Why Gates wouldn’t trade places with Sony in console wars

Two years ago I was over talking with the Xbox team and some of the folks over there explained the facts of life to me, which came back to me after reading that Bill Gates is very happy where he is right now. They were explaining why they were in a race with Sony to get the Xbox 360 done before Sony could ship its unit. At that time they expected Sony to ship at the same time as the 360.

They told me how console business works and why you need a console on the market for four years to make money.

Why?

1) Cost for the unit declines over time and you need that fourth year for Moore’s law to really kick in.
2) Attach rate (er, games sold per console) goes way up in fourth year.

They told me that’s why Xbox 1 lost so many billions of dollars.

The two graphs:

First year, you’ll lose $200 per machine (Sony is supposedly losing $300 on PlayStation 3).
Second year, you’ll lose $150.
Third year, you’ll lose $100 (although price will probably drop too).
Fourth year, you’ll lose $25 to $50, or if market conditions are good, you might even break even.

That’ll be offset by what the industry calls attach rate.

First year attach rate? Xbox is seeing something around eight games, if I remember right, and a pretty good run rate on Xbox Live, too (I’ve bought eight Live games, for instance, in addition to the seven games I have sitting at home).
Second year will see an additional three to four games. Each game is worth somewhere around $10 to $20 worth of revenue (out of a $60 game, I’d guess $20 goes to retailer, $4 goes to distributor, $20 goes to game manufacturer, and rest goes to Microsoft for licensing fees). So, to recoup that $200 lost on each console Microsoft needs to sell something like 15 games.
Third year, another three to four games (maybe more, cause by then there’ll be a huge market of consoles and game manufacturers will have built efficiencies so can kick out new games faster.)

So, if you have your console for three years, you’ve probably bought the 15 games that Microsoft needed to sell to break even. What happens in the fourth year? You buy games #16, #17, #18 and Microsoft (or Sony) starts making huge profits.

The Sony Playstation 2 is on its fourth/fifth year right now, which is why that’s a cash-generating machine. Xbox 1 never got more than three years, which is why that lost billions.

It’ll be interesting to see whether Sony can break this cycle and get more games sold per box (if Sony really is losing $300 per box it sells, it needs to see an attach rate that’s higher than Xbox to have any chance of breaking even).

So, why did Microsoft make this bet? To keep Microsoft’s foot in your livingroom. As more and more people get HDTVs that foot is going to be mighty important.

What do you think?

Comments

  1. I think Microsoft has been very wise with the Xbox 360. Despite small flaws (like playing only wmv video), it is a nice game machine and they have created several revenue streams around it. The Movie thing could be much bigger than people expect. Specially with rentals.

  2. I think Microsoft has been very wise with the Xbox 360. Despite small flaws (like playing only wmv video), it is a nice game machine and they have created several revenue streams around it. The Movie thing could be much bigger than people expect. Specially with rentals.

  3. The Movie Download thing for me has been the huge thing between whether I get a Wii or a 360 I mean both great console, the Xbox 360 just has a little something more to offer me which is great. Can’t wait should be recieving mine at Christmas plus Windows Vista as a late one. Can it get any better

    Josh Chandler
    http://www.techilious.wordpress.com

  4. The Movie Download thing for me has been the huge thing between whether I get a Wii or a 360 I mean both great console, the Xbox 360 just has a little something more to offer me which is great. Can’t wait should be recieving mine at Christmas plus Windows Vista as a late one. Can it get any better

    Josh Chandler
    http://www.techilious.wordpress.com

  5. Scoble, aren’t you forgeting live subscription’s? You got to pay for that too, but its more than worth it IMHO.

    Josh:
    Movie downloading is good but 24hr licence only is not. Hope its increased to atleast a week. If MS provides an all u can see subscription kinda service, then its really going to pick up.

  6. Scoble, aren’t you forgeting live subscription’s? You got to pay for that too, but its more than worth it IMHO.

    Josh:
    Movie downloading is good but 24hr licence only is not. Hope its increased to atleast a week. If MS provides an all u can see subscription kinda service, then its really going to pick up.

  7. Your thoughts on Microsoft gifting all Windows Vista (official) beta testers with the Ultimate/Business edition?

  8. Your thoughts on Microsoft gifting all Windows Vista (official) beta testers with the Ultimate/Business edition?

  9. one other note:

    those xboxLive subscription renewals, xboxlive arcade games, and all the micro-purchases are revenue split between the game-maker and Microsoft. There is NO retailer cut. In other words… MUY PROFITABLE.

  10. one other note:

    those xboxLive subscription renewals, xboxlive arcade games, and all the micro-purchases are revenue split between the game-maker and Microsoft. There is NO retailer cut. In other words… MUY PROFITABLE.

  11. Gates is right. I was Playstation all the way and bought a 360 in the summer because I was tired of waiting for PS3. And now we’re in a situation where I see no need to buy a PS3 because there aren’t any killer PS3 games (and probably won’t be for six months) and there are for 360. Gears of War. At this point there is really not compelling reason to buy a PS3 if you have a 360, even thought is is a technically superior machine. There aren’t any games to show it off. Sony has lost me and it’s going to take a lot to get me to buy one at this point.

  12. Gates is right. I was Playstation all the way and bought a 360 in the summer because I was tired of waiting for PS3. And now we’re in a situation where I see no need to buy a PS3 because there aren’t any killer PS3 games (and probably won’t be for six months) and there are for 360. Gears of War. At this point there is really not compelling reason to buy a PS3 if you have a 360, even thought is is a technically superior machine. There aren’t any games to show it off. Sony has lost me and it’s going to take a lot to get me to buy one at this point.

  13. Sony has another incentive to “lose money” on the PS3 – they use it to put blu-ray in your living room. This is a strategic goal for the company and so 300$ may not be that much to lose considering it helps them win the format wars.

  14. Sony has another incentive to “lose money” on the PS3 – they use it to put blu-ray in your living room. This is a strategic goal for the company and so 300$ may not be that much to lose considering it helps them win the format wars.

  15. If MS is able to reduce this cycle from 4 years to 3 years or 2 years, SONY will be in very bad position. Imagine next year MS come out with Xbox 4, a supper game machine that can play Xbox360, Xbox2 games (via virtualisation or something like that), has more processing power than PS3.

  16. If MS is able to reduce this cycle from 4 years to 3 years or 2 years, SONY will be in very bad position. Imagine next year MS come out with Xbox 4, a supper game machine that can play Xbox360, Xbox2 games (via virtualisation or something like that), has more processing power than PS3.

  17. Robert Aren’t the same people who do the Xbox 360 also doing the Zune?

    And don’t these same people have some kind of long term goal for the Zune as well, or will it some how be tied in with the Xbox eventually.

  18. Robert Aren’t the same people who do the Xbox 360 also doing the Zune?

    And don’t these same people have some kind of long term goal for the Zune as well, or will it some how be tied in with the Xbox eventually.

  19. “They told me how console business works and why you need a console on the market for four years to make money.”

    Stop posting this. They lied to you. That is pure BS for a plethora of reasons. One very good one is that Microsoft’s gaming division is still not profitable. Having a profitable quarter or two compared with billions of dollars dumped into it does not equal making money.

    But more importantly, Nintendo makes money on every system they have ever sold. The same goes for other console manufacturers who are no longer in the game. There is ample evidence that you don’t need to lose money for four years.

    Oh and disclaimer: Microsoft’s PR just gave me 12 months of Xbox Gold Live free and it has clearly made me biased towards them ;)

  20. “They told me how console business works and why you need a console on the market for four years to make money.”

    Stop posting this. They lied to you. That is pure BS for a plethora of reasons. One very good one is that Microsoft’s gaming division is still not profitable. Having a profitable quarter or two compared with billions of dollars dumped into it does not equal making money.

    But more importantly, Nintendo makes money on every system they have ever sold. The same goes for other console manufacturers who are no longer in the game. There is ample evidence that you don’t need to lose money for four years.

    Oh and disclaimer: Microsoft’s PR just gave me 12 months of Xbox Gold Live free and it has clearly made me biased towards them ;)

  21. Richard: the graph above explains EXACTLY why they aren’t profitable yet, and won’t be for two more years at least.

    Nintendo uses years’ old technology which isn’t as expensive.

  22. Richard: the graph above explains EXACTLY why they aren’t profitable yet, and won’t be for two more years at least.

    Nintendo uses years’ old technology which isn’t as expensive.

  23. “But more importantly, Nintendo makes money on every system they have ever sold. The same goes for other console manufacturers who are no longer in the game. There is ample evidence that you don’t need to lose money for four years.”

    Having a profitable console obviously didn’t do them much good if they are no longer in the game. And just because MS lost a few billion on the xbox hardware doesn’t mean the entire division has lost money.

  24. “But more importantly, Nintendo makes money on every system they have ever sold. The same goes for other console manufacturers who are no longer in the game. There is ample evidence that you don’t need to lose money for four years.”

    Having a profitable console obviously didn’t do them much good if they are no longer in the game. And just because MS lost a few billion on the xbox hardware doesn’t mean the entire division has lost money.

  25. Robert: what graph? But I wasn’t asking why they aren’t making profit to begin with. I know exactly how Microsoft handles Xbox and its financial plans. Covering it is what I do. I was pointing out that their four year plan did not come true for them.

    And if you look at the numbers, it would be absolutely impossible for Microsoft’s gaming division to ever be profitable were that really the plan. The Xbox was introduced four years before the Xbox 360. That means the Xbox should become profitable right when its successor is released. Trouble is because a new console is now on the market, the original gets marked way down and nobody makes games for it any more. If the past year was supposed to be profit, Microsoft has failed. Just look at the Xbox sales numbers. PS2 is a six year old system and it is slaughtering.

    Additionally, even if the Xbox was highly profitable at this point, it doesn’t change that a ton of money was spent on the Xbox 360. And do we need to wait another four years for the 360 to be profitable? At that point, will it cover the billions dumped into the gaming division? And most importantly, will there be an Xbox successor to replace it at that time? If so, that means unless Microsoft changes the way they plan on making money on the Xbox brand, they will never make money with their gaming division, certainly not in the way that Sony and Nintendo do.

  26. Robert: what graph? But I wasn’t asking why they aren’t making profit to begin with. I know exactly how Microsoft handles Xbox and its financial plans. Covering it is what I do. I was pointing out that their four year plan did not come true for them.

    And if you look at the numbers, it would be absolutely impossible for Microsoft’s gaming division to ever be profitable were that really the plan. The Xbox was introduced four years before the Xbox 360. That means the Xbox should become profitable right when its successor is released. Trouble is because a new console is now on the market, the original gets marked way down and nobody makes games for it any more. If the past year was supposed to be profit, Microsoft has failed. Just look at the Xbox sales numbers. PS2 is a six year old system and it is slaughtering.

    Additionally, even if the Xbox was highly profitable at this point, it doesn’t change that a ton of money was spent on the Xbox 360. And do we need to wait another four years for the 360 to be profitable? At that point, will it cover the billions dumped into the gaming division? And most importantly, will there be an Xbox successor to replace it at that time? If so, that means unless Microsoft changes the way they plan on making money on the Xbox brand, they will never make money with their gaming division, certainly not in the way that Sony and Nintendo do.

  27. [...] I’ve noticed for quite some time that Microsoft lost its innovation edge in the consumer space. I’ve even posted about its catch-up mentality back in 2005. Microsoft’s thinking, be it intentional or not, that they can buy their way into markets dominated by other leaders is flawed. Yes it worked in the past, and yes the Xbox 360 stands a solid chance of seriously challenging the Playstation, but overall, Microsoft’s efforts to penetrate search and music software/hardware have been weak. They’re way too much “me too,” and not enough edge. [...]

  28. The problem stems that those “market analysts” have no clue how Electronics works.

    Anyone thinking that Sony loses $300 on a PS3 doesn’t know anything about manufacturing.

    Sony plans to ship 6 million units by end of FY. Even if they only do 3 million units.. That’s close to $1billion. Do you really think anyone is going to do that???

    Those analysts probably calculate the prices by “buying” *one* chip at retail of each kind… Whereas Sony manufactures a lot of the chips themselves, and when they don’t, they will get massive discounts for ordering several million parts.

    That’s how business works.

  29. The problem stems that those “market analysts” have no clue how Electronics works.

    Anyone thinking that Sony loses $300 on a PS3 doesn’t know anything about manufacturing.

    Sony plans to ship 6 million units by end of FY. Even if they only do 3 million units.. That’s close to $1billion. Do you really think anyone is going to do that???

    Those analysts probably calculate the prices by “buying” *one* chip at retail of each kind… Whereas Sony manufactures a lot of the chips themselves, and when they don’t, they will get massive discounts for ordering several million parts.

    That’s how business works.

  30. @17 What the hell difference does it make that they are in different buildings? Organizationally, they are in the same division.

  31. @17 What the hell difference does it make that they are in different buildings? Organizationally, they are in the same division.

  32. Comparing Nintendo to the other two is ridiculous because Nintendo isn’t playing the same game.

    Sony and Microsoft are primarily going after two groups, all in the 16 and over age category:

    1) People who will buy damned near anything if it says HD on it, aka “Money, but no damned sense”. Robert is the poster boy for this group.

    2) Hard core gamers who only care about stats and technical details, and want games that play like every other game. Read: insanely complicated button combos, and you sit motionless like a cow with a fresh cud, for hours.

    Nintendo doesn’t care that they don’t have uber-advanced tech. They have solid tech. They also are the only one of the three that has stuff out in consistent numbers for the under 16 crowd and families. They’re going after people who want the physical act of playing the game to be fun, and not a combo memorization drill. Finally, if they can even halfway deliver on the promise of the retro game delivery, they will *own* the 30 and up market, which is pretty damned large and largeLY ignored by Sony and Microsoft.

    Let Sony and Microsoft beat each other bloody for the gamerz and the OMGHD crowd. Nintendo’s target audience is *far* larger, and heretofore ignored, and they’re going to be the only fish in a huge pond.

    Oh yeah, and they’ll have a great *little* game system that isn’t stupidly overpriced, and profitable from day one. All in all, I’d say Bill wishes he was in Nintendo’s shoes, or he would if his ego ever deflates.

  33. Comparing Nintendo to the other two is ridiculous because Nintendo isn’t playing the same game.

    Sony and Microsoft are primarily going after two groups, all in the 16 and over age category:

    1) People who will buy damned near anything if it says HD on it, aka “Money, but no damned sense”. Robert is the poster boy for this group.

    2) Hard core gamers who only care about stats and technical details, and want games that play like every other game. Read: insanely complicated button combos, and you sit motionless like a cow with a fresh cud, for hours.

    Nintendo doesn’t care that they don’t have uber-advanced tech. They have solid tech. They also are the only one of the three that has stuff out in consistent numbers for the under 16 crowd and families. They’re going after people who want the physical act of playing the game to be fun, and not a combo memorization drill. Finally, if they can even halfway deliver on the promise of the retro game delivery, they will *own* the 30 and up market, which is pretty damned large and largeLY ignored by Sony and Microsoft.

    Let Sony and Microsoft beat each other bloody for the gamerz and the OMGHD crowd. Nintendo’s target audience is *far* larger, and heretofore ignored, and they’re going to be the only fish in a huge pond.

    Oh yeah, and they’ll have a great *little* game system that isn’t stupidly overpriced, and profitable from day one. All in all, I’d say Bill wishes he was in Nintendo’s shoes, or he would if his ego ever deflates.

  34. Darcy, dear, the XBox division is not profitable, period — wishful thinking on your part notwithstanding.

    I think the impact of the Wii on holiday sells is probably being underestimated, We’ll see.

    The other thing I am wondering about is the mistaken notion of compatibility between the XBox and the Zune. There was an entry on a Forbes blog critical of the Zune, as most press has been. It was linked to at an XBox site and the enthusiasts descended. Not only could virtually none of them pass a junior high school level grammar and spelling test, they were under the impression that Zune and XBox video content are interchangeable. They also had bought into the ridiculous myth that Microsoft will allow Zune buyers to have any music files they purchased at the iTunes Store free. The blogger had linked to Pogue and Mossberg, but the XBoxers had never heard of them and I doubt they actually visited those sites. I’m wondering what the effect of learning learning they are wrong about so much will be on these people. Backlash against Microsoft?

  35. Darcy, dear, the XBox division is not profitable, period — wishful thinking on your part notwithstanding.

    I think the impact of the Wii on holiday sells is probably being underestimated, We’ll see.

    The other thing I am wondering about is the mistaken notion of compatibility between the XBox and the Zune. There was an entry on a Forbes blog critical of the Zune, as most press has been. It was linked to at an XBox site and the enthusiasts descended. Not only could virtually none of them pass a junior high school level grammar and spelling test, they were under the impression that Zune and XBox video content are interchangeable. They also had bought into the ridiculous myth that Microsoft will allow Zune buyers to have any music files they purchased at the iTunes Store free. The blogger had linked to Pogue and Mossberg, but the XBoxers had never heard of them and I doubt they actually visited those sites. I’m wondering what the effect of learning learning they are wrong about so much will be on these people. Backlash against Microsoft?

  36. I think that I don’t care, I dont’ have a 360, and I don’t have a PS3, I won’t get either of them because I guess i’m not that hard-core-of-a-gamer, however, the Nintendo WII looks cute & has an Innovative way to intruce gaming. Wokring int he Technical Industry, I think personally, that its not about how many processors a gaming console should have, its about how YOU feel about the technolgy your using.
    Let Sony Loose Money, Let Microsoft Loose Money, Let Nintendo loose money, Fact is, that won’t stop the evolution of technology. Think about it, in 5 more years, we’ll be going though it all over again, with the XBox 620, Playstation 4, and Nintendo Zeta ..

    So Does It Really Matter?

  37. I think that I don’t care, I dont’ have a 360, and I don’t have a PS3, I won’t get either of them because I guess i’m not that hard-core-of-a-gamer, however, the Nintendo WII looks cute & has an Innovative way to intruce gaming. Wokring int he Technical Industry, I think personally, that its not about how many processors a gaming console should have, its about how YOU feel about the technolgy your using.
    Let Sony Loose Money, Let Microsoft Loose Money, Let Nintendo loose money, Fact is, that won’t stop the evolution of technology. Think about it, in 5 more years, we’ll be going though it all over again, with the XBox 620, Playstation 4, and Nintendo Zeta ..

    So Does It Really Matter?

  38. Well, I’d enroll all Xbox team members in a lunchtime Economics 101 class. It’s not just getting each machine unit into the ‘black’, it’s about the overall market footprint and the R&D cost factors that went into it, not to mention the overall lifecycle of the product. What if after 4 years, volume demand is well lower? Get “black” per unit, but go “red” as lower demand. There are so many other factors, that a “4 Year Plan” strikes me as sooooo prototypical Microsoftian Soviet econ. They say they are a free-market company whenever sued, but their own forecasting and factoring is so “Planned”, that it’d make Milton weep. They will never ever be profitable on a macro level, for the billions spent already need a generation or a Halo 2 hit a week for 5 years…to catch up. (Agree with Richard).

    On the flipside, “lost calculations” are always invariably flawed, as only Sony knows the per unit costs, as they make some of their own components and get huge discounts for large orders, factors that the external analysts never can see. Perhaps a tad less hazy with Microsoft being that they aren’t already in the Electronics biz like Sony, and have to go more “retail”, but even there, only Microsoft knows the true numbers.

  39. Well, I’d enroll all Xbox team members in a lunchtime Economics 101 class. It’s not just getting each machine unit into the ‘black’, it’s about the overall market footprint and the R&D cost factors that went into it, not to mention the overall lifecycle of the product. What if after 4 years, volume demand is well lower? Get “black” per unit, but go “red” as lower demand. There are so many other factors, that a “4 Year Plan” strikes me as sooooo prototypical Microsoftian Soviet econ. They say they are a free-market company whenever sued, but their own forecasting and factoring is so “Planned”, that it’d make Milton weep. They will never ever be profitable on a macro level, for the billions spent already need a generation or a Halo 2 hit a week for 5 years…to catch up. (Agree with Richard).

    On the flipside, “lost calculations” are always invariably flawed, as only Sony knows the per unit costs, as they make some of their own components and get huge discounts for large orders, factors that the external analysts never can see. Perhaps a tad less hazy with Microsoft being that they aren’t already in the Electronics biz like Sony, and have to go more “retail”, but even there, only Microsoft knows the true numbers.

  40. So much for the xbox360. My son traded his in on a wii and other goodies. LOL so much for the latest and greatest. lol Gotta watch those kids. Market leaders of the future. NG soooooooooo Long. 1 month play time.

    What do you think?

  41. So much for the xbox360. My son traded his in on a wii and other goodies. LOL so much for the latest and greatest. lol Gotta watch those kids. Market leaders of the future. NG soooooooooo Long. 1 month play time.

    What do you think?