One of the world’s biggest investment firms appears to be very high on the prospects for Microsoft’s Xbox 360. Citing a significant cost advantage in the short and long term, as well as an early lead, Merrill Lynch believes that Xbox 360 will be an “early winner” in the next-gen console war.

Read on to see why they think Sony is in a world of hurt…

Leading financial management company Merrill Lynch has today released a report that analyzes some of the advantages and disadvantages for both Microsoft and Sony in the upcoming next generation console war (Nintendo was not part of the discussion).

Xbox 360 half the price of PS3 in 2006?

Titled simply “The Next Game Consoles,” the report gives the Xbox 360 a major advantage when it comes to cost. “Sony has in PS3 a console with plenty of impressive proprietary technology, but also a high manufacturing cost. The launch is coming just as Sony tries to come to grips with its deteriorating financial situation. Our analysis of the bills of material for the Xbox 360 and the PS3 indicates that the PS3 will not only be significantly more costly than Xbox 360 at launch, but will continue to operate at a cost disadvantage for several years,” stated Merrill Lynch.

With that cost analysis in mind, the report also predicted a key price advantage for the 360 by the end of next year: “Based on the cost analysis as well as our analysis of the two companies’ strategies, we think that Xbox 360 could be selling at half the price of PS3 in the latter half of 2006.”

Taking all of this into account Merrill Lynch (ML) expects the 360 to come out on top: “Taking Sony’s weakened financial condition and Microsoft’s deep pockets into consideration, we conclude that Microsoft’s Xbox 360 should emerge as the early winner in the next round of the game console wars.”

Digging deeper within the report, however, reveals that ML thinks the Xbox 360 (premium SKU) will sell for $249 when the PS3 launches for $500 later in 2006. This, of course, is a big assumption and Sony has not yet indicated any possible price points for the PS3, other than SCE president Ken Kutaragi hinting that it would be “expensive.”

Cell, Blu-ray driving costs way up

Apparently the big contributors to the hefty PS3 costs are its Cell processor and its Blu-ray drive, both of which are very new technologies.

“First and foremost, Sony’s decision to develop a completely new architecture – Cell – for the PS3 has been an extremely expensive undertaking,” ML explained. “The theory behind Cell has been that the architecture will find markets beyond the Playstation. Processor architectures have been in consolidation mode for the last 5 years, though, and we think it’s going to be difficult for Sony to find takers for Cell outside of the PS3. In particular, the notion that Cell is a viable competitor to mainstream PC processors is not credible. There are reports that Cell is being looked at for imaging-intensive applications that suit its architecture, but we can’t see anything that is likely to provide meaningful volumes. We believe that Sony must be focused on recovering a portion of the development costs for Cell with PS3 sales.”

Not only has Cell been expensive develop, but ML also estimates that the processor will cost much more to manufacture than the 360’s PowerPC chip ($160 vs. $100).

Regarding Sony’s choice of Blu-ray ML said, “The other major cost disadvantage lies with the Blu-ray drive that Sony plans to include… It’s possible that Blu-ray will emerge triumphant [in the next format war], but we very much doubt that the conflict will have been resolved by the time PS3 launches. The result is a drive that we estimate will be at least $75 more expensive than the plain vanilla DVD-ROM drive that Microsoft plans to include in the Xbox 360.”

Benefits of early lead

ML believes that Microsoft’s first-mover advantage will be key. The firm said that MS will likely break even during Year 1 and following that the Xbox business will be able to start generating profits. “Microsoft is in a strong position to assert its claim to #1 market share in the next generation console cycle with a lead in the launch. Microsoft is looking to build a large installed base, possibly around 10 million consoles by the end of 2006. The first year will be very critical, especially the Holiday season of 2005, during which an estimated 65% of console sales are likely to take place,” stated ML.

Furthermore, the report casts some doubt as to whether the PS3 will even make it to North America during 2006: “… given the manufacturing challenge that Sony faces with Cell, it’s possible that the PS3 does not make the holiday 2006 selling season outside of Japan.”

Other important tidbits found in the report include ML’s belief that the HDD will be an add-on for the PS3 (as it is with Xbox 360) and that MS could have another advantage with its GDDR3 RAM because of its broader applications, while the PS3’s XDR main memory is “not a product that has gained acceptance elsewhere.”

If ML’s predictions hold true, partners such as GPU maker ATI, WLAN chipset provider Marvell and memory chip supplier Infineon, as well as publishers EA and Activision, are expected to be the biggest beneficiaries of the 360’s success. Conversely, one of the big losers could be Sony’s graphics partner Nvidia (MS’ former partner on Xbox).

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