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Sega closed several Japanese arcades last year, including a few of its flagship Joypolis entertainment centers. And according to Sega Enterprises President Hideki Sato, Sega’s two biggest competitors in the arcade market, Taito and Namco, are about to close many of their arcades as well.

“Sega is dominant in the arcade business area, both as a game manufacturer and a location owner,” Sato says. “We have scrapped many of our centers recently. We have had to look at each location as a unique case and decide if it is a good location or not. But now we can begin to build again.

“Right now only Sega is making profits from the operation of amusement centers. Namco’s amusement centers are losing money right now because they did not restructure their amusement center business. That is why Namco announced that they will close a couple hundred amusement centers.”

And the arcade business is not the only segment of the game industry showing signs of distress — the home console business has also experienced hard times. According to research published by the Computer Entertainment Software Association, the trade organization representing the Japanese video game industry, software and hardware sales have fallen over the last few years.

Software sales dropped nearly 10 percent in 1999 to 328.5 billion yen, down from 352.9 billion yen the year before.

But the drop in software sales is nowhere near as staggering as the 21 percent drop in hardware over that same period, from 114.07 billion yen in 1998 to 94.2 billion yen in 1999. And with the aging PlayStation and weak PlayStation2 markets, there is reason to believe that software sales for 2000 will be even weaker; though spurred on by PlayStation2, the hardware market may well have improved.

“You cannot just generalize and say that the entire game industry is going down the tubes,” says Keiji Honda, president and COO of Enix. Thanks in part to the success of its Dragon Quest series, Enix had its highest profits ever last year, as consumers lined up outside stores last summer to purchase “Dragon Quest VII,” a role-playing game for PlayStation. To date, Enix has sold more than 4 million copies of “Dragon Quest VII,” and the game has not yet been released outside of Japan.

“With consoles, a lot of good hardware and software companies are going bad as well,” Honda says. “Enix, however, is about to announce that its largest profit margin ever was in this fiscal year. Capcom and Nintendo are doing really well as well.”

Several factors are likely contributors to the suffering game market. While entertainment industries generally thrive during times of economic hardship, history shows that console hardware sales are impacted in times of recession.

Another cause of the recent downturn may be a rather rigid seven-year cycle that has long plagued the game industry. With Sony’s PlayStation2 only a year old and Nintendo and Microsoft poised to release new systems, the game market is in the weakest part of its cycle. Consumers simply are not excited about the older systems, but they are not necessarily ready to move to the next system until they know what is available.

A more recent challenger is Japan’s ever-popular cellular telephone. With one out of four school-aged children carrying cell phones, phones have cut into the video game market.

“Millions of people are getting cellphones and they are spending huge money, like 10,000 yen per month or more,” says Sega’s Sato. Money that, Sato claims, used to be spent purchasing video games.

But the game industry’s future may come from joining cellular technology rather than fighting it. Nintendo has released a cellular peripheral for both Game Boy and Game Boy Advance.

“The center of interest among young people is diversifying,” says Hisao Oguchi, whose Hit Maker game development team has created such Sega hits as “Crazy Taxi” and “Top Skater.” “Cellphones are very big in Japan, and so unless the game industry comes up with different types and concepts of games, like for example network games, we will suffer. Game graphics definitely are improving, but the gameplay itself hasn’t changed.”

And that change, according to Oguchi and several other top designers, may well include adapting to the new world of mobile communications.