May 15, 2002 4:00 AM PDT

Microsoft trims Xbox price

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Microsoft fired the second shot in the video game industry's growing price war, dropping its Xbox system from $299 to $199 in the United States, effective Wednesday.

The cut follows by one day rival Sony's decision to make an identical cut in the North American price of its PlayStation 2.

The move leaves all the major game consoles--PS2, Xbox and Nintendo's GameCube--at $199. Nintendo said Tuesday it has no plans to lower the GameCube's price.

Microsoft said it would also make a similar cut in the Xbox price for Japan, where the console has met with a tepid reception. The machine will sell for about $193 (24,800 yen), down from the current $270.

IDC analyst Schelley Olhava said the cuts should have the desired effect of expanding video gaming to a more mainstream audience. The challenge for Microsoft will be coming up with software that will appeal to that type of audience. To date, the sole breakthrough hit for the Xbox has been "Halo," a violent shooting game unlikely to have universal family appeal.

"Microsoft has really focused on the hardcore gamer," Olhava said. "They just need to have more games. One of the things that will really motivate people to go for (Sony's) PS2 is there's such a big selection of games."

John O'Rourke, director of games marketing for Microsoft, said the price cut had been in the planning stages for several weeks and denied it was a reaction to Sony's move, although he acknowledged Microsoft originally planned to announce the cut next Monday, before the Electronic Entertainment Expo trade show begins in Los Angeles.


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"This price reduction is something we've been planning for a long time," O'Rourke said. "It's really part of our long-term strategy to broaden the audience for Xbox and get it in the hands of anybody who's interested in gaming."

Financially, Microsoft has the most to lose from price cuts. The PlayStation 2 has been on the market for almost two years and has sold more than 30 million units worldwide, giving Sony plenty of time to rein in production costs. Sony executives said late last year that they had reached the break-even point on PS2 hardware.

Xbox, on the other hand, has been available for less than six months and has been fairly expensive to manufacture from the start, owing to components such as a built-in hard drive.

Microsoft will help pay for the price cut by shifting assembly of the Xbox to China. The company announced it would shut down the Xbox assembly plant in Hungary, run by contract manufacturer Flextronics, late this year and move production to a Flextronics plant in Doumen, China. Microsoft said it would also open a second manufacturing plant in Asia, run by a company other than Flextronics, in the near future. Xbox supplies for North America will still come from the Flextronics plant in Guadalajara, Mexico.

Todd Holmdahl, general manager of Xbox Hardware for Microsoft, said the new plants would allow Microsoft to save manufacuting costs through lower overhead and reduced shipping costs from parts suppliers.

But Richard Doherty, president of research firm The Envisioneering Group, said the main advantage is that China has the cheapest labor costs in the world. "I think it's going to save them some tens of dollars per box, but there's not much room underneath that," Doherty said. "There's not that much pad left in labor--the rest of the cost is parts."

Doherty estimated that without the production switch, the price cuts would have Microsoft selling each Xbox for almost $200 less than it costs to manufacturer.

Doherty said the search for another manufacturing partner was also a cost-cutting move, rather than an indication of dissatisfaction with Flextronics. "You always like to have at least two bids in there...just as Microsoft does in high-volume disk replication for software."

O'Rourke said that part of the reason Microsoft can afford to lower the cost of the hardware is that games for the Xbox have been selling so well, with an average of 4.1 titles sold for each game console.

"The profit is really driven by the games in this business," O'Rourke said. "In selling the system, what you're doing is installing the sockets into which you can sell more games."

 

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