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Weekly Column

A Shot Across the Bow: The Real Strategy Behind Microsoft's X-Box Game System

Status: [CLOSED]
By Robert X. Cringely
bob@cringely.com

Did you see Microsoft's X-Box this week, introduced in a flurry of event marketing? It's this amazing, powerful video game system that ought to beat anything else on the market. That is when the X-Box hits the market, IF it hits the market. There is more to this story than Microsoft is willing to say.

Everything Microsoft does — EVERYTHING — is driven by competition, even the X-Box. This is in part because Microsoft is not a very creative outfit, but even more so it is because as the biggest, baddest, most powerful company in the software universe, Microsoft has the most to lose. So almost anything they do is in defensive reaction. Microsoft is continually protecting its turf, even if that turf appears to the rest of us as belonging to a company other than Microsoft.

The turf Microsoft is defending in this case is Redmond's right to the lion's share of the world's software revenue. If video game systems grow into platforms that can be perceived as competing with desktop and notebook PCs, well, Microsoft sees that as threatening its traditional revenue streams. To defend the desktop, Bill Gates announced a game system this week.

But does that make sense, to defend your primary revenue source by introducing a product that could conceivably threaten the primacy of that source? It does if you think like Microsoft thinks. Remember, this is a company that defended in Federal Court its bullying business tactics by saying they were only threats, that Microsoft didn't intend to follow through. The same could well be said for the X-Box. There is a real possibility the game system will never actually hit the market.

It's not that Microsoft wouldn't love to dominate the video game business the way they currently dominate the PC software business. If Gates can do that, he will. But that's a decision to be made months from now. The near-term issue for Microsoft is not how to dominate the game business, but how to destabilize the game business to protect its desktop software.

X-Box is that agent of destabilization. It looks great. It's exciting to developers. And it has that Microsoft name. What Redmond hopes is that game developers will be so taken with X-Box that they'll devote resources to developing for it, with the financial and human resources for that development coming at the expense of their other projects for the Nintendo, Sega, and Sony game platforms. That's why the project was announced at the Game Developer's Conference in San Jose. X-Box succeeds if all it does is slow down development of competitive products. Throwing a fourth major player into the business slows everything down, and most likely will lead to the death of products that are considered outside the game mainstream.

It's these products — the non-game products — that have Microsoft so worried. That John Madden Football would appear on every game platform is a no-brainer and doesn't bother Microsoft a bit. But web browsers, web-based productivity applications, and other non-game software bothers Microsoft a lot. So by threatening the core game business, Microsoft thinks it can force game hardware and software developers alike to defend that core business and give up the non-game projects. And it might well work.

What game developers should keep in mind is Microsoft's long tradition in the PC software business of introducing titles and initiatives that eventually just fade away. Every time Windows is threatened by some cross-platform software initiative, Microsoft announces its own version in a flurry of publicity only to have the effort misfire and go away. This happened in networking when the threat was from Novell, in the Internet space more than once when the threat was from Netscape, in office networking when it looked like Japanese office equipment companies might cut Microsoft out of that business. Whatever happened to MS-Net, to LAN Manager, to Microsoft at Work? Each was introduced with a crowd on licensees on the stage, yet hardly any products actually appeared.

The big threat in this case comes from Sony's Playstation 2, which I have covered before. In many ways, the PS2 is more powerful than current PCs, and as applications migrate to the web, it is even more threatening. Maybe we don't need local data storage after all. Maybe Windows compatibility isn't so important. Then there is the $100 million Sony is spending to develop non-game applications for the PS2. That $100 million bothers Microsoft a lot.

Sony and Microsoft are natural enemies. Each company is used to being atop its industry, each has vast resources, each covets the other's market share. Sony would love to steal Microsoft's control of the PC business. And Microsoft sees a fabulous growth path into games, in part because there is little anti-trust problem from going in that direction. In many ways, the advantage actually lies with Sony because, as a Microsoft licensee, Sony gets a close look at most of Microsoft's product plans. But since Microsoft isn't a Sony licensee, Redmond is pretty much in the dark about what's really coming from Japan.

But wait, hasn't Microsoft already spent millions on the X-Box? Didn't they demonstrate it in public? Wasn't it killer? Yes, yes, and maybe. Let's take these points in reverse order. The demonstration was amazing, its true, but amazing demonstrations don't always translate into amazing products. The X in X-Box may well mean the mystery hardware upon which it ran. Microsoft admitted the demo was an X-Box simulation running on hardware different from what will actually ship in a year or two. It's easy to do a killer demo if the demo system is crammed with tens of thousands of dollars worth of digital signal processors and memory. Microsoft skirts the edge on truthfulness in these things, and the company would have no qualms about presenting the software as real even if the demonstration hardware was beyond mortal affordability.

The most interesting part of this for me, though, is the cost. If Microsoft has already spent millions on the X-Box, aren't they too far into the project not to actually ship it? This is where Microsoft economics diverge from the economics that apply to the rest of the world. Most companies have limited resources and would have to make such decisions, but Microsoft has unlimited resources and can do whatever it chooses. Microsoft has no financial or manpower limitations on any project. The company's policy of aggressively hiring the best people it can find as they graduate from universities guarantees it a steady supply of labor. And since Microsoft will hire good people just to keep them from going to a competitor, there is always excess talent.

As for the money, there, too, Microsoft thinks in reverse. The fact is that Microsoft often looks for extra projects on which to spend money. Managers can get in trouble for not spending enough. Huh? It all comes down to stock price. Microsoft wants to keep its stock price rising, which generally requires steady increases in per-share earnings. Like every other public company, Microsoft's finance people are constantly trying to tune their books to keep Wall Street happy. But unlike every other public company, Microsoft actually makes too much money. The company is so profitable that an honest representation would be too much for Wall Street to handle. It would also blow much of Microsoft's ability to control the game by using excess earnings to give Wall Street just a little bit more than it expects each quarter. One way to do this is by maintaining a higher level of spending on projects that can easily be cut back. So throwing 100 extra engineers into Windows development or $10 million into X-Box are actions that can easily be reversed to recapture profits when, and only when, they are needed.

I'm not saying X-Box won't appear or that it won't be most of what Microsoft says it will. But I am saying that the future of X-Box is fuzzier than we might think from the publicity. More than anything else, this week's demonstration was Microsoft firing a round across Sony's bow.

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