Dynamics of Pricing in the Video Game Console Market: Skimming or Penetration?

Abstract

Nintendo lost its dominant position in the video game industry during the console war between its Nintendo 64 and Sony's PlayStation. However, Nintendo could have made several different strategic decisions to change the outcome. This article develops a structural model and investigates these alternative strategies through policy simulations. In particular, the author provides a framework to study firms' optimal pricing strategies under network effects, consumer heterogeneity, and oligopolistic competition. Consumer heterogeneity provides an incentive for a durable goods manufacturer to price skim, while network effects lead to an opposite motive for penetration pricing. The proposed framework incorporates these two competing motives under oligopolistic competition. The author estimates a demand system that allows for indirect network effects and consumer heterogeneity and then numerically solves for the Markov perfect equilibrium in firms' dynamic pricing game. Policy simulations indicate that Nintendo could have won the console war either with 10% more games or with a “head start” of one million units in installed base at the time of the PlayStation introduction.