The games industry is in a slump, and the European Computer Trade Show, held at Olympia over the weekend, was the dullest event for years. But the future looks good. Nintendo sent Shigeru Miyamoto, its Japanese superstar game designer, to show off its next generation Gamecube, Sony mounted a huge display around the PlayStation 2, and Microsoft had its two top games gurus rounding up developers to work for the forthcoming Xbox games console.

The games console business is cyclical, and everyone expects a boom to follow the bust. In fact, Ray Maguire, UK managing director of Sony Computer Entertainment, says he expects the business to come back bigger than ever, as it has following previous turns of the technology wheel.

Gaming is evolving from a niche market to a mainstream activity, "blending computer technology, DVD and music into one experience," he explains. "That's where we're going with the PlayStation 2."

David Gardner, managing director of Electronic Arts Europe, agrees that the PS2's ability to deliver close-to-TV-quality graphics should make the games industry "bigger than it has ever been, because you don't have to imagine it, you can see it. That's the big win we've been waiting 20 years for, and it's finally coming this Christmas."

The problem is that it's not here yet, so gamers are less keen to buy current machines that may have a limited life-span, and they want to pay lower prices for the games that run on them. This has reduced the games industry's income, and led to the current trough.

But while owners of next-generation consoles will no doubt be prepared to pay high prices for great new games, it will take years before there are enough of them to replace more than 70 million Play-Station owners, and more than 100 million Game Boy owners. Transitions take time.

Things will start to change on November 24, when Sony ships the PS2 in the UK, but Microsoft's Xbox is not due for another year, even if it arrives on schedule. (Both console hardware and Microsoft software are usually late, so I wouldn't bet on Microsoft shipping a console on time.)

Nintendo's Gamecube, code-named Dolphin, may be even later. It is expected to go on sale in Japan in March, and in the US in October 2001, but UK buyers will probably have to wait until 2002.

Worse, even the arrival of the PlayStation 2 may not give the software business the fillip it needs. Reports from Japan suggest that sales of PS2 games are relatively low, either because Japanese buyers are using their consoles as DVD movie players, or because the first games have been lacklustre. It normally takes at least 18 months to develop a great game, and the PS2 is reputedly very hard to program, so some software houses may have cut corners in the rush to market.

Either way, the PS2's problems have given Sony's rivals angles for attack.

In London on Saturday, Nintendo's Miyamoto - the creator of Mario, Zelda and other characters - argued that the Gamecube was a better platform. "We software people have been fooled in the past by claims from the hardware people" who don't deliver what they promise, he said.

The Gamecube, however, "is compatible with creating games: it's close to be being the ideal piece of hardware." Microsoft's primary strategy is to beat the PS2 with better technology, and Peter Molyneux, Britain's leading games designer, says: "the Xbox is unquestionably the most powerful of the next generation machines." But Microsoft is also stressing that it is by far the easiest to program, because the base technology - 733MHz Intel processor, Nvidia NV20-equivalent graphics chip, a stripped down version of Microsoft Windows 2000, DirectX 8 multimedia interface, hard drive, DVD player is already familiar.

Ed Fries, vice president in charge of Microsoft's games software division in Seattle, tells programmers: "You don't have to wait for an Xbox, you can start on a PC today."

Also, unlike their PS2 equivalents, PC programming tools are very highly developed, and millions of programmers already know how to use them.

Both Sony and Microsoft recognise that they are on a collision course, but neither seems too concerned, and Molyneux says the competition will be good for consumers. Separately both Sony and Microsoft seem to agree.

Maguire says that Microsoft and Nintendo putting "more energy into the marketplace" will increase interest in gaming, "so in one way they'll take market share, but they'll help grow a bigger market overall."

J Allard, general manager in charge of the Xbox project in Seattle, says: "We're going after the same market [as the PS2], and we're going to spend a ton of money, and we're going to have games that nobody's ever seen before, and raise the bar in the industry. Collectively we're going to grow this category significantly," he says, "as every generation of new consoles has done."

I ask Allard if the success of the Xbox will undermine the market for PC games. This is important, because the PC leisure software market in Europe is bigger than the games console software market - by $3,067m to $2,708m last year, according to research just published by Screen Digest and the European Leisure Software Association (Elspa).

"I think there are fundamental differences between PC games and console games," he replies. Allard says he associates words such as realism, solitary, and cerebral with PC games. "Age of Empires is much more thought-provoking than any console game." The words he associates with console games include approachable, social, and action. "With consoles, the rapid reward system is much more critical than the depth," he continues. "Console games have been more like comic books, and PC games have been more like the Iliad. That requires a little more thought, and if you don't read the whole thing you're not going to get it."

This, of course, reflects Microsoft's approach to developers. Both Allard and Fries are insisting that Xbox games must be designed for the console, not just carted over from the PC. But Allard is well aware the differences are blurred, and sees the potential benefit.

"We have a wonderful opportunity to take the depth of PC games and the approachability of console games and create new forms of entertainment. I think that of the bulk of Xbox games 85% will be just like other console games, but done better. But maybe 15% will have deeper content that takes us to a whole new level," he says.

Others are already seeing a whole new level: it's called the internet. That's where Sega has staked its claim, by including a modem with its Dreamcast console, and by launching an online service, Dreamarena. This enables Dreamcast owners to play online games and send electronic mail.

It also allows Sega to think about changing the way it makes money from games: perhaps it could charge for online play-time instead of for disc-based software that is subject to piracy and theft.

Sega's problem is that the internet has yet to arrive as a mass market for pay-to-play services, and the services that do exist are dominated by PCs. The Dreamcast may be able to get online, but it provides a relatively poor internet experience, partly because of the low resolution of TV screens that cannot display websites with anything like the quality of a computer monitor. The further worry is that some users may think Sega is deserting its core Dreamcast business - console gaming - when the online arena cannot generate equivalent revenues.

Sony's ambitions for the PS2 are also well known: it is intended to become a well-connected home entertainment centre. But as Gardner points out: "Right now, the games consoles don't have the sophistication of PCs for online use, so the PC market will continue to grow."

Right now, EA's most successful online gaming service, Ultima Online, is based on the PC. Even J Allard - who was the first Microsoft employee to run a server on the net, and who registered Microsoft.com - thinks the time is not ripe. He's launching a console using the tried and trusted methods developed by Atari and other companies 20 years ago, and that have been most successfully copied by Sony. As he'd told me at the Xbox's unveiling in March: "We are not confused: this is a single-function device entirely focused on the games market. We have to focus on creating great games."

In the long term, however, Allard says: "the internet is ultra-important, it's critical." He describes how frustrated he became when catching up with his email on the plane to London, because so many messages included links to websites: "it drove me crazy that I wasn't connected."

That would not have been the case four or five years ago, and Allard reckons that eventually "the same thing will be true of gaming. As soon as people subscribe to the Metal Gear Solid Mission of the Week, and everyone is talking about last night's mission, they'll never be satisfied with last year's static, standalone, disconnected game again.

"It's just a question of when that time will come. I think the Xbox platform is best suited to catalyse that shift, and I think we'll be instrumental in leading that charge," says Allard. "Are we pinning the success of Xbox on that? Absolutely not. Do we think gaming is going to go that way and never look back? You bet."

One of the interesting things about the cycles of the console industry, with its regular peaks and troughs, is that so far every generation has brought a different company to the top. Thus Atari (VCS) was followed by Nintendo (NES), Sega (MegaDrive/Genesis) and then Sony (PlayStation).

Sony must be the bookies' favourite to break the pattern and win two rounds in a row. But look ahead to the next cycle, where Microsoft's strength on the internet could tip the balance, and there might be a new champion. It's not Game Over yet.