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

Nintendo lost its dominant position in the video game industry during the console war between its Nintendo 64 and Sony's PlayStation. There were several strategic decisions that Nintendo could have made differently in order to change the outcome. This paper develops a structural model and investigates these alternative strategies through policy simulations.In particular this paper 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 solve 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