Beating Sony and Nintendo in the gaming console market is apparently worth billions to the software giant
By Dean Takahashi RED HERRING
June 24 — Microsoft executives are predicting heavy losses related to the Xbox video game console, but the company is prepared to keep supporting its central offensive against Sony and Nintendo by launching a version with new features next year.
MICROSOFT EXPECTS TO lose $750 million in the current fiscal year ending June 30 and another $1.1 billion in the next fiscal year, according to a source familiar with the matter. David Hufford, a Microsoft spokesman, declined comment on the financials.
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Meanwhile, the Xbox team has been working for about nine months on a machine that combines the features of the Xbox with UltimateTV, a set-top box that features digital video recording. Mr. Hufford said, “Regarding a hybrid box, we are moving full steam ahead with Xbox in its current state while staying deadly focused on games. Of course we have engineers looking at dozens of possibilities for the future of the console.”
“There is a debate going on if it is better for Microsoft to lose more money and get an installed base, or underperform in unit sales and lose less money,” said John Taylor, an analyst at Arcadia Investment in Portland, Oregon. “My sense in strategic sales is it is more important to get an installed base.”
Microsoft can absorb the Xbox losses. The company has an estimated $42 billion in cash reserves and, for the year ending June 30, it is expected to report a net profit of about $10 billion and revenues of $28.25 billion.
The costs of goods for every Xbox amount to $325, according to the source. That means that Microsoft is currently losing at least $150 on every box, and probably more due to shipping, advertising, development overhead, and return costs. Microsoft sells the box wholesale to retailers for $175. Microsoft would have to sell a lot more than three games apiece to break even.
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By contrast, Sony is believed to be losing only a small amount of money on the PlayStation 2, which costs an estimated $185 to manufacture. Sony recently began shipping a cost-reduced version of the PS2 with redesigned chips and fewer and smaller components in the box. Microsoft isn’t expected to do the same until the fall.
Sony has been aggressive. It cut the price of the PlayStation 2 in May by a third to $199, and Microsoft matched it. In addition, Sony cut the price of its first-party software titles from $49 to $39. Microsoft had launched its box in Europe at a price of the equivalent of $419, but cut the price to $266 due to slow demand. (Nintendo’s GameCube launched at $199 in the U.S. and has been cut to $149.)
The cost pressures on Microsoft are why it asked Flextronics to shutter a plant in Hungary and move assembly of the boxes to China, and they also explain why Microsoft is in arbitration with Nvidia over the price for the Xbox graphics chips. The XGPU, as it is called, is the most expensive component in the box.
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One problem for Microsoft is that it projects that its costs for the Xbox will decline slowly. The cost of the box may come down over five years from $325 to $225, according to the source. By contrast, Sony and Nintendo are expected to bring their costs down more steeply over time, largely because their machines don’t have an expensive hard drive.
Microsoft seems undeterred by the losses. Robbie Bach, the chief Xbox officer, said at the recent Electronic Entertainment Expo that Microsoft planned to spend $2 billion more on the Xbox over five years. To add features like digital video recording, the machine will need more costly components like TV tuners, extra memory chips, and a bigger hard disk. This combo box might launch next year for a price of $500. The product is controversial in part because it creates a conflict within the machine: will the game slow down so that the hard drive can record “BattleBots”? Balancing the needs of gamers and general users will not be easy.
With all that’s happening, Mr. Bach is going on a sabbatical beginning July 3. He has been the key senior executive in charge of the Xbox since 1999.
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