Sega pins its hopes on new games console

It may seem odd for the president of a crisis-ridden Japanese company to spend a morning playing computer games; but not if he is Soichiro Irimajiri, Sega president, demonstrating Dreamcast, the group's new games console.

The stakes are high. Last week's launch of the 128-bit machine, billed as a successor to Sony's 32bit PlayStation and the Nintendo 64, may be the last time Sega can push the reset button, according to Mr Nanako Sakaguchi, analyst at Dresdner Kleinwort Benson in Tokyo. Even Mr Irimajiri admits that if Dreamcast fails, he has no fall-back plan.

Dreamcast is the key to Sega's survival because its predecessor, the 32-bit Saturn, has been beaten into a pulp by Sony's PlayStation. In the first half of this year, the PlayStation captured 70 per cent of Japanese console sales, against the Saturn's 9 per cent and the Nintendo 64's 4.5 per cent.

Sony's success has cost Sega dear. It reported its first loss last year: a deficit of 43 billion yen (£238 million) after sales collapsed more than 24 per cent to 271 billion yen. With declining cash flow and 150 billion yen of convertible bonds due over the next two years, Sega urgently needs its share price to recover.

Unless Dreamcast succeeds, Sega's prospects are bleak. Its progress also has implications across the games industry, a cyclical sector that is nearing the end of a buoyant period.

The games market took off in the mid-1980s, only to collapse in the early 1990s when consumers became bored with the old 8-bit and 16-bit consoles. Sales soared after the launch of the 32-bit PlayStation and Saturn in 1994; but the 32-bit and 64-bit console market peaked in Japan this year, and will peak in North America and Europe next year.

Sony is working in secrecy on a successor to the PlayStation, incorporating digital versatile disc technology, as is Nintendo on a 64 replacement. But Sega will be the first of the three to test the next wave of games technology with the Dreamcast just as online gaming is increasingly popular, as is personal computer games software.

Mr Irimajiri is defiant. He insists that Dreamcast is Sega's PlayStation killer and the answer to its problems. "With the release of the Dreamcast, we're not competing with Sony and Nintendo any more, we're blowing them out of the water," he claims.

The first step, he says, is admitting what went wrong before. "We were arrogant," concedes Mr Irimajiri. "We thought we knew best. But the fatal flaw with the Saturn was that it was so difficult for third parties to develop software. We just didn't get enough good titles."

Sega has publicly apologised with a five-month television campaign. The first advertisement showed a Sega executive overhearing one boy telling another: "Sega sucks. I want a PlayStation." The campaign culminates in Sega admitting its products were substandard and promising to do better. "Sega may have sucked in the past, but we are now defining the future with Dreamcast," proclaims Mr Irimajiri.

The 128-bit machine has a double-density CD-Rom, providing additional memory for more complicated games. Its NEC-manufactured graphics engine produces three-dimensional graphics faster and more realistically than 32-bit machines.

However, its sales prospects will depend mostly on software. There will be just five launch titles, among them Virtual Fighter, Godzilla Generations and Sonic Adventure. A further 18 titles are scheduled for release before April.

Dreamcast's debut has been dogged by production problems with the graphics chip designed by VideoLogic of Britain and manufactured in Japan by NEC. Output has fallen below expectations. Only 500,000 machines will be produced this year against a target of one million - worrying for Sega as Christmas and new year are Japan's busiest sales seasons.

Sega has the advantage of being the only one of the three big games groups with a new console out in Japan this Christmas, but Sony and Nintendo are not prepared to cede the initiative. Sony is spending heavily on PlayStation advertising worldwide this winter, as is Nintendo, which launched a new The Legend Of Zelda game for the 64 in Japan last week and the US this week.

Mr Irimajiri hopes to sell 10 million Dreamcast consoles in Japan over the next four years, but says it will break even on sales of three million. However, the initial response to the Dreamcast in its domestic market will be critical in setting the tone for its international debut in Europe and North America next autumn, and that is where the battle for Sega's survival will be won - or lost.