A couple of weeks ago Harry McCracken and I were sharing some analysis on Microsoft’s financial performance which showcased http://www.businessinsider.com (you’ll note that out of around $8.5B of operating income Windows accounts for over $5.5B) that the Microsoft was largely living off of Office, Windows, and their enterprise businesses. Their entertainment business appeared to be more of a drag on the company than a benefit and I suggested they should have likely never entered the gaming market.

John Obeto over at Absolutely Windows clearly disagreed and thought we should debate this. He was first to post and you can read what he wrote here: http://absolutelywindows.com

John’s Argument

John breaks down his argument into several parts. First he argues that to expand Microsoft had to find new venues to expand and was restricted by anti-trust limitations as to what those venues would be. Second he argues that it needed to be a consumer product because they have more visibility and Apple has showcased they can be more profitable than the other likely choices. Third he argues that game consoles are the best choice because Microsoft has had trouble in set top box solutions that simply focus on content access. Fourth he argues that the Xbox and Xbox 360 were a great idea just badly executed. Fifth he argued that because Microsoft gets the same for Windows whether it is gaming or for email there is little point in putting a lot of resources into PC gaming and console gaming should be more lucrative.

He concludes by conceding that Microsoft should have supported PC gaming better but that the Xbox caused Sony to collapse and Sony was becoming a real threat. The close is assumed that therefore Microsoft had no choice but to enter the space and should remain in it.

Rebuttal

Since I started with the financials I’ll stick with them. Windows accounts for about 2/3rdsrd of Microsoft’s operating profit the contribution from Xbox is not material and has historically been negative, at times significantly so. Xbox consumes significant corporate resources and those same resources do not seem to be matched on the Windows side. Gaming pushes performance, performance pushes PC refresh, and PC refresh sells Windows. If they were to increase the contribution from Xbox by 100% the result would still fall largely in the margins of the Microsoft major platforms, if they were to increase Windows by 10% it would increase Microsoft’s bottom line by around 6% and likely blow out the quarter.

I concede that Sony was a risk but they didn’t fail because of Xbox they failed because they slammed Blu-Ray into their system which caused them to not only lose hundreds of dollars initially on every system sold (BOM cost was estimated at around $1,000 while price was in the mid $600 initially) but the price was higher than most wanted to pay. Wii came in both profitable and less than half the price which pretty much put them under. The motivation behind the disastrous Blu-Ray decision wasn’t Microsoft’s Xbox but the desire to beat HD-DVD which they did at an extreme cost.

If Microsoft had a PC platform that had the Xbox capabilities they likely could license it to OEMs who would position it against game consoles without Microsoft incurring the hardware risk or cost. Dell has indicated they would be interested in such an endeavor.

In short it is generally more lucrative and easier to enhance a business and model you do know rather than one you don’t and the financial results seem to prove this out for while Microsoft is one of the leaders in the console gaming space that leadership has not translated as well into profit as the same effort on Windows might have. Granted Vista would have been a problem regardless.

By going into a hardware business they put the PC OEMs on guard, effectively reduced the emphasis on PC churn and this contributed to interest by these OEMs in Linux, Android and the ChromeOS. The economic cost of the Xbox may never be fully known but it appears to be significant.

Conclusion:

Vendors should never go into competition with their partners and the Xbox in the end is like a simplified PC. While it is well done the economic cost in terms of Windows focus and OEM dissatisfaction is more significant therefore it appears that Microsoft would likely be better off, defined by more profitable and with a higher market valuation, had they not entered the console market and instead focused this same effort on Windows gaming.