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The battle between the Microsoft  Xbox One and the Sony PlayStation 4 is well under way. Actual sales for the first selling season won’t be announced for a while. And it probably won’t be until next year until we find out which console is really winning the next-generation sales competition.

But thanks to market research firm IHS, we know what each machine costs to manufacture, and that tells us a lot about how this console competition will unfold in years to come. The cost analysis tells us a lot about the choices that the console designers on each side made, and how those will affect the competition for years to come.

Microsoft’s Xbox One costs bout $471 to make, compared to $381 for the PS4. This naturally explains why Microsoft is selling the Xbox One for $500, while Sony is selling the PS4 for $400.

About $75 of Microsoft’s extra cost covers the second-generation Kinect motion-sensing camera. Microsoft believes that this technology is the future not only of games, but also of TV, as you can use it to change channels while watching television. Sony sells its PlayStation Camera as a separate $60 option, so it clearly doesn’t have the same confidence in peripherals that Microsoft has.


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The pricing difference is going to give Sony a cost advantage for years to come. Microsoft will have to sell a lot more games to make up for this gap. But the tough thing about that is that Sony’s games are going to look better at some point, as Sony invested more of its hardware dollars into creating a system with more graphics performance than Microsoft did. If Microsoft is to gain a technical superiority over Sony, it can only do so through the inclusion of Kinect in every base system for the Xbox One. That’s not a bet I would make, given the lackluster love that gamers have shown for motion-sensing games so far.

Another odd thing: Even though Sony has the better graphics performance, Microsoft’s processor from Advanced Micro Devices (the supplier of the microprocessor-graphics combo chip for both systems) costs $110, compared to $100 for Sony’s AMD processor. Sony deliberately spent more on its graphics memory chips, while Microsoft chose an older and cheaper memory system. Mark Cerny, architect of the PS4, explained earlier this year that Sony did this in the name of simplicity. Well aware that Sony’s PlayStation 3 was too complex to make games for, Cerny designed a system that was easy to understand and program games for.

The outcome will be interesting to watch. Any time that Microsoft decides to cut the price of the Xbox One, Sony will be able to react by cutting its price as well. That gives Sony a lot of competitive advantages in this generation. If Sony chooses, it has a chance to be the price leader in this generation, as it is showing at the outset. It could also choose to be the profit leader instead.

Rick Sherlund, an analyst for Nomura Securities, estimates that Microsoft will lose $1 billion on the Xbox One this year. Now that’s a loss leader, but it’s not so different from history.

Back in 2006, iSuppli (which was acquired by IHS) found that the PlayStation 3 with a 60-gigabyte hard drive cost Sony $840 to make. That was why Sony priced the initial machine at an untenable $600. By comparison, Microsoft launched the Xbox 360 Premium at a price of $399. The machine initially cost Microsoft $525 to make.

In those days, the console makers viewed the machines a loss leader. They embraced the razor and razor blades model, where they could lose money on the console and make money on the $60 games that they and their partners sold. But Microsoft had a big advantage on Sony, as it had the lower costs and Sony didn’t have much of an advantage, because game developers took too long to understand how to make games that ran on Sony’s eight-core Cell microprocessor. Sony never got a true competitive advantage over Microsoft in the entire generation, and it was always operating at either a unit or profit disadvantage to Sony.

In the first generation of the Xbox, launched in 2001, Microsoft sold its machine for $300 at the outset, even though the manufacturing cost was $425. That was too deep a hole, as Microsoft lost billions over four years. That machine was outsold by Sony’s PlayStation 2 machine by six to one. It led to huge losses, but Microsoft could afford that. And it accomplished the strategic aim of getting Microsoft in the console business.

The lesson of these numbers is that it is very hard to dig yourself out of a hole. If you start out at a cost disadvantage, then it is very hard to catch up with your rival.

On the other hand, the reason to create a more expensive machine is to gain a technological advantage. If Microsoft’s bet on version 2 of Kinect is a good one, then it will have something that entices gamers and gives Microsoft an edge over Sony for years to come.

Sometimes, cost matters. Neither company wants to sell a machine for below its costs at the outset in this generation. Will that cost them in the long run? It means that the gamer PC will outrun these machines sooner than it otherwise might. And it means that these machines may not “wow” gamers as much as they might have.

But neither company is going to be driven out of business by the upfront losses associated with each machine either. And that’s important. There are a lot of trade-offs in this generation of consoles, and the IHS numbers tell us a lot about the choices that each company made.

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