If the race to dominate the next generation of consoles were a three-car video game, Microsoft would be completing its first lap with rivals Sony and Nintendo stalled on the grid.

Sony will show a final version of its PlayStation 3 in Los Angeles this week at E3, the industry’s biggest trade show, while Nintendo is expected to unveil its Wii console.

But neither product is expected to go on sale until November, giving Microsoft’s Xbox 360 a year’s lead that could prove unassailable.

“We think that Microsoft is in a position to take the lead, materially, in the fifth-generation game console fight,” said Merrill Lynch analysts in a report last week.

They expect more than 12m Xboxes to ship in this calendar year and Microsoft to have 47 per cent of the market by the middle of the new console cycle in 2008, with Sony taking 33 per cent and Nintendo 20 per cent.

That would be a sharp reversal for Sony, now dominating the market with a 64 per cent share against Microsoft’s 16 per cent.

Microsoft is promising aggressive investment in the Xbox 360 over the next 12 months to maintain its lead and, at E3, will preview its Halo 3 game – a key title that should bolster its console sales as Sony enters the market.

“Microsoft smells blood in the water,” said Bill Watkins, chief executive of Seagate Technology, which has been in talks with Sony about including its hard drive in the PS3.

Sony can take some comfort from booming sales of its PlayStationPortable handheld device and the continuing strength of the PlayStation 2, reportedly showing a sales increase of about 25 per cent since the price in the US fell from $149 to $129.

Nintendo is stronger in handhelds with its Game Boy Advance and Dual Screen consoles, but Microsoft is thought to be preparing its own entry into this market.

For software publishers, the move to high-definition technology means higher development costs and lower sales initially as few consumers can get hold of the new consoles and the rest begin to lose interest in current-generation machines.

US console software sales fell 12 per cent last year and could fall another 12 per cent this year to $4.1bn, according to forecasts by PiperJaffray analysts. But these analysts predict sales will be 36 per cent higher at $5.6bn in 2008.

“There are some short-term challenges as we manage the transition,” says Neil Young, general manager of the LA studios of Electronic Arts, the world’s biggest publisher. “But when you reach that [mid-cycle] point, you’re back into the Golden Age.”

Shares in Electronic Arts fell to a 52-week low last week after it said it was spending its way through an uncertain phase to the detriment of profits as it tried to ensure continued leadership.

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