Microsoft Will Face New Competition With its Next Xbox

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Microsoft (NASDAQ: MSFT) sold over 300,000 units in the U.S. last month of a computer originally designed more than 7 years ago. Meanwhile, a computer it launched in the second week of February just surpassed 400,000 units this week. The former trounced its competition, while the latter paled in comparison to its peers despite a much stronger marketing effort. The former is the Xbox 360, the latter the Surface Pro.

You might argue that the two operate in completely different markets with significantly different competitors, and I couldn’t argue with you. But I believe Microsoft’s next-generation Xbox will compete more closely with its Surface competitors than its game console peers.

How the Xbox 360 found success

The Xbox 360 has been the best-selling game console for 26 months straight. In its early years, however, Microsoft found itself significantly outsold by Nintendo’s Wii despite a one-year head start. Unlike most consoles, which usually peak in sales between their third and fourth year after release, Microsoft sold more Xbox 360s in its last fiscal year than ever before, growing its entertainment and devices division revenue 60% from 2010.

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It turned things around with a new intuitive motion and voice controller, Xbox Kinect, and a shift in marketing from gaming console to entertainment console. The Xbox Kinect was Microsoft’s attempt to capitalize on Nintendo’s motion controlled gaming success. In less than 30 months, Microsoft sold 24 million Kinect units, which correlates nearly one-for-one with Xbox 360 sales.

More importantly, Microsoft shifted the position of Xbox 360 in consumers’ minds. Instead of comparing itself to Sony’s (NYSE: SNE) PS3, which has slightly better specs and a similar game selection, or Nintendo’s Wii, which had a hold on the low-end casual gaming market, it marketed toward families as a living room entertainment system.

Microsoft showed consumers the Xbox 360 is a single box that ties everything in the living room together. It’s for watching DVDs or Netflix, it’s for listening to music, and it’s for party entertainment with games like Dance Central. On top of all that, it’s still a high-end gaming system with exclusive titles such as the Halo series. It was an impressive feat of marketing, as the PlayStation 3 is nearly equally capable of doing everything the Xbox 360 can.

The next generation

Many expect Microsoft to continue its dominance of the console market with its next iteration of the Xbox, as the competition looks like its falling flat. The Wii U, released in November of last year, is not selling as well as originally expected, forcing Nintendo to cut its outlook for the quarter. And after a teaser billed as an unveiling 140-minute marathon event from Sony, some people are announcing Microsoft the winner of the console wars before it even releases a speck of information about its next product.

I expect Microsoft to continue its shift away from gaming with its next console, and focus more on the entire entertainment package capturing mainstream consumers. It ought to integrate the Kinect sensor with every device, which would bring first-rate Skype capabilities to everyone’s big-screens. Wedbush Securities analyst Michael Pachter believes Microsoft will integrate a TV tuner card, giving the Xbox DVR and television voice-control capabilities. Essentially, Microsoft could be making a killer set top box that also plays video games.

Its best strategy

That strategy would be wise, as the video game industry has come under pressure in recent years. Smartphones and tablets have contributed to the rise of casual portable gamers with inexpensive titles like Angry Birds and Plants vs Zombies.

As a result, video game revenue is on a steady decline, and was down 25% last month with console sales leading the way. Certainly, expectations for two new console releases later this year have contributed to the sales decline, but the pattern is clear – the gaming industry is in trouble.

What’s more, hardcore gamers are better suited to PCs. While game consoles used to perform as high-end gaming computers for low consumer prices, it appears we reached price parity several years ago. Cevat Yerli, CEO of Crytek - a game developer with inside information on both the PS4 and next Xbox - said it’s impossible for consoles to match game PCs ever again.

“If you predict how hardware evolves at the current speed of evolution, and then take consumer pricing evolution, already two years ago you could see, whatever launches in 2013 or 2014 or 2015, will never beat a PC again.”

Microsoft’s new competition

While the video game console market is considerably tame with just three main players, the battle for the living room is still heating up. New entrants into the space are popping up every month, from small names to big companies like Intel (NASDAQ: INTC), which – finally! – officially announced it’s building a TV-service last month.

In fact, Intel’s plans include a camera device to identify users and serve personalized ads. Intel Media boss Erik Huggers even compares the device directly to Microsoft’s Kinect. The potential for motion or voice control exists as well, as Intel works out deals with content providers to bring a complete cable-TV and DVR replacement to your living room.

There is, of course, the 800 pound gorilla – Apple (NASDAQ: AAPL) - that stands to compete in the living room as well. The company already has its foot in the door with its AppleTV set-top box, and could release a full-fledged SmartTV in the near future. An Apple television set could provide the same entertainment features as Microsoft as well as a Facetime app to compete with Skype capabilities. It could even bring popular iOS games to the big-screen, and wrap it up in one nice package.

Moreover, Microsoft will find itself competing against all television manufacturers. As the TV replacement cycle shrinks, and more SmartTVs are sold with more built in features, the appeal for a set-top streaming device diminishes significantly. Even with its voice-control and gaming potential, Microsoft’s Xbox will face some stiff competition from all-in-one devices from the likes of Samsung, Google, and potentially Apple - companies Microsoft has had significantly less success competing against in recent years.

The last generation

As a child that grew up with an affinity for video games, it’s sad to think we may be facing the last generation of what we call game consoles. Microsoft is poised to beat out Sony and Nintendo in the next generation of console sales, but I expect those sales to be significantly diminished from the spectacular performance of the current generation (3 of the top 5 best-sellers of all-time).

The landscape is shifting, and the battle for the living room is still just beginning. Microsoft has the potential to create a great product, but the competition is fierce and will come from all angles. Investors shouldn’t be expecting the company to continue the level of success it saw in 2011 and 2012 into the future with its next Xbox.


Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple, Intel, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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