Microsoft Xbox Case Study

This mini-case was prepared by John Greco (T'02--MBA Fellow, Center for Digital Strategies) of the Tuck

School of Business at Dartmouth under the supervision of Visiting Assistant Professor Melissa M. Appleyard. It

was written as a basis for class discussion and not to illustrate effective or ineffective management practices. The

authors gratefully acknowledge the support of the Glassmeyer/McNamee Center for Digital Strategies, which

funded the development of this case. CDS Case #02013. Version: March, 2002.

© 2001 Trustees of Dartmouth College. All rights reserved. For permission to reprint, contact the Center for

Digital Strategies at 603-646-0899.

Case #6-0011

Microsoft's Xbox Gamble

The meeting between Microsoft and Capcom, a Japanese video game publisher, was

going poorly. One of the Japanese game developers at the table in Capcom's Tokyo

headquarters said, "We know the philosophy of Nintendo. Game is toy. We know the

philosophy of Sony. Game is entertainment. What is Microsoft's philosophy?" Kevin

Bachus, who was then director of third-party relations for Microsoft's Xbox console,

replied, "Game is art."

--Red Herring "The Game of War" 1

In the fall of 2001, Microsoft found itself in the unusual position of being a late entrant in an

unfamiliar market as it prepared to release its Xbox console. Microsoft's Xbox would

compete head to head with the latest generation offerings from Nintendo and Sony.

Questions abounded as the new console faced an uncertain economy and strong competition.

Would the market accept the new platform that offered higher performance but at a higher

price than the competition? Could Xbox attract enough well-known game titles to make

consumers choose it over the competition? Could the market support three players? How

would the gaming market evolve over time, and would it accommodate a broader strategy

that extended beyond video games? As Microsoft prepared to launch the box, the company

anticipated absorbing $2 billion in losses before attaining profitability.2 The market waited

eagerly to see the results of the battle that promised to shake up the video game industry and

possibly markets beyond.

Genesis of the Gaming Industry

Video games sprang from the imaginations of scientists in research labs in the late 1940s and

did not reach the mainstream until arcade games became popular in the early 1970s. After

1 Red Herring; The Game of War, Dean Takahashi, October 15, 2001

2 The Economist; Extending Its Tentacles, London, October 20, 2001; Vol 361 Issue 8244

Xbox

Tuck School of Business at Dartmouth--Glassmeyer/McNamee Center for Digital Strategies 2

no. 6-0011

being rebuffed by larger arcade providers, a new start-up named Atari marketed its first

video game, a simple table tennis game known as Pong, to restaurants and bars. By 1972

people wanted to play these games at home and Magnavox began selling the Odyssey, a

system that included several hardwired games and had no provisions for expandability.

Although cumbersome to use, as it required screen overlays to play the game, nonetheless

Magnavox sold 100,000 units in Odyssey's first year on the market.

A number of firms, including Atari, Bally, Coleco, and Fairchild Camera & Instrument

quickly rushed to compete with Magnavox by offering their own games that attached to the

television set. This early stage of the TV-based video game industry, with single-game

product offerings that were at best clumsy consoles with rudimentary two-dimensional

effects, was characterized by a fragmented industry structure.

In 1977, however, Atari again unleashed a new era in the industry. Atari introduced the first

programmable home video game, the Video Computer System--later known as the Atari

2600. (See Exhibit 1 for a complete timeline of the industry.) The concept of

programmability meant that the home video market could capitalize on the growing craze in

arcade games by packaging them for home use. Users purchased cartridges with the game

program burned into memory and inserted them into a slot on the console. The console was

no longer constrained to playing only the games provided at the time of console purchase. It

could adapt to gamers' tastes and play the home versions of the latest arcade games.

Atari Gains Market Power

Once programmability became the established model, the home video game market took

flight and the field of competitors narrowed considerably. By 1981 Atari held 67% of the

4.55 million unit video game market reaching $3 billion in annual sales.3 Atari owed much

of its success to its knack for licensing popular arcade titles such as "Space Invaders" and

porting them to the 2600 unit. As evidence of the popularity of "Space Invaders" in the