Video Games Up, Japan Casts Shadow - Analyst Blog

The video game industry witnessed growth in the month of February. According to market research group NPD, gaming industry sales rose from $1.33 billion to $1.36 billion, reflecting an increase of 3.0%.

Despite analysts predicting a 28% decline in Hardware sales, the segment experienced a rise of 10%. The reason for upside remains unclear right now, as NPD no longer segregates hardware sales by platforms. It is however likely that Microsoft's (MSFT) XBOX 360 and the Kinect controller contributed to the increase in sales (Microsoft said that Xbox 360 sales increased 27% in February to 535,000 units).

The addition of the Kinect controller drove up the price, resulting in higher average selling prices, which in turn drove average selling prices among console hardware.

Nintendo's 3DS system, slated for release at month-end can be seen as another potential sales driver in the near term. The handheld gaming device, which allows users play games in stereoscopic 3D without the special glasses, has been very popular in Japan, where it was released in late February.

Nintendo management has assured that the earthquake has not impacted its operations materially and that the 3DS launch in the U.S. and Europe remained on track.

The surge in hardware sales is a positive for the video game industry in 2011.

Though software sales fell 5.0% on a year-over-year basis, it was better than the analysts' expected decline of 6.0% to 10.0%. Video game publishers Electronic Arts (ERTS) and Activision (ATVI) differ from NPD, since NPD does not consider the software sold through Microsoft's Xbox live, Sony's (SNE) PlayStation Network or Apple's (AAPL) iTunes.

On the software side, Activision's Call of Duty: Black Ops remained at the top spot for the fourth consecutive month. Capcom climbed to the second spot riding its new release Marvel vs. Capcom 3, while Ubisoft's Just Dance 2 slipped to the third spot.

Sony's new title Killzone 3, released this month, had a slow start and was at number 8.

Accessories and peripherals sales sprung 22.0% from the previous year largely on the back of continued strength of Microsoft's Kinect motion controller.

Going forward, the analysts expect used games, game rentals, subscriptions, digital full-game downloads, social networking games, downloadable content and mobile games applications to contribute to the bottom lines of the game publishers.

Downloadable content (DLC), which are basically add-on packs that are sold to users buying games through retail, appears to be an area with prospects. Activision will be making use of this opportunity at the end of the current quarter, when it plans to release Call of Duty: Black Ops - First Strike, the first add-on content pack.

We believe the video game industry is seeing many changes due to the increasing contribution from digital downloads, used game sales, game rentals, subscriptions, social network games and mobile game apps.

However, cut-throat competition within the industry will make it difficult for any single company to see any significant market share gains in 2011. Moreover, increasing competition from social networking companies such as Facebook remains a major concern.

The impact of the Japan earthquake is also uncertain as of now. It is encouraging to note the confidence expressed by Nintendo management based on the location of its operations in Southern Japan, while the Northern part of the country has been worse affected. However, other Japanese companies may not have been that lucky.

Sony has shut down its game servers temporarily, which could impact sales for an indefinite period of time. Also, while most companies are still in the process of determining losses, there is a growing fear of a radiation leak at Japan's Fukushima nuclear plants, which increases the risk of operation and could result in prolonged shut down of operations all over Japan.