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Old Forbes dude calls Microsoft's gaming attempts a 'disastrous endeavour'

12:25 PM on 04.20.2007 // Robert Summa

For most of us that have an Xbox 360 (that works), we love it. In fact, I'd say for most gamers nowadays in the North America regions, the 360 has more or less become the next-gen console of choice -- maybe mostly due to the fact that both Nintendo and Sony haven't caught up software wise in this new generation.

Well, according to an old and crusty financial type, Microsoft isn't doing anything right when it comes to video games. Speaking through his Forbes blog, Mr. Roger Ehrenberg (Forbes has a blog now?) says that Microsoft has been on a "disastrous endeavour." He goes on to say the following, while shaking his cane in the air:

After taking a step back and looking at some objective numbers (taken from Microsoft's  (nasdaq: MSFT -  news  -  people ) own financial statements and comparative console sales figures extracted from and, I have concluded that gaming has been a disastrous endeavor for Microsoft, particularly from an investment perspective.

The seeds of this failure are evident from its sales performance in Japan, particularly when comparing its 18-week sales figures (which is about how long the Wii and PS3 have been out relative to those of the most successful console releases).

More ramblings after the jump. 

But why is it a failure, really? The old man speaketh:

Let's first consider Microsoft's Home & Entertainment Division ("H&E"), which includes Xbox 360, Xbox, Xbox Live, Consumer Software and Hardware Products, and IPTV. Making money, i.e., the creation of long-term shareholder value, has got to be the ultimate driver of Microsoft's gaming (and H&E) strategy, right? Well, after five years and over $21 billion invested, all they've got to show for it is $5.4 billion of cumulative operating losses, and Xbox 360 doesn't appear to be the silver bullet to turn things around.

I think it is also interesting to note that Microsoft's actual disclosure shows only revenues and operating losses--I backed into and show expenses below for explanatory purposes. Why might it be that Microsoft has strayed from the classic "revenues minus expenses equals profits (losses)" disclosure? Perhaps because it doesn't want investors to focus on the fact that more than $21 billion has been invested in a business that has performed so poorly, with unclear prospects for improvement.

Sometimes these cold, stark facts seem to get lost in the shuffle. Xbox 360 (a meaningful part of H&E) might be a fine product, but if so, why is it so financially disastrous to its maker? I understand the concept of selling a console at a loss in order to lay the foundation for recoupment of original investment, plus operating losses, plus attractive financial return through gaming, but what is it going to take to turn things around? Nothing short of a tectonic transformation in perception of Xbox 360 relative to its competitors.

The target audience is to blame then? 

Sure, the Xbox 360 can be righteous and cool with hard-core gamers, but this is not a sufficiently large user base to recoup the magnitude of investment Microsoft has made in its gaming platform. So if this is Microsoft’s strategy, it’s got a problem. And if the strategy is really more mass-market, then it’s got some serious repositioning to do relative to the Wii, which is both cheaper and more accessible to Ma and Pa and Timmy and Tammy gamer. In short, I am at a loss. Correct that: Microsoft is at a loss. $5.4 billion and counting.

As far as Japan’s role here, consider that over 19 million PS1s and 20 million PS2s were sold in Japan alone, close to the total worldwide sales figures for the original Xbox console. Success in the Japanese market is a key part of getting the game developers to buy into a platform, for which they invest substantial sums and create titles. Plus, people want to buy consoles with better game libraries. Success in Japan is frequently a precursor to success globally, which makes it particularly attractive for game developers who are looking to amortize their development costs over as large an installed base as possible.

If, for instance, the Wii is hot, you get shops like EA turning themselves into pretzels to build their title libraries for the Wii console. And if your particular console isn't hot? Well, let's just say that developers aren't going to be laying out big bucks to invest in the platform.

It is instructive to look at where the last major console releases were 18 weeks after launch in Japan. Basically, if you did well in Japan during this time frame, you had a chance to have a blow-out product. If you didn't, well, you didn't. The Xbox did better than the Xbox 360, and even the PS3 has done better than the Xbox 360. But success in Japan is not a guarantee of a runaway success, as the GameCube proved. Without question, Japan is an important and critical market for building a globally successful gaming platform, and an early read of the tea leaves does not bode well for the Xbox 360.

And this is clearly not lost on Ballmer's Boys in Redmond. Microsoft's vision of the gaming console as the window into the living room is a big, big bet, and one that clearly hasn't paid off thus far. The emphasis on HDTV as being a key factor driving broad-based console sales kind of misses the point. Is the Wii successful because of its zippy graphics and technological superiority? No. It is successful because it is fun. And because it appeals to a broad audience. And because it is comparatively cheap. The Microsoft strategy sounds more like a niche strategy for hard-core gamers, in which case it's investment in a console strategy should be smaller and more targeted.

Microsoft needs to take a long, hard look at its gaming strategy--and, in fact, its entire H&E strategy. At what point, regardless of its virtually endless financial resources, does it say "enough is enough"? Would we have been better served by returning the extra cash to shareholders rather than investing it in a franchise that seems to have questionable prospects for turning around? These are the kinds of questions Microsoft management should be asking. And hopefully, for shareholders' sakes, they are.

Robert Summa, Contributor
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