Dreamcast could easily turn into a nightmare for Sega

Outside Joyopolis, Sega's flagship amusement centre located on a manmade island in Tokyo Bay, young Japanese couples wait in the spring sunshine for their turn to enter. Joyopolis is designed for dating.

At ground level the complex has huge rides, including giant pendulums with snowboards on which the boys and girls can show off their prowess to partners. On the next level are games in which the couples compete against each other.

Finally, the top floor, lit more intimately, offers virtual reality rides that encourage partners to reach for each other in fright. Sega considered a fourth-floor "love hotel" with rooms rented by the hour to round off the experience.

Even without the love hotel, Joyopolis is a huge hit with Tokyo's youth. But life for its owner is less joyful: it is fighting for survival after losing 45 billion yen £356 million in the year to March.

Despite the success of Joyopolis, Sega has had problems both in operating amusement centres and supplying games to them. Last week, it announced the closure of its British and Australian centres - including Segaworld in the Trocadero centre in London's Piccadilly.

Nor is Sega alone among Japanese consumer products groups in facing problems. Its arch-rivals Nintendo and Sony, whose PlayStation has dominated the home computer games market in recent years, have their own problems with sustaining growth.

Sony announced last week that sales of the PlayStation fell last year from 22 million to 17 millon. The current generation of machine - still using outdated 32-bit technology - seems to have passed its peak of popularity in the Japanese market.

Here, Sega could have an edge. Sony will only start selling its new PlayStation II - with 128-bit technology - to Japanese consumers in December. At least until then, Sega has a window of opportunity for its new Dreamcast games machine.

Sega launched Dreamcast in Japan - the only country where it is on sale - in November. Mr Soichiro Irimajiri, the company's charismatic president, said at the time that Dreamcast would not only compete with Sony and Nintendo, but would "blow them out of the water".

Sega has taken to heart the lessons of the 1990s, when the PlayStation swept it aside. It has launched an advertising campaign in Japan aimed at revitalising its stodgy image with young games players.

The television campaign began with an advertisement showing Mr Hidekazu Yukawa, a senior Sega executive, overhearing two boys saying: "Sega sucks". This pithy criticism strikes him to the quick and he sets off to develop a product to satisfy this demanding market, a process that culminates in the launch of Dreamcast.

Dreamcast is impressive. Even Mr Irimajiri's lack of proficiency when he demonstrated Sonic the Hedgehog, Sega's mascot, to journalists last November did not detract from the quality of the graphic display.

As Sonic raced along a three-dimensional track, the 128-bit processor lent the landscape around him an almost cinematic quality. In comparison, the 32-bit PlayStation looks almost as dated as a game of Space Invaders.

But superior technology will not be enough to make Dreamcast a hit. If it was, PlayStation and the Nintendo 64 machine that is its other rival would already have sunk without trace in the Japanese market.

The biggest lesson of PlayStation's success is that it is software - the games themselves - not technology that sells consoles. Nintendo 64 has been hammered by PlayStation despite its faster processing power because of a lack of games.

Warburg Dillon Read, the investment bank, estimates that by March this year, 54 million PlayStations had been sold, compared with only 24 million N64s. It is no coincidence that there were 3,264 PlayStation titles available, against 120 for the N64.

Nintendo's mistake was to ration the number of new titles in an effort to maintain quality, believing that it knew what the public would like, rather than leaving it to the market to decide.

Its caution was prompted by the problems at Atari, a rival that during the 1980s destroyed confidence in its products by issuing large volumes of sub-standard software.

But Sony's tactic of investing big sums to help software developers to create large quantities of games proved successful. If some games were less than exciting others, such as Resident Evil 2 in which pollution-induced zombies roam a US city, proved huge hits.

Sony also recognised that software can be highly profitable. The marginal cost of production is so low - and prices so high - that software generates about 70 per cent of Sony's game business profits.

In the face of Sony's onslaught, Sega launched Dreamcast with just five titles. Even now only 27 are available. That, combined with early production problems, meant that Sega missed its target of 1 million console sales by March 31st by 10 per cent - not disastrous but disappointing nonetheless.

The question now is whether Mr Irimajiri can take advantage of the company's technological lead. The window is narrow, although the successor to the Nintendo 64 - the N64DD - has been delayed so many times that analysts believe it may never arrive.

By contrast, Sony has already announced specifications for the 128-bit PlayStation 2, although many analysts believe its deadline of shipping in Japan by December is optimistic.

Sega is taking measures to make it easier for software developers to design games for the machine. Nevertheless, the problem for Mr Irimajiri, a former senior executive at Honda, is that he is having to bet the entire company on one product.

The PlayStation has become hugely important for Sony - generating 40 per cent of operating profits last year - but the company, like Nintendo, has huge cash reserves and could survive a significant reversal.

For Sega, Dreamcast is more than a game, it is a matter of life or death. The group is heavily indebted and has 100 billion yen of convertible bonds coming due in September next year at 7,910 yen.

At Dreamcast's launch, Mr Irimajiri was asked what he would do if the machine failed. He said there was no contingency plan.

Sega's slogan last year was "Dreams begin here". There is a real risk that Dreamcast could turn into a nightmare for Sega - one that is far more scary than any of the virtual reality rides at Joyopolis.