Xbox 360 Q&A: Intel from the field

With so much already known about the next-gen Xbox, you'd think the conversation among industry analysts would naturally gravitate toward more unknowns--the PlayStation 3, Nintendo's Revolution, even the seldom seen but widely touted Phantom.

Analysts, however, are a wily bunch--skeptical, analytic (of course), and a bit on the hard-boiled side sometimes. If you think you know all the angles, pull up a chair with PJ McNealy or Michael Pachter for an earful of even more questions that remain unanswered.

Such is the case with the 360. What you see so far is definitely not what you get.

Earlier this week, American Technology's PJ McNealy put his thoughts down in a memo to investors, stating that "Microsoft is positioning its multi-tiered online services and capabilities with the next-generation box to be a crucial differentiator from Sony's next-generation console." He sees an early November launch date for the console and considers the possibility that Microsoft may discontinue the current Xbox model "later this calendar year."

In addition, McNealy sees the next-gen Xbox hitting the street at a price point in the $300-to-$400 range--a figure consistent with other analysts.

He is wagering on a single SKU for the box rather than a two-tiered SKU lineup based on HD capacity. On the topic of hardware allotment by region, and likely software library at launch, McNealy estimates that through December 31, 2005, Microsoft will "target" shipping 1.8 to 2.4 million HW units, "with North America getting the most, Europe second, and as few as 200k or 300k to Japan." He expects 15 to 25 titles during that early launch period.

On Wednesday, UBS analyst Mike Wallace sent his company's clients a 100-page "E3 Companion," a deeply written roundup of what to expect from the major publishers next week.

Reflecting on what Microsoft has accomplished in 2004, he gave the newbie hardware manufacturer high marks. "Microsoft’s Xbox had a good year in 2004, as hardware unit sales grew 28 percent year over year and software dollar sales increased 47 percent."

He called 2004 year-on-year growth in the area of installed base at 53 percent, to 11.9 million, crediting an early price cut, a holiday hardware bundle, and the launch of Halo 2 as key drivers.

As for other analysts and their view of both past performance and future prospects? We had to seek them out. David Cole, the senior analyst at DFC Intelligence, checked in from Austin TX; Wedbush Morgan senior analyst Michael Pachter checked in from Southern California; and Boris Markovich of TerraNova Institutional signed on from Manhattan.

GameSpot: Gentleman: From what you know about the next-gen Xbox, are you impressed?

David Cole: Yes, I think they got all the bases covered, and I think the system will be very customizable, which is a major trend in the game industry, being able to create and control your own experience.
Michael Pachter: Very. The box appears to be incredibly powerful, and I'd guess it will take years for software developers to fully exploit its potential.

GameSpot: Early reports say the PlayStation 3 will be up to three times more powerful than the Xbox 360. If that's the case, what do you think it will mean for the 360's chances when Sony releases its console next year?

Cole: The danger of releasing early is that the competition will leapfrog you technologically. That being said, the PS2 was the least powerful of the current gen. Really it all comes down to games. The new systems are so powerful that it is going to be hard for developers to max them out from a technology standpoint without breaking the bank.
Pachter: As I said about the next-gen Xbox, I don't expect developers to be able to exploit the full potential of these boxes for years. My guess is that the extra "power" will be adapted for other uses, like multimedia streaming or watching several television programs at once.

GameSpot: Does being first to launch give the 360 a significant advantage over the next-gen boxes from Sony and Nintendo?

Cole: I would say it evens the playing field as opposed to giving a significant advantage. This is a long-term battle over several years and you can easily see Sony launching a year after MS and catching up within a matter of months. The main thing is it gets developers/publishers on board releasing software so that by the time competing systems come out there is a more robust product lineup. This is how Sega competed with market leader Nintendo on the Genesis and Sony did it with PSOne. In both cases Nintendo caught up quick in terms of overall hardware, but they let the competition build big software libraries that ensured long-term sales.
Pachter: Obviously, Microsoft will have 100 percent market share until one of the others launches. Although I expect the next-gen Xbox to end up at around 35 percent market share overall, the head start should ensure that it gains share over last cycle. Sony and Nintendo will be playing catch-up for a few years.
Boris Markovich: We believe that being first to market is a significant advantage for Microsoft, just as it was in the last generation for Sony.

GameSpot: Is it an advantage Microsoft can maintain through the launch of the other systems?

Pachter: "Can" is a yes; "will", I don't know. I think that in order to sustain its first-mover advantage, Microsoft will have to get a lot of support from third-party publishers. I don't expect a lot of exclusive third-party content, and if I'm right, consumers may not perceive much of a difference once the other consoles are launched.
Markovich: During the life cycle of the next-generation consoles, we expect Microsoft to gain share from the current generation at the expense of Sony. We think that by the end of the next-gen cycle, the US market-share battle between Microsoft and Sony will be neck and neck.

GameSpot: The perfect price point for the 360 is what?

Cole: $300.
Pachter: Free would be nice, but I'll bet that the stripped-down version is $300 or more. I think that they could do well at $400. Higher could be a problem.
Markovich: We are expecting $299-$399 retail.

GameSpot: Backward compatibility: How important?

Cole: Backward compatibility is a neat early life-span feature that people soon forgot about. I think it is overrated because if you have a library of titles you presumably already have the game system and it is no problem to hook 2 systems up to the same TV.
Pachter: I think it's very important. Although most gamers probably wouldn't utilize the features, backward compatibility maintains the value of a consumers' Xbox software, and I think that many people who just bought Halo 2 would like to think that they didn't waste their money.
Markovich: Backwards compatibility is very important for the perception that the current installed base of Xbox software will continue to work for years. Microsoft needs to get both gamers and investors on their side, so perception is often more important than reality. Our discussions with gamers and publishers about real-world experience indicate that it certainly is not critical.

GameSpot: If you are Sony, how worried about the 360 are you?

Cole: The stakes for Sony are enormous. Sony has had dominant market share, but now they have to start from scratch. Trying to build that level of market share again will be very difficult even if everything goes just as planned. One advantage for Microsoft is that they don't depend on games for profits. Nintendo is 100 percent dependent on games for its profits, and Sony is becoming increasingly dependent. When you have competition willing to take a big loss, that is tough.
Pachter: I think that Sony has conceded first-mover advantage to Microsoft after a great deal of consideration. Sony has every intention of squeezing as much value out of the PS2 cycle as they can. In the "razor and razor blade" model, Sony makes its money on the software, or the "razor blades." They don't care if you buy the Sony "Trac 2" blade or the Sony "Mach 3" blade, as long as you buy a Sony blade. It appears to me that they are confident that when Microsoft launches its version of a three-blade razor, there will still be plenty of people buying the double-bladed cartridges from Sony. If the next-gen Xbox is not backward compatible, that could really help Sony.

GameSpot: Have you written Revolution off as meaningful competition, or is there a place for it on the same shelf as the PS3 and the 360?

Cole: Microsoft and Sony have written off Nintendo when talking publicly. Hopefully that is not the case in their private plannings. One interesting thing about Nintendo is that consumers that first bought the NES are just now starting to have a large number of kids that are reaching game-playing age. Will these new Nintendo parents have brand loyalty? Just one of many interesting possibilities.
Pachter: Not at all. It's tough to talk about the Revolution, because we just don't know much about it. Nintendo has promised to do something completely different than we've ever seen, and I would never count them out. Remember, these guys have a phenomenal software library, and they're the ones who invented handheld and the touch screen (with the DS). I wouldn't make the mistake of underestimating them. It's just that they have played it pretty close to the vest. I have to credit them for trying a different spin, and we'll see what happens. My guess is that they're going to make their box sufficiently different that it could drive dual-console ownership in a much larger percentage of households. That way, Sony could end up with 55 percent, Microsoft with 35 percent, and Nintendo with 35 percent penetration (these add up to 120 percent).
Markovich: Nintendo's amazing software library and development capabilities guarantee a certain minimum shelf space.

GameSpot: What are the three most significant marks Microsoft has to hit for the Xbox 360 to build on what it's earned with Xbox 1?

Cole: 1) Hit titles: Halo made the Xbox and another Halo would be nice. 2) Continue the online experience: Xbox Live was a winner. 3) Make software publishing economical for third parties so that they can maximize the system's capabilities and still make money.
Pachter: I can't see how they fail to build. They've done a great job with the third parties, they've exploited the online niche, and they're pretty far along with media capability. The only thing that they have had trouble with is exclusives, and Sony and Nintendo have such deep libraries of first-party content, it will be tough for Microsoft to keep pace.
Markovich: More proprietary titles like Halo (either in-house developed or exclusive deals with publishers).

GameSpot: What's your advice to Microsoft: discontinue the original Xbox with the 360 launch, discount to $99, or maintain pricing for the foreseeable future?

Cole: Sony had great success extending the life of the PSOne. Microsoft has a nice tool to market to consumers with Xbox Live. If they can get budget-conscious consumers to try the Xbox at $99, that could be a great way to get them into the brand and ready to step up to the next level.
Pachter: I'd suggest that they maintain pricing and look to redesign the box (as Sony did to its PS2) so that they are in a position to cut price. There are tons of people out there from middle-class backgrounds who don't have a box yet, and it would be smart to try to make the current-generation Xbox a "starter kit" for the next gen by winning more converts.
Markovich: We currently see that consumer demand for the current Xbox is still strong. We expect Microsoft to continue to support the current console for several years.

GameSpot: Your guess: Average selling price (ASP) on Xbox 1 software will drop precipitously on the 360's launch or stay as is?

Cole: ASPs always go down as a system ages.
Pachter: That depends completely on backward compatibility and maintaining production of the current Xbox. If neither of these occur, ASPs will drop a lot. If both occur, ASPs probably drop gradually over a couple of years.
Markovich: Post-Xbox 360, new Xbox titles will probably drop to $39.

GameSpot: Which publishers appear to you to be best positioned for the 360 launch?

Cole: EA always, Ubisoft has had some strong success with Xbox.
Pachter: No question that Electronic Arts will be there in a meaningful way. The others will all have at least one game, and many will have two. I don't think it makes much difference if they are there from the first day, as long as they're all ready with their full lineup of front-line games in year two.
Markovich: A number of the major publishers are gearing up for strong Xbox 360 launches. We expect to see these titles unveiled at E3.

GameSpot: Wireless controllers: stroke of genius or insignificant attribute?

Cole: Very cool feature. Once you go wireless you never want to go back.
Pachter: Stroke of genius (in 2000, I think!). I think that wireless controllers make these boxes feel newer than the old ones, and think that will ensure greater penetration for the next generation. People like my wife might put up with a couple of consoles in the living room if there are no wires laying around.

GameSpot: Gentlemen, thank you.