Roger Ehrenberg submits: The success (or lack thereof) of Microsoft's (MSFT) Xbox 360 has been a hotly debated topic across both the blogosphere and mainstream media, with an amalgam of sober and utterly confused views depending upon one's vantage point: analyst, investor or gamer.
After taking a step back and looking at some objective numbers - those taken from Microsoft's own financial statements and comparative console sales figures extracted from VGChartz.com and Wikipedia.org - I have concluded the following:
# Gaming has been a disastrous endeavor for Microsoft, particularly from an investment perspective;
# The seeds of this failure are evident from their sales performance in Japan, particularly when comparing their 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; and
# This early failure in the key Japanese market has a compounding negative effect on worldwide console sales, as game developers are less willing to invest in high-risk projects for console platforms that are shaky out-of-the-gates, which makes it less attractive for gamers to buy these consoles, and so on.
Before digging into the data, I'd like to clarify a key point: my perspective is that of a financial analyst. Therefore, my primary interest is in the strategic and financial implications of business decisions, in this case the Xbox 360 and Microsoft's Home & Entertainment strategy, and NOT whether or not the Xbox 360 is a rocking product.
As I've stated before, I have many friends who think the Xbox 360 is awesome. This, however, is not my concern. And to state the obvious for those who know me and/or are regular readers, I am neither a fanboy nor an investor in single stocks, so I have no interest in partisanship one way or the other. I am only interested in truth and understanding, and if a few people get their noses bent out of shape in the process, sorry.
Hemorrhaging Home & Entertainment
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. I have used a set of numbers from historical annuals that seem to change by $100 million or so year-to-year; I'm not sure why this is, but the numbers are close. Regardless, it is not a pretty picture from a financial perspective.
Making money, e.g., 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 - Expenses = Profits (Losses) disclosure? Perhaps because they don't want investors to focus on the fact that over $21 billion - the market cap of a sizable independent company - has been invested in a business that has performed so poorly, with unclear prospects for improvement. Could this be the reason? Hmmm.
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 + operating losses + 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 the Microsoft offering relative to its competitors.
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 the strategy, they've got a problem. And if their strategy is really more mass-market, then they've got some serious re-positioning to do relative to the Nintendo's (NTDOY.PK) 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.
The Importance of Japan
It is interesting to consider a few key points about Japan and its role in the gaming world after a little thought and analysis of historical figures:
# Success in the Japanese market is a key determinant of success in the worldwide market. In fact, one might say that is a necessary but insufficient condition for a globally successful console platform. Sony and Nintendo have absolutely thrashed Microsoft in Japan, and it shows in the global console sales figures. For historical reference, consider that over 19 million PS1s and 20 million PS2s were sold in Japan alone, close to the 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, which makes 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 Electronic Arts (ERTS) 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.
# Success in the Japanese market creates a virtuous cycle - sell consoles, which induces developers to create titles, which makes it easier to sell more consoles, more games, more consoles, etc., etc., etc. In the absence of such a cycle, a console maker is fighting an almost impossible uphill battle towards success on the global stage.
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.
See how the Xbox did better than the Xbox 360? Even the PS3 has done better than the Xbox 360. But success in Japan is not a guarantee of a run-away 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. Remember the promise of runaway success in Japan back in 2005?