Microsoft: What’s Up With Xbox?

Summary

Microsoft wants to end the console war for good – and might actually be able to succeed.

The individual pieces are in place, but MSFT has struggled to execute similar strategies in the past.

Xbox could slingshot ahead in the PC gaming space if the strategy works.

Introduction

Phil Spencer, head of Xbox for Microsoft (NASDAQ:MSFT), recently announcedthe shift to “Universal Windows Applications” and a world of Xboxes with “upgradeable” hardware. This would eliminate the need for console generations and convert Xbox into the same hardware utilization model enjoyed by PC gamers.

This is a huge shift in strategies and represents a unique opportunity for Microsoft to gain an advantage over Sony (NYSE:SNE). In actuality, this ends the console war (which is already over in favor of the PS4) and shifts the competitive landscape. Microsoft would be more at odds with Valve Software’sSteam platform, Blizzard (NASDAQ:ATVI) Software and League of Legends than the Sony PlayStation. If successful, this strategy could leave Sony behind, depending on how PlayStation adjusts to the new market dynamics.

In this article, I attempt to explain the nuance of this strategy as well as the pros and cons and what it means to Xbox in the future.

Source: Ars Technica

Consoles Versus PC Gaming

The typical (and longstanding) debate of which is superior – PC versus Console – goes something like this:

Consoles offer a “closed system” that is an inexpensive (compared to PC gaming) and reliable way to get into video games. Software is specifically designed to work on the console hardware, games (generally) run pretty well, and there is little to no major troubleshooting or technical fidgeting to get things working.

Additionally, the console offers about 5-7 years of life where you do not need to worry about upgrading the hardware. Developers generally design their games around whatever hardware limitations might exist. Generally, the console hardware is outdated at time of release compared to PC, and by the end of the console generation, the hardware is easily 3-4 iterations behind what is available to the average consumer in the PC market.

On the PC side, hardware costs are typically higher, but the user is offered a range of flexible options and a very “open” hardware ecosystem that can be upgraded over time. Games may or may not work on particular hardware depending on how outdated it is, but if you want the highest definition experience, you can upgrade into whatever works with your current configuration. Also, games are not tied to your specific machine, and if you upgrade to something better, you can take your library with you easily and play all of your old content.

Console games tend to be more expensive than their PC equivalents, and more physical copies are sold on the console versus the PC, which is dominated by various digital content delivery services. Steam and other digital distribution platforms occasionally run crazy sales where incredible deals can be found at prices consoles rarely ever see. Also, the library of games that a PC has access to is far larger than any console library. PC games can also include higher complexity that utilize the mouse and keyboard interface (PC gamers have been known to call console users “peasants” from time to time).

In years past, console exclusive software releases have played a major part in driving the sales of one machine over another, but in the current generation, the majority of games are released multi-platform (with the major exclusion of any Nintendo (OTCPK:NTDOY) or Sony first-party releases).

For more information on the typical PC versus console generational gap, please refer to the graphic below or this ExtremeTech article. As you can clearly see in the graphic, the PC performance graph takes a “linear” approach. The console is more of a “stair step” by generation. Essentially, Microsoft is positioning itself to convert Xbox from the console line to the PC line.

Breaking Down The Strategy – Key Concepts

The “immortal Xbox” strategy is clearly an attempt to convert the Xbox console into a “PC gaming” machine, but the early indications are the universal Windows application/Xbox ecosystem would be the only available content to play. It is unclear whether MSFT would eventually open the Xbox ecosystem to the Steam library or other non-Microsoft stores, but it is highly unlikely as it would seriously damage Microsoft’s ability to sell software through its own content distribution service.

In theory, Microsoft’s strategy makes perfect sense as the console/PC gap has been shrinking little by little every generation up to the present day where the Xbox One and PS4 are basically PCs in everything but name and operating system (even less so on the Xbox One which runs Windows).

The concept of upgradeable consoles is not new (and it has always failed in prior attempts) if you remember the days of the 16-bit era when Sega had the 32x and the 64-bit era when Nintendo released the 64DD for the N64. Those consoles were far different than the current generation which offers digital downloads and far superior scalability of software. If Microsoft handles this correctly, each game could have an “upgrade/downgrade” graphics option depending on what level of Xbox it detected, similar to the graphics option settings found in nearly every PC release. This would be far simpler for developers to build around.

Currently, Xbox One is far behind the PS4 in the console race. This strategy shift could put Microsoft back on equal footing and “one up” Sony sling-shotting Xbox ahead after an upgrade cycle or two (while the PS4 continues to chug on the original release hardware).

Sony will have a challenging time matching MSFT’s strategy as it does not have the giant Windows OS installed base. One option Sony could have would be a “PS4/2” with full backwards compatibility and compatibility with the Steam Linux marketplace. At some point in the future, all the consoles could be technically streamlined “Steam boxes” that may have console-specific exclusives as an incentive to purchase a particular brand.

Potential Pitfalls

There are some potential pitfalls to Microsoft’s strategy. One issue will be the PC gaming user base is heavily invested into the Steam store as well as other specific individual platforms, such as League of Legends or Blizzard’s various franchises. Valve has a huge share of PC game digital distribution, and owns a big chunk of the market share (around 15%). These users will have a hard time abandoning their content libraries and “open” PC hardware to shift to a “Windows store” if the Xbox hardware restricts access. Previous attempts by Microsoft to entice PC gamers into its content distribution platforms have not gone well (Games for Windows was an abomination), and the current Windows store also has major issues if it wants to compete.

If Microsoft thinks gamers will flock to the Windows store and it does not release a Steam-competitive content marketplace, the effort will most certainly flop. Also, the console user base prefers the console experience for a reason – it is reliable and inexpensive compared to alternative options. Adding the complexity of some games not working or suffering from inferior performance without the right “upgrades” will further fracture the user base and turn off the average console user. As I mentioned previously, the console upgrade concept was attempted previously by Sega, Nintendo, and Atari, and it did not go very well. Perhaps, Microsoft can overcome the marketing and technical failures of previous generations, but it should definitely be careful.

Upside Potential/What Does This Mean For MSFT?

The PC gaming market is estimated to be worth around $27b. If Microsoft successfully implements its strategy, it will give it a huge advantage in the next console cycle as the company will be removing Xbox from a head-to-head battle with the next-gen PlayStation. Bridging the console-PC gaming divide would be a major win if it was accomplished, especially if a best of both worlds result gave us flexible and open-ended hardware with the reliability and ease of use of the typical console. Microsoft may figure out the “Steam box” before Valve does.

MSFT could finally be leveraging its native advantage of Windows OS installed base over Sony, but we should be skeptical until further details of the strategy are revealed. The fusion of the PC gaming market and console market will give access to significantly more potential users and a strategic edge to Microsoft that would not be easily duplicated by any of its competition. Also, Xbox upgrades could give Microsoft a future advantage in the VR space if it provides an easier or lower barrier to entry for average users.

Currently, details are sparse, but the future success of Xbox hinges on Microsoft’s ability to execute. Be on the lookout for more news with special consideration for the content delivery restrictions and “hardware upgrade” specifics before placing a bet on the future of Xbox.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Article originally posted on Seeking Alpha

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