan B is maybe my Plan A,” the president said in an interview with Fox Business Network. “My Plan B is that if we don’t make a deal, I will tariff and maybe not at 25 percent, but maybe at 10 percent, but I will tariff the rest of the $600 billion that we’re talking about.”

The President may have been referring to the total value of the goods to be tariffed with his reference to $600 billion. The US has placed a 25 percent tariff on $250B worth of Chinese goods already and is preparing to target a new round of tariffs on an additional $300B worth of goods. It’s this second group that the console manufacturers are trying to avoid being lumped in with.

We would not expect these tariffs to have any impact on the timelines Sony and Microsoft have set for their next round of launches. Whether or not they’ll impact the prices the consoles launch at — that’s a very different question. If we assume that Sony and Nintendo are targeting a $400 to $500 price point and that they both were willing to launch at cost or below, the numbers are grim. A 25 percent tariff on a $400 console would raise the price to $500, while a $500 machine would jump to $625. Neither console manufacturer is likely to want to absorb a hit that large at the beginning of a cycle when manufacturers already have the hardest time turning a profit. At the same time, no console manufacturer is going to want to be undercut by a competitor willing to eat the cost, either.

If these tariffs go ahead and Sony, Microsoft, and Nintendo can’t get exceptions for themselves, it wouldn’t surprise me if both companies took a tuning pass through their hardware BOMs, looking to cut cost absolutely everywhere they can. Every penny of the cost they can eliminate is a penny that doesn’t have to be passed on to consumers.

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