X Is For Entertainment

While competitors dithered, Microsoft used its Xbox videogames to sneak into living rooms. Now it's ready to dominate home entertainment the same way it did home computing

By David M Ewalt
Published: Jul 10, 2012
Image: John Keatley/ Redux for Forbes

Cookie Monster wants a snack. Sure, he could have a handful of you-know-whats, but even a Muppet has to watch his waistline. So he decides to grab something healthful. “Maybe if me jump up and down, me can shake fruit out of this tree,” the fuzzy blue monster says to his television viewers. “Okay. Help me jump!”

Muppets have always broken the fourth wall. But for the first time, Cookie can actually tell if kids are responding. When they do, his googly eyes shake wildly and leaves fall from the tree. “Oh boy, oh boy,” Cookie cheers. If the child refuses to budge, he invites his fuchsia friend Telly on-screen to do the jumping instead.

This is Kinect Sesame Street TV, a fully interactive version of the award-winning educational programme that goes on sale exclusively for Microsoft’s Xbox game console in September. The Xbox’s Kinect accessory comes with cameras and microphones and can see and hear the kids as they watch and play. “Kids generally learn through play, and this is an opportunity to get them off the couch and involved,” says Terry Fitzpatrick, chief content and distribution officer for Sesame Workshop, which has produced Sesame Street since 1969. “Microsoft recognised the value of it immediately.”

Parents can buy the disc wherever videogames are sold, except to Microsoft this is not a videogame—it’s a TV show you can play. Also on the disc is a version of “Elmo’s World” that films you with the Kinect camera and puts you on-screen with Elmo in real time. It’s fun for kids, but this is a serious salvo in the fight with Sony, Apple, Google and a dozen other players to control your family television. “The living room is very important,” says Microsoft CEO Steve Ballmer in our interview in a conference room just outside his Redmond, Washington office. Ballmer, in regulation button-down and khakis, spent 30 minutes just on the future of the Xbox.

“It’s a place where there’s a high volume of consumption of digital goods and services. So Xbox is very important.”

High-volume consumption is an understatement. Yes, people are spending more time on their computers and smartphones. But watching the tube remains almost a full-time job for the average American, who puts in nearly 35 hours a week, according to research firm Nielsen. And that habit has not migrated to Windows PCs. Ninety-eight percent of view time is still spent staring at a traditional TV set. Americans spend $91 billion a year on cable and satellite subscriptions, and advertisers spend another $72 billion reaching them there. This remains a fat enough cow to move the needle, even at mighty Microsoft.

So the Xbox has become Ballmer’s weapon of choice, one that his company has aggressively moved to position as something more than a toy used to play a little Call of Duty or Madden NFL. Over the last 10 years, while its rivals have dithered and misfired, Microsoft has been feeding its living-room secret weapon a nonstop diet of software updates and hardware upgrades. This spring, for the first time, subscribers to Xbox’s Live online service in the US spent more time consuming video and music than multiplayer games. Globally, the hours spent on Xbox Live have grown 30 percent year over year, including gaming and entertainment, while video consumption has risen 140 percent.

In some ways the Xbox is emerging as an alternative for those who want to cut the cable cord. On-demand movies and TV? Xbox can stream more than 200,000 high-definition titles. Premium channels? Game of Thrones rages on via HBO Go on Xbox. Live sports? Xbox has ESPN, every regular-season Major League Baseball game and Ultimate Fighting.

In effect, the Xbox is Microsoft’s profitable Trojan Horse. The console’s latest version, the Xbox 360, is the top seller in the US. Worldwide, since the 360 debuted in November 2005, customers have snapped up 67 million units, generating $56 billion at retail. Its sales still outgrow those of all other rivals.

Once installed, Microsoft’s real game begins. The Live service has more than 40 million members in 35 countries. Microsoft makes money selling them points they can use to rent videos or download games. An estimated 17 million Live members pay about $50 a year for a Gold membership, which gets them access to Netflix, HBO Go, ESPN and multiplayer gaming.

In May, Microsoft effectively stopped treating Live like an add-on for a videogame console and started pricing the console as a loss leader for an entertainment platform. Rather than pay $199 just for the unit, users can now get an Xbox for $99—as long as they also take a two-year contract to Xbox Live Gold. This new low price looks even better when you consider you don’t need to buy a new TV, which is what Samsung and, soon, Apple want you to do. “If you want to start a phenomenon,” says Ballmer, “it doesn’t start with thousand-dollar-plus devices that sell at unreasonably low volume and need major room redesigns.”

Terry Fitzpatrick of Sesame Workshop saw Xbox Kinect as a way to get kids off the couch
Image: David Yellen for Forbes
Terry Fitzpatrick of Sesame Workshop saw Xbox Kinect as a way to get kids off the couch

Plenty of companies do sell rival boxes to deliver online video to the TV: Cisco, Google, Apple, TiVo, Sony, Roku. But none of them does what Xbox can do. Because it was born to play games, has the hands-free Kinect controller and sports a hefty hard drive, the Xbox is the strongest player in interactive television. Forrester analyst James McQuivey says that only about half of the people who rush out to get Net-connected TVs even bother to connect them to the internet at all. In fact, Ballmer is working to persuade the big pay-TV players—Comcast and Verizon are already Xbox partners—to allow their customers the choice of an Xbox over a cable set-top.

“Will a TV need both boxes? No,” says Ballmer. “We ought to be able to relieve the world of the expense of having a set-top box. ... There’s no economic value in having two boxes that do the same thing.”

Let’s play a game. Call it Living Room Domination. In level one your mission is to sneak into enemy territory. Microsoft started playing in 1998 when the Xbox division was set up in a skunkworks office away from the main Microsoft campus and across the road from a gravel pit at the end of the 520 freeway.

It wasn’t Microsoft’s only bid for the living room. In 2001 Bill Gates unveiled two gadgets during his keynote at the Consumer Electronics Show. One was the heavy cube of black plastic called the Xbox, Microsoft’s freshman entry into what was then a $20 billion global videogame business. Like its biggest competitor at the time, Sony’s PlayStation 2, the Xbox offered high-powered graphics, a DVD player and the ability to connect to the internet. The second gadget was UltimateTV, a set-top box that received DirecTV’s service and worked like TiVo’s digital video recorder. “Music, television, reading and gaming, none of them will be the same,” said Gates.

Things didn’t go exactly as planned for UltimateTV. Microsoft killed it in 2003 after DirecTV was purchased by EchoStar, which made its own set-top boxes. The Xbox fared better. By the time the original console was replaced in November 2005 by the Xbox 360, it had sold 25 million units and generated $15 billion in revenue. Microsoft moved more units than industry veterans Sega and Nintendo, though it came in a distant second to the blockbuster PlayStation 2. (The PS2 is now the best-selling console of all time, with 150 million units sold.)

Even if Microsoft was aiming past the videogame market, much of the Xbox’s success can be tied to a good ol’ shoot-’em-up called Halo, a sci-fi adventure series available only on Microsoft’s console. When the first Xbox hit stores in November 2001, many gamers purchased the console just to play the title. Halo 2, out in 2004, turbocharged the popularity of Microsoft’s then two-year-old online service. Within 18 months of the game’s launch fans spent more than 710 million hours playing against one another online.

Microsoft was smart enough to make Live a centrepiece of the Xbox 360. It required a broadband connection so that Microsoft could add features like universal voice chat, more downloadable games and extras, and the ability to buy and listen to music. By November 2007, Xbox Live’s fifth anniversary, the service had over 8 million subscribers.

A year later Microsoft finally made good on Gates’ vision of convergence and began building up the on-demand video library. A big software upgrade redesigned the box’s user interface, integrated the Live service across all menus and added other streaming video services. By February 2010 Xbox Live had 23 million members. In November 2010 came the Kinect sensor, a beer-bottle-size device packed with an array of cameras and microphones that track users’ movements and listen to their voices, allowing the Xbox to be controlled through speech and motion instead of a clunky game pad. With 8 million sold in its first 60 days, it set a Guinness World Record for the fastest-selling consumer electronics device.

“We haven’t just shipped a bunch of transistors and left them in their current state. We’ve rewritten the operating system twice. We’ve updated and added new types of hard- ware, and we’ve grown our roster of content partners,” says Don Mattrick, president of Microsoft’s Interactive Entertainment Business, the division responsible for Xbox and Xbox Live. “As we’ve increased functionality for gaming, we’ve seen usage increase on both sides of the house.”

In level two of Living Room  Domination, you come out of hiding and start blowing things up. At the annual E3 videogame industry trade show on June 4, Microsoft made a series of announcements designed to widen its lead in the entertainment space, such as 24/7 live programming from all ESPN channels (it used to be only selected events and highlights), including Monday Night Football; Xbox SmartGlass, a technology that extends the Xbox experience to computers, phones and tablets; and a Nike interactive workout program.

Microsoft also signalled how central Xbox has become to its broader consumer strategy by announcing a rebranding of the also-ran Zune music subscription music service as Xbox Music. And soon, when you watch a movie or listen to music on a Windows PC, you might have to click an icon marked Xbox.

Nike threw its weight behind Xbox after seeing the hands-free capabilities of the Kinect camera in action. The new “Nike+ Kinect Training” product watches users while they perform a series of exercises and analyses their movements. If it notices you’re struggling with push-ups, it might add more arm exercises to the workout. If it sees you have a bum knee, it might reduce the number of jumping jacks and squats. “Kinect gives us the ability to tailor the program for different people,” says Stefan Olander, vice president of digital sport for Nike.

New products like Nike+ Kinect come to life in “The Great Room” a space in Studio D, one of the buildings that house Xbox staff on Microsoft’s campus. The room is like a wealthy game geek’s private lounge, with cushy couches, custom cabinetry and flat-screen TVs. It’s where employees host visitors, demo new products and play games.

The hot new demo they’re showing now is the aforementioned SmartGlass, a technology intended to patch the seams among your Xbox, Windows PCs and mobile phone, even an iPhone or Android. SmartGlass lets you watch a movie on your tablet and then press a button to transfer the film to your Xbox, which puts it on your TV right where you left off. Once the show is on the big screen the tablet becomes a smart controller and can play interactive features or display info about the film.

HBO is now integrating SmartGlass technology with the hit fantasy series Game of Thrones. When viewers watch the show on their TV, their tablet or phone will display a map of the show’s current location or a family tree when a new character appears on the screen.

In future versions of the bestselling Madden NFL franchise, SmartGlass will allow players to choose their plays on a tablet instead of TV menus. It’s a simple idea but one with major repercussions: Nintendo’s Wii U game console, due in stores this fall, features a touch-sensitive controller rather like a tablet computer. By offering the same functionality to anyone with a Windows-powered phone or tablet, Microsoft takes away one of the Wii U’s unique selling points.

Nintendo’s Wii has been the undisputed leader of the current console generation, moving more than 95 million units, but its success was based in part on the appeal of Wii’s motion-sensitive controllers to first-time videogame players. Microsoft’s Kinect allows them to ditch remotes entirely. Users can wave a hand at the screen to fast-forward, or simply issue verbal commands like “Xbox, fast-forward” or “Play Iron Man.”

Nintendo may have been prescient in its efforts to expand the game business, but it has fallen behind in its entertainment offerings. Wii owners have only a few video options, including Netflix and Hulu Plus. Tony Elison, Nintendo of America’s senior director and general manager of network business, says the company “is aiming to significantly expand its digital business” with the Wii U.

Sony is the bigger threat. It has sold more than 64 million PlayStation 3 consoles, and its PlayStation Network offers many of the same content choices as Xbox Live. Sony is also developing technology that allows users to share content between devices, such as its PlayStation Vita handheld, which can transfer games back and forth to the PlayStation 3 or work as a controller in certain PS3 titles. Jack Buser, senior director of PlayStation digital platforms for Sony Computer Entertainment America, says the company will expand that technology to all kinds of other Sony products. “Because we’re all connected through the Sony entertainment network we’re able to provide experiences that would be very, very difficult for a company who is purely making a single piece of console hardware to replicate,” he says.

The wild cards are Google and Apple. Google’s first connected TV got lots of attention, but little sales. It is trying again this summer with offerings from LG, Samsung, Sony and Vizio. Apple’s hotly debated TV could also be out by the end of the year. The latest rumour has Apple coming out with a big flat-screen north of $1,000, exactly what Ballmer says consumers don’t want. (Of course, he also said consumers didn’t want a $500 iPhone.)

After only a decade, Microsoft, a software company, has built a stronger hardware product than anyone else has in the space. And a new console, nicknamed Xbox 720, is expected to be unveiled next year with lots of media-centric features. If the Xbox division keeps growing as it has, it will account for far more than the 7 percent of Microsoft it does today.

Steve Ballmer says he knew exactly when the long-awaited digital living room arrived. “We never had an Xbox at our beach house because my wife thought it was too distracting for children,” he says. “Then when Kinect came out, she told me, ‘I’d really like one of those for when Grandma and Grandpa come up to visit.’”


(This article is excerpted from the latest Forbes India 20 July, 2012 issue which is now available at news stands and book stores. You can buy our tablet version from Magzter.com)

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