By Peter Suciu
FORTUNE -- A big battle is brewing in the world of video games. The battlelines for the living room were drawn this week at the Electronic Entertainment Expo (E3), the annual trade show for all things video games, as Microsoft and Sony solidified their plans to introduce new consoles this year.
Microsoft's (MSFT) presentation this week was all about software. Last month the company officially unveiled the Xbox One, its third console and the first all-new one in eight years. In a rapid-fire press conference, Microsoft offered a glimpse of 13 upcoming titles for the season and announced that the Xbox One will arrive on November 21 for $499.
Following its Monday morning press conference in Los Angeles, it looked like it was score one for Microsoft, but then Sony (SNE) made quite the power play and introduced its own lineup of what could be "must play" games, and more importantly announced that the PlayStation 4 would also arrive this holiday season and for $100 less. That could be enough that Sony actually wins the first round. "For those sitting on the fence, $100 goes really far," says Lewis Ward, research manager for gaming at IDC. "Historical precedence suggests that the average console fan isn't willing to shell out a lot more money for a product, even one they think is great. That amount of money is essentially two games for free."
While there is still a lot that can happen between now and November, what makes this particular hardware cycle unique is that, while this is the fourth system from Sony and third from Microsoft, the two companies have never tussled over new consumers during the same holiday season.
Sony introduced its PlayStation 2 in 2000, a full year before the original Xbox came out, and in the end Sony won that round. Microsoft went for a "do-over" with the Xbox 360, which it introduced in 2005, in that case a full year before Sony released its pricier PlayStation 3. This time the two battle it out in the same year, and Microsoft has the more expensive system. That could be a serious cross to bear for the company this time. "$100 is a big deal, and Microsoft has to educate consumers about why their console is worth it," says Michael Pachter, head of research for the Private Shares Group at Wedbush Securities. "That value proposition isn't immediately apparent, as gamers don't appear convinced that having Skype is important enough to justify forking over $100 for the privilege."
Even with the announced prices, it is all but a foregone conclusion that at launch both companies will actually lose money on every video game machine sold. With new systems, both companies will take the "razor and blade" model, where the system is sold at a slight loss and the profits come from selling the software. This could be why both companies also took out the big guns to show a slew of unique first-party titles (published respectively by Microsoft or Sony) and exclusive third-party games from key publishing parties. "The exclusive titles are absolutely important," says video game industry analyst Billy Pidgeon of BP Research. "Getting those exclusive titles, including third-part exclusives, can make the difference."
While each company wants to move as many units of hardware as it can, the real key is getting an installed base and seeing software sales. In turn it is the software that also helps sell the system. "Both companies showed great software, (and) console sales ultimately depend on software," Pachter adds. "It is important for each to build a large community to promote their brands, so early sales are crucial. This is where pricing comes in, and unless Microsoft can sell the value proposition of the higher priced Xbox One, they may lose some share."
At this week's E3, the gaming press declared a winner -- at least vocally -- at Sony's press conference when the price was announced, but also when Jack Tretton, president and CEO of Sony Computer Entertainment of America, announced that Sony would continue to support the sale of used games. This is in stark contrast to Microsoft's announced approach, which could require an always-on connection to the Internet and which would limit how games could be traded in. That could also give Sony an early edge. "The used games and requiring the web connection could lead to Sony having a strong initial sales cycle," says IDC's Ward. "However, this is the first salvo in a 10-year war, so even if Sony has strong sales in the fourth quarter and a gamer friendly approach to used games, there is so much more that is going to happen."
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