"Nintendo faces the biggest challenge in its corporate history." That's the bleak assessment of a study released today by market forecast firm In-Stat/MDR entitled "Video Game Console Market Entering Cyclical Downturn." With the next generation of consoles due in less than two years, the report surmises that the current crop has hit middle age, and its sales have peaked. The report also echoes the widely accepted conclusion that neither Microsoft's Xbox nor Nintendo's GameCube will ever take the lead from Sony's PlayStation 2, which sold its 60 millionth unit in September.

　　However, while many analysts think the race for the number two console is neck-and-neck, the In-Stat/MDR report puts Nintendo dead last, despite the GameCube's recent price drop and sales volume increase. The reasons? GameSpot asked Reed Business analyst Brian O'Rourke, coauthor of the report, to break down why he thinks the GameCube has fallen behind.

　　GS: The summary of your report says that "Nintendo faces the biggest challenge in its corporate history." Is that challenge external or internal?

　　Brian O'Rourke: The challenge is primarily external but partially internal as well. Nintendo, for the first time, is facing two competitors who are large, very well-funded, and absolutely determined to succeed in the game console market. Sony is the most recognizable name in consumer electronics. Microsoft is the most recognizable name in software and measures its Xbox marketing budget in the billions of dollars. Nintendo is also facing internal challenges. It has always depended to a great extent on first-party must-have franchises to carry it. However, in this generation, some of its software that's based on franchise characters, like Mario, has not been as successful as in the past. In addition, attempts to create new franchises, like Pikmin, have not been as successful as anticipated. This puts a tremendous financial strain on Nintendo because its third-party relationships have not traditionally been as strong as its competitors.

　　GS: Your report claims that the Xbox has passed the GameCube in market share, but Nintendo claims its sales have quadrupled since the GC's price cut, so it is now number two.

　　BO'R: I don't doubt that the price cut to $99 will help Nintendo sell GameCubes in the short term--over the next six to nine months--and will help raise revenues. I do question whether the price cut will help Nintendo to regain the number two position. Also, what will be the long-term cost of the price cut? A 33 percent price cut will tap into Nintendo's profit margins. And when it wants another shipment boost, will it cut prices again? And tap into profit margins again?

　　GS: Why do you think the Xbox has done better than the GameCube?

　　BO'R: There are two reasons the Xbox has been able to move ahead of the GameCube. The first is the marketing budget. At E3 2002, Microsoft announced a $2 billion marketing budget through 2006 to promote the Xbox and its online service Xbox Live. That's a staggering sum of money in the console business and has bought the Xbox excellent brand recognition. Secondly, Microsoft is selling more than a game console. With DVD movie playback, Xbox Live, and the recent release of its Music Mixer product, Microsoft is moving the Xbox beyond a simple game console to a more wide-ranging entertainment experience. In a sense, the game console business is now about more than simply a living room gaming machine, and Nintendo, with the GameCube, is unable to provide that.

　　GS: What do you think Nintendo has to do to regain the number two slot? Can it be done in the current game console life cycle?

　　BO'R: I think it will be very difficult for Nintendo to regain the number two slot worldwide. The GameCube is outselling the Xbox in Japan, but the Xbox is outselling the GameCube in both Europe and North America. Unless the GameCube price cut is able to significantly raise North American shipments over the long term, I don't see Nintendo regaining the number two position.

　　GS: Your report predicted that the GC and the Xbox will never reach the PS2's 60-million-consoles-sold mark. Do you think Sony's lead will continue after the next generation of consoles are unveiled?

　　BO'R: Yes, barring any significant delays in releasing its next generation console, Sony should remain in the number one position in the next generation. Since its entry into the market in 1995, Sony has proven that it knows what gamers want. This is seen by the fact that the PlayStation/PSOne and the PS2 are the two leading game consoles of all time (excluding handhelds).

　　GS: Your report predicts that the next generation of consoles will see even greater sales (an estimated 50 million units in 2005) than the current generation (42 million units in 2002). Why is that?

　　BO'R: The history of the gaming market over the last 10 years or so shows two trends. One: The market is cyclical. It rises with the introduction of new consoles and slows down as the market saturates--and in anticipation of the release of next-generation consoles. Two: Each successive generation of consoles outsells the previous generation. There is no certainty that either of these trends will continue. But with the entry of Microsoft into the market and its determination to succeed--and with the determination of Sony to maintain its advantage--I believe the next generation of consoles will offer a combination of technology and price that will continue the success of the game console market.