November 14, 2002 9:27 AM PST

Microsoft pushes Xbox online

Microsoft on Friday will raise its stakes in the gaming market with an elaborate new online service for its Xbox video game console.

The new service, which lets Xbox users play games over a high-speed network connection, is unlikely to have any immediate impact on Microsoft's position in the game market, analysts said. But it gives the company a strong entry into the niche, in comparison with competitors such as Sony and Nintendo, as the company builds its market share for the future.

"They're basically playing for the future with Xbox Live," said Schelley Olhava, an analyst for research firm IDC. "I don't think it's going to be one of those features that get people to run out and buy the Xbox...Microsoft sees it as an investment. They really feel that if they build out the infrastructure now, it's going to serve them well in the future."

Estimates are that the company will be lucky to have a million Xbox Live subscribers by the end of next year, and Microsoft's most optimistic projections call for 10 million subscribers by the time a new version of the Xbox is introduced around 2005.

Analysts estimate that building the global network for Xbox Live will account for at least a quarter of the $2 billion Microsoft has said it intends to spend to establish its video game console.

Matt Rosoff, an analyst for research firm Directions on Microsoft, agreed that Xbox Live is a long-term play for the software giant.

"What they're trying to do is increase the shelf life of the Xbox," he said, "They want to create network effects they think will lock consumers into the Xbox for the long term. If they've got the 10 million Xbox Live users they're shooting for, those people are much more likely to stay with the Xbox when they come out with the next generation."

In the short term, Xbox Live gives Microsoft a distinct advantage over competing consoles. While Sony introduced an Internet adapter for its PlayStation 2 console last month and Nintendo recently launched online capabilities for its GameCube, Microsoft is putting its faith in far more ambitious plans than either company's move.

Instead of leaving it to game publishers to provide online options, Microsoft will handle all infrastructure needs for Xbox Live. The company has assembled four massive server farms to handle Xbox Live traffic, including a main data center near company headquarters in Redmond, Wash., that employs military-grade security measures.

Xbox owners initially will pay $50 a year for the online service, which will require a high-speed DSL (digital subscriber line) or cable connection to the Internet. Xbox Live will serve as a common portal for online games offered by publishers such as Sega and THQ Interactive.

Scott Henson, director of platform strategy for Microsoft's Xbox division, said the Xbox Live effort is encouraging publishers to move into online gaming more quickly.

"The overwhelming response among publishers has been very positive," he said. "They like the division of labor, where we focus on the infrastructure and they focus on the games...They're seeing that we've really thought about the business model, that we want this to be a long-term viable business for us and the industry."

Billy Pidgeon, an independent market researcher focusing on the game industry, said Xbox Live's centralized approach also puts the onus on Microsoft to deliver top-notch customer service.

"Any hassle people have to go through is going to be a big turnoff," he said. "With the PlayStation 2, they can blame it on the publisher. With Xbox, it's all Microsoft; they're going to take the blame for any issues consumers have. They really need to have the customer service nailed down."

While initial subscriber expectations for Xbox Live are modest, the online service should give Microsoft a crucial edge in winning over the high end of the gaming market, said James Preissler, an analyst for investment banker Investec. Hard-core gamers who already play PC games online will look at Xbox as an attractive addition or alternative to PC gaming and help build the audience for Xbox, he said.

"For the next year or so, they need to have a focus on catering to the high-end gamer; they have to build a core niche audience," Preissler said. "In that sense, I think Xbox Live is make-or-break. If they fail at that, they've failed completely."

Hard-core gamers will help Microsoft build credibility for the Xbox and spur game developers to create titles that eventually will attract a broader audience, Preissler said.

"The high end of the gaming market is tens of millions of users potentially, so it can keep them afloat," he said. "And if they can win over that core gaming audience, they'll have a large enough installed base that they'll get more of the mass-market games."

Microsoft's Henson agreed that initial Xbox Live offerings--mostly sports and shooting games--are geared more to hard-core gamers, but he expects that to change as the service matures. "You're going to see some experiments with card games and board games--more casual games," he said. "There are lots of ways we can expand the content to suit a more mainstream audience."

Xbox Live faces several physical barriers in attracting that mass-market audience, however, including the low take-up of broadband access, such as DSL or cable, among U.S. households. Xbox Live won't work with dial-up Internet service.

Henson said that while the current broadband market is a limitation, Xbox Live is likely to motivate many consumers who have been holding off to upgrade to broadband.

"Not only do we see it as a tipping point for broadband adoption, but we've talked with a lot of broadband providers, and they see the same thing," he said.

For homes that do have broadband, there's a good chance it isn't in the same room as the Xbox. Setting up a home network is still too complex and expensive for the average consumer, Preissler said.

"The reality is that the lack of easy-to-use networking solutions for the home is going to limit the console space for at least the next few years," he said. "On the plus side, if part of your business is selling 75-foot Ethernet cables, you'll probably do quite well in the next year."

Henson said Microsoft is working with retailers and hardware manufacturers to make it easier for customers to hook the Xbox into a home network.

"We want to do as much as we can as far as education and getting people ready (is concerned)," he said. "And we want to make sure the experience is worth it whenever you've got the setup that will let you experience Xbox Live."

 

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