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When the original Xbox video-game console went on sale in 2001, it wasn’t clear why Microsoft, known for staid workplace software, was branching out into fast-paced action games. But Microsoft decided that capitalizing on the popularity of gaming could help the company position itself for the coming wave of home digital entertainment.

“Microsoft saw the writing on the wall,” says David Dennis, a spokesman for Xbox. “It wanted to have a beachhead in the living room.” Ten years later, the Xbox 360 is currently the second best-selling video-game system in the United States, according to market research firm NPD, behind Nintendo’s Wii and beating out Sony’s PlayStation3, and making Microsoft a contender in the fierce battle to serve up entertainment on demand, especially from Internet video services. Analyst firm BCC Research estimates that $144 billion was spent on “digital living room” devices worldwide in 2010, and that this figure will grow to $226 billion by 2015.

In 2000, Microsoft looked like an unlikely competitor to Sony and Nintendo, which had built console gaming into a billion-dollar industry. Although it had dabbled in PC games, its entire business model revolved around Windows, Office, and other software for enterprises. Its hardware division produced mice and some other peripherals, not sophisticated consumer electronics.

Still, Microsoft was sitting on nearly $5 billion in cash. It could afford an experiment that even in the best case would be a money loser for years, says Rob Sanfilippo, a former Xbox developer at Microsoft who now is an analyst at Directions on Microsoft, a research firm. (In fact, Microsoft did lose money on the Xbox for the first six years. In total, the divisions that housed the Xbox from 2002 through 2007 lost about $7.5 billion, according to regulatory filings, before posting an operating profit of $426 million in the 2008 fiscal year.) The Xbox was designed to play to Microsoft’s corporate strengths, in particular building tools and support for the programmers who would actually make the games.

Crucially, Microsoft also leveraged its networking experience, adding an Ethernet port to every Xbox as standard. In 2002, the company launched its Internet-based Xbox Live service, which made it easy for people to play against online opponents. This put Microsoft ahead of Sony and Nintendo, which did not make networking a standard feature of their consoles until 2004 in Sony’s case and 2006 in Nintendo’s.

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Credit: Microsoft

Tagged: Business, Business Impact, The Business of Games

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