Microsoft Xbox: 2001-2014

Introduction

Microsoft Corporation (Nasdaq, “MSFT”) founded in 1975, is a publicly traded company based in Redmond, Washington. The primary businesses within Microsoft include the Windows Operating System and Microsoft Office, a software suite of word processing, presentation and spreadsheet applications for businesses and individual consumers. As of the fiscal year ended June 2014, Microsoft generated approximately $86 billion in revenue, and $22 billion (25%) of net income. On the corporate website (www.microsoft.com) Microsoft lists key pillars of their growth strategy, including the development of future leaders through diversity and educational programs, and focusing on product innovation by creating the accessibility of technology information in order to drive market excellence.

Microsoft is segmented into engineering, operating and functional groups. One such group, called the “Devices Group,” headed by Stephen Elop, has responsibility for hardware devices such as smartphones, tablets, and Xbox. Xbox started as a video gaming console in 2001, but since then has evolved into an online, eighth-generation gaming brand that supports multiple streaming services (www.microsoft.com). Prior to entry into hardware devices Microsoft had tied its entire company to a business strategy that would leverage and enhance the operating systems and computer software products.

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Xbox Launch: 2001

The transition into hardware involved significant risk for Microsoft. Initially the Xbox was given their own strategy formulation apart from close headquarters scrutiny. The change made sense: business units are closer to their customers, costs and competitors.   Nevertheless, as Whitney points out (1995), new risky business units can fail, just as headquarters can fail, by losing focus and synergy on organizational priorities and capabilities.

The Xbox strategy, however, began by using the software foundation as a “common base of knowledge” from which Microsoft could experiment with new products in new industries (“Marketing Strategies – Microsoft’s Xbox,” n.d.). One of Microsoft’s chief concerns had been that their product line-up was getting old. New and innovative products like Xbox were intended to change that image and improve the Microsoft brand.

Microsoft adopted Porter’s (1980) four competitive strategies for Xbox (Dess & Davis, 1984). Xbox is labeled under “focus,” since it has a narrow technological focus, that of the video gaming industry. In addition, the Xbox strategy utilizes “differentiation” since the business seeks to offer additional specialized products and services in addition to the gaming console. The $299 console is considered to be an “investment,” from which the purchase of games and online video streaming services can generate profitability and cash flow (“Marketing Strategies – Microsoft’s Xbox,” n.d.). That strategy has worked well for Microsoft’s Xbox as it has for their primary competitors Sony (PlayStation), and Nintendo (Wii). The objective is to provide customers a gaming and entertainment experience that exceeds competitors’ offerings in terms of fun and graphic quality. The target market is primarily male gamers, both children and adults that enjoy novel products. This helps differentiate Xbox from Nintendo Wii since Nintendo has as a primary value proposition a “healthy” experience that can include exercise and education.

Since the introduction of Microsoft’s Xbox in 2001, the three dominant gaming companies, Microsoft Xbox, Sony, and Nintendo have traded market share several times. The primary differentiating features of what determined whether one company would create an advantage over another company was the graphics quality and consumer excitement around the development of the games, such as Microsoft’s “Halo.” After five years of losses in the business unit, Xbox 360 entered the gaming market with a promise of more memory and better graphics. Not until late in 2013 did Xbox attempt a revolutionary upgrade to the Xbox platform called: Xbox One. The most significant difference with the Xbox One was that all of the Microsoft operating, engineering and functional groups were brought back into one umbrella strategy, requiring all employees to work together to achieve goals and objectives.

After more than a decade of product improvement and competitive games, each of the three major gaming competitors sought to move beyond simply a strategic model of console-game, and to differentiate themselves further from each other in order to create their own distinct advantage.

Both Microsoft and Sony, Xbox’s chief rival, are located in the western U.S. In Silicon Valley, the most concentrated group of software designers, work on developing an unending product pipeline of new and exciting video games. Apart from this concentration there is not a lot of gaming software development activity. The largest game retailer is GameStop, with approximately 50 retail stores in the greater Los Angeles region. Other retailers include Electronics Boutique, Toys “R” Us, and most retail chain stores such as Sears.

Key Partners in the Xbox Value Chain

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Strengths, Weaknesses, Opportunities and Threats (SWOT)

Strengths

  1. Microsoft is a large company with deep resources and significant management expertise. Xbox can leverage engineering, software and functional organizations within a technology company to support ongoing product development efforts.
  2. Microsoft Xbox is a strong brand, along with customer loyalty, that translates into strong pricing power.
  3. The adjacent products, such as the Xbox game “Halo,” for example, are tied exclusively to the Xbox console hardware, providing a proprietary product annuity stream over several years, as long as the popularity of the game remains.
  4. The advent of Xbox has provided an “innovative” dimension to the Microsoft brand.
  5. Since Netflix (2008), Microsoft has added to Xbox more than 60 services, including Hulu, Comcast’s Xfinity, and Amazon (Russell, 2014).

Weaknesses

  1. Microsoft is under the spotlight from a vocal community of avid technologists, gamers and computer geeks. These people have strong reactions, opinions, and are apt to post these opinions to public forums, debate about the merits of new products, and if an aspect of Xbox is deemed weak or problematic, create negative customer goodwill through these discussions and posts.
  2. Microsoft is a large company, and as such, finds incubating new products and innovative ideas an especially formidable challenge given the maze of bureaucracy that has developed as the firm has grown. The inclination is to develop products and services that leverage their existing core competencies. Yet, while this seems admirable, it may result in products that are not quite what the customer is looking for or expecting.
  3. Microsoft, at its core, is a software company. The hardware business is an entirely new and different undertaking, and the costs of manufacturing and distributing hardware significantly more expensive than software. The supply chain is extensive, and the temptation to produce low-cost consoles ever-present. Microsoft was the first gaming company to include a hard disk drive for storage in their early consoles. This proved to result in negative gross margin on hardware sales (“Microsoft’s Xbox One Almost Went Entirely Disc-less After E3,” 2014).
  4. The entertainment industry is fraught with parental concerns about violence, sexuality and gaming addiction. Xbox must tread carefully to ensure their products are not offensive and that customer acceptance will follow each new game.
  5. At $499 for the Xbox One, young potential gamers of modest financial means will struggle just to get started with their gaming experience.

Opportunities

  1. With the combination of Internet connectivity and the utilization of the cloud, Xbox can sell products and services with a global reach.
  2. With low-cost bundled packages for emerging markets, Xbox could expand their overall total available market. Combinations of bundled products and services in general, given the vast offering from Microsoft, present further attractive possibilities.
  3. Greater innovation can lead to new and exciting products that address the entire niche of “home entertainment.”
  4. More third party partnerships, especially with Hollywood studios and others tied to consumer entertainment, could yield breakthrough product offerings.
  5. Expanding the total available market by appealing to females, as wells as disparate cultures throughout nations around the world.
  6. Professional gaming is a large market, and continuing to grow at a high rate. Multi-user hardware such as high-end headphones (Dr. Dre, Beats) may generate high margin hardware and accessory sales (Wagner, 2006).

Threats

  1. The gaming market is maturing, competition is consolidating, accretive business will result more and more from the strategy of taking market share, expanding the total available market will be more and more difficult in the future.
  2. The disruptive factors unknown to the Xbox team can take the business by surprise. In a technology segment, with fickle consumers changing their tastes, and fast moving new upgrades to products and services such as on-demand video, innovative breakthroughs are common.
  3. An ongoing willingness on the part of competitors to continuously cut the console prices to gain market share. Since it is difficult to predict the accretive revenue and gross margin stream that follows a given hardware purchase, gaming companies are tempted to almost give the hardware away in a kind of “razor / razor blades” marketing strategy.

In 2013 Microsoft shifted the Xbox strategy to be more inclusive from a corporate standpoint. Specifically (Bass, 2013), the new Xbox One was to debut November 22, 2013 consistent with Steve Ballmer’s (Microsoft CEO) new “One Microsoft Strategy.” Corporations that manage more than one business model and more than one business strategy find geometrically increasing complexity and pressure on the organization and its workforce (Casadesus-Masanell & Tarzijan, 2012). Mr. Ballmer sought simplification through unity, cohesion through cooperation, and product leverage through integration. The idea within the new strategy was to knit the product groups together in a way that the hardware, systems, software and functions would work more cohesively and efficiently.

Inside the Xbox One was the latest Windows 8 operating system to make further software development easier. To further differentiate the Xbox One from Sony’s newest PlayStation 4 (which was released around the same time), Microsoft added a variety of new features such as the ability to watch HD Blu-ray movies, “Live TV,” and cloud networking that would require perpetual Internet connections. This last feature, a requirement for continuous Internet connection, would turn out to be more damaging for Microsoft than it was helpful. Assembly/Edelman, the leading public relations market researcher for several Microsoft businesses was hired to promote the launch of the new Xbox One.

The requirement for online connectivity with the new Xbox One met with negative customer backlash initially. While the gaming community posted hostile online reviews, competitor Sony responded with ads showing the ease of sharing games, featuring one gamer handing a disk to another gamer. Yet Sony too has had its share of problems to overcome with their own gaming product called PS Vita, the follow-on product to the successful PSP handheld device. While precise hardware unit sales are unavailable, estimates of the combined hardware of both PS Vita and PSP devices is well below their expected 10 million per year after the launch more than two years ago. Similarly, Nintendo’s Wii U sales, along with a general lack of excitement about GamePad, is reported as perhaps the worst misstep in the history of the company’s gaming business (“The Difference in Sony, Microsoft, and Nintendo’s Reactions to Failure,” 2014).

For the month of December 2013, Xbox One had attained number one status in terms of console sales in the U.S., selling almost 1 million units in December alone. The prior major Xbox platform, Xbox 360 (2005), also sold 643,000 units in the same month, earning it third in market share for its generation. Combined, the two platforms of Xbox were able to hold 46 percent of the hardware market in terms of share, achieving 10 percent growth from the prior year.

Total retail spending on the Xbox platform (Xbox One and Xbox 360) in December was $1.4 billion, fully 50 percent of the software and hardware total U.S. retail sales spend. In the U.S. alone consumers purchased almost 3 games since the launch of Xbox One. Fans continue to show their excitement for the new generation Xbox One games, with U.S. consumers purchasing an average of 2.9 games per console since launch (Source: NPD Group, December 2013).

According to Microsoft Corporation’s 10-K filed with the SEC July 31, 2014, Xbox revenue has increased to $1.7 billion per year, while annual costs rose to $2.1 billion on the heels of the new Xbox One investment. New gaming platforms require a significant investment, so it is not clear what the forecasted cost run rate will be 3-5 years out, nor did Microsoft provide future revenue guidance in their annual report and their corresponding analysts’ call.

Conclusion

Much has been written about Microsoft’s initial vision for the Xbox to become the gateway into home entertainment. Perhaps the original vision was never fully realized and in fact Xbox landed somewhere between that vision and just being another gaming product. To support the thesis that the business model was a failure, writers such as Koen, Bertels, & Elsum, (2012) point to the financial losses generated by the business unit. With cost reductions in the hardware supply chain, however, increasing revenue on game sales including licensing revenue for the in-house developed games, as well as the Xbox Live Gold subscriptions ($60/year) it may not be difficult for the business unit to turn profitable in several years. The unknown in all of this is that given eight generations of consoles across three major platforms, Xbox, Xbox 360 and Xbox One, 2001, 2005 and 2013 respectively, another major platform development could be expected in the next five years or so, requiring yet another large infusion of research and development costs.

Although Microsoft may see its primary competition coming from new console releases from Sony and Nintendo, there is another external aspect of competition that could radically change the entire gaming market. Hagiu and Herman (2012) argue that the biggest challenge to gaming consoles will come from tablet and mobile-based games, as well as the cloud. Given Nintendo’s claim to own the “casual gamer” niche, it may be most at risk as these less intensive gamers will show desire to use their smartphone or tablet to download and play games. Cloud-based gaming lends itself to less complex games that could be played on simpler devices that are cheaper than the investment in sophisticated gaming consoles. At this stage it appears both Microsoft and Sony do not have any near-term plans to embrace cloud-based gaming however. Perhaps a fourth competitor will emerge, in the form of a disruptive innovator, that prosecutes the lower-cost platforms across the cloud and multiple devices, appealing to gamers around the world in terms of affordability, flexibility, with a gaming ubiquitous platform.

 

References

Bass, D. (2013, November 21). Xbox is a test for the One Microsoft Strategy. Bloomberg

Businessweek. Retrieved from http://www.businessweek.com/articles/2013-1121/xbox-is-a-test-for-the-one-microsoft-strategy.

Casadesus-Masanell, R & Tarzijan, T. (2012). When one business model isn’t enough. Harvard

            Business Review, 90(1/2), 132-137.

Dess, G. G., & Davis, P. S. (1984). Porter’s (1980) generic strategies as determinants of

strategic group membership and organizational performance. Academy of

           Management Journal, 27(3), 467-488.

Koen, P., Bertels, H & Elsum, R. (2012). The three faces of business model innovation:

Challenges for established firms. Research Technology Management, 54(3), 52-59.

Marketing Strategies – Microsoft’s Xbox. (n.d.). Retrieved from

http://teamxbox.wikidot.com/marketing-strategies

Microsoft Corporation. (2014).10-K Annual Report 2014. Retrieved from Edgar database

http://www.sec.gov/edgar.shtml#.U_krvEuBlfM.

Microsoft’s Xbox One almost went entirely disc-less after E3. (2014, January 3).

Forbes.com. Retrieved from

http://www.forbes.com/sites/insertcoin/2014/01/03/microsofts-xbox-one-almost-went-entirely-disc-less-after-e3/

NPD Group Press Releases – Market Trends News – npd.com. (December, 2013).

Retrieved from https://www.npd.com/wps/portal/npd/us/news/press-releases/

Russell, K. (2014, April 3). How business is positioning the Xbox to take Amazon, Roku and

            Apple TV. Retrieved from

http://www.businessinsider.com/the-xbox-is-microsofts-strategy-for-the-tv-2014-4

The difference in Sony, Microsoft, and Nintendo’s reactions to failure. (2014).

Retrieved from http://www.fool.com/investing/general/2014/06/23/the-difference-in-sony-microsoft-and-nintendos-rea.aspx.

Wagner, M. G. (2006). On the scientific relevance of eSports. In International Conference on

            Internet Computing (pp. 437-442).

Whitney, J. O. (1995). Strategic renewal for business units. Harvard Business Review, 74(4), 84-

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