Video games are a fast growing form of entertainment and have captured a similar market size as the movie box office and music sales. In 2008, the North American video game market reached $21.33 billion and people continued to spend a greater portion of their free time playing them. As of August 2007, Nintendo has become the best selling console in the world (9 million units sold worldwide), with Microsoft's Xbox 360 (8.9 million) and Sony's PlayStation 3 (3.7 million) trailing.  The Wii's performance is impressive considering that Microsoft launched 12 months ahead of both the Wii and PS3.
Video game console wars heated up to new levels in November 2006 with the launch of Sony's advanced PlayStation 3 (PS3) and Nintendo's Wii. Both Sony's and Microsoft's console offerings upped the ante by producing advanced and expensive hardware which took advantage of the trend towards high-definition media (e.g., HDTV). It is widely believed that both high-end consoles are subsidized by their respective manufacturers in order to gain market share and appeal to consumers who would not pay their high prices otherwise; the base PS3's retail price is currently $499 and the base Xbox 360 costs $399 (as of July 2007). The Wii, on the other hand, delivered a lower cost platform ($249 base) with a highly interactive controller technology. It is believed that Nintendo makes a sizable gross margin (about $100) from the sale of each console hardware unit.
Much is at stake in the battle of video game consoles. The adoption of consoles depends heavily on the content available for them, as video games--like movies--have become increasingly hit-driven. All three companies publish a catalog of their own video game software as well as receive royalties from video game companies such as Electronic Arts and Activision (ATVI), the market leaders. In addition, both Sony and Microsoft have placed a significant bet on gaining entrance into the home entertainment market as both the Xbox 360 and PS3 consoles play music and movies as well as connect to the Internet. Sony in particular is leveraging the PS3 to propagate its Blu-Ray technology, a media format for high-definition video; if the PS3 succeeds, then Sony will reap benefits not only from video games but also from licensing Blu-Ray technology for movies and other digital media using its proprietary format.
Microsoft is obviously the primary beneficiary if the Xbox 360 platform "wins" the console wars. Its platform had a 12 month headstart on Sony's PS3 and Nintendo's Wii. However, the Wii outsold this console in January and February of 2007. Microsoft also published several popular games, including the Halo franchise. Halo 3 exceeded sales of $125 million on its first day of release.
Microsoft is currently not leading the next-generation console competition with 2.4 million units sold as of the end of April 2007. In contrast, the PS3 had sold approximately 1.3 million units and the Wii sold about 10.5 million units.
In 2007, Microsoft wrote down $1.5BN in Xbox 360 related charges, as technical design flaws led to widespread product defects. The charge was mostly composed of the cost of repairing defective systems.
One significant unknown factor driving the success consoles is content. For example, many believe that Microsoft's previous generation Xbox console would not have been nearly as successful if it were not for its Halo franchises, one of the best selling franchises in the history of video games; the Halo 2 title exceeded sales of $125 million on its first day of release--better than any video game in history. However, in 2008, Wii topped all others in the software arena with the four top selling video games of the year. Wii Play reigned king of 2008 selling 5.28m units.
Software has historically generated two-thirds to three-fourths of the overall video game market, which was approximately $40 billion in the U.S. in 2008. Console games accounted for about two-thirds of software sales with the rest coming from PC and hand-held software.
Like the movie industry, the video game content sector is becoming hit-driven, where a few titles make up the bulk of all sales. In addition, production costs for video games has increased significantly--again, like movies--such that certain franchises have become extremely valuable and depended on for success.
One threat to the overall video game console market is the rise of massive multiplayer online games (or MMOGs). While both the Xbox 360 and PS3 have Internet capabilities, MMOGs are based on the Internet and are a potential disruptive threat to console games because they require no hardware or software purchases. Instead, these popular games typically run on a subscription-based model.
Mobile games has grown rapidly--tripling in the last 5 years to around $2-3 billion in 2006--as part of a growing trend of casual gaming. Mobile games have the advantage of an extremely large installed base of over 2 billion users worldwide.
For more on video gaming, see Rock Band vs. Guitar Hero.