Is Microsoft breaking up with video games?
What looked like the company’s breakthrough in running a successful consumer business was hit hard with a new wave of layoffs and cancellations to the backdrop of Xbox’s lagging numbers. Is this it?
Dear Readers,
Amid new tariffs, trade deals, digital taxes being announced only to be rescinded days later, President Trump suggesting his administration could look into deporting Elon Musk as well as arresting New York Mayoral candidate Zohran Mamdani, the stock market is unfazed. Both the S&P 500 and the Nasdaq hit fresh all time highs. The combined market cap of the Magnificent 7 - Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla - now makes up 33% of the entire S&P 500, which is a level of concentration that is historically high. Looking at the price/earnings ratio of the companies in the S&P 500, additional warning signs are starting to flash.
“The S&P 500’s P/E ratio has been getting a lot of attention from investors, as it currently trades at around 30x 12-month forward earnings, well above its historical average of 21x over the past 25 years, and a level that has only been exceeded in 1998-2000 and 2020-2021, which on both occasions preceded steep bear markets.”
How appropriate was it for the Instagram algorithm to share this epic Billy Joel rendition about markets that get too detached from fundamentals with me this morning?
Maybe we are living in a simulation after all.
Onto this week’s story.
Microsoft just announced a fresh rounds of layoffs. The forth cut in the past 18 months sees the company reduce its workforce by 4%, meaning 9,000 people will be impacted. Among the Microsoft divisions that was hit the hardest was its gaming business unit Xbox Games. As a part of this restructuring, Microsoft is shutting down a number of studios and cancelling unreleased games in development, some of them were titles that already saw gameplay trailers released last year and were getting close to being launched. In the words of Phil Spencer, CEO of Microsoft Gaming:
“To position Gaming for enduring success and allow us to focus on strategic growth areas, we will end or decrease work in certain areas of the business and follow Microsoft’s lead in removing layers of management to increase agility and effectiveness.”
All of this comes just a couple of years after Microsoft made its biggest acquisition in its history, buying Activision Blizzard for almost $69 billion. CEO Satya Nadella explicitly called out video gaming as one of the three core strategic pillars for Microsoft’s growth.
Microsoft has always been dying to have a strong consumer-facing business. But the company that is pretty much synonymous with B2B enterprise technology just never seemed to get it quite right. The Activision Blizzard deal was meant to be a game changer (pun intended). But given this news and the increased emphasis on anything related to AI, it does beg the question:
Is Microsoft breaking up with video games?
The rumor mill was churning on maximum velocity last week already, with different gaming industry experts chiming in to propose solutions to what Microsoft should do before the details and the scope of this restructuring were clear. By far the grandest of them all: Microsoft should spin out its entire gaming business Xbox and merge it with Epic Games to create what would likely be one of the five biggest gaming companies in the world, and the largest in the US. While I don’t think this will happen (VERY different cultures, Epic seems to have little desire to get into hardware) there is another more radical solution that would flip the hardware driven gaming business that’s reliant on numbers of consoles sold every few years on its head.
Before we get into potential solutions, let’s take a look at what got Microsoft into this position and the current landscape.
Slumping console sales
As of February this year, the Xbox Series X/S have totaled sales of close to 32.5 million devices. The number of PlayStation 5 consoles sold in the same timeframe? 74.1 million. PlayStation’s market share grew 3.2% year-over-year, whereas Xbox’s shrank along similar proportions. The PlayStation had one of its strongest sales quarters ever, and the Nintendo Switch 2 is breaking all sorts of records. Console sales aren’t slumping - Xbox sales are.
Lagging Game Pass adoption
Since its inception, the Game Pass has seen strong growth, but it seems to be plateauing. It now sits at 35 million subscribers, which is far below the target of 50 million they had set for 2025, and a far cry from the 100 million target the company originally gave.
Cloud gaming slower to roll out
Cloud Gaming, a user’s ability to play any game, on any device, anywhere they go while seamlessly switching between devices and not loose any progress in their game, has been hyped since 2018. In 2021, articles with titles such as “Is cloud gaming at the tipping point?” were everywhere. Four years later, it has made some, but not a lot of progress. The technology definitely has potential, but it’s further out and consumer adoption is slower than expected.
New portable console - made by a third-party
The recently announced Xbox handheld console ROG Xbox Ally is met with a lot of skepticism. Most notably, Xbox founding member Laura Fryer referred to the company’s roadmap as “chaos” and shared her take on the most recent hardware release.
"There is literally no reason to buy this handheld. Obviously, as one of the founding members of the Xbox team, I'm not pleased with where things are today. I don't love watching all of the value that I helped create slowly get eroded away. I'm sad because, from my perspective, it looks like Xbox has no desire — or literally can't — ship hardware anymore. So, this partnership is about a slow exit from the hardware business completely. Personally, I think Xbox hardware is dead."
There’s a lot here that certainly hasn’t lived up to expectations, and especially the performance of Game Pass has been disappointing to say the least. However, Microsoft still has incredible gaming assets that are revered by hundreds of millions of people - Call of Duty, Minecraft, Candy Crush, The Elder Scrolls, Halo, Fallout, Doom. The list goes on. Microsoft has economic leverage because of these games and IPs with consumers - and the immediate reaction industry analysts jumped to was the following: make the games exclusive to the Xbox console and it will increase the number of Xbox units sold.
I think that’s the wrong conclusion.
First, hardware sales always have a scalability problem. There’s only so many people that can afford to buy a new Xbox for $400-$800 every few years, especially when the differentiation between two generations of consoles becomes increasingly harder in terms of value delivered to the consumer. Even Apple is running into this challenge with its iPhone, and both Apple and the iPhone are far stronger consumer brands than Microsoft and Xbox respectively.
The second reason is that you’d want as many people as possible to play your games, but this is especially true for free-to-play games that thrive on audience size and monetization of that audience inside the game. More is better. So restricting access to games by going exclusive restricts access to audiences and limits the growth of the games themselves.
And there’s a third reason, which is antitrust related. Part of the reason why Microsoft got its acquisition of Activision Blizzard approved was the concession to ensure Call of Duty will still be available on the Sony PlayStation. Walking this commitment back and adding even more exclusivity will raise unnecessary concerns with federal regulators.
In sum: exclusive games content won’t materially impact hardware sales, limit access to audiences and hence growth, and will increase regulatory scrutiny. It’s a bad business model that’s stuck in the past.
But: there’s a kernel of truth hidden in the above idea. That is that consumers will spend more money the more value they receive for their dollars. Access to games, maybe partially exclusive content, early access, discounts, and more can all be a part of giving more value.
This is where we now move to the solution I propose in how Microsoft can accelerate its gaming business, inject a much needed jolt into GamePass, while at the same time get out of the hardware-focused sales cycles with a device that lacks meaningful differentiation.
One subscription for everything gaming
Yes, you read that write. I think Microsoft should go all in on a subscription model. How does that make sense given its subpar success with its Game Pass subscription? Here’s how.
Currently, Game Pass pretty much focuses on access to a library of games, preferred access to new game releases, and a selection of online multiplayer features.
What if Microsoft completely rethought this subscription service and the value it delivers for consumers by making it about access to the entire Xbox universe and turning it into a cultural experience, rather than positioning it as another subscription with access to games content? The type of subscription I’m proposing here would see users pay a monthly fee higher than the current levels (something in the $30-50 range) and it would include the Xbox console itself.
Yes, no more leaning on one-off hardware sales. You’d still make the console available for one-off purchase, but the goal with the Xbox has to be to nurture people into a recurring revenue model using the hardware as an alluring value factor and one piece of a much larger puzzle:
Users subscribing to this new Xbox service would receive the new Xbox upon release, ideally 1-2 weeks before it becomes available to the general public, at no extra charge. The hardware upgrade simply is a part of the subscription.
You can include hardware accessories with it and give out limited edition controllers for players that have unlocked a certain status across the Xbox games library (10,000 hours played in Minecraft? Xbox sends you a personalized note and a custom controller right to your home).
The suite of Xbox games could see more exclusive content (in-game characters, consumables, maybe even entire extension packs) only available for subscribers.
The subscription should include access to invite-only physical events focused on new game launches or new hardware releases. Grant access to the developers and studios making the players’ favorite titles and lean into leveraging the fandom.
Subscribers should have access to enhanced social features that allow them to play with friends, socialize with them, meet new friends, chat, hang out (this is where acquiring Discord before it goes public and roll it up into the Xbox ecosystem would make a lot of sense).
Xbox could make a variety of discounts or preferred access items available to subscribers by setting up partnerships across the ecosystem. Want to see the new A Minecraft Movie in theatres? Your tickets get dropped into your account for the theatre of your choice to see the movie before everyone else. Amazon Prime wants to make the new Fallout season for its streaming service? Let Xbox subscribers see it first.
I could go on listing more and more ideas, but you get the point. This is actually a type of service that Apple was rumored to be contemplating to put in place to fend off slowing iPhone sales.
The goal is to give consumers so much value that they won’t even think twice before signing up. Microsoft has to go all-in on making it about the consumer, the player, and really take care of them. The benefit for Xbox? A uniquely positioned offering that shifts the business model from one-off hardware sales to a recurring revenue model and simultaneously enriches the ecosystem across which Microsoft can generate data to learn.
What should this subscription service be called?
Xbox Valet.
In other news
Paramount settled an ongoing lawsuit with the Trump administration against its network CBS of its use of air time of its show 60 Minutes during the last presidential election. Paramount agreed to pay Trump a settlement of $16 million. Now, everyone expects that the merger between Skydance and Paramount will magically be cleared and green lit. If the $16 million feel like a bribe to you, trust your gut on this one.
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