Console War Continues… What Should Sony Do Next?

The console war continues…. as writers of Forbes notes: “you’ve been hit with a disruptive attack. A competitor you dismissed has successfully changed the game in your industry. Analysts and investors are clamoring for your response…or your head. What should you do? “

Executives at Sony (nyse: SNE – news – people ) are trying to answer this question today as the video game leader struggles to figure out how to respond to recent disruptive moves by rival Nintendo (other-otc: NTDOY – news – people ). Early signs suggest that Sony is choosing the path of least resistance–and least potential.

Competition in the video game console industry has been fairly straightforward over the past two decades. Companies succeeded by providing better quality graphics, more sophisticated game play, and a wider array of games. Over the past few years, historical industry leader Nintendo had drifted down to third in the industry league table as Sony and Microsoft (nasdaq: MSFT – news – people )’s raw power and wide range of titles outpaced Nintendo’s continually clever game play.

All of that changed last Christmas. While Sony’s PlayStation 3 and Microsoft’s Xbox 360 continued their steady march up market, Nintendo innovated in a different direction. It focused its effort on making game play significantly simpler and more intuitive. A chip made by Massachusetts-based Analog Devices (nyse: ADI – news – people ) called a “three-axis accelerometer” embedded in the controller for Nintendo’s Wii system measures movement in three directions. The controller allows consumers to use natural motions to have characters swing a tennis racket, toss a bowling ball, cast a fishing pole, and so on.

Nintendo’s strategy was a conscious attempt to reach the “non-gamer,” the person who found existing video game systems too complicated and time consuming. The system is so easy to use that even video game novices can enjoy game play within minutes. By all accounts, Nintendo’s effort has been a massive success. Nintendo can’t make its $250 Wii fast enough to meet demand. Nintendo’s stock is up close to 50% this year, and its market capitalization has surged past Sony’s market capitalization. Part of the reason? Sony’s video game unit recently reported losses of close to $2 billion.

Sony needs to catch up quickly, too: in the month of June, the Wii outsold the Playstation 3 in Japan by a six to one margin. Nintendo’s simple DS handheld system has similarly outpaced Sony’s more sophisticated PlayStation Portable.

Microsoft is facing its own struggles, as well. It recently announced that it would take a $1 billion charge to correct flaws with its Xbox 360, and analysts are beginning to suggest that Microsoft should spin off its money-losing video game decision.

Recently, Sony took action intended to remedy is sales slump. The Wall Street Journal reported that the company slashed the price of its PlayStation 3 console by $100 (to $499) to boost sales. While sales might increase, this alone will not solve Sony’s problems. Unlike the Wii, which is a profit-maker for Nintendo, even at the older, higher price Sony took a loss on the PlayStation 3 console in the hopes of making fat profits on sales of new games.

There are at least some public signs that Sony still doesn’t understand exactly what is going on. The president of Sony Computer Entertainment America, while acknowledging that Nintendo deserves credit for the Wii, told Fortune, “If you look at the industry, any industry, it doesn’t typically go backwards technologically. The controller is innovative, but the Wii is basically a repurposed GameCube. If you’ve built your console on an innovative controller, you have to ask yourself, Is that long term?”

But Nintendo hasn’t truly gone backwards technologically. It has simply innovated in a different way. It understood that the barrier to new consumers using video game systems was the complexity of game play, not the quality of existing graphics. By removing that barrier, it has been able to compete against nonconsumption and create a significant growth business. It is a classic disruptive strategy.

Others in the industry are well aware that Nintendo has hit on an important, innovative new-growth area. John Riccitiello, CEO of Electronic Arts (nasdaq: ERTS – news – people ), the world’s largest publisher of video games, recently told The New York Times that one of the main reasons his company’s growth has stalled at about $3 billion in annual revenues is the difficulty of actually playing the company’s video games.

“We’ve become a niche,” Riccitiello told the Times. “Eighty, 90 percent of the resources that are put into play by us and most of our competition are in building sequels of games that super-serve teenage boys with fast thumbs.” Riccitiello believes the greatest source for growth will be outside these core gamers—just the type of folks Nintendo is targeting.

So, assuming Sony is able to fully internalize the importance of Nintendo’s disruption, what should the company do now? One option would be to not respond at all. One pundit noted that any response by Sony would only validate Nintendo’s approach, which could end up helping Nintendo. While the risk of validation is real, our belief is that ignoring Nintendo’s approach would be a mistake. Assuming Sony chooses to respond, it has three options. The seemingly simplest option is to just come up with a copy-cat version of Nintendo’s controller that works with one of Sony’s existing consoles.

While this would be the quickest path to market, it has some real risks. Nintendo’s system has been optimized around its controller. Simply sticking a motion-based controller onto an existing system could result in a highly disappointing product. The controller would remain an afterthought, as opposed to an integral part of the product.

The second option is to repurpose Sony’s “legacy” product (PlayStation 2) into a me-too version of the Wii. To do this, Sony would develop a new controller, lower the price of the PlayStation 2, and try to get game developers to create motion-based games for the platform.

Done properly, this approach would have some strategic merit and it could take some wind out of Nintendo’s disruptive sails. However, Sony would likely face fierce internal and external resistance if it followed this path. Analysts would wonder why Sony was intentionally cannibalizing its higher-end, higher-margin product. Engineers might wonder why they are “wasting time” on a low-tech product.

Also, this approach is unlikely to create a blockbuster growth business. Sony would in essence be following a sustaining strategy against Nintendo. While it might carve out a reasonable market position, it is unlikely that this move would redefine the category the way Nintendo has.

The final option is for Sony to try to “disrupt the disruptor.” Instead of following a me-too strategy, Sony could seek to truly develop a category-changing project. While this approach would take more time and require greater investment, it has the most long-term potential—if Sony can figure out a different measure of performance on which to compete in the video game market. For example, perhaps the company could take another run at the handheld market, where there still seems to be substantial room for growth.

So what will Sony do? Rumors indicate that it is planning on following the first approach, sticking a new, motion-sensitive controller onto an existing console. Our perspective is that this is the worst of the three options. Instead, we’d recommend that Sony follow the second option to buy time while simultaneously undertaking efforts to develop an entirely new way to play in the video-game market. The key to success is realizing that the market is still replete with nonconsumption. Nintendo has shown one way to appeal to the non-gamers, but Sony could find others.

It isn’t easy for a company that has been thumped by a disruptor to respond. Trying to force-fit the disruptor’s new approach onto an existing business runs the risk of creating a disappointing product that further illustrates the novelty of the disruptor’s solution. Companies in the middle of a disruptive wave need to think about how they can disrupt the disruptor and find a new way to redefine the space. While this approach seems to carry the most risk, if done correctly, it actually has the greatest chance of real success.

*Excerpted from a recent issue of Strategy & Innovation. For more analysis from Clayton Christensen, Click Here. Clayton M. Christensen is a professor at Harvard Business School and the co-founder of Innosight LLC, a Watertown, Mass., innovation consulting company.

(via Forbes) (picture courtesy of HCW.com)