The Microsoft Xbox team was faced with the issue of which strategic choices would give it the best edge against the upcoming Sony PlayStation 2. Initially called "Project Midway" within Microsoft, the console project has the objective of countering the possible threat posed by the expansion of the original PlayStation into a broad entertainment platform with the birth of PlayStation 2. Seamus Blackley, chief instigator for the Xbox within Microsoft, and his colleagues had an appointment with Michael Dell, CEO of Dell Computer with the purpose of convincing Dell to manufacture Xbox videogame consoles running Microsoft software. It is the intention of the team to produce a machine somewhere between a standalone videogame console and a PC tailored to play video games. However, it is still unclear where along the spectrum from a dedicated console to PC Microsoft should position the Xbox.
Harvard Business School (707501-PDF-ENG)
Nov 30, 2006 (Revision: Feb 6, 2007)
Case questions answered:
Case study questions answered in the first solution:
- How does Microsoft go beyond the Microsoft Xbox to drive strategic growth? Please consider the following elements in your case analysis: Strategic Challenge, Industry Analysis, Rivalry, Threat of Substitutes, Threat of New Entrants, Bargaining Power of Buyers, Bargaining Power of Suppliers, Overall Industry Analysis, Firm Analysis, Competitive Advantage.
Case study questions answered in the second solution:
- Evaluate NEC’s and Sega’s strategies for challenging Nintendo in video games.
- Evaluate Nintendo’s decision to delay introducing a 16-bit video game system. Was this a good decision? Use quantitative analysis to the extent possible.
- How attractive is the videogame console industry in 1999? How do game publishers increase the size of PIE in the industry?
- Should MS allow any developer to publish games? Should it charge royalties to developers? Who should produce the Xbox machines? How should the machines be priced?
- Imagine you are Michael Dell in September 1999: do you take the Xbox deal?
- Imagine you are the CEO of Electronic Arts in 1999 (a major producer of games). Do you hope Microsoft succeeds in this market? Why? Is there anything you can do to make sure it does (or doesn’t) succeed?
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Case answers for Microsoft Xbox: Changing the Game?
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Introduction – Microsoft Xbox: Changing the Game?
With the advent of high-tech portable and mobile devices, portable gaming is now a viable threat to the traditional video game console industry. Despite portable devices’ technological inferiority, consumers are spending a greater percentage of their disposable income on portable games and gaming systems.
Portable gaming, working as a disruptive technology, is forcing Microsoft and the traditional game console industry to compete with low-priced games on portable devices.
Declining Demand for Video Games
Demand for portable gaming has grown exponentially over the past few years. Revenues from portable games were only half a billion in 2008, $5 billion in 2010, and are expected to be $16 billion in 2016. The overall mobile application market nearly doubled in 2009 and continues to exhibit high growth rates (Flurry).
Moreover, revenues from the video gaming industry have been decreasing since it hit its peak in 2008, down by 17% in 2011 (Exhibit 1). When considering overall market share, traditional video games are losing ground to portable games (Exhibit 2).
Flurry Analytics measured that iOS’s and Android’s revenue share of the game software category grew to 8% in 2010, from just 1% in 2008 (Exhibit 3).
Drivers of Growth in Portable Gaming
Portable gaming has sustained its growth and has successfully maintained a competitive advantage against video games due to the technological advancement in portable devices, more portable gaming options for casual gamers, lower development cost, lower time to market, and the implementation of various pricing strategies.
Advancement of Portable Devices
While portable devices are technologically inferior to consoles and video games, manufacturers are continuing to improve their graphics and CPU power. These devices are now becoming a platform for independent programmers and companies to develop games for all types of consumers.
While most of the game offerings for mobile devices are currently sub-par to the offerings available for the console industry, improvements in specifications for portable devices are creating an opportunity for simple and more advanced games. Games which traditionally could only be played on video game consoles, such as Electronic Art’s Mass Effect, can now be played on portable devices.
Convenient Options for Casual Gamers
The growth of portable gaming has been meteoric in the past few years due partially to more options for gamers on their portable devices. Portable gaming is a convenient alternative to video games for consumers who are interested in playing “casual” games on devices they already own without the need for additional equipment.
While game selection for portable devices was limited in the past, the boom in these devices has catalyzed developers and communities to create more gaming options. Consumers now have more options to purchase and play games on multiple platforms, such as Android, iOS, and Facebook.
Development Cost and Time to Market
Video games played on the current generation of consoles require an average budget of $15 to $20 million and have average development times of 1.5 years. The average game played on portable devices costs $6,500 and only half a year to develop (Meloni). The lower investment in both time and funds attracts many developers to the portable gaming market and creates a cost advantage over video games (Meloni).
Portable games are also priced using a plethora of strategies to target a variety of consumers. Portable games can gain revenues by charging a one-time fee, which can range from $0.99 to $50.00 per application. Games can also be free for the user, and the developer earns profits through in-game purchases and advertising revenues.
Developers also have the choice of offering a limited version of the game for free and then charging for the full version game (Meloni). The ability to use different pricing strategies allows developers to target customers who are not willing to spend large one-time purchases on games and then use a variety of gimmicks to earn revenues.
Focal Firm: Microsoft
Microsoft’s current video game console, the Xbox 360, has sold over 67 million units since its release in 2005. Despite rampant success worldwide, Microsoft has no device designed to challenge competitors in the portable gaming industry.
Therefore, it will face difficulties in the near future, as the gaming market share shifts from traditional video game consoles to handheld gaming devices, phones, and tablets. Microsoft must act quickly to develop a sustainable plan to compete against the growing portable gaming devices market.
The following industry analysis uses Porter’s Five Forces framework to identify which industry components capture value and the overall attractiveness of the industry.
Three main players concentrate on profits in the US video game console industry: Nintendo, Sony, and Microsoft. Withing a console generation, users incur high switching costs when moving from one company’s console to a different console. Therefore, it is important to lock the customer in initially and make them loyal to the brand. As competition among these rivals increases, there is increased pressure for the firms to drive their product prices down and decrease margins.
The entire video game console industry is now threatened by the advent of portable gaming devices. Nintendo and Sony both have portable gaming devices, such as the 3DS and PS Vita, respectively, while Microsoft has no such device. Microsoft, therefore, has lost its chance to become a first-mover in the current generation of handheld devices. As more users switch to portable games, Microsoft will be faced with a declining market share.
Threat of Substitutes: High
Video game consoles must compete with the growing market of online and handheld gaming devices. According to a study conducted at Duke University, the market share of gaming consoles is expected to decline to 45% by 2013, while the use of mobile games is expected to double to almost 20% (Exhibit 7).
From 2009 to 2010, game console sales dropped 13% to $6.3 billion, indicating the negative effects these substitutes are beginning to have on game console incumbents’ revenue. As the number of mobile devices increases throughout the market, more casual gamers are turning away from their stationary home consoles and playing more mobile games (“WRAL Tech Wire”).
Unfortunately, there are also innumerable substitutes outside of the video gaming industry that compete with console producers for the consumer’s leisure time.
Threat of New Entrants: Medium
Designing and manufacturing a new console requires not only economies of scale but also expensive physical and human capital. These high investments deter firms from entering the game console market because it can take years to develop the necessary gaming technology.
Despite these relatively high barriers to entry, companies that already have an existing technology design infrastructure could feasibly develop innovative console offerings.
Bargaining Power of Buyers: Low to Medium
Fortunately for game console producers, the consumers do not have much choice when switching to a different home entertainment console (only three main players – Sony, Nintendo, and Microsoft).
However, with an increasing number of users playing games on portable devices, price-sensitive buyers may choose to play cheaper games on handheld devices instead of purchasing an expensive console.
Additionally, consumers typically only buy one console per generation and therefore lack strong buying power associated with purchasing in bulk.
Bargaining Power of Suppliers: High
Nintendo, Sony, and Microsoft all outsource their console manufacturing to third-party vendors, such as Foxconn and ASUSTeK (Mann). As such, the suppliers garner significant power because they control the day-to-day production of the consoles. Since quality is a very important factor, Microsoft, Sony, and Nintendo must ensure that they choose an appropriate, responsible supplier. Additionally, there is the threat of forward integration by these manufacturers since they have the production capability.
Overall Industry Analysis
The game console industry is good for incumbents because there is profit potential. New entrants, however, will face struggles when trying to capture value within this industry, especially within the first 10 years of entering, due to high capital investments in the beginning.
Therefore, the industry is moderately attractive for existing firms but relatively unattractive to new entrants. With the growing threat of portable gaming as a disruptive technology, incumbent firms now face competition from mobile phone developers as well.
In terms of technical specifications, there is little to differentiate the Microsoft Xbox 360…