Microsoft Corporation (MSFT) Will Face New Competition With its Next Xbox

Microsoft Corporation (NASDAQ:MSFT) sold over 300,000 units in the U.S. last month of a computer originally designed more than 7 years ago. Meanwhile, a computer it launched in the second week of February just surpassed 400,000 units this week. The former trounced its competition, while the latter paled in comparison to its peers despite a much stronger marketing effort. The former is the Xbox 360, the latter the Surface Pro.

Microsoft Corporation (MSFT)

You might argue that the two operate in completely different markets with significantly different competitors, and I couldn’t argue with you. But I believe Microsoft Corporation (NASDAQ:MSFT)’s next-generation Xbox will compete more closely with its Surface competitors than its game console peers.

How the Xbox 360 found success

The Xbox 360 has been the best-selling game console for 26 months straight. In its early years, however, Microsoft found itself significantly outsold by Nintendo’s Wii despite a one-year head start. Unlike most consoles, which usually peak in sales between their third and fourth year after release, Microsoft Corporation (NASDAQ:MSFT) sold more Xbox 360s in its last fiscal year than ever before, growing its entertainment and devices division revenue 60% from 2010.

It turned things around with a new intuitive motion and voice controller, Xbox Kinect, and a shift in marketing from gaming console to entertainment console. The Xbox Kinect was Microsoft’s attempt to capitalize on Nintendo’s motion controlled gaming success. In less than 30 months, Microsoft sold 24 million Kinect units, which correlates nearly one-for-one with Xbox 360 sales.

More importantly, Microsoft Corporation (NASDAQ:MSFT) shifted the position of Xbox 360 in consumers’ minds. Instead of comparing itself to Sony Corporation (ADR) (NYSE:SNE)’s PS3, which has slightly better specs and a similar game selection, or Nintendo’s Wii, which had a hold on the low-end casual gaming market, it marketed toward families as a living room entertainment system.

Microsoft showed consumers the Xbox 360 is a single box that ties everything in the living room together. It’s for watching DVDs or Netflix, it’s for listening to music, and it’s for party entertainment with games like Dance Central. On top of all that, it’s still a high-end gaming system with exclusive titles such as the Halo series. It was an impressive feat of marketing, as the PlayStation 3 is nearly equally capable of doing everything the Xbox 360 can.

The next generation

Many expect Microsoft Corporation (NASDAQ:MSFT) to continue its dominance of the console market with its next iteration of the Xbox, as the competition looks like its falling flat. The Wii U, released in November of last year, is not selling as well as originally expected, forcing Nintendo to cut its outlook for the quarter. And after a teaser billed as an unveiling 140-minute marathon event from Sony, some people are announcing Microsoft the winner of the console wars before it even releases a speck of information about its next product.

I expect Microsoft to continue its shift away from gaming with its next console, and focus more on the entire entertainment package capturing mainstream consumers. It ought to integrate the Kinect sensor with every device, which would bring first-rate Skype capabilities to everyone’s big-screens. Wedbush Securities analyst Michael Pachter believes Microsoft will integrate a TV tuner card, giving the Xbox DVR and television voice-control capabilities. Essentially, Microsoft Corporation (NASDAQ:MSFT) could be making a killer set top box that also plays video games.

Its best strategy

That strategy would be wise, as the video game industry has come under pressure in recent years. Smartphones and tablets have contributed to the rise of casual portable gamers with inexpensive titles like Angry Birds and Plants vs Zombies.

As a result, video game revenue is on a steady decline, and was down 25% last month with console sales leading the way. Certainly, expectations for two new console releases later this year have contributed to the sales decline, but the pattern is clear – the gaming industry is in trouble.