Xbox One Fails to Rattle the MSFT Cage

by Adam Benjamin | May 23, 2013 7:00 am

Microsoft (MSFT[1]) has unveiled the future of Xbox[2].

As I pointed out a couple months ago[3], the console war is Microsoft’s to lose — and the revelation of the Xbox One was Microsoft’s first shot at getting ahead in the next battle.

After Sony’s (SNE[4]) mystery-heavy event in February, the ball was in Microsoft’s court to get consumers and investors alike excited about the next generation of entertainment. So, did the big event do what it needed to?

Well, there’s two sides to this story — what Tuesday meant to gamers, and what it meant for MSFT shareholders:

The User Side

Tuesday’s event cemented Xbox’s change from gaming console to comprehensive entertainment center. Microsoft opened with a demonstration of how users could seamlessly switch from games to movies, movies to TV, and TV to Internet — all with simple voice commands via Kinect technology.

The demo seemed like a significant improvement over the 360’s much slower controls. The ability to instantly jump between applications is a natural evolution for a system that has placed a much greater focus on entertainment peripherals like Netflix (NFLX[5]) and ESPN in recent years.

Microsoft is investing even more into the expansion of its entertainment division with a live-action Halo TV series. The show will be produced by 343 Industries — the studio behind Halo 4 — with involvement from Steven Spielberg. 343 Industries already produced a live-action Halo web series that won awards for cinematography and production design.

As it turns out, it wasn’t until 30 minutes into the event — halfway through — that anyone talked about video games in any depth.

Microsoft announced a special partnership with Electronic Arts (EA[6]) for the company’s EA Sports franchises: Madden, FIFA, UFC and NBA. (Though neither EA nor Microsoft has specified past calling it a special partnership.) The reigning Worst Company in America[7] isn’t necessarily the first company you’d like to hear Xbox is making a “special partnership” with, but it is notable that Xbox One will have an advantage over Nintendo’s (NTDOY[8]) WiiU, which won’t carry the upcoming Madden 25. 

Microsoft closed the event with a look at Call of Duty: Ghosts for the new console, showing how the game compares to its predecessor. The graphics looked crisp, the movement looked natural … but we didn’t get to see any actual gameplay. And gamers probably won’t get to see the new engines in action until E3 in June.

The Investor Side

MSFT shares responded to all of these announcements with a shrug, slipping fractionally. Considering the Xbox One is supposed to be the future of entertainment and all, you’d have to imagine Microsoft was hoping for a more positive response.

So what were investors unimpressed with?

Nothing about the Xbox One jumped out as a must-have innovation — like, for example, the original Wii’s intuitive motion controls.

Also, most of the features and projects announced Tuesday require a lot of up-front costs and won’t immediately generate profits.

Start with the fact that companies typically sell brand-new consoles at a loss. They depend on games and software to make money until the price of components comes down — usually years later[9]. Even if Microsoft toes the same line as Sony — which says it’s adamant that it won’t absorb the same kind of loss[10] launching the PS4 that it did for the PS3 — and the Xbox One merely breaks even, that still won’t be a point of immediate cheer.

Not to mention, big-name video games are getting more expensive to put on shelves. Production and marketing for new installments of major franchises, like Halo 4 or Skyrim, can easily eclipse $75 milllion[11]. And while the $60 price tag for new games usually means bigger release-day profits compared to films, keep in mind that these games take years to develop. (Development time for films vary, but typically a year or two shorter from the start of production, compared to video games.) While Microsoft doesn’t have to worry about development costs for third-party franchise games like Madden or Call of Duty, core franchises like Gears of War and Halo are part of Microsoft Studios, which means the company will still have plenty of production costs to cover.

Microsoft’s foray into filmed entertainment will have similar issues. Film and television require lots of upfront production costs, and make that money back slowly over time. So even if the Halo TV series were guaranteed to be profitable (which it isn’t), investors might not see the return on that investment for a couple of years.

But perhaps the biggest reason for investors’ indifference? The fact that Xbox is a pretty small part of Microsoft’s big picture. The company’s Entertainment and Devices Division only accounted for 13% of overall revenue in 2012, and Xbox was only responsible for about a third of EDD revenue, according to Q1 reports.

So unless Microsoft had executed the most embarrassing launch ever or unveiled the most innovative product in recent memory, Wall Street’s reaction Tuesday would have been difficult to avoid.

Bottom Line

Microsoft is still leading Sony and Nintendo in the endgame of the current generation consoles: The Xbox 360 has been the top-selling console[12] for 28 months, though those sales should drop (as they have been) as we approach the launch dates for PS4 and Xbox One.

Until then, it’s tough to say what will happen with the next generation. Sure, we have the hype and specs from the announcement events, but we don’t know how the console controls or what the games feel like. Expect to hear more qualitative reactions coming after E3.

Personally, I think Microsoft has the best grasp on how the game has changed. Single-purpose gaming consoles don’t have much staying power in a world where 84% of tablet owners[13] play games. But one console that lets you watch movies and TV, play games, Skype with your friends, browse the Internet and more … simultaneously? That kind of device is much more relevant to the way people now consume entertainment.

The Xbox One has the potential to branch out beyond its predecessor’s audience. It’s too early to say just how far — or if it will succeed — but we should get more clues in the six or so months leading up to the console’s release.

Just don’t expect MSFT shares to turn on a dime every time we get a new detail during the coming months.

Adam Benjamin is an Assistant Editor of InvestorPlace. As of this writing, he did not hold a position in any of the aforementioned securities.

  1. MSFT:
  2. future of Xbox:
  3. As I pointed out a couple months ago:
  4. SNE:
  5. NFLX:
  6. EA:
  7. Worst Company in America:
  8. NTDOY:
  9. usually years later:
  10. won’t absorb the same kind of loss:
  11. eclipse $75 milllion:
  12. top-selling console:
  13. 84% of tablet owners:

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