American University a Look Into Microsofts Entry to Gaming Console Industry Paper

User Generated

ABABCNAQN

Business Finance

American University

Description

  1. Evaluate the attractiveness of the video games consoles industry prior to Microsoft’s entry. Is this an attractive, moderately attractive or unattractive industry for Microsoft to diversify into? Explain why.
  2. Evaluate Microsoft’s resources, capabilities etc. and whether those will allow it to do “well” (i.e., whether it will win) once it enters the industry. You may use any of the internal analysis tools we have discussed in class (and in the textbook), such as the resources and capabilities framework (VRIN), its strengths and weaknesses pertaining to its resources and capabilities in this new industry, or a value chain analysis (or all three).
  3. Evaluate the long-term profitability of Microsoft in this new industry. What is likely to happen to this industry after Microsoft enters? Here you can evaluate the financial forecasts of Microsoft and in the industry, consider retaliation by competitors, how the industry structure changes favorably or unfavorably, or do some sensitivity analysis on the financials and profitability forecasts.
  4. Given your analysis above, was Microsoft’s decision to diversify (enter) into the video games console business a good decision or not? Take a definitive stance (yes or no).

Unformatted Attachment Preview

Xbox Online December 14, 2001 Microsoft Xbox Online Greg Canessa gazed at the Cascade Mountains as the evening sun settled in the west. Canessa, Business Development Manager and Lead Planner for Online Games (and a lifelong gamer), was contemplating the outcome of the online strategy the team had selected for the console. The brief historical landscape of online video games was strewn with failed ventures, but Microsoft was counting on a new technology environment to create a golden era of global multiplayer interaction. For a company that could easily rest on its laurels, Microsoft was taking a huge and very public gamble that a game console would become a centerpiece of delivering online gaming. Microsoft was a behemoth in the software industry. The company frequently recorded more annual profits than the rest of the software industry combined and was sitting on a $36.2 billion war chest of cash.i By 2001, the ubiquitous Windows operating system ran nearly 95% of the personal computers in the world.ii Since Bill Gates and Paul Allen founded Microsoft in 1975, the company had always been noted for being aggressive in defending its “home turf,” and relentless in attacking new ones. However, this entry into the gaming business was Microsoft’s biggest leap ever outside of its core software business, putting the company in an unfamiliar role as a consumer electronics and game maker. Why was Microsoft betting so much on the home gaming console industry? The industry appeared to be attractive, but a respected competitor had recently exited the market. Was there enough market potential to justify Microsoft’s hefty investment? Would online gaming provide a market opportunity for consoles? There were many PC gamers online, but fewer than 1 million were paying for access. Could the game console potentially reduce the importance of the PC? Sony was betting that the multimedia and online capabilities of the PS2 would move the consumer away from the computer and in front of the television. Would the Xbox, with its advanced technology and online capabilities, trump the competition? Greg leaned back and wondered whether the Internet-connected Xbox would preserve Microsoft’s place at the top of the technology food chain for a third decade. The Video Game Industry History In 1975, an agreement between Sears Roebuck & Co. and Atari ignited the home video gaming industry. Sears gained exclusive rights to sell a console that played Pong to the home consumer, and consequently, Atari reached overall sales close to $40 million.iii This milestone marked the beginning of the highly profitable home computer and video game console industry. In the late 1970’s, Atari launched the 2600, a gaming console that played games on cartridges. While not the first cartridge system, the 2600 was the first commercially successful console, with high sales and market penetration. Meanwhile, the precursor to modern online gaming emerged in the form of Multi-User Dungeons (MUDs), which offered users This case was prepared by Ira Hall, David Ibrahim, Hemant Mandal, Clint Perez, Bryan Richards and John Schumacher under the direction of Professor Allan Afuah at the University of Michigan Business School. -1- Xbox Online December 14, 2001 access to a shared adventure game over a computer network. Most MUD gamers were university students and research scientists from the 1970s through the 1990s. In 1985, the introduction of the 8-bit Nintendo Entertainment System propelled the mainstream consumer gaming industry to new heights. Soon thereafter, Sega launched its highly popular 16-bit Genesis. In 1995 and 1996, game hungry consumers rushed to purchase Sony’s PlaysStation1 console and Nintendo’s N64, ushering in yet another generation of video game consoles. The industry reached loftier heights with the appearance of Sega's 128-bit Dreamcast console in 1999 and Sony's PlayStation2 (PS2) in fall 2000. The Dreamcast included a 56-kilobyte modem for online gamingiv and the PS2 allowed users not only to play games, but also watch DVDs and listen to audio CDs.v Online Gaming By the late 1990s, online gaming had begun to show potential for mass consumer appeal. According to the Interactive Digital Software Association (IDSA), approximately one third of Internet users regularly played online games. 43% of those playing online games had been doing so for less than a year, a signal that this form of entertainment was in an early stage of growth. 79% of online gamers were between the ages of 25-55, with 60% of those in the 25-44 year old demographic. The IDSA study showed the potential of the online game market, but it also offered a cautionary note: 89% of those who played games online indicated that they were not willing to pay to do so, and only one in ten online game players paid for a subscription to any of the online game services.vi Leading technology analysts predicted that the American video game market would grow to $40 billion by 2003. They also forecasted that online gaming subscription revenues in the US would grow from $270 million in 2001 to $4.6 billion in 2005.vii Low broadband1 penetration restricted online gaming to parlor games that required little bandwidth over phone/modem lines (e.g. Solitaire). In 1997, two role-playing games achieved popularity online in the PC arena, primarily across narrowband modem lines. Electronic Arts’ Ultima Online and Sony’s EverQuest each attracted 200,000 to 250,000 subscribers at $9.95 per month. The combination of Ultima Online and EverQuest generated 55% of online gaming revenues in 2000, which were $106 million in 1999.viii By 2001, the two most comprehensive gaming websites were the Microsoft Game Zone (“the Zone”) and EA.com, Electronic Arts’ online and e-commerce business. The Zone and EA.com offered to connect PC gamers to other players who had the same game installed on their PCs. They also offered games directed towards families and casual players. These online communities were counting on rising broadband usage to trigger heavy usage. By 2001, 21 million households had gained broadband Internet access.ix Industry Segments While online gaming was beginning to attract attention, in 2000 the home video game industry consisted primarily of three main segments: hardware, software and accessories. The hardware segment included game consoles (e.g. the Sony PlayStation), portable game players (e.g. the Nintendo GameBoy) and personal computers. The software segment featured the games that ran on the hardware. The accessory segment consisted of game controllers and other peripherals. Online communities had just entered the stage. These communities ran games through the Internet but did not sell hardware or software. See Exhibit 1 for a breakdown of 2000 industry revenues for these segments. Business Models and Pricing Software generated 70% of the total revenues for the home video game industry. Console manufacturers sold hardware for minimal to negative margins and then earned higher margins on sales of video games and accessories for the consoles. 1 Broadband is considered any service that provides 128kbps bandwidth or higher. -2- Xbox Online December 14, 2001 Historically, console makers profited from this loss leader strategy in three ways: 1. Console manufacturers produced game software and earned revenues directly from the game sales. 2. Console manufacturers negotiated royalty agreements with 3rd party software publishers to publish games for their system. Console manufacturers received payments upon the sale of each game. 3rd party software game sales accounted for 75% of all video game sales in 2000.x Exhibit 2 shows market share for the biggest software publishers. 3. Console manufacturers profited from selling accessories and peripherals for their systems. They also licensed rights to create accessories to 3rd party hardware manufacturers like MadCatz and Gameshark. Industry observers monitored the success of the loss leader strategy through metrics such as the “attach rate.” This rate measured the number of games sold for each individual console in a given year. The greater the attach rate, the greater the likelihood the console maker would achieve its profitability goals via the loss leader strategy. Exhibit 3 charts historical attach rates for three of the leading consoles from 1995 to 2000. Online gaming communities were all PC-based to date and some charged subscription fees for the use of their services. For example, EA.com charged individuals a $10 monthly fee for each premium game title a user wanted to play online, and allowed the user to play less popular games for free. In other cases, users had access to free online games, usually through an individuals’ private server. A gamer might host a game like Quake, with other users buying a CD version of the game and playing online through the host’s server without additional fees. Under a third model, game publishers sold titles through retail stores and then matched gamers against one another at no additional charge. The gamers were responsible for finding servers and Internet connections through which they could play online. Games such as Blizzard Entertainment’s Starcraft used this model, though its Battle.net website auto-assigned servers. Unique Online Gaming Challenges As console makers, software developers and online communities sought new online gaming opportunities, they grappled with two major points of uncertainty. These companies questioned how readily consumers would change their video game playing behavior. Gamers were accustomed to playing at home by themselves or against visiting friends by simply inserting a disk or cartridge into the console and starting a game. They were used to using the Internet for web browsing or electronic mail exchanges. Microsoft and its rivals were betting these individuals would comfortably move online to play against unseen competitors.xi These companies were also uncertain about whether traditional offline console gamers would pay to play for the extra features online gaming offered. Competitive Landscape Microsoft’s Xbox would face competition on various fronts. At the start of the 21st century, two players dominated the game video game console market. Sony and Nintendo, both Japanese manufacturers, controlled roughly 70% of worldwide industry revenues in June 2001 through their PlayStation (1 and 2) and N64 lines.xii The companies enjoyed extensive user bases, popular products, tremendous brand recognition, and widespread distribution. Console manufacturers also faced competition from the game software industry. Software accounted for 70% of the total industry’s revenues in the U.S.xiiiWith the bulk of profits coming from royalties on video -3- Xbox Online December 14, 2001 game sales, Sony and Nintendo published their own titles and relied upon 3rd party software developers to broaden the product line. While 3rd party support was vital for console survival, 1st and 3rd party games often competed with each other for sales. The 3rd parties were responsible for 76% of all retail games sales with the remaining 24% coming from the manufacturers’ in-house game development.xiv Competition in the software arena came from games developed by Sega, Electronic Arts, Activision, and Take-Two Interactive Software, among others.xv Popular titles sometimes became “franchises” in their own right. Franchises commanded premiums for developers and even drove sales of consoles via increased user loyalty. See Exhibit 4 for a list of some popular game franchises. Together the hardware and software companies competed for an $18.7 billion worldwide market in 2000.xvi With the 2000 release of Sony’s PS2, the June 2001 release of Nintendo’s Game Boy Advanced hand-held system, and back-to-back launches of Microsoft Xbox and Nintendo GameCube in November 2001, the competition had reached an epic scale. “We are entering a golden age of video games!” exclaimed John Steinbrecher, CEO of Electronics Boutique Great Britain, a mall based game retailer. “You get a big console release. You sell a lot of hardware that year. The following two years you sell a lot of software to support it. We have an 18-month period where there will be four console releases. That's unheard-of in my 15 years in the industry.”xvii Online communities added a new twist to the video game industry. These communities frequently hosted video game competitions via the Internet that featured PC gamers from across the globe. MSN Gaming Zone, EA.com and Gamespy emerged as early pioneers in this area. In addition, these sites offered free and subscription-based services that either complimented CD-based games or stood alone as entertainment products. EA’s Majestic was one such product that combined a $9.95 per month subscription with CD-based content. Microsoft and Sony both saw potential for adding an Internet subscription model to their game consoles. Video Game Systems Sony Sony towered over the video game system industry. Between 2000 and 2001, it had sold over 20 million PS2 consoles worldwide. Between PS1 and PS2, Sony had achieved 50% market share throughout the world, with its largest sales volume coming in the United States and Japan.xviii Sony, a consumer electronics and entertainment colossus (with total dollar sales double those of Microsoft), distributed its products through national American consumer retailers (Wal-Mart, Best Buy, etc.), specialty gaming retailers (Electronics Boutique, Funco), online retailers (Amazon.com, etc.) and Sony’s Playstation.com web site.xix Sony stimulated frenetic demand for PS2 by undersupplying its consoles during the October 2000 product launch, creating long lines and shortages to heighten consumer interest. Sony began establishing an online gaming presence for its console in 2001. Sony partnered with Cisco Systems to offer high-speed Internet access and joined America Online in developing e-mail and instant messaging.xx Sony aimed to get PS2 users online in 2002 through the sale of a broadband attachment for the console.xxi Nintendo Nintendo had successfully entrenched itself in the console market, displacing earlier manufacturers like Atari and Intellivision. Nintendo introduced the N64 in 1996, expecting it to be the market leader. To the -4- Xbox Online December 14, 2001 industry’s surprise, Sony’s Playstation1, introduced a year earlier, took the lead instead. Hobbled by reliance upon cartridges, the N64 endured higher production costs than Sony, which played games on cheaper, higher-memory CD-ROMs.xxii Over the years, Nintendo’s in-house development efforts spawned several popular franchises such as Super Mario Brothers, Zelda, and Pokemon.xxiii Nintendo also expanded its scope with its wildly successful Game Boy hand-held system. GameBoy sold 100 million units worldwide and controlled 95% of the hand-held gaming market.xxiv By the fall of 2001, Nintendo was preparing to launch a new console, the GameCube. Applying lessons learned from the N64, Nintendo duplicated on proprietary DVD’s and planned to increase its portfolio through greater reliance upon 3rd party developers. In fact, only two of the 15 launch titles would be inhouse games, the rest coming from external developers like Electronic Arts and LucasArts.xxv Additionally, Nintendo would leverage its installed base of GameBoy Advanced users by allowing the new GameBoy and GameCube to interact with each other. Over 60% of Nintendo's consumers were under eighteen. The company intended to use that segment as a starting point for future growth. As one Nintendo executive explained, “Our goal is to keep the core demographic we're so strong in and build on it by having more games for older audiences. We'd like to keep them for a lifetime by getting them while they're young, but we want to compete in the entire market.”xxvi GameCube also featured an expansion port for future modem / broadband adapter to permit play over the Internet.xxvii Still, Nintendo showed little faith in this prospect. “The revenue model for online gaming is still uncertain,” argued Atsushi Asada, Executive Vice President at Nintendo. “It may have some potential in the future, but it will take time. The infrastructure simply does not exist.”xxviii Nintendo was also concerned about its young core audience. These young consumers had little disposable income and no credit cards to buy online services.xxix Software Through deals with companies such as Activision, Take Two Interactive and LucasArts, the three console makers hoped to convince consumers they offered the greatest variety or quality of video games. Some deals were for exclusive rights to a game. Others were non-exclusive and allowed developers to create game versions for all three consoles. Each console manufacturer sought exclusive titles that could attract more consumers to their machines. Sega An international leader in the arcade and home video game industries throughout the 1980s and 1990s, Sega had recently fallen upon hard times. Sega was in the console business until its Dreamcast product, launched in late 1999, failed on the worldwide market. Although it sold 2.9 million units in the U.S., Dreamcast suffered from a lack of 3rd party developer support (EA did not develop games for Dreamcast). Additionally, its launch was so close to PS2’s that many consumers simply held out for Sony’s product. Dreamcast was the first product to offer Internet access through a built-in modem. Sega built SegaNet, an online network for Dreamcast players to play each other online, which cost $100 million to develop. While a first mover in online gaming for consoles, Sega ultimately suffered $420 million in losses in 2000 and terminated production of the console.xxx, xxxi, xxxii -5- Xbox Online December 14, 2001 In 2001, Sega decided to focus on developing games for Xbox, PlayStation2, and the GameCube.xxxiii Sega agreed to produce thirteen games for the Xbox during 2001, and signed agreements to provide additional gaming software for both PS2 and GameCube. All three console makers sought Sega’s software due to the company’s groundbreaking success in building three-dimensional graphics and voicerecognition software into video games. According to an executive at Electronic Boutique: “There's good will toward Sega from consumers. The quality of their game play is top-notch, and they have great franchises.”xxxiv With high quality games, Sega could draw many consumers toward the Xbox, or it could lure them toward PlayStation2 or GameCube. Electronic Arts With $1.3 billion in annual revenue, Electronic Arts (EA) was the top independent game publisher worldwide. EA was known for successful sports franchises such as FIFA Soccer, Madden NFL Football and NHL Hockey, which had large followings in the console market. EA was also known for PC games, including Ultima Online and The Sims (developed through its Maxis subsidiary). EA had the resources to develop games for all three next generation consoles at once. Microsoft, Nintendo, and Sony all expected to win console buyers and software royalties through the games, but it was not clear whether consumers would gravitate towards one console or another based on the fact that EA planned to produce for all three. All three manufacturers hoped to sign agreements for exclusive rights to certain EA games in the future. Companies like EA emphasized both online and offline gaming. Even though console games sold more, the game product life cycle was much shorter than that of online games. The typical life cycle of an offline console game was six months as compared to several years for an online game. On average, a company such as EA would invest $10-20 million to develop a high quality game. Developers could prolong life cycles by offering upgrades and updates. Even if companies initially sold fewer copies, they could expect residual revenues for several more years. Online Communities AOL Time Warner Sony partnered with AOL Time Warner to create a broadband strategy that would bring AOL’s electronics, media, and communications businesses to Sony devices via four gateways: TVs, PCs, PlayStations and mobile phones. Under the agreement, Sony would incorporate AOL tools and features into the PS2 platform, enabling consumers to use instant messaging, chat and email on their gaming systems. The alliance provided Sony with access to AOL’s 32 million online subscribers and Time Warner’s 12.7xxxv million cable television subscribers. AOL Time Warner also owned substantial content in the form of magazines, movies, music, television and the web. In addition to the Sony alliance, AOL had an existing online entertainment agreement with Electronic Arts, which ran the AOL games channel. Yahoo! Yahoo! created and maintained its own online gaming site for members of the Yahoo! community. With 2.8 million users per month, Yahoo! Games tended to offer low-tech parlor games like backgammon and hearts that could be played with other members of the community.xxxvi While Yahoo! had no plans to create a community for more sophisticated PC and console gaming, it did have an alliance to manage, maintain and co-brand with many of Sony’s web sites. -6- Xbox Online December 14, 2001 Other Online Communities Many smaller gaming communities existed on the Internet with varying degrees of success. Some communities like Gamespot (owned by Ziff-Davis Publishing) and Adrenaline Vault existed as game information services, posting game reviews, previews and forums for players to communicate with each other. Other communities were more robust, offering software that allowed gamers to connect to and play each other online. Gamespy was one such community, offering Gamespy Arcade for Windows PC users. Xbox Console “The future of gaming starts today, and it starts with Xbox. Xbox is a key part of our strategy to drive the digital entertainment revolution and deliver the future of interactive entertainment to the home. It's a great example of how Microsoft is innovating. But, most important, it's incredibly cool.”xxxvii - William H. Gates III, CEO of Microsoft Xbox Launch Against the backdrop of stiff competition, Microsoft muscled its way onto the scene with a $500 million marketing campaign and a rumored $2 billion in development costs. Microsoft entered with only a modest history in designing video games for PCs, with 4% market share for the PC game industry.xxxviii Microsoft had no experience in manufacturing game consoles. Even so, the company brought its Xbox to market in mid-November of 2001 and garnered high initial praise from the industry and gamers alike. Sony watched Microsoft’s entry with a combination of confidence and concern. The Japanese rival wondered whether its new competitor might fundamentally alter the industry. Sony CEO Kunitake Ando cautioned, “The biggest threat to PlayStation2 is that the Xbox changes the industry's life cycle. It is unclear how long we can keep [our] business model.” Traditionally, consoles sold in five-year product life cycles, allowing manufacturers time to recover startup costs for hardware, but Xbox might reduce the life cycle to three years or even less. Similarly, if Sony were to respond by unveiling a PlayStation3 on a shortened production schedule, it could jeopardize Microsoft’s ability to recover the Xbox’s high entry costs.xxxix In the meantime, Sony prepared to defend its flagship product with a $750 million worldwide marketing assault and an army of gaming software developers.xl Factors Fueling the Xbox Launch Industry analysts pointed to three major factors driving the company’s product launch decision: • Booming Industry. According to Banc of America, the industry would generate $18.7 billion in revenues during 2001 – more money than the entire Hollywood movie industry would generate that year.xli The revenues would derive from the sale of video game consoles, console games, personal computer games, and arcade games. The U.S. market alone was worth $8.1 billion in 2000. • Trojan Horse Strategy. Video game consoles demonstrated a growing breadth of functionality. In the 1999 Comdex trade show, Sony CEO Nobuyuki Idei declared, “The PlayStation2 is more than a game machine. It can be more than a communications product…more than a personal computer!”xlii This statement concerned Microsoft executives. In 2001, Microsoft’s Windows software loaded on consumer PCs was the company’s fortress into the home market, with 95% market share in operating systems. Sony’s statement signaled a new threat to this dominance. Perhaps Sony would soon offer a potent substitute to the home PC, directly challenging Microsoft’s lock on the home market. -7- Xbox Online December 14, 2001 • Supplement “PC” Revenue Stream. The PC industry was in its fourth decade and as such was beginning to show signs of saturation and maturity, lowering growth rates and hurting profitability. See Exhibit 16. Building the box With design feedback from developers, the Xbox team set out to engineer the actual console. The company had to overcome two major hurdles. First, its competencies were firmly grounded in software development, not hardware. Second, PS2 had a one-year head start. The Xbox team had to create a quality product quickly before Sony’s PS2 built an insurmountable lead in the market. Microsoft first focused on deepening its team. The company scored a coup by hiring away two Sony veterans, Toshiyuki Miyata and Naoto Yoshioka, to work on designing and developing the Xbox. Both men had been instrumental in the launch of Playstation1, and they would greatly shorten the development process. Next, the Xbox team faced a critical design decision: should the console’s internal chips be created from scratch; use existing, off the shelf technology; or use some mixture of the two? The biggest concern was the console microprocessor. Sony had partnered with Toshiba to design and manufacture custom microprocessors for its consoles, while Nintendo had partnered with IBM. These companies engineered their microprocessors from the ground up to achieve high-quality CD sound and fast processing of complex graphics. Though creating a custom processor might seem ideal, development time and costs dictated otherwise. Microsoft settled on a processor already on the market, the Intel 733 MHz Pentium III, which was slightly modified for the Xbox. The Intel chip also guaranteed that the system would be able to run a stripped down Windows operating system. Using a Windows/Intel environment had three beneficial effects. First, Microsoft could shortcut a lengthy and expensive operating system development process by just adapting its established Windows 2000 software. Second, developer tools would be more “PC-like”, giving some game programmers an instant familiarity with the design process. Third, Windows-based tools would draw in PC game developers who had never created or ported games to consoles before. “We can do our next Doom on the Xbox, but it won’t run on the PlayStation2,” explained John Carmack, cofounder and owner of id software, the company responsible for the wildly popular Doom and Quake series for PC’s.xliii Microsoft contracted NVIDIA Corp. to manufacture a derivative of its high-end GeForce3 chip for graphics processing. One of the most costly components to the system, the NVIDIA chip allowed the Xbox to render polygons2 at twice the speed of PS2. Other off-the-shelf components would allow the Xbox to get to market quickly while trimming development costs. Cracking the Consumer Electronics Business Microsoft now sought to enter a market dominated by two highly respected companies, Nintendo and Sony. Over the past twenty years, the console gaming industry had existed as a duopoly, with two console makers dominating the market at any given time. Microsoft had some experience in the PC gaming and peripherals space, but home consoles would present a different set of challenges for the organization. On top of that, Microsoft sought to penetrate the online gaming sector, which had its own set of competitive dynamics. 2 Polygons are the most basic element in creating 3D video game graphics. Programmers can greatly increase a game’s realism by “painting” more polygons per scene. -8- Xbox Online December 14, 2001 For Microsoft to build a sustainable and profitable Xbox customer base, it faced issues regarding: • Targeting a Market • Developer Support • Pricing Against Competition • Product Differentiation Identifying a Target Market Both Nintendo and Sony had been successful because they realized early on who their target consumers were. Nintendo attracted adolescents, typically aged 6 to 14. The Sony PlayStation1 and PS2 attracted older, more casual gamers aged 18 to 34. Both companies’ consoles also sold well beyond their target markets. Significant crossover existed between age groups and levels of interest. After lengthy discussions, Microsoft decided to position the Xbox to attract older gamers, aged 18 to 34. Market research indicated that these players were key influencers for younger players. By targeting this segment, Xbox would compete head to head with PS2. Priming the Developer Pump In order to concentrate on bringing Xbox successfully to market, Chief Xbox Officer Robbie Bach moved his handpicked team from the company’s main headquarters to its own office a few miles down the road from the Microsoft campus headquarters. This move allowed Bach’s team to focus solely on developing the Xbox apart from Microsoft’s famously strong culture. Traditionally, Microsoft was a tough negotiator with software developers, extracting very favorable terms. In the console market, the tables turned. Microsoft had little market power in video games, but desperately needed a network of third-party developers. Ed Fries, VP of games publishing, pushed the organization from dictating terms to listening to developers: “We were the new guys, and everybody was really anxious to tell us what was frustrating and limiting about the development process with the existing consoles. Then we went out and built the system they said they needed to make great games.”xliv The Xbox team not only abandoned the company’s usual hard-nosed tactics, but even consulted with industry game developers for nearly a year before beginning design work. By fall 2001, Microsoft had signed agreements with over 200 companies to develop games for the Xbox. Sony had approximately 300 developers at that time. Microsoft’s contractors ranged from small development firms to powerhouses like Activision and Electronic Arts. While the Xbox team seemed to be attracting significant interest in the developer community, the question still remained about how to differentiate the console from the PS2 and GameCube. After all, major developers could easily place their bets on all three consoles to maximize their profits and hedge their bets against any one console failing. Without differentiating factors, there would be little reason for consumers to buy the Xbox, especially from an untested newcomer. Gamers would likely continue flocking to the PS2 with its huge installed base of titles and backward compatibility with PS1 games. Pricing Against Competition The Xbox would enter the market at a price of $299. The GameCube would enter the U.S. market at $199 during the same week as the Xbox, and Sony was already selling its PS2 for $299 in the U.S. To -9- Xbox Online December 14, 2001 remain competitive, Microsoft would have to monitor how the market responded to the aggressive GameCube pricing, and how Microsoft priced online services and accessories for the Xbox. Achieving Differentiation To differentiate itself from the pack, Xbox’s design team inserted an Ethernet port for broadband Internet access and an 8-gigabyte hard drive directly into the console. Broadband access would allow Xbox users to play games online, talk to other gamers over the Internet, surf the World Wide Web, and download game enhancements. The hard drive would allow users to store digitized music, create and save personalized game scenarios, load detailed graphics more quickly, and add other applications to Xbox in the future. Not to be outdone, Sony announced the release of a broadband/hard-drive add-on module for the PS2 for early 2002. Users would have to purchase the module at an additional cost, estimated to be between $100 and $150. Nintendo also planned to release a broadband adapter for the GameCube at some point in the future, but was intent on developing an online gaming strategy first. Clearly, the next battleground for console manufacturers would be fought online. However, add-ons traditionally sold poorly in the console market, never penetrating more than 20% of the installed user base. Microsoft Online Gaming Getting Into the Zone Electric Gravity, Inc. created the Internet Gaming Zone (later known as the Zone) in October 1995. With slow connection speeds, the website offered turn-based games such as bridge and chess to about 1,500 gamers. Microsoft purchased “the Zone” - as it was casually known - in June of 1996. AOL and CompuServe had also offered similar gaming options for several years. Meanwhile, Doom by id Software was taking the PC gaming world by storm. This program offered fast-paced, first-person, shoot’em-up style action, and, for the first time, a killer app for online gaming. The ggame allowed players to fight each other in real-time. In 2001, the Zone was the largest online gaming site on the web. Choices for entertainment ran the full spectrum from puzzle and card games for beginners, to complex strategy and action games such as MechWarrior for hard-core players. The site counted more than 22 million gamers as members, with 800 weekly tournaments and 130 games.xlv Many of the major game titles even had annual online championships that crowned supreme gamers and handed a check for $50,000. For 9 of the titles, Microsoft requires individual subscriptions ranging from $1.95 for 24-hour access to $99.95 for a year (exhibit 6). Together with a game development and publishing unit, Zone.com and Xbox form Microsoft’s Games Division.3 This division was separate from the MSN division, though there were overlapping interests and technologies. The MSN website is the home page for Microsoft’s Internet Service Provider (ISP)4 3 Zone.com is part of the Online Games Group, which owns the Zone.com, plus online infrastructure and technologies for all Microsoft first party games (i.e. client server and peer-to-peer matchmaking, statistics and tournament systems, back end support infrastructure, etc.). Online Games Group also manages the out-of-game experiences and community features for these games. – Greg Canessa, Microsoft 4 ISPs connect end-users to the internet via modem (dial-up, cable or DSL) for a monthly fee. The largest in the U.S. is AOL Time Warner with a reported 32 million users as of 11/01. - 10 - Xbox Online December 14, 2001 arm. From all outward appearances, the Zone.com fit smoothly into the MSN general site. Microsoft’s aim was to offer exciting content and a compelling community, thereby driving eyeballs to MSN.com. Widening the audience also required MSN to put a more beginner-friendly face on the site. According to Eddie Ranchigoda, a product manager for the Zone.com, "We've always had a strong hard-core following, but in the last year or so we've really seen a spike in casual gaming, mostly due to our puzzle games…Casual gamers tend to “turn and run” when they see a registration process or a dark, gloomy hard-core gaming site”.xlvi Microsoft Television Interests and Investments Microsoft’s other foray into consumer electronics was in the cable television and direct broadcast satellite market. Microsoft offered a digital video recorder/interactive television appliance for sale to consumers known as Ultimate TV. In 2001, the company offered the product to DirecTV satellite cable service subscribers only. For the television system operators (cable companies, satellite companies, terrestrial broadcasters), Microsoft offered the Microsoft TV Platform. The platform allowed system operators to develop a variety of interactive TV services for consumers, including email, Internet, interactive programming, electronic program guides, and digital video recording. Additionally, Microsoft invested in various system operators. Microsoft made a $3.0 billion investment in Telewest, the number-two cable TV operator in the United Kingdom, a $1 billion investment in U.S. cable operator Comcast Corp, and a $5 billion investment in AT&T.xlvii Microsoft also publicly announced its intention to support either Comcast or Cox Communications in their bid to buy the AT&T Broadband cable business, the largest cable operator in the United States. Where To Go From Here? Canessa noted that “the Zone is really the only successful example in the games business of a ‘hybrid gaming site’ -- meshing a web-based card, board and puzzle game experience for casual gamers with a premier PC gaming destination for hard-core gamers.” It might be unwise to upset this successful formula. On the other hand, the Zone.com could return to its roots as a hardcore player destination, more in line with the Xbox demographic. Could Microsoft MSN find a balance mass appeal with gamer cool? With complete system control and significant influence over developers, Microsoft might limit online Xbox play to the Zone. Alternatively, Microsoft could opt for an “open” platform allowing players to choose any online community, including EA.com. Theoretically, this would allow Xbox consoles to play against PS2, GameCube, even PC gamers. Moreover, there was a question of pricing. Only a handful of MSN’s games had subscription pricing and those generated little in the way of revenues. The MSN division compounded the challenge with expensive pricing schemes for broadband access (Exhibit 5). Although the Zone could generate more revenues through a subscription model, gamers might not be willing to pay additional fees. Conversely, offering free access would generate a huge community, but Microsoft’s bottom line would hinge on volatile banner ad revenues. Could either model compensate for per unit losses Microsoft incurred on console sales? Now that the Xbox had launched, Greg knew there would be tough decisions ahead. As he turned back to his desk, he thought about capturing his ideas in a memo to his boss. - 11 - Xbox Online December 14, 2001 Exhibit 1 – Video Game Product Segments Exhibit 2 – Software Publishers Market Share This case was prepared by Ira Hall, David Ibrahim, Hemant Mandal, Clint Perez, Bryan Richards and John Schumacher under the direction of Professor Allan Afuah at the University of Michigan Business School. - 12 - Xbox Online December 14, 2001 Exhibit 3 – Historical Software Attach Rates Exhibit 4 – Game Franchises - 13 - Xbox Online December 14, 2001 Exhibit 5 – MSN Pricing (as of 11/15/01) MSN Internet Access Plans and Pricing 3 months free dial-up service Your first 3 months of unlimited access are free! Low monthly rate of $21.95 a month guaranteed until 2003 Offer ends December 31, 2001 Learn more about this plan MSN Broadband 2 months free when you sign up for a year! Get 2 months free when you sign up for 1 year of MSN Broadband Free self-installation kit including use of DSL modem (a $395 value!) Free activation (a $99 value) Pricing starts at just $39.95 a month $1.50 each additional hour after 10 hours Offer ends December 31, 2001 Learn more about this plan MSN® TV (WebTV): 2 months free and $50 savings Get affordable Internet access without a computer Save $50 with a mail-in rebate Offer includes 2 months free MSN TV Service Hurry, offer ends January 31, 2002. Learn more about this plan MSN Internet Access dial-up hourly plan $9.95 per month for 20 hours of Internet access $1.50 each additional hour after 20 hours Learn more about this plan MSN Broadband free use of modem and no term commitment Use of DSL modem, self-installation kit, and 10 hours monthly dial-up service included free $99 activation charge Pricing starts at just $39.95 a month $1.50 each additional hour after 10 hours No term commitment - 14 - Xbox Online December 14, 2001 Offer ends January 31, 2002 Learn more about this plan MSN Broadband basic plan $199 self-installation kit including use of DSL modem $99 activation charge Pricing starts at just $39.95 a month $1.50 each additional hour after 10 hours No term commitment Offer ends June 30, 2002 Source: MSN Website - 15 - Xbox Online December 14, 2001 Exhibit 6 - Zone.com Game Subscription Plans (as of 11/15/01) Subscription Name Price ($US) Description 9.95 Seek adventure in this online role-playing game! Your first month is free. This subscription renews monthly. 3 Month Subscription 29.95 Yearly Subscription 99.95 Play and participate in all of the Bridge Club game rooms and tournaments! This subscription renews every three months. Rack, stack, shuffle the cards all year around with your Bridge partner! All tournaments and game rooms are open to all Bridge Club members. Asheron's Call 1 Month Subscription Bridge Club CyberStrike 2 Monthly Subscription 9.95 Get full access to all combat modules for your CyberPod. This subscription renews monthly. 9.95 Enter the doorway to the mythical world of Elanthia a stormy realm of enchantment, danger and intrigue. This subscription renews monthly. Monthly Subscription 9.95 1 Day Subscription 6 Month Subscription 1.95 49.95 Signup for unlimited thrills and adventure. This subscription renews monthly. Brace yourself for 24 hours of unlimited action. Enjoy six months of flying at a discounted rate. DragonRealms Monthly Subscription Fighter Ace GemStone III Monthly Subscription 9.95 Enter the living world of swords and sorcery. This subscription renews monthly. 9.95 Journey back in time to a land filled with powerful deities, villainous monsters, and mystical phenomena. This subscription renews monthly. Monthly Subscription 9.95 1 Day Subscription 6 Month Subscription 1.95 49.95 Pilot your customized tank through a city at war. This subscription renews monthly. Wreak maximum havoc for 24 hours. Enjoy six months of climbing the ranks and earning your reputation as the terror of the city. Source: Zone.com website Hercules & Xena Monthly Subscription Tanarus This case was prepared by Ira Hall, David Ibrahim, Hemant Mandal, Clint Perez, Bryan Richards and John Schumacher under the direction of Professor Allan Afuah at the University of Michigan Business School. - 16 - Xbox Online December 14, 2001 Exhibit 7 – Product Spec Comparison Hardware cost Average game cost Games available (expected by Christmas 2001) Central Processing Unit speed Graphics processor Polygon / second Audio channels Online gaming DVD playback Total memory Built-in hard disk U.S. release date Microsoft Xbox Nintendo GameCube Sony PlayStation2 $299 $49.99 15 $199 $49.99 7 $299 $49.99 130 733 MHz 485 MHz 912 MHz 233 MHz 116.5 million/second 256 Yes Optional 64 MB Yes November 15, 2001 162 MHz 6-12 million/second 64 Optional No 40 MB No November 18, 2001 147 MHz 66 million/second 48 Optional Yes 23 MB No October 2000 Exhibit 8 – The Consoles Microsoft Xbox Nintendo GameCube - 17 - Sony PlayStation2 Xbox Online December 14, 2001 Exhibit 9 - Lehman Brothers Report Microsoft has clearly made a strong marketing commitment to Xbox, and in fact, it is estimated the company will lose $125 on each Xbox sold. We point out that retailers announced in early September that they had sold out of Xbox pre-order bundles, which retail at $499 each, and include extra controllers and a few games. We expect approximately 15-20 games to be available or the Xbox game system at launch, and approximately 30 games by year-end, likely supporting revenues after the sale of the hardware. We expect the most popular software titles to retail at roughly $50 each, with low-to-mid-range price points of approximately $25-$30. Exhibit 10 – Game Margins (3rd Party Titles) Exhibit 11 – Software Value Chain Duplication/ Packaging (outsourced) Developers Publishers Distributors Retailers Activision LucasArts Microsoft Sony Take Two Electronic Arts Wal-Mart Best Buy - 18 - Consumer Xbox Online December 14, 2001 Exhibit 11 – Software Value Chain (cont’d) Developers: Game Developers designed and wrote the software code for Video Games. Distributors: Game distributors distributed the game titles to retailers. Publishers: Publishers produced, marketed and distributed the titles created by the developers. Most publishers were also developers and distributors. Some analysts also estimated that publishers themselves developed 50% of all game titles. This trend was due mainly to the fact that in-house development of software was more profitable than third party software, and publishers desired a steadily growing inventory of titles. Retailers: Retailers were the front-end to the consumers. The major retail distributors, like Wal-Mart, had a growing influence and were demanding greater discounts on game titles. Exhibit 12 – Online Gaming Value Chain Consumer A Internet Svc. Provider A Retailers Publisher Website Consumer B Internet Svc. Provider B Wal-Mart Best Buy Comcast AOL Time Warner Microsoft/MSN/Zone.com Sony/SonyStation.com (Yahoo!) Electronic Arts/EA.com Gamespot Nintendo Retailers: Retailers were the front-end to the consumers. The major retail distributors, like Wal-Mart, had a growing influence and were demanding greater discounts on game titles. Internet Service Provider (ISP): ISPs provide consumer the means to access the Internet. This is accomplished with dial-up or broadband modems on the consumer side, and connection/hosting hardware on the ISP end (modems, servers, etc.). Comcast is an example of Broadband only service provisioning through their cable network. Website: These are web-based communities that host games, usually charging a monthly fee for premium games. Gamers can meet and play interactively either using local PC game CDs or entirely online using a browser. - 19 - Xbox Online December 14, 2001 Publishers: Publishers produced, marketed and distributed the titles created by the developers. Most currently available games have on-line gaming code built in to allow interactivity. Publishers provide technical support and co-branding to online communities. Exhibit 13 – Narrowband versus Broadband Gaming is one of the most popular application and one of the activity drivers for broadband. News Consumer Transaction Community* Entertainment Portals/ISPs Other % of time spent while on narrow band – 3/2000 (15.9 hrs/month) 4% 1% % of time spent after switching broadband – 9/2000 (21.4 hrs/month) 4% 9% 43% 14% 35% 32% – Composition of the time increase: Gaming 75% Others** 12% Sports 10% Adult sites 3% 5% 15% 8% 19% to *Includes e-mail, chat, personal web hosting, and interest group **Includes animation, multimedia, television, kids, hobbies, and lifestyle content Source: McKinsey & Company Exhibit 14 – Gamer Profiles Gamers can be distinguished along two dimensions. Pay nothing Offline Online (currently PC only) Play on PC or handheld Play classic and casino games devices Example: puzzle, bridge Pay software Play on console 4 to 32 players Private individual host own servers Gamers find a server with lower ping to reduce latency Game publishers like EA.com host match-making service with “game rooms” at their own cost Example: Quake, Unreal From a few hundred to few thousand Subscription for playing online Hosted by game publishers Example: EverQuest 4 to 8 players Subscription for playing online Hosted by game publishers Pay software + subscription Pay subscription - 20 - Xbox Online December 14, 2001 Example: Need for Speed Source: McKinsey & Company Exhibit 15 – Online Adventure Worlds Today, three major pay-software+subscription games generate $30mn in cumulative retail sales and $70mn in annual subscription fees. (The total annual sales of game software in 2000 was $6.5bn – WSJ 2001) (About 35.1mn people play online games – Jupiter Media Metrix) Title EverQuest Ultima Online Asheron’s Call Total Subscribers 250,000 185,000 150,000 585,000 Publisher Verant Interactive (Sony) Electronic Arts Turbine Entertainment (Microsoft) Source: McKinsey & Company Exhibit 16 - PC Unit Sales - 21 - 4 49.0 36.3 3 1 299 209.3 350 FY'02 49.0 36.3 3 1 249 174.3 300 10 FY '03 49.0 36.3 3 1 249 174.3 250 11 FY '04 49.0 36.3 3 1 249 174.3 250 12 FY '05 49.0 36.3 - 22 - Notes and Sources 1 Microsoft's fiscal year ends on June 30th 2 Figures are a conservative composites of data from various media, broker and market research sources 3 1 199 139.3 250 13 FY '06 Assumptions 1 Assumes wholesale price is 70% of retail price 2 Assumes 75% 3rd party software sales with royalties of $7/game for Microsoft, and 25% sales of in-house software with $30 gross margin for Microsoft Software/Game Prices and Costs Retail $ price per unit 2 Production $ cost per unit Software Game Sales ("Attach Rates") Unit game sales per customer in first year of a customer's Xbox ownership Unit game sales per customer per year after first year of Xbox ownership Console Prices and Costs Retail price per unit 1 Wholesale price per unit Production cost per unit Console Sales Unit sales (# of Xbox units sold in millions) Exhibit 17 – Xbox Financial Data December 14, 2001 Xbox Online Xbox Online December 14, 2001 i Microsoft 10-K. September 30, 2001 Deutsche Bank Alex. Brown analyst report, Sept 25, 2001; p.19 iii “I.C. 1977,” Donald A. Thomas Jr., www.icwhen.com; revised 1/12/01 iv “Gaming Experience,” Stanley A. Miller, Milwaukee Journal. November 20, 2001 v “State of the Industry Report”. Interactive Digital Software Assoc. 2001 vi Ibid vii “X Marks the Spot.” Rodney Chester, Courier Mail. November 17, 2001 viii Bank of America Analyst Report, p. 68. May 2001 ix “Report: Broadband Home Users Jump”. Alorie Gilbert, News.com. December 11, 2001 x Bank of America; May 5th, 2001, p. 35 xi Bank of America; May 5th, 2001, p. 35 xii Deutsche Bank , Sept 25, 2001; p.19 xiii Bank of America, May 5th, 2001 p. 30 xiv Bank of America, p.35 xv “Video games are hot”. Larry MacDonald, Montreal Gazette. November 21, 2001 xvi Bank of America; May 5th, 2001, p. 29 xvii “Good at Games”. Catherine Wheatley, The Independent (London). June 13, 2001 xviii “This 3-Way Slugfest is No Game,” Black, Jane; Business Week Online, Dec. 13th, 2001 xix “Scoring the Game”. Lila LaHood, Fort Worth Star Telegram . October 27, 2001 xx “Playstation Wins More Net Support”. Melanie Farmer, CNET News.com, May 16, 2001 http://news.cnet.com/news/0-1006-200-5945953.html. xxi “Where the Net's Your Playing Field”. Alex Pham, Los Angeles Times. November 8, 2001 xxii “Let the Games Begin”. Sharon Pian Cain, The Seattle Times. October 25, 2001 xxiii Ibid xxiv Ibid xxv “Have a Super Monkey Ball With the Cube”. Tom Ham, Washington Post. November 16, 2001 xxvi “Let the Games Begin”. Cain. xxvii “GameCube Stripped for Action”. Alex Lau, The San Francisco Chronicle. November 14, 2001 xxviii “Gaming War Faces Fresh Battles”. Paul Abrahams, The Irish Times. May 25, 2001 xxix “Where the Net’s Your Playing Field”. Pham. xxx “Gaming Experience”. Stanley A. Miller II, Milwaukee Journal Sentinel . October 25, 2001 xxxi “Sega to Charge for SegaNet Access”. Alex Pham, Los Angeles Times. October 25, 2001 xxxii “Corporate Spotlight: New Path for Sega”. Kelly Zito, The San Francisco Chronicle. August 12, 2001 xxxiii “Sega Sports Titles Go Multiplatform”. Tommy Cummings, The San Francisco Chronicle. November 22, 2001 xxxiv “Corporate Spotlight: New Path for Sega”. Zito. xxxv “Who Will Sign Up for AT&T Broadband?”. Robert, Frank, The Wall Street Journal. December 13, 2001 xxxvi Nielsen/Netratings, June 2001 xxxvii “X Marks the Spot.” Chester. xxxviii Prudential Financial Analyst Report, p. 7 xxxix “Gaming War Faces Fresh Battles”. Abrahams. xl Ibid xli “The Game of War”. Dean Takahashi, Red Herring. November, 2001. xlii “The Paranoia Principle”. James Surowiecki, The New Yorker. November 26, 2001. xliii “The Game of War”. Takahashi. xliv “It’s a New Playing Field for Microsoft”. David Becker, Zdnet. November 15, 2001 xlv “Microsoft's Zone.com offers easy intro to online games”. Bill Hutchens, The News Tribune. November 2, 2001 xlvi Ibid xlvii “Software Giant to Pay $3 billion for British Concern,” Reuters, October 23rd, 1999 ii - 23 -
Purchase answer to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Explanation & Answer

View attached explanation and answer. Let me know if you have any questions.

1

A Look into Microsoft’s Entry to Gaming Console Industry

Student full name
Institutional affiliation
Course full title
Instructor full name
Due date

2

Question 1
The attractiveness of the video games consoles industry, was moderately attractive for
a software giant such as Microsoft to venture into. This is showcased by the presence of
already established games console manufacturers Sony and Nintendo. These manufacturers
had already dominated the market therefore making the entry of a new competitor to the
industry a difficult proposition (Xbox Online, 2001). This attractiveness is improved by the
presence of good networking capabilities creating room for the growth of gaming particularly
online gaming was now widely accepted. Online gaming as interactive digital software
association noted that as a third of internet users during the late 1990s, a third of internet users
engaged in online gaming (William H. Gates III). This was based on the study that IDSA
conducted signified the growth of the online gaming industry
Question 2
With the stiff competition, Microsoft made its way into the industry with a budget of
$500 million marketing funds and a proposed budget of $2 billion on expenses. Microsoft
initially entered into the market as developers for video games for Personal Computers, which
had a 4% share in the PC gaming industry (Xbox Online, 2001). Microsoft had no prior
expertise in the production of game consoles. Despite its shortcomings, the entity brought its
gaming console (Xbox) to the market in the middle of November in the year 2001, which
receive...


Anonymous
Really great stuff, couldn't ask for more.

Studypool
4.7
Trustpilot
4.5
Sitejabber
4.4

Similar Content

Related Tags