Microsoft Gaming "A Disaster"

[James]

According to investor Roger Ehrenberg.

http://www.forbes.com/hom...n_re_0418soapbox_inl.html

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 (taken from Microsoft's (nasdaq: MSFT - news - people ) own financial statements and comparative console sales figures extracted from VGChartz.com and Wikipedia.org), I have concluded that gaming has been a disastrous endeavor for Microsoft, particularly from an investment perspective.

The seeds of this failure are evident from its sales performance in Japan, particularly when comparing its 18-week sales figures (which is about how long the Wii, made by Nintendo (other-otc: NTDOY - news - people ) and PS3, made by Sony (nyse: SNE - news - people ) have been out) relative to those of the most successful console releases.

This early failure in the 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.

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. Making money, i.e., 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 minus expenses equals profits (losses)" disclosure? Perhaps because it doesn't want investors to focus on the fact that more than $21 billion has been invested in a business that has performed so poorly, with unclear prospects for improvement.

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, plus operating losses, plus 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 Xbox 360 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 Microsoft's strategy, it's got a problem. And if the strategy is really more mass-market, then it's got some serious repositioning 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.

As far as Japan's role here, consider that over 19 million PS1s and 20 million PS2s were sold in Japan alone, close to the total 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. Plus, 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.

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. The Xbox did better than the Xbox 360, and even the PS3 has done better than the Xbox 360. But success in Japan is not a guarantee of a runaway 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. 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. 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.

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.

[phoenix1967]

Before the headline, it even says "Advisor Soapbox".

This guy is an Asshat who is obviously not seeing the strategy of gaming consoles as an important part of the entire business.

Either that, or he hasn't dissected the profitability of the PS3 since he conveniently doesn't mention the fact that Sony's losing almost $200 per console. By his logic, does that mean that Sony should bail out of producing consoles?

The strategy to sell consoles at a loss has always been something that manufacturer's were willing to absorb since the software sales were to more than make up for it. A point which he neglects to delve into as well.

Nintendo succeeds for the reasons he states. They do appeal to a larger audience and casual gamer. And they do have the lowest costed product. But to isolate Microsoft in the next-to-last paragraph and omit Sony from the discussion is total bias since both are strategizing around the HD market.

I give this guy no cred whatsoever.

[Tondog]

Phoenix:

[img width=260 height=192]http://www.court-records.net/rips/objection.gif[/img]

Did you read the whole article? He's saying that it's doing decently here, but it's doing miserably in Japan, which is a key market in the video game world. In fact, 360 is doing worse than it's predecessor over there.

What his biggest point, however, is that they have LOST 5.4 billion on this gaming effort, which is a gigantic loss. Now, he does not really bring up Sony's profitablity, but I think they were profitable in the long run with PS2. And it isn't truly fair to say this kind of thing about Sony when they've only had their new system out for a couple months as opposed to a year and a half with Microsoft.

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 Microsoft's strategy, it's got a problem. And if the strategy is really more mass-market, then it's got some serious repositioning to do relative to the Wii, which is both cheaper and more accessible to Ma and Pa and Timmy and Tammy gamer.

That is EXACTLY what I think is the biggest problem with XBox! They want to be everybody's console, but they don't show it with their game lineup.

Phoenix, just because he says XBox is not doing very well does not mean that he's some shill for Sony, he's just concerned about MS's strategy. He's got some very legit points here. The reason why he didn't bring up Sony's profitablity, is that this is all about Microsoft. He did mention Nintendo because it fit into his point about MS appealing to hardcore gamers.

[The Metamorphosing Leon]

Yeah M$ lost mass cash on their first box, that's why I always say Halo is the only reason X-Box still exists, and it's true.

[OatBob]

Sorry to make y'all read more, but read the guy's real opinions here.

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

More comments on that later.

[Tondog]

Hey Leon, interesting figures here...

Top 5 worldwide selling XBox games

Halo 2 (7.89)
Halo (6.43)
Tom Clancy Splinter Cell (2.93)
Fable (2.60)
Grand Theft Auto Double Pack (2.22)

Let's go US only just for fun...

Halo 2 -  6.11 million
Halo -  4.91 million

XBox sold 16.34 million in America.

37% of American XBox owners have Halo 2
30% of American XBox owners have Halo

Let's look at PS2 and GTA:SA in America...

It sold 7.89 million, and PS2 has sold 37.975 million, thus 21% of American PS2 owners own Grand Theft Auto: San Andreas. Interesting eh?

Sorry, I'm such a number geek.

EDIT: I changed the listing of XBox games that sold more than a million worldwide. It was off quite a bit.

(All data from VGChartz.com)

[The Metamorphosing Leon]

See? True...trueeeeeeee.

[Tan]

Has anyone here read "Opening The Xbox" by Dean Takahaski? It's a good read about how the Xbox came to be and why. Microsoft looks long-term and whether or not the Xbox or it's successors make or lose money only matters as how it fits into the bigger picture. Here's another good article to read:

Why the Xbox Brand is About More Than Money:

Back in April of 2006, Roger Ehrenberg over at Yahoo Finance wrote an interesting article on Microsoft's continuing losses in the gaming industry, and still champions some interesting points. After $5.4 billion lost on their Home and Entertainment division between 2001 and 2006, Ehrenberg asks, why is Microsoft still in the gaming business? No matter how you look at it, even if the H&E division saw a tremendous increase in profitability in 2007, meaning they reverse their billion dollar a year loss, it'd still take several years to recoup what they've already spent. Several years just to bring them back to where they were before the original Xbox released.

The article does have a point, but at the same time I think overlooks some significant factors - specifically, it looks at the venture entirely from the perspective of the one division, instead of looking at the company vision as a whole. Unlike companies like Sony, which tend to split off their ventures into separate corporations - with different companies for music and electronics, for example - Microsoft has kept their core divisions in-house. Their profits and losses are viewed from the perspective of the entire company, which makes it viable for a division to lose money as long as it satisfies the goals of the company at large. For example, if somehow having an Xbox in the living room allows Microsoft to sell more copies of Windows Vista, where they truly make their money, then it's not unreasonable for them to take a loss on one division if the benefits to the entire company are substantial. From a numbers perspective as an individual unit, the Xbox brand has not been profitable, but it doesn't make it automatically a bad investment, as the article suggests.

So what purpose does the Xbox serve for Microsoft as a whole?

Microsoft, Nintendo, and Sony all talk about expanding the market beyond the hardcore gamer. Most people assume that only Nintendo is doing this with the Nintendo Wii, because the Wii targets the casual gamer. In actuality, all three systems are doing this, but in different ways. Where as Nintendo is expanding to reach a larger gaming audience, Sony and Microsoft (and Apple, for that matter) are attempting to sell the PS3 and Xbox 360 as a media device to people not interested in games much at all. Hence the Playstation's Blu-ray, the Xbox 360's downloadable movies from Live, and Apple's introduction of Apple TV. Where as Nintendo is expanding the market by trying to entice people into gaming, Sony and Microsoft are trying to do so by drawing people that normally buy consumer electronics.

Why is this valuable to Microsoft as a whole? Microsoft, along with Apple, believes that the living room of the future will be significantly tied to computers. For better or worse, Microsoft is attempting to control how media is fed to your living room on the assumption that the tie-in to their operating systems, like Vista, will promote their ability to sell you things like computer software. Someone at Microsoft does not want control of the consumer electronics in the living room to go to either Sony or Apple. In that sense, the Xbox 360 exists not strictly to make money, but to be a key player in a larger battle plan. To look at a single division of a company that derives the vast majority of its resources from other sources and declare it a waste without first considering its ramifications to the true money-making divisions is a mistake.

Finally, the article assumes that you need Japan in order to be successful in the gaming market. The reasoning goes that if you don't have Japan, then the system won't have a large enough install base to woe developers into making games for it. This reason ignores the 800-lb gorilla in the corner that completely trumps any comparison to any console that has come in the past. XNA. Microsoft's introduction of XNA is potentially one of the most significant moves the company has made in the game industry since its start.

Fundamentally, XNA allows a developer to write code for the Xbox 360, and then easily recompile it to run on Vista. That means when trying to decide between building a game for Xbox, Wii, or PS3, the developer has to compare the install base of the Xbox 360 and Windows Vista against the install base of the other two.

If install base is all that matters, Microsoft wins hands down.

Personally I have little or no use for the Xbox's media capabilities, movie downloads etc. etc. I bought one because it has good games I enjoy. But like the Zune or MSN TV or even the Dreamcast with it's Windows CE it's all about what it does for the whole company and how many devices it can replace in one's living room.

They knew 10 years ago consoles would surf the web, have movies, music, internet access, IM, etc. etc. and they set themselves up accordingly. I may think this bonus crap is useless for any new system if all I want to do is play games, but I can still respect their insight and planning that they knew where the winds of change were going. To have built a hardware and games system with their respective divisions from scratch in a couple short years and Outsell the Gamecube is still nothing to sneeze at.

I know they won't take first place in marketshare and I'm glad for that. First place gets all the shovelware crap and makes it hard for good games to shine or stay above the din so to speak. Much in the way the Dreamcast has a hardcore following because it's good games were more prevalent. But then again I'm a bit of an underdog sympathizer, INTV, SMS, TG16, Jaguar. 

[Sauza12]

That was actually a pretty interesting read.  I knew that the XBox 1 was something of a money pit for Microsoft, but from what I've heard the 360 is making up a lot of ground the XBox lost.  I guess they still have quite a ways to go.

Microsofts failure in Japan has damn near become a joke by this point.  I know that Japanese gamers never bought into the XBox, but the numbers are reaching NGage levels now. 

[Tan]

I guess some habits are hard to break. Japan is no longer the center of the developer universe anymore and Microsoft just doesn't get it yet. Hell even some of Nintendo's most popular franchises are made with North American or European teams (Metroid, Paper Mario etc). Also most of the biggest selling games or series for any system are Western/Euro made now unlike the past.

They should've let the Japanese market demand determine their efforts. I'm sure importers would make up numbers as pitiful in Japan for the Xbox/360 as the millions spent marketing it against Sony and Nintendo have accomplished.

[Tondog]

Sauza, actually, Xbox is doing worse in Japan than N-Gage did worldwide. The latest numbers I could find on N-Gage were from E3 2006, where Nokia said it has shipped 4 million units to date (Source: http://www.allaboutsymbia...vellia_Would_Be_Proud.php). As far as Xbox in Japan is concerned, 360 has sold 373,713 units to date over there, and the first one sold 477,809 in it's complete lifespan. So, yeah, less than a million total Microsoft systems have been sold in Japan. Far off from N-Gage levels.

Sorry for saying that XBox fans, but it's the truth. However, I'll make you feel better with another comparion. XBox is a good deal more successful than Virtual Boy was in Japan, and a little better than Virtual Boy did worldwide (770,000 world wide and 140,000 in Japan according to http://www.virtual-boy.org/virtual%20boy.htm). Props to MS for beating Virtual Boy and Wonder Swan Color! Maybe you can beat Wonder Swan, Dreamcast, Saturn, and PocketStation next! 

[OatBob]

dude, compare apples to apples next time not 'worldwide totals for a cell phone/handheld' to 'Japan-only totals for a dedicated game system'.   That is a meaningless comparison, worse than the quarter (three months) to four-month totals that have been brought up before.  At least the Virtual Boy comparison was "fair".

The Xbox 360 is doing poorly in Japan, but do a fair comparison next time.  However, it is clear that in its first 16 months it has nearly caught up with the originals lifelong total.

[Tan]

Only half a dozen or so of the 50 some games that sold a million or more on the Xbox and the 360 combined are from Japanese Companies, maybe a few more had them involved. I wonder when Microsoft will clue in and figure that out.

[Tondog]

dude, compare apples to apples next time not 'worldwide totals for a cell phone/handheld' to 'Japan-only totals for a dedicated game system'.   That is a meaningless comparison, worse than the quarter (three months) to four-month totals that have been brought up before.  At least the Virtual Boy comparison was "fair"

Tan brought up N-Gage, so I just researched it because I thought it would be an interesting comparison.

However, it is clear that in its first 16 months it has nearly caught up with the originals lifelong total.

Uh, it's doing a little worse than the original did in the same amount of time and still has about 105,000 to go to meet the original's lifetime sales. However if 360 continues its downward sales trend that's been going on since January, it won't make the original's sales.

http://vgchartz.com/japco...60&type=0&align=0

[Tynstar]

So what Japan is not the center of the gaming universe anymore. They don't want the Xbox type games and I don't want their funky ass games.

I am not saying anything on VGChartz is wrong but where do they get there info? It is a terrible looking site, ads all over the place and charts is spelled chartz.