Will they ever reach the end: The boom in video games has set off a race for an electronic future that will revolutionise home entertainment. Gail Counsell examines what's at stake

AN EXCAVATOR was working overtime in the Nevada desert in 1984. It was burying millions of unsold computer game cartridges, casualties of one of the most spectacular consumer voltes- faces of modern times.

The year before, Christmas had stretched from January to December for the computer games industry. The phenomenal success of 'consoles' - home computers designed for playing games - and especially the popularity of the machines produced by the US company Atari - had generated a huge demand for game software.

But greed had been the undoing of the business. Anyone could produce games which would work on an Atari console, and just about everyone did. Children rapidly grew tired of paying good money for poor games. Oversupply met consumer disenchantment. Millions of surplus cartridges were dumped or, like Atari's, buried.

Yet that was not the end of the story. A few years later another excavator was digging the same stock up. Computer games were suddenly hot property again, and old Atari consoles and the software to play on them were in demand.

It turned out to be a mixed blessing. It was an obscure Japanese company, Nintendo, which had been making playing cards for more than a hundred years, that was responsible for raising the formerly US-dominated industry from the grave.

Atari was left selling its resurrected products to eager buyers in East European nations. Unlike Western consumers, they could not afford the state- of-the-art Japanese consoles which had re-invigorated the games market.

So was born a part of the much-lamented US-Japan trade deficit - a staggering 10 per cent of which was blamed last year on Nintendo.

But the Japanese company has done more than irritate protectionist US senators. Computer games have become a highly profitable industry. And that has become the seed-bed for reshaping the entertainment industry.

At around pounds 1bn a year, Nintendo's earnings are bigger than Microsoft's or IBM's, and within a whisker of those of Matsushita, the world's biggest consumer electronics group. Last year Nintendo made more money than all the American film studios put together.

Indeed, in the past 12 months Nintendo has earned twice as much as the electronics giant Sony, on a sixth of its sales and a tenth of the staff. In a recession, Nintendo's profits have continued to rise, while other Japanese companies have seen their earnings shredded.

Nor is Nintendo alone; Sega, its smaller, more aggressive rival, may only have earned a third as much as Nintendo last year, but at pounds 360m, pre-tax profits were up 60 per cent.

Although Nintendo's outperformance on the stock market has been spectacular, it is eclipsed by Sega. Since the middle of 1989 Nintendo's shares have risen by more than 65 per cent, at a time when the Nikkei Dow has fallen 40 per cent. But Sega's shares stand more than 650 per cent higher.

The trend seems set to continue. This year more than pounds 5bn of computer games software will be sold worldwide, with almost as much again going on 'game-specific' hardware. Between them, Nintendo and Sega will probably account for half of total sales.

Half of all the money spent on computer games will be in the US, where an astonishing 80 per cent of the market is claimed by Nintendo.

Nintendo's - and subsequently Sega's - success has been based on the simple but brilliant expedient of controlling the software produced for its machines. No one may make a game for a Nintendo console without asking - and paying - Nintendo (which insisted on doing the manufacturing and packaging, as well as charging a licence fee for every game sold) for the privilege.

This not only means that Nintendo is guaranteed a cut of any profits being made, it has also removed the twin dangers of oversupply and poor quality.

When Sega decided to muscle in on Nintendo's territory, it paid the group the ultimate compliment of imitating its software strategy.

Nintendo had realised that if it created the right games, children would buy the machines simply to play them. Super Mario was born, a computerised character which in its third incarnation (the Super Mario Bros 3 game) sold 14 million copies, generating more revenue than any movie apart from ET Sega produced Sonic the Hedgehog to perform a similar function.

Playing computer games has become a 'phase' of childhood. Already several such 'generations' have passed through it. But, as for Disney or Enid Blyton, new generations of consumers are constantly being born - a recipe for continuing profits. In the UK alone, there are 26 magazines devoted exclusively to the needs and interests of Nintendo and / or Sega game players.

But another reason why the longevity of computer games seems assured is that they are coming out of the toy-room. Many of the children of the early 1980s are now adults. Such magazines as Time Out and Smash Hits treat video games as another form of entertainment, reviewing them as they do the latest records.

Thus anyone under 25 is used to the idea of computerised entertainment, an attitude which will fuel the growth industries of the future as the segment of the population they represent expands.

'When we first started a magazine called Computer and Video Games, no one imagined it would still be around 12 years later,' says David Kelly, a publisher with Emap, the magazine group. 'When video games first came along with Atari, everyone thought they would have a very limited life.

'Yet that's not happened. Partly that's because the technology has leapt ahead - the graphics have got better, the games themselves have got more interesting.

'But also the products have broadened as people have grown up. There are a lot of people aged from 20 to 30 who have grown up entirely used to the idea of game-playing.

'The only difference is that - maybe with a break in between when they discovered the opposite sex - while they used to play Space Invaders, they now play golf or flight simulators. And increasingly in future they'll be using CD machines, interactive television and virtual reality. That's the point. It's all growing up with them.'

The name of this metamorphosis is 'Multimedia'. It is the future of the business, and the stakes are very high. Not surprisingly, therefore, everyone, from Sony to Time Warner, from AT & T to Philips, wants a slice. The big question is whether the traditional entertainment and consumer electronic giants will be the winners, or the nimbler video-game companies, with their surer instinct for what is street-credible.

The battle has already been joined over compact disc technology. Machines which (usually plugged into a television) will use CDs rather than floppy discs or cartridges have a number of advantages.

'The immediate future is CD,' says Kelly. 'CDs cost a fraction of the cost of cartridges to produce and are capable of delivering a product that is an order of magnitude better.'

Nick Bubb, a retail analyst with the broker Morgan Stanley, agrees. 'The real question is what will happen next Christmas. And a large part of that will be CD.'

So far there are two candidates. The Dutch electronics giant Philips has produced its CD-I machine, which has failed to attract much support. It is seen as too expensive, but most observers agree the main error has been trying to sell it as an educational tool.

Sega and Nintendo have a gift for understanding how to sell to children, but Philips sold over their heads to their parents. It didn't work.

Sega has also released a CD machine, though it has to piggyback on its established console, the Mega Drive. The publicity for this couldn't have been more different from the Philips approach - the baffling 'Pirate TV' ads. But it was a success - the 70,000 or so manufactured for the UK have all but sold out. Sega is now preparing an upgraded version for release before Christmas.

Nintendo has yet to release its CD machine. It is thought to be waiting until it has a technologically superior machine which won't need piggy-backing. 'Sega wanted to be seen as at the leading edge of technology in this area, so it rushed out its CD machine,' says one industry observer. 'It's not that good, but it's first.

'Nintendo prefer the idea of building a CD into their next- generation machine, so that when it comes, it's a quantum leap in technology. They are making a fortune out of cartridges and they think: 'Why undercut existing profits?' '

But will people want to buy the next generation? 'Yes, because they will be that much better than cartridge games,' says Kelly.

The main point about CD game machines is that they are Trojan Horses. Get them into the house to play games, and you can do many other things with them too. Putting an encyclopaedia on CD is child's play.

But it is a relatively short step to a CD machine which is fully interactive. Not only will you be able to play games on it, you will be able to plug it into a cable / telephone system; that will give you access to enormous libraries of information and software, as well as provide links with the outside world.

Already the fight is on to establish a technical standard and an embryonic network. Several groupings have emerged which aim to exploit this shift, most notably the US link-up between Time Warner, the cable and film giant, TCI the cable operator, AT & T, the telephone company, and Electronic Arts, the biggest American game software company.

They have an alliance with 3DO, a company set up by Electronic Arts' founder, to produce a CD machine to sit on top of the television and be fully 'interactive'. It is the ideal solution for couch potatoes, who would be able to dial up a pizza, rent a video, do the home shopping and zap the monster, all without leaving the settee.

To this end, 3DO isn't selling itself as a computer game company, but a more expensive, more upmarket computerised entertainment device. It envisages living in harmony with Nintendo and Sega when it makes its debut next year. That may be so. But past experience has shown that corporate Japan is less than happy about sharing its bed with corporate America.

(Photographs and graph omitted)