Whenever we talk about the Xbox, the PS3 and the Nintendo Wii, it still appears to us that the PS3 is the real power engine among the three, and that it will have the longevity and software backing which will enable Sony to continue to dominate gaming. Not everyone agrees with us, and sometimes we think we’re just saying it out of habit, just because of the way we have lived through the past generation of PS2 dominance. So periodically, when something comes along to suggest that perhaps this view is reasonable, we take some confidence from it. There was plenty this week.
First off Microsoft launched over a year ahead of the PS3 and the Wii, and this appeared to give Microsoft an inevitable lead in the market. Now it has tried to bury bad news last week, the day after independence day, over a recall to a number of its Xbox 360 devices, which was caused by the huge number of failures the devices were going through out in the market.
Microsoft estimates suggest that that this is set to be the most expensive recall in gaming history, with a price tag of $1.1 billion placed on it. Given that JupiterResearch just issued a report saying that the 2007 games console market is worth $12.8 billion, so that suggests that Microsoft just took a hit that is 8.6% of the entire annual market volume. The amount of money involved suggests that as many as a half of the machines has this flaw, and that could create a huge amount of discontent among gamers.
In terms of revenue, if that estimate is anything like accurate, then it equates roughly to one quarter’s revenue for the Entertainment and Devices group which last quarter lost $330 million, and which suggests a massively inflated loss for the next set of figures.
The problem is global and Microsoft said simply that it would expand the Xbox 360 warranty to three years of coverage to include any customer who experiences a general hardware failure indicated by three flashing red lights, a problem that it has been experiencing in the market. So far it has been charging customers to fix the problem, now it realizes that it is a design fault and it has changed the design going forwards and says that anyone that paid for this specific fault to be fixed can now come to it for a refund.
The estimate is from Microsoft and is in the form of a $1.05 billion to $1.15 billion pre-tax charge that Microsoft will take on its earnings for the quarter ended June 30.
‘The majority of Xbox 360 owners are having a great experience with their console and have from day one. But, this problem has caused frustration for some of our customers and for that, we sincerely apologize,’ said Robbie Bach, president of Microsoft’s Entertainment & Devices Division. ‘We value our community tremendously and look at this as an investment in our customer base. We look forward to great things to come.’
The company said the problem is not caused by a single component in the console, and says it relies on 1,700 components and 500 million transistors. The problem began to appear over the last three to four months, Bach said, and only then in devices which had ‘significant usage’. That’s the thing about good games consoles, they get constant usage.
The loss that Sony incurred a year ago on the recall of a battery design for Dell and Apple PCs was estimated to cost it up to $250 million and for this it was pilloried through the press for a full two months. The Microsoft story has already been all but dropped, after scant mention in the US press, which loves a winner and tends to see things in a pro-Microsoft way.
But the problems don’t end there and already a Florida man has filed a class action lawsuit calling for a payment of $5 million against Microsoft for what appears to be yet another defect in the Xbox 360. This one he says causes scratches on game disks which makes them unusable, and was first reported on the gaming site Joystiq. So how many other people out there are complaining that they’ve lost their entire game catalog to a faulty machine we wonder?
Our point is that Microsoft has always had a tendency to release things before they are ready. This is institutionalized within Microsoft, and its first several editions of Windows almost killed the operating system, rather than making it a world beater, because they were launched fill of problems.
We warned of this in the early days of the Xbox 360, PS3, Wii fight. Sony had the problem of working on a chip that was brand new, that professed awesome power, but which was always going to be tricky to harness which is why we have said that at that device and its development software matures, it will be able to get more and more form the new chip.
Microsoft always appeared to have the easiest run in. Both Microsoft and Nintendo used an earlier IBM Power chip, and were denied access to the latest and greatest Cell chip that is in the PS3, but both had to adapt to new chip architectures from their previous designs and in Microsoft’s case built a device which was not compatible with prior generation games.
But when a company that has never designed hardware, beats to market not one, but two companies which are expert at it, then there has to be a real concern that the software house has cut a few corners, and that this might lead to the kind of financial hits that Microsoft is now taking.
Sony was admonished for its delay and for its higher price and internally that has put paid the to career of the original PS2 architect, Ken Kutaragi, who announced his retirement shortly after the belated launch of the PS3.
We always used to get emails saying don’t write off Nintendo whenever we wrote about this war, and this we attributed to game player loyalty, and little more. Hindsight now tells us that Nintendo, like Sony, spent a little longer getting its new business together, but researched it well enough to take a commanding lead in the instantaneousness of its offering, especially the way the new handheld controller worked.
Laughably Microsoft, about 18 months ago, leaked a public opinion (said it out loud in a trade paper interview) that Blu-ray technology was fundamentally flawed, that it was not ready, it was held together with string, and that Sony would not be able to make it reliable enough in time to bring it to market. Replace the world Blu-ray, with the word Xbox 360 and we are closer to approaching the truth of the situation.
It is this combination of selecting the wrong High Definition technology, and launching too early that has now come back to haunt Microsoft, and once again, if any sensible business man gets his or her hands on the management of the Entertainment and Devices Division at Microsoft, the financials say to do only one thing, for the sake of the Microsoft investor, sell it off.
But Microsoft investors are not best known for bullying the company, and it will be a cold day in hell before a group of private equity players thinks its worth buying Microsoft, in order to improve its cashflow.
At least Microsoft has done the decent thing for its customers by declaring the change in policy, which is far better than waiting until the press have a field day with the issue, dragging it through blogs and discussion boards for 6 months, as happened in the Sony PR disaster over downloading a rootkit into PCs as a form of audio DRM ‘ a move which cost it legal actions, apologies, and a huge enforced public climbdown.
But after the Holiday, and as E3 approached Microsoft began its move to turn the Xbox into a device which allows film downloads with playback on a TV set. Make no mistake about it, the Xbox and the PS3 (though not the Nintendo Wii) are rivals to the Apple TV device, and the second front of the cold war is all about video.
Sony’s ace in this department has been the inclusion of a Blu-ray drive, bundled into the PlayStation 3, and it is this move that single handedly has proved decisive in the High Definition storage format battle with Toshiba. Regardless of what the US does now, Blu-ray has won globally, and the price advantage and few scant months lead that Toshiba held at the tail end of last year, is already eradicated. Last week we were made aware of the first ‘sponsored’ piece of ‘independent’ research that suggests that people don’t buy games consoles to watch films, so the Blu-ray devices in the PS3 shouldn’t count.
But if the number of PS3s which have Blu-ray did not win that war, then why are so many more Blu-ray disks being sold compared to those in the HD DVD format? And remember the differential is huge outside of the US, the only country to ship any HD DVD devices in volume.
This means that the Microsoft Xbox is laboring under a huge disadvantage in its choice of video peripheral. Microsoft will almost certainly have to allow a partner (god forbid it would work on its itself) the right to attach a Blu-ray drive to the Xbox 360.
At home I have a PS2, and have had it since they first came out. During that time I have had 6 dedicated DVD players, which are now all broken or all temperamental over which disks they read accurately. The PS2 has never let me down, and similarly all over the world, gamers remember this.
Other Sony device owners remember that over the past 20 years Sony devices have managed to read just about every video format, effortlessly, despite losing out on prior rounds of video format wars. That’s how you build a brand, and although Sony engineering is no longer considered quite so robust among Japanese investment analysts, that brand remains hard to squash.
Microsoft’s problems all come from the desire to fight on all fronts, and compromise at no point in its efforts to dictate to a market. It chose a different High Definition DVD technology from Sony because it wanted to be different and for no other reason. If it had thrown its weight behind the Sony Blu-ray effort instead of bad mouthing it in the press, it wouldn’t be sat in a dwindling portion of the video market, and it yet it would still have a huge console lead.
Now that it has lost this video devices battle, Microsoft has to take the HD format war online. Already through its Xbox Live! network it has been winning in terms of network connections against Sony and this week at E3 it announced a deal with Disney, of all people, for the inclusion of an unspecified number of High Definition films available for Microsoft points ‘ its console currency ‘ for download.
Sorry to be a film ignoramus, but looking through the titles of the films available we don’t notice any blockbuster hits, in fact we didn’t recognize any of the films Microsoft listed. It takes no effort or investment to produce one file copy of a film in a format that Microsoft can play, whereas it takes a huge amount of effort to pay for a HD DVD manufacturing run, so this is an experiment, and the only type of experiment that Microsoft can do to salvage the console video market, by turning it into an online only market
Sony has always been shockingly slow on the provision of networking facilities for its devices. It is behind on the PS3 network as it was behind on the PS2 networking before it. It was also behind on the provision of a music store, and lost the entire market to Apple’s iTunes simply by launching late, and without conviction. If it has learned any lessons from this it has the film content to fight back against Microsoft’s successful Xbox Live.
Sony’s reaction to the Microsoft warranty embarrassment is to turn the screw on the Xbox 360 over price. It knows that it has 120 million PS2 owners out there and that even if all the Xbox 360 owners were once PS2 users, it still has 100 million loyal gamers to shoot for.
So Sony has cut its device price by $100 in the US, dropping the top end device to $500, just $20 more than the Xbox 360 when it is bought with the optional HD DVD disk player.
Sony is a master at this type of tactic. It created a price sandwich in the stores in the previous generation, where if a gamer wanted the cheapest device it bought a Nintendo Game Cube, and Sony kept the price of its dominant, top of the range console just above the Xbox. Microsoft must think that it has enough of a brand in this market now to stay firm on price and not be forced to lower its pricing. A rumored price drop by Microsoft did not materialize at the E3 show, so it is sitting and waiting and looking at the retail figures. Don’t be surprised if it is forced into a price cut in a month or so by stalled sales.
The Sony trick is to take all the profit out of the Xbox, and constantly discourage its management from continuing the fight, mostly because Sony can rely subsidies for the devices coming from the huge spend per console on games that PlayStation gamers have spent in the past.
But all this is happening at a time when the PS3 is still component constrained. It has not yet launched the device globally and Sony can ship as many devices as it makes still, and yet it has already sold around half as many machines as Microsoft, despite its 15 month market lead. The Nintendo Wii is doing more that satisfying the lower end of the price sandwich and it is quietly outselling everyone, with a very low priced product that is exceptionally popular.
Microsoft is perhaps relying on the fact that today an Xbox can be bought for $300 with no extras and no hard drive, and the cheapest PS3 is still over $100 above this because it comes with a Blu-ray drive. But already Microsoft missed its target of 12 million devices to be shipped by the end of June, and it is likely that news of the warranty issue is going to slow that further. As components come online Sony will drive down pricing further, not low enough to catch up the device numbers of Nintendo, but enough to further place doubt in the mind of those 100 million gamers out there which might have had their eye on an Xbox, but which will now be wary.
The next thing for Microsoft is to come out with a new version of the Xbox, which instead of focusing on inclusion of an HD DVD drive, will focus on a larger hard disk drive. That suits the strategy of shifting to online delivery of video, leaving it somewhere to store downloaded video, for play back later.
Perhaps that also explains why last week Microsoft recruited Katherine Styponias as general manager of its Media & Entertainment Group to work with major content suppliers, tempting her away from Prudential Equity, where she was the most senior cable, entertainment and satellite equity analyst.
Perhaps it is her job to forget the past dalliance with the wrong DVD technology and the hardware that makes up the Xbox, and turn this into a content war.
You would imagine that she would have her work cut out for her. Disney is affiliated with Apple, and Sony owns three Hollywood studios. News Corp and its Twentieth Century Fox studio wants to work out its own online offerings through MySpace etc’, while Warner will naturally try to make AOL strong with its content. That leaves only Paramount and Universal where Microsoft can get real content.
In the end Microsoft has to make the Xbox a success, or fall out of not only the gamers market but the home video and home networking market. It has spent around $6 billion trying to get a foothold in the home and the Xbox 360 is the basis of all of its consumer devices going forwards.
In effect it is the last device where it has hopes of getting to grips with the likes of Apple and Sony. In the meantime its own PC division also launched its Games for Windows campaign at E3, which seems to give out the message, play games on the your PC and you don’t have to buy an expensive new Xbox 360 which might take you down technological blind alleys. The campaign unveiled 30 new titles from top game publishers Eidos, THQ and SEGA.
If you were in the Xbox division, wouldn’t you be tempted to curse your own PC team for offering gamers a way out of the console wars.