Sony is holding a showcase tomorrow, September 15, and it’s likely to reveal the PlayStation 5’s price and release date. But how does a company like that pick a price for something like a PS5? How does manufacturing and cognition factor into the price we see on store shelves?

Well, that’s what I’m going to talk about today. Here’s how a price is made.

Bill of materials vs. total costs

The bill of materials (BOM) is how much it costs a company to acquire all of the components to build their product. For Sony and Microsoft, this includes making deals with important vendors like AMD to acquire the SOC (system on a chip) and with NAND flash (which is what powers SSDs) manufacturers to include storage.

These costs are likely the first thing that comes to mind when we try to determine how much we should pay for something. And the BOM is a crucial part of the arithmetic that companies do when they pick a price. But it’s really only a starting point because, for one thing, it doesn’t even take into consideration all of the costs.

Bloomberg reported that the PS5 costs Sony around $450 to produce. That number is probably close, but we don’t know if that’s the full cost of production, the cost of manufacturing, or just for the bill of materials. The difference is that cost of manufacturing would include things like assembly and quality-assurance processes while cost of production would include everything involved with creating a product to be shipped.

Making consoles is expensive

Even cost of production doesn’t reflect everything console companies spend money on, though. Creating a game-playing box comes as a result of years of research and development, which is expensive. Once you have a finished console, you also have to package it, ship it, and sometimes store it. Packaging alone can add up to $15 per console.

Companies struggle to tighten out the slack in their supply chains, but that is complicated logistical work that requires a lot of upfront spending as well. And it comes with a risk of failing to meet demand, which may force you to pay for speedier shipping options. Sony is doing just that by stocking Delta flights with PlayStation 5s, but this is significantly more expensive than sea-based cargo ships.

New console hardware also comes with growing pains. That means failures for finished products, but it also means low yields for those SOCs. Taiwan-based TSMC etches the SOCs for AMD, Sony, and Microsoft onto giant wafers. They then must cut the SOCs out of that wafer like slicing apart a tray of brownies. But companies pay TSMC for the entire wafer, and a Japanese Bloomberg report from yesterday claims that only 50% of the SOCs on certain wafers are usable in PlayStation 5s. Sony is going to have to eat the cost of the unused SOCs.

For its part, a Sony spokesperson commented to GamesBeat on the Bloomberg story:

While we do not release details related to manufacturing, the information provided by Bloomberg is false. We have not changed the production number for PlayStation 5 since the start of mass production.

Note that Sony does not mention anything about its SOC yields.

Supply and demand vs. building a community

At a certain point, a console manufacturer understands all of its costs. It then has to decide what to charge its customers. And while those might seem intrinsically linked, the cost only really acts as one variable in an equation that primarily involves supply and demand.

You know this one. The demand is how much consumers want a thing, and the supply is how much access they have to that thing.

At launch, the consoles will be very limited, but that won’t always be the case. So Sony isn’t going to price the PS5 at $1,000 just because it could probably sell a lot at that price in the first month.

But demand is more complicated than the availability of the hardware. It’s also about access to select, exclusive games and the quality of multiplatform games. Demand for those experiences is high, but the supply is limited because you cannot just get God of War anywhere. You have to pay Sony for that experience. And people are willing to pay a lot for access to that.

When it comes to consoles, however, the manufacturers want you to have access. They’re trying to build a community.

Gamers rise up

Sony and Microsoft get a licensing fee when developers sell games. They also have online stores where they take a 30% cut of all transactions. That works a lot better if people can afford the required hardware.

And while gaming is a massive business, it’s also surprisingly tight-knit and insular. People identify as gamers in a way that people don’t identify as readers, for example. This is something that the PlayStation and Xbox brands can take advantage of by appealing to loyal followers. But it’s also something that can backfire.

In 2011 and 2012, Microsoft looked at its data and saw that people used Xbox 360 to watch video and play games online. So when it designed the Xbox One, it did so with a focus on TV and online functionality. But just because those things lined up with people’s behaviors does not mean it was what gaming fans wanted. Gamers revolted and happily picked up the PS4 for $100 less even after Microsoft reversed many of its always-online requirements.

Gamers see themselves as a community, and if they decide something is unfair, it takes a monumental effort to appease them.

For Sony, that means a $600 PS5 is dangerous. The system would likely still sell at that price, but it could come at a cost of angering gamers who are expecting $500 at the most.

PlayStation 5 vs. PlayStation 5 Digital Edition

Another major factor in deciding the price is how to position the two versions of the PS5 against one another. The full version and the discless digital model have all the same specs. And a Blu-ray drive is relatively cheap ($50 at the most extreme and likely a lot less). So does Sony charge $50 less? Maybe. A lot of factors will play into that choice.

Small number in front

Microsoft announced the price of the Xbox Series X as $499.99. And that’s $500 because a penny is meaningless except for the fact that people perceive $499.99 as significantly less than $500. This is in part because we associate a series of zeros with large numbers. But it’s mostly about that number out in front.

Putting a “4” at the front of the number is huge. It’s even more important for the Xbox Series S, which leads with a “2” for its $299.99.

Marketers love this effect, and Sony likely wants to take advantage of it for the PS5. But that puts it into an interesting position.

If Sony sells the PS5 for $499.99, it doesn’t make a lot of sense to sell the Digital Edition for $50 less at $449.99. Both numbers have a “4” out front. This is going to make the Digital Edition feel like a bum deal (regardless of its actual value). And $299.99 for the Xbox Series S versus $449.99 for the PS5: Digital Edition is even worse.

If Sony is worried about Microsoft’s pricing, getting a “3” at the start of the price with PS5: Digital Edition at $399.99 makes the most sense.

The decoy effect vs. pushing consumers toward digital

But pricing the PS5 against itself comes down to what is most important to Sony right now. Does Sony want to funnel PlayStation fans into digital ownership or is it more concerned about taking a loss on hardware sales?

Sony may want people to buy PS5: Digital Edition because it gets a higher profit margin from downloads versus physical media. That could serve the company well in the long run.

In that case, expect a $100 difference between the two PS5 variations.

But Sony may just want to guard against losses on hardware. If the PS5 is losing money at $500, which is possible, then the PS5: Digital Edition would lose even more at $400. The company would potentially make up that difference over time, but it may have reasons for desiring profits now instead of later.

In that case, Sony could deploy the decoy effect. The most famous example here is movie-theater popcorn. The vendor sells a small popcorn for $4, medium for $8, and a large for $8.50. In that situation, you don’t even look at the small, you think about how you can’t pass up on paying just 50 cents more to get a large instead of a medium.

If Sony would prefer customers spend more money upfront on the standard PS5, it could create a decoy effect with a $449.99 price for PlayStation 5: Digital Edition. If the full PS5 is $499.99 — and especially if the PS5: Digital Edition is hard to find — people will focus on just paying $50 more to get a no-compromises PS5 instead of any comparisons to the Xbox Series S.

PlayStation 5’s price will say a lot about Sony’s strategy

Whatever Sony decides, it should tell us a lot about its overall strategy.

If we get systems at $400 and $500, it likely wants more gamers to embrace digital gaming going forward. If it goes with $450 and $500, it wants to compete with Microsoft while maintaining a higher price. And if goes with anything over $500, it’s only because it is less worried about Microsoft than it is about its own profits for the next several quarters.

Oh, and if it undercuts Microsoft, then who cares what it means? Let’s just enjoy saving some cash and let Sony worry about that.