MSFT, Xbox 360 and Japan: Failure-in-a-Box

The success (or lack thereof) of Xbox 360 has been a hotly debated topic across both the blogosphere and mainstream media, with an amalgam of sober and utterly confused views depending upon one's vantage point: analyst, investor or gamer. After taking a step back and looking at some objective numbers - those taken from Microsoft's own financial statements and comparative console sales figures extracted from VGChartz.com and Wikipedia.org - I have concluded the following:

• Gaming has been a disastrous endeavor for Microsoft, particularly from an investment perspective;

• The seeds of this failure are evident from their sales performance in Japan, particularly when comparing their 18 week sales figures (which is about how long the Wii and PS3 have been out) relative to those of the most successful console releases; and

• This early failure in the key Japanese market has a compounding negative effect on worldwide console sales, as game developers are less willing to invest in high-risk projects for console platforms that are shaky out-of-the-gates, which makes it less attractive for gamers to buy these consoles, and so on.

Before digging into the data, I'd like to clarify a key point: my perspective is that of a financial analyst. Therefore, my primary interest is in the strategic and financial implications of business decisions, in this case the Xbox 360 and Microsoft's Home & Entertainment strategy, and NOT whether or not the Xbox 360 is a rocking product. As I've stated before, I have many friends who think the Xbox 360 is awesome. This, however, is not my concern. And to state the obvious for those who know me and/or are regular readers, I am neither a fanboy nor an investor in single stocks, so I have no interest in partisanship one way or the other. I am only interested in truth and understanding, and if a few people get their noses bent out of shape in the process, sorry.

Hemmoraging Home & Entertainment

Let's first consider Microsoft's Home & Entertainment Division ("H&E"), which includes Xbox 360, Xbox, Xbox Live, Consumer Software and Hardware Products and IPTV. I have used a set of numbers from historical annuals that seem to change by $100 million or so year-to-year; I'm not sure why this is, but the numbers are close. Regardless, it is not a pretty picture from a financial perspective. Making money, e.g., the creation of long-term shareholder value, has got to be the ultimate driver of Microsoft's gaming (and H&E) strategy, right? Well, after five years and over $21 billion invested all they've got to show for it is $5.4 billion of cumulative operating losses, and Xbox 360 doesn't appear to be the silver bullet to turn things around. I think it is also interesting to note that Microsoft's actual disclosure shows only Revenues and Operating Losses; I backed into and show EXPENSES below for explanatory purposes. Why might it be that Microsoft has strayed from the classic Revenues - Expenses = Profits (Losses) disclosure? Perhaps because they don't want investors to focus on the fact that over $21 billion - the market cap of a sizable independent company - has been invested in a business that has performed so poorly, with unclear prospects for improvement. Could this be the reason? Hmmm.   

Sometimes these cold, stark facts seem to get lost in the shuffle. Xbox 360 (a meaningful part of H&E) might be a fine product, but if so, why is it so financially disastrous to its maker? I understand the concept of selling a console at a loss in order to lay the foundation for recoupment of original investment + operating losses + attractive financial return through gaming, but what is it going to take to turn things around? Nothing short of a tectonic transformation in perception of the Microsoft offering relative to its competitors. Sure, the Xbox 360 can be righteous and cool with hard-core gamers, but this is not a sufficiently large user base to recoup the magnitude of investment Microsoft has made in its gaming platform. So if this is the strategy, they've got a problem. And if their strategy is really more mass-market, then they've got some serious re-positioning to do relative to the Wii, which is both cheaper and more accessible to Ma and Pa and Timmy and Tammy gamer. In short, I am at a loss. Correct that: Microsoft is at a loss. $5.4 billion and counting.

The Importance of Japan

It is interesting to consider a few key points about Japan and its role in the gaming world after a little thought and analysis of historical figures:

• Success in the Japanese market is a key determinant of success in the worldwide market. In fact, one might say that is a necessary but insufficient condition for a globally successful console platform. Sony and Nintendo have absolutely thrashed Microsoft in Japan, and it shows in the global console sales figures. For historical reference, consider that over 19 million PS1s and 20 million PS2s were sold in Japan alone, close to the worldwide sales figures for the original Xbox console.

• Success in the Japanese market is a key part of getting the game developers to buy into a platform, for which they invest substantial sums and create titles, which makes people want to buy consoles with better game libraries. Success in Japan is frequently a precursor to success globally, which makes it particularly attractive for game developers who are looking to amortize their development costs over as large an installed base as possible. If, for instance, the Wii is hot, you get shops like EA turning themselves into pretzels to build their title libraries for the Wii console. And if your particular console isn't hot? Well, let's just say that developers aren't going to be laying out big bucks to invest in the platform.

• Success in the Japanese market creates a virtuous cycle - sell consoles, which induces developers to create titles, which makes it easier to sell more consoles, more games, more consoles, etc., etc., etc. In the absence of such a cycle, a console maker is fighting an almost impossible uphill battle towards success on the global stage.

It is instructive to look at where the last major console releases were 18 weeks after launch in Japan. Basically, if you did well in Japan during this time frame, you had a chance to have a blow-out product. If you didn't, well, you didn't.

See how the Xbox did better than the Xbox 360? Even the PS3 has done better than the Xbox 360. But success in Japan is not a guarantee of a run-away success, as the GameCube proved. Without question, Japan is an important and critical market for building a globally successful gaming platform, and an early read of the tea leaves does not bode well for the Xbox 360.

And this is clearly not lost on Ballmer's Boys in Redmond. Remember the promise of runaway success in Japan back in 2005?

From Afterdawn.com 12/04/2005:

By next summer Microsoft hopes to have sold one million Xbox 360 consoles in Japan. This is a pretty high target when you consider that the first Xbox console has not yet even sold half a million units in Japan. Japanese gamers also seem to be more interested in Sony's upcoming PlayStation 3 (PS3) console than the Xbox 360. Japanese Xbox business manager Yoshihiro Maruyama, revealed this target to one-time publication Dengeki Xbox 360.

"It's only a target," Maruyama said, "but the one million mark is a figure we'd like to reach by next summer. And then, we'd like to go to 1.5 million, then 2 million in next year's end of year sales rush. We believe the one million mark to be an important figure. If we cross one million, it will be easier for developers to do business, so we'd of course like to reach it quickly."

Fast forward to today: Mr. Maruyama's words ring hollow. As we approach Summer 2007 Xbox 360 still isn't even at 1 million units. The Japanese launch was a dud, and Mr. Maruyama was subsequently replaced. From Gamesindustrybiz.com 02/16/2006:

Yoshihiro Maruyama, the Microsoft executive who oversaw the launch of the Xbox 360 in Japan, is to take on a new role in the company's entertainment and devices division.

He will be replaced by Takahashi Sensui, who has been at Microsoft Japan for four years and worked closely with Maruyama on the Xbox 360 launch. Sensui, who was previously director of Xbox Japan's marketing department and game content group, will hold the title of general manager.

Quick: can you name another senior gaming executive that was kicked upstairs after a disappointing product launch? You guessed it, Mr. Ken Kutaragi of Sony. I feel like we've seen this movie before. And these movies tend not to end well.

An Issue of Strategy

Microsoft management has been talking about cultivating a more global, diversified user base for quite some time. Consider the words of Peter Moore, Microsoft Corporate VP, when speaking at the ELSPA International Games Summit way back in the middle of 2005:

Speaking at the ELSPA International Games Summit in London, Microsoft corporate VP Peter Moore has predicted that the company's first-mover advantage with Xbox 360 will allow the console to reach 10 million installed base "very quickly."

********************

He reiterated his colleague J Allard's comment, made at E3 last month in Los Angeles, that the next-generation could touch a "billion consumers" - but clarified slightly, saying that he was referring to the industry as a whole, including all three next-generation consoles, rather than simply to Xbox 360.

Speaking about the factors which will drive the growth of the next generation, Moore talked about the industry's need to broaden its audience, both geographically and demographically - and highlighted the growth of high definition television as a key factor which will drive next-gen consoles to new consumers.

It seems to me that there is a disconnect between stated objectives, strategy and execution. Microsoft's vision of the gaming console as the window into the living room is a big, big bet, and one that clearly hasn't paid off thus far. Mr. Moore talks about the need to broaden its audience across both geographies and demographics, yet the emphasis on HDTV as being a key factor driving broad-based console sales kind of misses the point. Is the Wii successful because of its zippy graphics and technological superiority? No. It is successful because it is fun. And because it appeals to a broad audience. And because it is comparatively cheap. The Microsoft strategy sounds more like a niche strategy for hard-core gamers, in which case it's investment in a console strategy should be smaller and more targeted. Would Lamborghini try to sell to everyone? Of course not; it would target those who the company knows value its features and are willing to pay for them. This is basic stuff.

They are just not in sync with the Consumer Era of Computing thesis I've written about, something that Apple and others have done quite well. A hard-core high-end gaming console or a console for everyone?  The Zune as the answer to the iPod? I don't know who was in those focus groups but clearly that was a mis-read from a market perspective. Are these miscues a function of unwieldy size or simply flawed strategy? I don't know, but something is clearly amiss. And these weaknesses are apparent all across the firm.

Bottom line, Microsoft needs to take a long, hard look at its gaming strategy - and, in fact, its entire H&E strategy. At what point, regardless of its virtually endless financial resources, does it say "enough is enough." Would we have been better served by returning the extra cash to shareholders rather than investing it in a franchise that seems to have questionable prospects for turning around? These are the kinds of questions Microsoft management should be asking. And hopefully, for shareholders' sakes, they are.

The author does not hold a position in the securities of these companies.

Comments

[Jeremy Charette]

Roger,

One last thing I'd like to mention, which you should really take into consideration. You say a successful launch in Japan is a good indicator of global success, and you point to the PS2. Keep in mind, the PS2 was the cheapest DVD player available on the market when it launched in Japan. It sold over 2.5M units in 18 weeks because people were buying it to play DVDs. The attach rate was abysmally low (less than 1 game per console sold), and Sony was appalled. As the price of DVD players dropped, things began to even out, but this was the primary reason for the PS2's rocketship launch sales.

[ThisIsBS]

Is this a Sony fan website, because Sony's loss is WAY more than Microsoft's. This is a complete joke. The main reason why the PS3 did so well in comparison to the XBOX 360 in Japan is because of the Japanese protectionism laws. The country knows that buying foreign goods is terrible for the economy. This is one thing the majority of American's don't understand. We need to promote national spending and decrease outsourcing.

BTW this whole post is complete BS, you're much better wasting your time playing video games.

[Jim Freehold]

An overdue analysis.

Looking at the comments, those pro or con the XBox and/or the whole MS strategy overlook possibly the most revealing point you raise: the way MS appears to have changed its financial reporting on this.

The company has been long known for its conservative reporting practices. And surely MS is more expert on its own figures and market wins/losses than anyone.

If they are starting to bend the truth about the reality, then that betrays their own lack of confidence in the situation, and says so much more than what anyone else could -- especially game fans who insist "it's a whole new market" and "the old rules don't apply."

Over the years it's been clear that, if MS were investing someone else's money, it would have become known worldwide as a serial venture killer long ago. It is blindingly obvious to industry observers that the company's legacy products -- OSes, office suites, and servers -- are the only reliable revenue generators . These also happen to be the products that rode the rapidly rising tide of Intel-based technology, a sea change that will not occur again in our lifetime.

Had the company been able to understand the historic forces outside its control that contributed so deeply to its success, it would not be operating under a delusional "scaling the castle walls" strategy.

But then, Bill Gates himself not long ago (I believe in a Newsweek interview) referred to his own company as "the Borg."

Weakening reporting practices would be simply a sign that the delusional thinking had become fully institutionalized and was reaching final stages.

[Bill D.]

I cannot argue that there is something terribly wrong with the whole next gen launch. Wii is making inroads because of its cross family, age and gender appeal. PS3 and XBox 360 are floundering because of two reasons, faulty hardware and high prices. Whether that is actually true or not doesn't matter, its what I see as the prevalent perception with most of the people I talk to each day.
For instance, the other day in a very well known north american retailer, I was informed that I really should purchase the extended warranty package because of the high probability that either the 360 or the ps3 would fail due to over heating. Now that is a perception that even permeates main stream retail.
No wonder the majority of customers are sticking with what they have, or purchasing new, low cost ps2's or maybe even squeezing the budget to buy a wii because of its broad appeal.
Besides, how many people have HD Tv's? I am the only one I know of out of all of my friends,..and I had to really work hard to get what I got.
The machines, the graphics, the playability, the technology is all there, what isn't there are the consumers willing to front cash to launch this new wave of high tech gaming. So they are waiting,...I know I am.

[switch]

saying that Xbox 360 in general and xbox live in particular are a mistake or wrong strategy is rather short sighted.

In 3-4 years when xbox live becomes the third horse for msft, everyone will see why throwing billions of dollars was worth it.

and honestly - much better to put money into xbox than do a stupid share buy back.

[benditlikebuffett]

If you are going to call the $21b of expenses an investment, you have to call the revenue that investment Produces, a RETURN on investment. If you don't your analysis is FATALLY flawed.

[HiveMind]

Good article, though I think your conclusions and assertions are a little blunt and assumptive. I am pretty sure that, especially under Ray Ozzie's perceptive command, that these questions are most probably being asked and considered within the ranks at Redmond. I think Microsoft are in a very difficult phase of their evolution, where they are reinventing themselves as an entertainment/media business in the face of declining/fragmenting operating systems and application software market.

It is a big gamble, and yes, their judgement seems to be a little off, especially when compared to the canny Nintendo crew, but you seem to assume there is no introspective reasoning at MS central, in the face of multi-billion dollar losses.

Despite my general distaste for the ways and methods of Microsoft, the one thing I am sure of is: they are VERY conscious of what they are doing, and where they are going.

[Sisyphus]

"What's 'normal' about selling a product for a loss? It's a risk and should only be done if you think you can get away with it."

Ding Ding. Obviously you dont know about the console market then. The hardware, the gatepiece, is traditionally sold at a loss, with the real money made on software license revenue. Challenge 1 is to get the hardware in the house. Challenge 2 is to feed it with a regular supply of compelling content that people will buy. Fall short in either and you fail. Fall short in #1 (what Sony is doing as we speak) and it wont matter about how well you're doing at #2 because households without consoles cant play games anyway.

Currently MSFT is doing so-so, but not horribly, at #1, and better at #2. Sony is doing terribly at #1 and so-so at #2.

"b) Japanese publishers own a big part of the worldwide market. At the moment there are 5 publishers with more than a billion $ in yearly revenues: EA, Konami, Activision, SquareEnix, Take 2. 2 of them are Japanese. Doing well in their home market will help any system to garner their full support."

You say this is part of what makes the Japanese market qualitatively important, more than the 17% or so it represents of the market. I fundamentally disagree. These developers will go where the license revenue is, even if it isnt in their own market.

You dont have to agree. The proof is in the pudding. X360 is an absolute dog in Japan. Yet that hasnt stopped Japanese developers from jumping off the PS3-exclusive ship to announce the release of games like Devil May Cry 3, Virtua Fighter 5, Ace Combat, and others for Xbox 360.

By your logic they would not care. Apparently, they do, and they DON'T care about how badly 360 is doing in the Japanese market - only how well it is doing overall worldwide and the potential license revenue they get (they do have to reach ROI on their game of course).

Thus, again, to summarize:

Using Japan as a Basis To Predict the Overall Console Market, and Doom for MSFT: FAIL

[mutantmagnet]

"Honestly, I'm trying to argue with this guy intelligently but... " -Ben Jones

Atleast you are using the keyword 'trying'.

"360's main competition is the PS3. Which of course, the article conveiniently ignores." - Ben Jones

The article's focus is to explore what people need to think about when investing in Microsoft. Once you understand that you can stop feeling so defensive.

" If he was, he should know the normal (not Nintendo) model is, lose money for the first 2-3 years of a console, gain it back and more on the last 2-3 years as hardware costs decrease and software sales rise."

"And losses are part of the (non-Nintendo) model, as this maroon might need to learn." -Ben Jones

What's 'normal' about selling a product for a loss? It's a risk and should only be done if you think you can get away with it.

Do you really think Nintendo is the only company to set a precedent for selling consoles at a profit?

The Atari 2600 proportionally was more expensive than the PS3 for its time by $160 or a factor of +32% (http://curmudgeongamer.com/imgdisplay.php3?shotfile=console-prices-relative.png ) and it was sold at a profit, albiet meager profits.

"MS cant do well in Japan because Japanese are extremely nationalistic and for the most part wont buy American industry products. Blaming MS for that is just stupid." - Ben Jones

http://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx?Language=E&Country=JP,US

Regrettably it is always at a consistent deficit, but the United States has always been one of Japan's top trading partners and vice versa.

---------------------

Anyway I have to correct myself when I said earlier Atari didn't have competition when they pioneered the gaming industry. They did have competition.

[Lowman]

Your an idiot and most of these readers have the information commented already to prove that your an idiot. Go back to college for something other than writeing hippie.

[Richard A.]

"I think tHe Japanese market is important because of the Japanese developers. I have no sources to back me up on this one but in discussion with gamers they frequently point japanese developers have a historical tendency to back the consoles that do well in their territory regardless of worldwide sales."

This was once true. In the past consoles were mostly made by Japanese companies (Sega, Nintendo, Sony), and were release in Japan a year(in the US) or two (in Europe) before the rest of the market.

Now add to the mix exclusive games set to release to only one console and you have very powerful Japanese Developers.

EX.- Final Fantasy VII (playstation only game) sold 2.3 million copies(in 3 days) in Japan in Jan 97. This greatly boosted sales of the Playstation in Japan and fueled further development of games for the Playstation. When the game was release in the US, in Sept. 97, it sold 500,000 copies(breaking records) and boosted more US sales. With the sales boost in the US, more development was given to the Playstation.

Everyone falls into line. Rinse and repeat.

Now enter MSFT with the Xbox 360. They release the system world wide(US, Japan, Europe) within a 1 MONTH window! Sony and Nintendo follow MSFT down the world wide path.

Now all Developers are stuck and the market is a bit of a mess. Big Japanese developers are already positioning themselves for a Nintendo Japanese market.
Best example of this is Square Enix's(maker of Final Fantasy) and its move to have its second biggest franchise be a Nintendo DS only game and not a Playstation 2/3 game. This move marks a huge win for Nintendo and a major lose for Sony.

As for the US/Europe they have a strong lineup this fall. A strong lineup that is mostly made up of Xbox 360 games. Halo 3 should sell over 10 million units (and boost 360 sales). Games that were once exclusive to Sony are now showing up on the 360 (See Japanese games like Devil May Cry 4, Resident Evil 5). While the Nintendo Wii and Ds lite seem to be selling out everywhere.

The market is no longer the same. Old rules do not apply.

[Tom Ross]

Jeremy,
Could you provide a link that confirms that XBox Live is seeing 25 million -paid- downloads per quarter? Otherwise I tend to believe that Microsoft is including free downloads like patches and free demos in this number, similar to how they don't break out numbers for Gold.

Further, your claim that 40-60 % of these downloads are paid video content and people prefer to rent 2 GB movie downloads is speculation. MS does not give specific figures for TV and Movies, Apple does. It's easy to mock about those tiny 8k of Apple's daily movie sales, but you conveniently chose to ignore the 5.5 million daily music sales.

By the way, the attach rate is 25 songs per iPod (2.5 billion songs sold for 100 million iPods), not 13 per user as you claimed. iPod sales themselves are not flat (yet) as you have stated, but were up 50% in 2006 over 2005 (from 31 to 46 million units) and are expected to be up 30% for the first quarter of 2007.

mutantmagnet,
The estimate that the 360 is sold not below cost anymore was made by iSuppli, not MS. If it really does, MS' report for the March quarter will show. H&E lost $300 million in the December quarter and $100 million in the September quarter, in line with a year ago.

Ben,
Why don't you take the time to check Sony's numbers during the PS2 launch. For your convenience, here is a chart:

http://www.tom-ross.de/sonysce06.png

The PS2 dented one year for Sony Computer Entertainment (2001), with operating losses of around $400 million. By the 2nd year they were profitable again.

More to the point, any successful videogames company has won the market on first try, from Atari to Nintendo to Sony. Saying that the $4 billion losses of the original Xbox were due to forgivable early mistakes, market conventions and building a successful brand just doesn't cut it. The 360 inherited huge debt and it's not looking like it can be the outstanding success to pay the debt back.

On Japan,
I agree that Japan is an important market, but also that it's not pivotal and a console could conceivably thrive without winning Japan. A good rule of thumb for the respective market sizes would be:

20 % Japan
40 % North America
40 % Europe and Other

What makes Japan qualitatively important is:

a) It's the most mature market. Consumers' tastes are more varied and sophisticated. Here trends can be spotted that may arrive in the US or Europe years later.

b) Japanese publishers own a big part of the worldwide market. At the moment there are 5 publishers with more than a billion $ in yearly revenues: EA, Konami, Activision, SquareEnix, Take 2. 2 of them are Japanese. Doing well in their home market will help any system to garner their full support.

[Jeremy Charette]

"Music and Video sales could be a new revenue stream, but Microsoft is shy about sales numbers, while Apple is pretty open about them: Right now they're selling about 5.5 million songs, 100k TV shows and 8k movies - per day." - Tom Ross

Microsoft has stated that they are seeing 25 million downloads on Xbox Live every three months. Assuming that better than half of those are gaming downloads that puts Microsoft's TV show and movie downloads at 10-15 million per quarter. Better even than the iTMS, with some 9 million per quarter. Xbox Live Video Marketplace has been a runaway success, and is growing by leaps and bounds. They are pounding Apple in the movie download space, largely because they offer movie rentals insteads of purchases.

[mutantmagnet]

(1) AppleTV is sold at a profit. XBox 360 isn't. - DaveD

THis has been reiterated many times but obviously a citation is needed.

http://www.techspot.com/news/23612-microsoft-makes-tiny-profit-on-xbox-360-hardware.html

I don't know for sure what it is now but I think the profits rose to $100 at this point.

"The PS1 was essentially a monopoly." - Mark

As I understand it, it was a refuge from Nintendo and an alternative to Sega.

" In fact, one might say that is a necessary but insufficient condition for a globally successful console platform." - Roger

I forgot to ask about this one last time I posted. That's a contradiction. Could you clarify where your thoughts were going with this when you tried to give us this visual detail of the importance of the japanese market?

"1. Japan is not as significant a market as you think. North America and Western Europe are the jewels. " - Paul

I think tHe Japanese market is important because of the Japanese developers. I have no sources to back me up on this one but in discussion with gamers they frequently point japanese developers have a historical tendency to back the consoles that do well in their territory regardless of worldwide sales.

If this trend is true this makes me wonder if Japanese companies are only going multiplatform in the short term but will end up backing the Ps3 and Wii at the greater exclusion of the xbox once the ps3 proves it has a comparable growth rate to the xbox world wide.

The ps3 is struggling but it isn't in an insurmountable position. The Ataris proportionally cost slightly less and mildly more than the ps3 and they had to deal with the hassle of actually creating a market for videogames even if they didn't have direct competition like Sony currently does with MS and Nintendo.

[Ben Jones]

This is pretty much one of the stupidest articles ever.

360's main competition is the PS3. Which of course, the article conveiniently ignores. Of course, 360 is more or less destroying the PS3. USA sales to date are 5.3m 360, 1.2m PS3, and 360 has outsold PS3 every month both have been out, where Xbox rarely outsold it's competitor PS2.

5.4 billion losses..who cares? Microsoft has 30 billion in the bank it's shareholders are begging it to spend. 5.4b over six years now, is less than 1B a year, a paltry figure to MS. All that to establish a very powerful Xbox brand in that time, was worth it.

MS is poised to defeat Sony for the high end of the market within two generations, nuff said.

Also Japan is important, but the USA is far MORE important. MS cant do well in Japan because Japanese are extremely nationalistic and for the most part wont buy American industry products. Blaming MS for that is just stupid.

Nintendo can do all it wants with the Wii, the problem is the Wii is not a trojan set top box. That is what MS and Sony are worried about. MS needs to worry about Sony, and they're killing Sony. MS wants to be set up where you get IPTV on your Xbox, you stream PC media on your Xbox, you download movies and TV on your Xbox. So far, it's working out great.

And losses are part of the (non-Nintendo) model, as this maroon might need to learn. How much has Sony lost on PS3 so far? The idea is to win it back over the second half of the life cycle, which it's looking good for 360 to do that for sure.

Does this guy ever look at Sony and say they need to get out of the business? See that's what I dont understand. MS is MUCH richer than Sony as a corporation, yet over the years I've heard so much about how MS is losing too much to continue. But nobody ever says Sony needs to get out of the market. Sony has been barely making a profit, and their videogame division has been losing BILLIONS to support PS3 over the last couple years. Which company is really in a better position here? Where are the constant call that Sony needs to leave videogames? Huh? Huh? Where? It's like "look, Ms is losing billions! They need to leave the industry" "Well, look at Sony over there. They're losing billions too!" "Oh, well, dont worry about Sony! It's ok whenever they lose billions on videogames no problem nobody talk about it or suggest they need to leave the business!". Sorry, that crap is not flying with me.

Like I say, this "analyst" is not very knowledgable about this business. If he was, he should know the normal (not Nintendo) model is, lose money for the first 2-3 years of a console, gain it back and more on the last 2-3 years as hardware costs decrease and software sales rise. It's called CYCLICAL. So how is he surprised that 1.5 years in 360 project has lost money? Seriously how? Has he checked Sony's game division losses? Wow, I think he'll find that shocker, they have a new console and they're losing a lot of money right now! In fact their losses put microsoft's 360 losses to shame! In fact, if he even goes back to check the uber succesful PS2's early years, it lost Sony a lot of money at first too!

This is like videogame business 101, and this guy claims to be a financial analyst writing about this industry. What a joke.

The Xbox, it's true, never gained it's losses back, BUT, the reason was it was built on a bad hardware model. MS bought the chips from Nvidia and Intel who did not lower prices. This time around, MS owns the IP of the chips in 360. They can shop the fabbing anywhere they want, which leads to competition and lower prices, consequently 360 hardware will not be a money pit late in it's life like Xbox was. It will be more like Sony's PS2, which lost a lot of money early on but where is it today? Dirt cheap, profitable hardware, and selling a lot of profitable software. This is a very key point the author doesn't understand, the key difference in the Xbox business model versus the Xbox 360 business model. I recomend for more info on all this, to educate himself as he is obviously very uneducated in this market, he should read Dean Takahashi's book "The Xbox360 uncloaked". This will all be explained in there.

This guy doesn't understand the simple fact that unlike Xbox, Xbox360 is poised to begin making money in years 2 and 3 and on. He's looking at a snapshot 1.5 years in and seeing a small picture, and he doesn't understant the business at all. He could have looked at a snapshot of PS2 1 year in and declared it a failure too, based on his very own reasoning here.

Honestly, I'm trying to argue with this guy intelligently but his last sentence

"With Nintendo edging them out in the gaming market and Apple doing the same in the OS market, MS may quickly find themselves with no profitable divisions left. Don't laugh: it happened to Sony. It can happen to MS just as easily."

Is a joke and proves he's just a dime a dozen virulent Microsoft hater. Apple edging ms out in the OS market? LOLOLOLOLOLOLOLOL. Check their market share sometime dude, I think it's like 2.5%. Apple in the PC space is a corpse. Apple delayed Leopard so they could get Boot Camp to work with Vista. That's Apple's big hope for selling it's OS these days, "hey, you can run Vista on it too! Please buy us..please?" Oh, and wasn't it linux that was supposed to kill windows two years ago? Whatever happened to that? Apple has it's niche market for rich ladies but it's never going to interrupt MS PC dominance as log as you can buy a decent windows laptop for $599 or desktop for $399 a price Apple can never match with their proprietary (and low volume) hardware model.

Anyways back to Xbox360. Looking clearly at the situation we see: Xbox 360 is poised to be profitable, is DESTROYING it's real competitor Sony (outselling it 2-1 monthly in the USA). And as I said, who cares about Nintendo? Nintendo doesn't want to be your set top trojan horse box, and as such they're really not any threat to MS no matter how much they sell. They're a small narrowly focused gaming company, and that's all they'll ever be. A toy company, essentially.

Next we need to talk about Japan. Which is the bigger market USA or Japan? Well, USA=300 million population, Europe=..I dunno, 400-700 million, Japan =128 million. Japan's population is also aging rapidly. Japan has become less and less imprtant in the global games market arguably. Xbox1 pretty much proved you dont need Japan at all to succeed.

Here's another big thing, Western games dont sell in Japan. So guess what, Western developers, crucial to USA and Europe markets, dont care about Japan! They care about..USA 1, Europe 2. And oh look, those happen to be 2 places where Xbox 360 does well. Hmm, lets say Electronic Arts, biggest third party in the world, has a hot new epic game they want to develop. Well, this game will feature hi-def GFX, so the Wii is out. Which will it go to, PS3 or 360? Well, take a guess..360 has ~ 5X the userbase of PS3 and growing...this game is certainly not going to be PS3 exclusive.

Japan has rejected the PS3. It's setting new record sales lows every week and selling under 60k a month there right now. It sold a new record low 13k there last week. Wii is destroying it in Japan. As such, all Japanese devs developing epic high-tech games looking to sell big must look to the West, and what do they see? Xbox360 dominating. Hmm, wonder why DMC4 just jumped ship to 360? Wonder why MGS4 will? Wonder how long Final Fantasy 13 is a PS3 exclusive? It's simple economics my friend. Why would Square stick to PS3? It has an anemic userbase in all territories. They'll either go to 360 also, or go to Wii. They HAVE to. Do you see now?

Finally I want to touch on the Wii. I've already explained how, Wii does not really compete with 360 or PS3. So, even IF it keeps selling as great as it is now, it really will hardly affect the 360. But I think there's a good chance that users tire of the Wii, and that it's sales slow as HDTV gets further adopted. This may or may not happen, but the point is it can only be good for microsoft. If it does, there's a very good chance 360 and not Wii will end up the #1 console in the West, perhaps worldwide.

Xbox 360 has a price cut, Halo 3 and tons of other big epic software (Too Human, Forza 2, Lost Odyessy, Blu Dragon, Shadowrun, Mass Effect, Bioshock) coming this year. It's currently outselling PS3 ~2-1 each month, which will clearly continue all of 2007, and it already has a huge install base lead. It's really lined up incredibly nicely for MS.

[Tom Ross]

I'm not convinced that other products could be blamed for H&E losses. Microsoft sold a few 100k of the Zune before Christmas at a loss of maybe $50 or $100. This cannot amount to a loss of more than $50 million.

And H&E doesn't only contain loss makers. The Mac Business Unit is part of this Division, and Microsoft has stated many times that the MacBU is very profitable. MSN and Windows Mobile should be about breaking even. Windows Games should turn a profit. MS mouses and keyboards are profitable for sure etc..

We will have to wait and see how much damage the Zune can cause when it's on sale for a full year (2007), but basically the XBox is selling in mucher bigger volume and bigger volume means bigger losses right now.

The 360 will see cost reductions, but not more so than the PS3 or Wii and therefore will not have a price advantage. There's a perspective to stop losing this much money, but nothing to regain those $5.4 already lost.

Live to me does not look any more precious than any regular game sales. It makes no difference if Nintendo sell 6 million Mario games (which they do) or MS sell 6 million 12 month tickets for Live (which they don't, because not every Live user is buying the Gold service). It should be looked at in that respect, not as a whole new revenue stream.

Music and Video sales could be a new revenue stream, but Microsoft is shy about sales numbers, while Apple is pretty open about them: Right now they're selling about 5.5 million songs, 100k TV shows and 8k movies - per day. Apple's media players attract a bigger and more diverse audience than the 360 so I don't think that Microsoft will have an easy time in this business either.

[Jeremy Charette]

DaveD -

I don't own MSFT stock. Or AAPL stock. I'm not financially invested in my commentary.

I point out the design and engineering features of the 360 because they're part of a larger strategy by Microsoft. They're learning from their mistakes. The choices they've made so far will allow them to increase the likelihood of turning a profit, and also allow them to use the 360 to tap into additional non-gaming revenue streams.

I'm not defending the 360 from those who say it's a piece of crap. It isn't, and I think all of us here agree on that. The question is, can Microsoft effectively leverage the platform to start turning a profit in H&E? I think the answer is yes, but it's going to take another 6-24 months before that happens.

As far as your Apple TV comments, the 360 does sell at a profit. The 360 is more expensive than the Apple TV, yes ($420 with a remote control and hard drive), but it also -does- more than the Apple TV. It's a more capable platform than the Apple TV is, with several advantages. Plays DVDs, allows users to purchase content on the device itself, supports high-definition playback resolutions up to 1080p, plays games...the list goes on. It costs more, but it does more. It's scalable, something the Apple TV isn't. The Apple TV's hardware is running at the limit of what it can do.

Apple TV is a short term reactionary product. It's designed to counter the Xbox 360, cable set-top boxes, and TiVo. Apple TV is a stop-gap measure while Apple comes up with a long term home entertainment strategy.

Apple is innovating, which is why it's attractive to investors. They've created a market niche for themselves with the iPod and iTunes, but that market is reaching saturation. The next step is down. Apple TV and the iPhone have effectively camoflaged the fact that iPod sales are slowing rapidly. The attach rate for the iTunes Music Store is abysmally low at around 13 songs per iPod owner. Apple turns more of a profit because it sells much of it's product direct, allowing them to make retail profit margins on hardware sales. They also have tight price controls in place, further maintaining profit margins. No doubt about it, they've been smart, but they're also setting themselves up to be overtaken by a smarter, faster, more nimble competitor. They're turning into Microsoft, and Microsoft is busy trying to reinvent itself in a Version 2.0 market.

Purely dollars and sense, sure, Apple looks attractive, while Microsoft looks like a lumbering giant, particularly H&E. But that's a very short sighted view. Microsoft is making smart moves in H&E, and is about to jump to the front of the pack.

Oh, and I do own an iPod. And an Xbox 360. And I love them both. But I don't buy my music from iTunes, and I won't in the future. I'm not a Microsoft fanboy, or an Apple hater. I just see the engineering side of things, and the potential that the hardware holds, since that's what I do for a living. The 360 is a strong platform, now it's up to Microsoft to turn that potential into dollars.

[dirtbound]

DaveD,

This Blog posting is actually based on whether or not Microsoft is making sound decisions in regard to their XBOX division. I am not defending the other poster you are having a conversation with, just starting another conversation between you and I.

Read the post I made at around 3:04PM today to get up to speed on my views.

I understand where you are coming from... and yes I like a close friend of mine are both MSFT & XBOX 360 owners.

I think the major oversight in this blog posting is that the 360's best days are still months away. The console is being sold at a profit "Today" the accessories are being sold at a profit "Today". There will always be ongoing support costs for developing new accessories, games and Live (online) services. The problem is that this "article" (blog post) is attempting to predict the performance of this division based on historical data from an industry that has seen drastic changes over the past 3-4 years.

It also acts as if Microsoft’s biggest "in-house" productions 6-7 of which are releasing later this year are of no importance to the performance of the division.

As someone who DOES play games... discusses the issue daily in forums, on the Live service with fellow gamers and has ongoing debates such as this along with having a personal stake in the company. I feel that what they are doing is both "on-course" and "well planned".

Microsoft has penetrated the market, talk of XBOX is more prevalent than ever before and the fruits of labor will begin to show within not to distant future.

Comparing the XBOX 360 to AppleTV is just plain off-base. AppleTV selling at a profit cannot be compared to the XBOX 360 "initially" selling at a loss, purely based on the technology that is inside the two different devices. Not to mention that the overall goal of the two products is totally different. Let's not forget that at it's base the 360 is still a games console, and the software for that console is the main selling point.

Live, Live Marketplace and Video Marketplace are growing areas of potential profit. Video marketplace as I'm sure you are aware is already off to a good start. We will wait and see what happens with that, but when you step back and look at the picture of the 360... video marketplace is really the ONLY thing that can be compared to AppleTV. The rest of the console is from a totally different city.

Profits will come, just as they did with the PS2, PS1, N64, SNES, NES, Genesis, Master System etc...

It is natural in this industry to sell the latest and greatest at a loss. However with the 360 already turning a profit on hardware 18 months after it's initial release, the next 18 months will be interesting.

[minkymcmanus]

You argue that a poor sales figures for the Xbox 360 in Japan foreshadow the failure of the console. I am not sure that this is true.

You draw conclusions from the opening sales figures, from launch to week eighteen, of various consoles in Japan. However, drawing generalisations from specifics can lead to strange conclusions. Consider the same sales figures from the United States: http://kotaku.com/gaming/nintendo/charticle-the-first-four-months-249629.php. The figures at this website almost conure up an alternate reality, one in which the original Xbox won the last console war, the Playstation 2 in fourth, behind the Dreamcast and the Gamecube. The same figures show that the best-selling console of all time was, of course, the all-conquering N64; and that the two consoles with the highest software attach rates (so often boasted by Microsoft for the 360) were the original Xbox and the much-loved Dreamcast; as we know, one of these consoles burned $4 billion, the other died painfully.

Turning to the sales figures noted in your article, and considering the example above, I am reluctant to draw generalisations. You are, of course, correct to show that the Xbox 360 sales, at one hundred and twenty thousand consoles sold in Japan, is not a happy figure. It is half the total for the original Xbox during the same timeframe. Contrast this with the Playstation 3, with almost eight hundred thousand consoles sold, showing that sales for the Sony machine outperform the 360 over sixfold; yet its figures are around a third less than the corresponding Playstation 2 sales. Of this generation, only the Nintendo Wii beats its predecessesor, the Gamecube and almost twice over, with two million units sold to Japanese gamers.

Despite its poor showing, I doubt that success or failure in Japan will make or break the Xbox 360. You argue that poor sales will shrink the number of developers and games, further limiting console sales, a kind of vicious circle; I disagree as there is enough consoles have been sold elsewhere. Despite a huge user base for the previous generation of consoles, development is now focused on next-gen. With its head start, Microsoft can claim over half of that total; whatever happens in 2007, it would be a reasonable assumption that the console would retain at least a third, a substantial audience for developers to target. If anything, it is the newer consoles that must prove their viability: compare the rush by EA to develop Wii titles - http://www.bloomberg.com/apps/news?pid=20601087&sid=amWmy6_JG16U&refer=home - with the 'wait and see' attitude of Eidos and other developers toward the PS3 - http://www.joystiq.com/2007/03/30/eidos-holding-out-for-better-ps3-install-base/. With XNA allowing easier development and also deployment to the PC, these become added advantages to the 360 proposition (and the latter perhaps at the core of the Microsoft strategy). Nor should the bankrolling and support of first and second party developers be underestimated: Bungie's Halo 2 gave Microsoft a quarter in which it made profits with the original Xbox, as it happens, the only quarter and the sequel will also be a huge help to the bottom line.

There is little doubt that AAA titles will be developed for the 360. However, few of these titles will cater specifically to Japanese tastes. If Microsoft can maintain a strong line-up for a this audience, following Blue Dragon, the exclusive Capcom titles, Lost Planet and Dead Rising, and securing 360 versions of games like Katamari, Virtua Fighter and Devil May Cry, consoles will sell. Consider that over a third of Blue Dragon sales in the first week included the purchase of the console. However, the fact that sales during that week were only eighty thousand copies suggests that it will be a struggle for Microsoft to succeed (having lived in Japan for three years, my hunch is that it will be an insuperable struggle... their loss).

Ultimately, popularity with Japanese gamers will not condemn the console. A head start, strong sales elsewhere, and experience with the original Xbox will help to create a profitable business for the first time. With a change of suppliers and production processes, break-even or small profit has been reached on console sales; compared to an estimated loss of between $240 and $310 on each PS3. Software and accessory purchases are high, as are Live memberships and transactions (Live now second only to iTunes in electronic content sales) The electronic entertainment division forecasts a profit; admittedly moved from one fiscal year to another. Your figures for Microsoft P&L do show the financial disaster that was the Xbox, but do not reflect more recent figures. Consider first quarter 2007: loss of $95 million on revenue of $1.3 billion. Losses still, but one suspects not for too much longer. Not that Microsoft is averse to loss-leaders, and if its consoles prop up PC gaming (i.e. OS licencing) or even become a foothold in the living room, it may be money well spent. Also, for a cash-rich company, unable to develop its core business for fear of anti-trust and competition laws, where else is there to go? So, while the 360 might turn a profit and soon, it is the comparison with its rivals by which it will be judged.

As your figures, and the market generally, show, it is the two consoles aimed at a high-end, hard core, gaming market that are suffering. No surprise in a market not mature for high definition gaming (less than 5% have HD sets in this country). The 360 has 'sold' ten million only because it has crammed the retail channel with stock; the user base is probably closer to eight. The initial sales figures for the PS3 flatter to deceive. Demand has dropped in the US and Japan and the initial frenzy at launch in Europe quickly evaporated. It might have been the most successful console (and, possibly, product) launch in the UK, one hundred and sixty five thousand units sold in a week; yet demand dropped by 82% the following week and has remained sluggish. Yet the Wii is sweeping up: in this country, still invariably out of stock at most retailers.

After the wild and continuing success of the DS, the hunch is that the Wii will prove more than a fad and that gamers are less concerned about hardware, graphics and performance than gameplay, teamplay and fun. The 360, sandwiched between Nintendo and Sony, has the opportunity to hold and gather market share from each, or lose out to both. Games like Viva Pinata, Guitar Hero, the Live Arcade and playing online will have the chance to meet the challenge of Wii (a price cut would help). The simultaneous launch of GTA with the PS3, Live, an expanding library of decent games as well as AAA-titles like Gears of War and Halo 3 may give it a solid chance against the Sony machine (again a price cut rather than an Elite configuration would help hugely).

It is games that sell consoles, the Wii as proof. The line-up for the 360 looks solid and should also sell consoles. GTA with a 360, or GTA with a PS3 for twice the price, should be an easy call this autumn. The future looks bright for the 360 and rumours of its demise have been greatly exaggerated...

[DaveD]

Interesting article. Roger, I'm going to read some of your archives - as this is my first visit to your site.

The remainder of my comment is for Jeremy. You sir, are obviously a fan of XBox. Me? I'm not a gamer, and don't plan to own one.

The question is - are you also a MSFT stockholder. Because that is what this article is about.

I wouldn't comment, except your third (or maybe fourth, sorry, I lost count) defensive post included the AppleTV.

You see, I won one, am a fam of Apple, and own quite a bit of stock in AAPL.

Here's my question for you - can you separate Microsoft from MSFT? Because now that I disclosed that I own Apple and AAPL, I'm curious about you.

Here are a few facts:

(1) AppleTV is sold at a profit. XBox 360 isn't.

(2) AppleTV pre-sold over 100,000 units. Microsoft only reports units shipped, not sold.

(3) AppleTV costs less than XBox.

(4) AAPL is up 750% over the last 5 year period. MSFT is up 20%.

(5) For every link you could provide to a site that panned the AppleTV, I could provide you with a corresponding site that praised it.

Objectivity is the best friend of any investor Jeremy. Each of the facts I posted above say that one company is ahead of the other - big time - in terms of investor interest.

One more question Jeremy. Where did Roger say - at all - the the XBox 360 was a piece of s***? I'm asking because all of your defensive arguments seem to be based on that. And yes, before you take my words as saying anything like that - from what I've heard and seen, the XBox 360 - other than being somewhat loud for the bedroom - is an excellent product.

It's just a product worthy of nothing more than venture capital at this point - from an investment standpoint.

[dirtbound]

Martin,

Emotion is exactly what you are displaying with "your" comments. A little hypocritical if I may say so.

Let's analyze these comments.

Comment: "Once they start making their products reliable and beneficial to use, then people will change their opinion of MS."

Response: Not reliable? Well if your definition of reliable is sacraficing compatability for reliability you "may" have a point. Of course if I wanted to work with an operating system that has minimal industry penetration, Apple would be my first choice as well.

Not beneficial? That's purely your opinion, how do I not benefit from the environment of standardization that Microsoft has created both in the workplace and at home?

Comment: "MS perpetuate this with the worst free-mail service"

Response: Pick another service. Obviously free-mail isn't a primary goal for Microsoft.

Comment: "...the most ugly and most clunky interfaces (to all their products)"

Response: That's amazing, ugly is again purely your opinion and also full of emotion. Clunky? Well I can go from my Windows XP system to my Windows Mobile device and feel like I am in very familiar territory. Neither of which feel ugly or clunky "in my opinion".
And to get back on topic here, XBOX 360's interface has neither been considered Ugly or Clunky and when perceived flaws are found they make improvements to resolve any issues. The Live interface is today the benchmark for online features on consoles and there are no arguments to say otherwise.

Comment: "and a oomplete disregard to that oft overlooked accounting asset 'Goodwill'."

Response: You don't always get a cookie when you want one either. But again when speaking in terms of XBOX 360 and Live, Microsoft bends over backward to add features and products that they feel the consumer most wants. Yes they do it to try and corner a market and pull in developers to "their" standard... it's business.

Comment: "They have a negative halo effect, rather like a stink effect."

Response: Not really deserving of one when you are comparing Microsoft to a company who's biggest success is the modern day equivalent to the walkman.

Comment: "I owned an XBox. I bought it for Halo. Nothing compelled me to keep it."

Response: Nice one to wrap up your comments with, not only does it show that you made a classic blunder (buying before trying). It also shows complete bias in your feelings toward the console which falls directly in-line with your comment on the company as a whole.

In closing, from what I have gathered you just simply don't support or agree with Microsoft's business practices. Every bit of what you brought up was founded on your emotions toward those business practices.

[Mark]

Perhaps my point of view is slightly different but I think you are missing a few key issues.

People buy consoles for the games. Unless they want a cheap dvd player (ps2) or blue ray player(ps3.)

The PS1 was essentially a monopoly. Nothing was able to touch it for a variety of factors. Developers made games for it despite the fact that the Sony source code is horrible. Sample code is frequently wrong and broken... I could go on. But there really wasn't a choice.

PS2 was in a similiar boat. The Xbox is many times easier to develop on however the PS2 had a larger install base at the start AND many developers were able to port their PS1 engines to PS2 with little difficulty. This provided a strong launch portfolio AND a steady stream of ever more polished games.

This is NOT the case with the next gen market.

There is no good way to port from PS2 to PS3. All engines will require a massive rewrite (ie. from scratch.) Having worked on PS3 dev kits for over a year, I can tell you that Sony support is spotty at best and a time suck in the average case.

The 360 is a dream to develop for. The console itself provides a ton of performance metrics/monitoring. The 360 XDK is seemlessly integrated into Visual Studio. (Btw, ProDG is a requirement for PS2/3 development and can be considered a barrier for entry when porting over.)

The Unreal3 engine will actually provide the strongest reason why the 360 will maintain stronger market share. As of right now, PS3 support is still lacking in the engine. 360 support is fine. The engine is HEAVILY optimized for the 360 (thanks to the 50+ engineers MS loaned Epic for GoW.) The PC builds are also fast and stable. There is plenty of middleware support. The Visual Studio tie ins are topnotch (with the latest code drop you can even debug unreal script in the VS debugger.)

This all has a marked effect on the P&L. Risk drops when there is a very strong and successful 3rd party engine with a solid game track record. This translates into more investors willing to back 360 titles. Since 360->PC ports are quite easy (ie. build the other version) this provides even stronger incentive for many games to go cross platform.

Games drive profits.

[Allen]

So seeing as how the Japanese also don't buy American cars should the American automobile manufacturers just pack it in and cease to try and make cars?

Bottom line is that the Japanese are very unlikely to buy any console that isn't made in Japan period. That is no reason to give up and not try and compete.

Also home and entertainment as a division has loads of problems unrelated to the Xbox if anything the 360 is one of the few bright spots for the group.

[jeff]

My take is simply that MS, though they are interested in profits, don't really care if the xbox EVER makes them any money.

For example, MS benefits by keeping their stranglehold on the PC gaming industry by locking in more and more vendors to their proprietary Direct X.

MS cares little about the Xbox's profits and more about the leverage it gives them in other areas.

MS also has a Bush-like "Stay the Course" mindset. they still think "Hey! We're Microsoft! of course we'll eventually own the market if we just funnel money into the project and play a little dirty."

those are my thoughts on the matter.

[Martin]

It was curious reading all the comments. Obviously there are some who are posting with emotion, rather than intellect, which will always happen with a perceived attack.

I think that MS suffers from the reverse of the 'halo effect' which is benefitting Apple at the moment. Apple have worked hard to make sure that every experience you have with one of their products leaves a good impression. Thus whenever they drop the ball, they get even more bad press than other companies. Sony was like this too for years. Produce great products. Make the customer proud to own your hardware. When I looked for a DV video camera, Sony was my first choice. No other manufacturers even got a look-in. Unfortunately that's not the case now.

MS has never had this attitude. They are willing to drop a market cold, leaving partners and consumers up the river without a paddle. They have dominated the work-place, and then wonder why so many people don't want to take their products HOME. Sure, people do take MS products into their home, when they feel they have to, but MS products have never been associated with 'making your life easier', or enhancing your life. They have a negative halo effect, rather like a stink effect. Once they start making their products reliable and beneficial to use, then people will change their opinion of MS. But that is not the case. MS perpetuate this with the worst free-mail service, with the most ugly and most clunky interfaces (to all their products), and a oomplete disregard to that oft overlooked accounting asset 'Goodwill'.
I owned an XBox. I bought it for Halo. Nothing compelled me to keep it. MS needs a culture shift toward keeping customers through goodwill, rather than through lock-in.