Last week at the Gamescom trade show in Germany, Sony finally announced a cheaper version of its struggling PlayStation 3 games console, the PS3 Slim, which is expected to reach the shops early next month. American and European consumers will see PS3 prices fall by $100 and €100 respectively to $299 and €299, while UK buyers will see a £50 price drop to £249.99.

Andy House, president of Sony Computer Entertainment Europe, undoubtedly heard the cries for a £100 price cut in the UK, but given Sony's financial problems, £50 is the best he can do. He knows most consoles are sold after the price drops below the £200 barrier, but Sony is closing factories and shedding staff, and the PS3 is selling at a loss. As his chief executive Sir Howard Stringer recently quipped: "I lose money on every PlayStation I make – how's that for logic?"

House says Sony is trying to broaden the console's appeal beyond the gaming fan base. "I think the lower price point gives you the opportunity to branch out into more of a family market," he says. "We've put in place new brand positioning before the PS3, and the strapline is 'The game is just the start'. The idea is to have a broader entertainment offering."

"At our press conference, I spent a considerable amount of time talking about the improvements we've made to PSN [PlayStation Network], and we confirmed the launch of a video delivery service in major markets in Europe this November. We also talked about catchup services for television available on PS3, with the BBC's iPlayer for the UK market.

"Within the gaming world, we're moving from a relationship that ended when we sold them [customers] a game to one where their relationship with us begins with that game, and obviously takes its life online. And also, the PS3 is a multifunctional device and a gateway into multifunctional entertainment."

This was always the core PlayStation 3 strategy, of course, but with the emphasis on selling Blu-ray movies. House puts a positive spin on this: "We're very fortunate in having a sister company that's a Hollywood movie studio, with whom we're working in close collaboration," he says. But Blu-ray got embroiled in a battle with HD DVD, and Microsoft's focus on its Xbox Live online strategy turned out to be much more successful. The future, surely, is downloads.

But times are hard. At this point in the games console life cycle, the three main suppliers – Sony, Nintendo and Microsoft – should be growing sales as their machines benefit from price cuts and the appeal of their growing software catalogues. Instead, the market is in decline and they are all having to watch the pennies.

Nintendo has been hit worst: sales of the all-conquering Wii fell from 5.2m to 2.2m units for the second quarter, a 57% decline compared with the same period last year. Nintendo's revenues fell by 40% to 253bn yen (£1.6bn), and profits were down by 61%. But at least it made money, unlike Sony and Microsoft's entertainment divisions.

At Sony, PS3 sales fell from 1.6m units last year to 1.1m in the same quarter, while sales of the PlayStation Portable plunged from 3.7m units to only 1.3m. Both suffered the ignominy of being outsold by the antique PlayStation 2, which shifted 1.6m units. Still, the division that contains Sony Computer Entertainment lost ¥39.5bn ($418m) in the quarter, which is more than Sony's overall corporate loss of ¥37bn.

Microsoft was the only one of the three to claim an increase in console shipments to 1.7m units compared with 1.3m in the same quarter last year, though this was only after it reduced prices. Overall, Microsoft's entertainment and devices division saw revenues slip by 2% to $1.6bn and last year's $106m (£65m) profit turned into a $31m loss.

Microsoft was able to cut prices by updating its console to use a processor fabricated using a more advanced 45nm process. Sony, which launched later than Microsoft, has now reached the same stage and the PS3 Slim similarly benefits from a move to 45nm. The new processor is cheaper to manufacture, uses about 11% less power and generates less heat. Sony has therefore taken the opportunity to reduce the size of the case, just as it did when it launched the slimline version of the PlayStation 2. Or, you might say, just as Microsoft didn't, following its struggle to stop the Xbox 360 from overheating.

Sony has also benefited from a huge reduction in the cost of fitting a Blu-ray drive, which pushed the original PS3 manufacturing cost to something approaching $850 per unit. Chief financial officer, Nobuyuki Oneda, said Sony had reduced the manufacturing cost by "about 70%, roughly speaking". This would put the unit cost at about $250 – not counting marketing and advertising or the dealer's profit margin – on a machine that sells for $299.

Console manufacturers traditionally make up the difference from profits on high-priced games and peripherals, but you can understand Stringer's dislike for the short-term financial consequences. And if the cost estimates are roughly correct, the PS3 is still in a deep financial hole from which it will take years to recover.

This is the main reason for thinking that John Carmack, a founder of id Software, is wrong in speculating that Sony could be the first to "jump the gun" and move to the next generation with a PlayStation 4.

"I'm very intrigued as to why that speculation has emerged," says House. "I would have thought the new model is indicative of a much longer life cycle. The overall trend for me is that we've moved away from a short-term, toy-based life cycle to one that more closely resembles other consumer electronics devices. One of the reasons we feel tremendously confident about the PlayStation 3 business is that the [online service] allows us to offer a new value proposition to entrants to the market, while at the same time, adding value to the PS3 experience for existing users."

Carmack's speculation is based on the fact that delays to the PS3's launch put it behind Microsoft in the product cycle. Sony is now trailing in third place. Being first with a next-generation console could change that, but it's hard to imagine what the next generation PlayStation would look like.

Sony aimed high with the PS3, and paid heavily for the development of the Cell processor and Blu-ray drive. Taking either of those forward would be even more costly. It's much easier to imagine a new Xbox 360 with a faster processor, Blu-ray instead of DVD and Project Natal body control functionality built in. And the Wii, which is relatively underpowered and has much worse graphics than the PS3 or Xbox, could easily be improved.

Still, the lower price of the PS3 Slim is certain to boost sales in the short term, and it remains to be seen whether Microsoft will respond. Being ahead of Sony on the cost-reduction curve, it could cut the Xbox 360's price. But having just announced its first-ever fall in annual revenues, Microsoft might not be keen to do that.

Even with Wii sales collapsing, it seems unlikely that the PS3 Slim will win the important Christmas sales battle. However, at least it's still in the fight.