Is Microsoft Just Playing Games?

Cable World, June 11, 2001 by Richard Cole

The new Xbox has a broadband hookup, leading to concern that it's no mere game console, but a full-service set-top in disguise. Still, Nintendo's and Sony's turf may be lucrative enough without taking on cable.

While the kids await fast-paced action and cool graphics, much of the buzz surrounding Microsoft's Xbox game console in the cable industry concerns its unique built-in broadband connection. Because the company has faltered in its efforts to plug into the cable business through traditional means, some analysts have suggested the Xbox is a "Trojan horse" intended to evolve into a set-top box and home-networking device once it's entered the household. Some think it may be the killer app that will ultimately drive consumers to pay for the broadband connections most cable operators are marketing--making it a boon to MSOs. But Microsoft would have you believe it's just playing games.

The Redmond, Wash., software giant launched the next-generation box last month to compete with Sony's PlayStation 2 and Nintendo's upcoming GameCube and is gearing up to spend $500 million marketing the device, which is not scheduled to ship until November for the Christmas season.

Microsoft executives and independent analysts make a convincing argument that the Xbox won't mutate into anything else in the foreseeable future.

"Anything you build into a box that [doesn't have] to do with gaming simply takes away from the game experience," says John O'Rourke, Microsoft's director of game sales and marketing. "It's like the idea of a phone-toaster--it could be rationalized ... but it isn't what a consumer wants. They would really rather have a very good phone and a very good toaster." In any case, analysts note that Microsoft is already involved in and struggling with STB software and is unlikely to open a new front.

Forrester Research analyst Eric Scheirer says it's hard to read Microsoft's long-run intentions, but using the Xbox as a multipurpose networking device isn't a sound approach. "I think it's very unlikely that that's actually going to succeed, if that is the plan," Scheirer says. "Consumers already have PCs; they already have set-top boxes. The cable MSOs are being very aggressive about rolling out new set-top capabilities."

One extra capacity the Xbox boasts, as does Sony's PS 2, is its ability to play DVDs on TV. At least one company, Los Angeles-based Metalepsis, has produced two interactive movies that will play on the Xbox and PS 2 and allow the viewer to interact with the material.

O'Rourke, however, says Microsoft doesn't believe the DVD capability is an important mover for the Xbox. Surveys found that only 15 to 20% of likely Xbox buyers were interested in using the console to play DVDs. For them Microsoft will sell an extra DVD remote control for $29.

Most important, Microsoft, with $23 billion in total sales last year, doesn't need a hidden agenda to jump into the video game market--the potential revenue speaks for itself. This year's video game sales are projected at $6 billion, putting gaming in reach of the $7.7 billion Hollywood box-office figures for 2000. The Digital Software Association puts 2001 PC and video game sales at $10.5 billion and notes they have climbed at a steady 15% rate since 1997. Game sales made up a third of rival Sony's year 2000 profits (although the costs of launching PlayStation 2 will deflate revenue this year).

With Microsoft, Sony and Nintendo all building and promoting new boxes, game makers project sales of 200 million consoles by 2005, generating game-software sales that could run to a staggering $60 billion, or $100 billion if you throw in handheld devices. That revenue potential explains why Microsoft is willing to sell the Xbox for $300 and lose $2 billion on the hardware before turning a profit in 2005, says Merrill Lynch analyst Henry Blodget.

Cable operators could profit from the new console's broadband connection, although that could take time. "I absolutely do believe the Xbox will help drive demand and adoption of broadband," says Microsoft's O'Rourke. "It won't be the only thing, but it is certainly a really powerful component."

Microsoft has made a big bet on the broadband connection, emphasizing the Xbox's superiority. Rival Sony had shown the market potential with online "men in tights" multiplayer games like EverQuest, which runs on a personal computer. Some 300,000 people have bought the EverQuest CD for up to $30 a pop and then have paid $10 per month to play online with other fans. Forrester has projected the online MPG game revenue at $1.6 billion this year.

Microsoft built in its broadband connection. to attract those PC online game players. Sony is fighting back, responding with an AOL deal that, later this year, will allow buyers to add an online connection to their PS 2, but will require another purchase. But even Microsoft acknowledges that its online gaming initiative isn't quite ready for prime time. O'Rourke says Xbox online games won't launch until the first half of 2002 because the company wants the games to run seamlessly with its hardware. But the games will be coming.