Digging profits out of Xbox

Microsoft is looking to squeeze a profit out of the gaming market with a new royalty program tied to the release of its next Xbox console.

Only accessory makers that get Microsoft's blessing--by forking over a slice of their sales to the software maker--will be able to produce Xbox 360 gamepads, steering wheels, joysticks, and other controllers.

In addition, to ensure that only authorized products connect to the new console, Microsoft is adding a security mechanism that will be available exclusively to those who sign a deal with the company. The Xbox 360 console, announced in May, is slated to go on sale this holiday season.

The new royalty program could be part of Microsoft's goal of turning a profit with the Xbox 360, something the company was not able to do with the prior generation console, said IDC analyst Schelley Olhava.

"Microsoft has made it very clear that it's all about profitability" with this generation of console, Olhava said. "Maybe this is a way they are looking to make additional revenue off of the Xbox [360]." But, she said, the move could also be intended as "a way to ensure quality products make it out the door," reasoning that makers willing to pony up a share of the proceeds would be the kind of companies that make more-reliable gear.

Microsoft declined to comment on the royalty structure for the program or outline how it compares with the logo-only program for the original Xbox. "We want to make sure the customers are getting the best experience possible," a company representative told CNET News.com.

According to a contract between Microsoft and Mad Catz Interactive, the software giant will get a share of the wholesale revenue generated by the accessory maker's Xbox 360 add-ons. An edited version of the contract was filed by Mad Catz as part of the company's annual report to the Securities and Exchange Commission. The edited document does not state the percentage cut that Microsoft will get from the accessory sales.

The decision to seek royalties from console controllers is not unlike a move Apple Computer made earlier this year in which it sought to get as much as a 10 percent cut from iPod accessory makers that wanted to display Apple's "Made for iPod" logo. The move was referred to by some analysts as tantamount to a "tax" on the iPod economy.

The Mad Catz agreement, which refers to the Xbox 360 console by its Xenon code name, also hints at the type of security that Microsoft may use to ensure that third parties work with it to produce Xbox 360 add-ons.

"'Security Feature' means Microsoft's proprietary protocol used to validate authentic devices on the Xenon platform as implemented in a Xenon Chip or other implementation method designated by Microsoft in writing," according to the Mad Catz agreement.

Programs that seek royalties from accessory makers are not unprecedented. Indeed, game console makers make most of their money off of similar royalties charged on sales of the game software that runs on their machines. Nintendo pioneered the "Seal of Quality" years ago as a way to nail down game-related revenue. But the moves from Apple and Microsoft appear aimed at expanding the concept.

At the same time, the software maker's move carries some risk, Olhava said, noting that some of the appeal for third parties is the ability to offer controllers cheaper than the official Microsoft-branded accessories.

"There could be less opportunities for third-party peripheral makers, just because the market opportunities may not be there, because they cannot bring out products that are priced low enough," Olhava said.

It's unclear whether Microsoft's licensing plans will affect the market for third-party devices. The Microsoft representative would not say how the company expects the more stringent requirements to impact the market for third-party accessories.

Companies that have made accessories in the past have not outlined any plans for the Xbox 360. A representative for Logitech declined to comment on the company's policies, but said, "We plan to have at least one product at launch."

A Radica Games representative declined to comment, while representatives for Thrustmaster and Mad Catz did not return calls seeking comment.

However, Mad Catz has said in regulatory filings that developing accessories for the new Xbox console is one of the company's "key initiatives" for the coming fiscal year.

The Mad Catz license agreement also puts limits on the type of controllers that third parties can make. Most notably, the add-on products can only be of the corded variety, while Microsoft itself is supporting wireless controllers.

In addition to the restrictions on wireless products, the Mad Catz contract excludes light guns, memory units, hard drives, and cheat cards. Licensed peripherals include gamepads, steering wheels, arcade sticks, flight sticks, and dance pads.

Microsoft declined to say if others might be licensed to produce such things or whether the company had separate deals for wireless add-ons.