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Market research firm Merrill Lynch Japan Securities recently estimated that it would cost Sony $494 to build a single PlayStation 3 console, but the company will have to sell its gaming machine for about $399 so that not to be much more expensive compared to Microsoft Xbox 360; such price which would result in $1.18 billion losses on hardware in the first year.

Merrill Lynch Japan estimates that the machine’s main components – namely its Cell chip, NVIDIA RSX graphics processor and BD-ROM drive – will cost about $101 each. After adding the other electronics that will be used in the PlayStation 3, the machine’s production cost goes up to $494, a news-story over GameSpot web-site claims.

Due to the fact that Sony’s forthcoming game console is likely to face fierce competition from Microsoft Xbox 360, which is expected to cost around $299, Merrill Lynch Japan Securities assumes that Sony would sell its console for $399 in the U.S. and for $410 (44 800 yen) in Japan. If the report turns out to be correct, that will mean Sony would suffer a loss of more than 130 billion yen ($1.18 billion) during the first year of the PlayStation 3 release.

It is normal for game console companies to lose money on the console hardware during initial sales of a gaming machine. But just as soon as sales of games start to pick up, game console designers fight their money back. For instance, the PlayStation 2 cost $364 in Japan and $299 in the USA when in launched, which caused Sony Computer Entertainment a loss of $458 in the first year; but the next year the firm recovered and hit $759 million profit.

One of the problems for Sony could be price cut on Xbox 360 when the PlayStation 3 launches, which would force the Japanese company to follow with similar move and face additional losses of $730 million in the second year of the PlayStation 3 and $457 million in the third year, Merrill Lynch warns.

“Whether consumers think a product is expensive or cheap all depends on the balance between its appeal and price. Our ideal [for the PS3] is for consumers to think to themselves, ‘OK, I’ll work more hours and buy it.’. We want people to feel that they want it, no matter what,” Sony Computer Entertainment president Ken Kutaragi told Toyo Keizai newspaper.

Sony Computer Entertainment’s chief declined to comment on the price of the PlayStation 3, but said that even despite of the price that was higher than that of competing products Sony managed to outsell the rivals.

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