John Ellis – Investor Relations
Robbie Bach – President, Entertainment and Devices Division
Mindy Mount – CFO, Entertainment and Devices Division
Ben Schachter – UBS
Rick Schilling – Galiant Group
Brent Thill – Citi
John Difucci - Bear Stearns
Microsoft Corporation (MSFT) 2008 CES Financial Analysts Call January 7, 1969 9:00 PM ET
I give an extra welcome to those of us joining via the web. My name is John Ellis I work at Microsoft Investor Relations as does my colleague Emily Zander in the back. She recently joined the group and helped coordinate this event. We’re of course joined today by Robbie Bach, president of our Entertainment and Devices Division and Mindy Mount, CFO of our Entertainment and Devices Division.
We’re going to follow the same format as we have in the past, Robbie’s going to make a few introductory remarks and then we’ll spend the vast majority of our time answering your questions. Should you ask a question, consider this as implied consent to have your voice or likeness included in our webcast, both live and recorded along with the transcript of this session atthe Microsoft investor website.
Continuing ina similar vein of disclosure, please be aware that today’s presentation may include forward looking statements based on our current expectations and assumptions about the business and are subject to risks and uncertainties. Our actual results could differ materially because of risk factors we may discuss today and have identified in our most recent 10Q and 10K filings.
You should also note that we are right in front of our earnings release, we arein our quiet period, so we will not talk about business results of the December quarter outside of what was discussed last night in the keynote speech.
Additionally we won’t be updating any financial guidance today, as much as you may try. With that I’d like to thank Rob and Mindy for their time and I turn the floor over to Robbie.
Thanks John. Thanks everybody. I thought what I’d do is spend as little time as possible reviewing what we did last night but just doit in case people didn’t seeit and just summarize what we discussed last night and then try and turn it over to you for questions on any number of directions you want to go.
Basically what Bill and I tried to do last night was lay out two levels of things going on. The first is his long term vision for how he sees the next digital decade laying out, what are things he thinks are important and the direction we’re going. We saw that certainly in the first part of his speech where he talked about it directly and then you saw itat the end of the speech where we did the demo using the new work from the Microsoft research group, talk about how mobile phones, cameras and other things might be involved in the business in the future.
The second thing we wanted to do is talk a little bit about things that are evolving in the current business. Whether that be things we’re doing in the online space, we did a very nice demo on Windows Live last night, we talked about how Live is going to be a central part of the services we deliver and the work that we do going forward. We also showed some technology during the evening around new ways of interfacing with technology whether that was the touch work we did on Surface, or whether that was the voice work you saw us do with Tellme and in the Microsoft Auto case was also quite exciting. And then you saw talk from a technologies perspective the work we’re doing around social interactions with what we’re doing with Zune and Zune social and how that plays out.
There were also a number of announcements made on content partnerships, certainly an important part of the work we do. I’ll highlight the MSN NBC announcement around the Olympics as being a particularly important one. Both our MSN business and our online business as a whole in the business I manage, the announcements with Disney and ABC for their television content and MGN for the movie content, certainly were highlight announcements.
We also wanted to highlight some business results and performance from the previous year. I talked quite a bit about metrics around Xbox, some of which you had heard during the press release a few days before, some of which was through last night. I think notable amongst that are three data points. One, the 17.7 million consoles sold thus far [life] to date. The second, and I think a phenomenal number, is the 10 million members on our Xbox Live service, about six months in advance of when we were anticipating reaching that number and we’ve seen certainly in the months of November and December a rapid acceleration on that service, very excited about that. And then the third number was the number we talked about in terms of revenue and we took the US market, where we have the best data because of MTD and through the month of November, Xbox has been about a $2.5 billion dollar business, that’s about $1 billion ahead of Nintendo and about $2 billion ahead of where [the seat three has been]. Certainly, Nintendo does better than that in units, because their price-points are lower and their attach on games is significantly lower than ours as well. Our view is we should be looking at the entire business, the ecosystem we’re building, since that’s what’s going to determine how things are going to happen in the future.
We also talked a couple of other metrics around businesses, 1 million TVs on our Media Room service, that is a dramatic increase. I’m not sure I could have quoted you a number last year, so that’s a big step up in that business, we see rapid acceleration there. Media Center, we made several announcements there around support from Samsung and HP, the important point being there that the easier we can make it to get digital content to the television, the more effective we’re going to bein the connected entertainment space. And if we can do that ina way that doesn’t require yet another box connected to a TV, all the better. That’s why it’s very exciting to see HP bring their media smart TVs with extended technology actually built into the TV, with a network connection built into theTV as being a very important step forward in that area.
You saw the Auto demo was I think indicative in part of the natural interface work that I talked about, but also indicative of a nice new relationship we have with a new industry that I think we can grow over time. In the grand scheme of our business, it’s not a huge business in the grand scheme of E&D, but on the other hand, from a technology and customer perspective, it’s actually quite abig business and important part of what we’re doing with connected entertainment.
So with that, I think I will pause and we’ll turn it over to you to ask questions and I’ll try to answer, Mindy will try to answer, we’ll tell you if we run afoul of John’s descriptions up front and if we can’t answer a question and John will give me a signal and we’ll go from there. Questions, either person in the front go ahead. Please wait till we pass the mic for people who are listening on the web.
Ben Schachter – UBS
The last thing you mentioned almost in passing a deal you did with BT around turning the Xbox into a…
Thanks for reminding me. Yes.
Ben Schachter – UBS
I wonder if you could really elaborate on what that means, when that might come in the US, what’s the strategy there? And the second question, if you could just give a general thought on the idea of console cycle.
Ben Schachter – UBS
Something about the length, how is it different now than what we’ve…
Sure, so let me talk about theBT announcement. Last year at this time, we showed Xbox 360 acting as a set-top box for what was then called our IPTV service but we now call Media Room, and, as you know we have about 20 Media Room partners around the world. BT will be the first one to offer Xbox 360’s, basically you would go buy an Xbox 360 from T, that box would function just like a regular Xbox 360 would, and in addition would have the client’s software on it to run as a set-top box from BT Vision service. That enables them to deliver video on demand, DVR functionality and other functionality to their customers.
That’s an exciting step forward for us ina number of ways. For us, it means deeper penetration of Xbox, from our customer’s perspective it’s one less thing connected to the TV, from BT’s perspective, it’s effectively a set-top box they don’t have to subsidize because there’s actually real functionality built into the set-top box that people would actually be willing to pay for. So it’s a nice win-win-win around and for customers they just geta better integrated experience.
So, that will roll out at BT, we are talking to other network operators about that functionality and have been. I will tell you that for a good portion of 2007, network operators said that’s something we definitely want to do and right now we want to work on scaling our implementation of Media Room, both the work with Microsoft we’re doing as well as the work they were doing in the back office and in their installation work.
Clearly this is new businesses for them so they’re gearing up and getting that figured out. What you now see, I’d sayin this last quarter of work is, we’ll pass those hurdles now and now they are looking beyond how to expand the business, so I think you will see us continue to build new opportunities with other network operators beyond BT. But BT will be the first.
To your second question about the lifecycle for this generation of consoles, I’d saythe following, I think certainly as you’ve seen with DS2 and the midlife of that product, there should be every expectation that the life cycle of a 360 will be certainly longer than an Xbox lifecycle was. And the Xbox case, we artificially shortened that lifecycle because of the economics on the box. Consuming that lifecycle wasn’t beneficial from a P&L perspective. In this case because of the way we built the economics into the console, we’d be much more in a position to extend the life even if after some date we come out with another console.
So independent of predicting the cycles of the industry per se, you should think of Xbox as having a slightly longer lifecycle this time than it did last time, certainly more of a tale in terms of our ability to continue to sell in that marketplace. Nothing specific in terms of years or dates or anything like that, but this is a general philosophy in how we’ve approached the business, that’s the way we think about the business cycle forward. Other questions? I’ll come down the row next.
Rick Schilling – Galiant Group
Rob, could you talk about margins in terms of the -- I don’t want to talk about this past quarter -- but with Halo 3 I’m sure it’s good, but with the direction going forward now that you’ve got the software ramped up and the volumes where they are, how would you think about volumes over the next couple years.
You mean on the Xbox business or just overall?
Rick Schilling – Galiant Group
Well, I’m thinking the Xbox business but I think that kind of drives the overall business.
Well it does and it doesn’t. Let me talk about E&D first then I’ll come down to talk about Xbox. E&D on a margin level, if you think Microsoft has gotten a little complicated on a margin level, E&D on a margin level is actually quite complicated because of the number of businesses we’re in and the difference business models that each of them has and so none of the margin structures for any of those businesses arethe same.
We have some businesses that are pure package goods retail software businesses, like Mac Office, which has a certain margin in the structure associated with it, we have businesses that are pure hardware businesses, like my keyboard which hasa completely different margin structure associated with it, we have businesses that are royalty businesses, like Windows Mobile business, that is yet another margin structure associated with it.
If you take Xbox Live, just as an example, within the Xbox, you have an advertising business, a download business and a subscription business all baked into one, so that has another margin business. Media Room, you should think about as being a client-server model, much more like our sequel server business, so that has yet another client license, server license, maintenance model that goes with it. Atthe E&D level, it makes doing a margin analysis, I’ll say, quite complicated. You do have to at some level break it down into some of the component businesses to actually have a reasonably intelligent conversation about how it goes and I know that makes modeling for you guys that much more complicated.
The other thing to remember about that margin discussion is the way money goes from revenue to contribution margin of profit is different in each of those businesses as well. Some of them are low revenue businesses but high margin, soit makes top line and bottom line quarter to quarter a little tricky. Managing that makes that a little tricky.
Relative to Xbox, I’ll just saythe following in terms of how we think about this. The model continues to drive the console itself to neutral and gross margin and do that as closely as we can and like I said before sometimes we’ll be right side up on that, because we’ll beat a point where we haven’t lowered prices but consoles costs have come down and sometimes it’ll be the other way around, but over time you should see that level itself off. This is absent the warranty currency charges that we took last year, but that’s an additional added component to what we did.
And then, on the money is in games, peripherals and Xbox Live, Xbox Live, I would have said in the first generation of Xbox, neither here nor there on the T&L, Xbox Live today, with 10 million members and 3 different business models, you know actually hasa meaningful impact on what we do, the business we can track and measure and see profitability and all the businesses.
So, that’s kind of the way you have to think about the components, then within the games business you have to divide it into a couple different components, there’s third-party business, which is again a royalty business and then there’s our first-party business, some of which is internally developed titles, some of which is stuff we publish outside. So that’s kind of the tour Rick, I don’t know if that helps, that’s kind of the tour. In terms of trend, with the exception of what I highlighted with Xbox Live as its continued growth has helped contribute. I don’t think there’s a lot to change sort of trend perspective.
I think most of it’s sort of what we’ve been saying for a while, certainly very different from Xbox1, that I would say, the margins are actually quite different from Xbox1. We had a question down the aisle from Rick, so…
Maybe we could just dig into the Xbox Live number there a little bit. Partly, how are you monetizing, you’re monetizing mainly the subscriptions I imagine at this point, could you also do some color on the 10 million users, I’d imagine Halo had abig effect on that, are you seeing differences in the subscription rates and do you have new goals now for year end?
Let’s drill down a little bit on what we see going on Xbox Live. Certainly the largest form of monetization is subscriptions. Predominately that’s $49 a year, there’s a few other plans that you can be on, but most, the vast majority of people who are subscribers, what we call Gold Members are on a $49 a year plan. I will say that the mix of business that is download and ad based is growing, percentage base it’s growth quite big, percentage in terms of the total still quite small, but we dosee that taking a bigger piece of the pie over time.
I think for the foreseeable future subscriptions is still the predominate form of monetization there. But I do like having the balance of the three, it enables us to make offers and reach a set of customers that we could not reach with a subscription offer, because a subscription offer is a multi-player gaming offer and that reaches a certain set of customers. What’s nice about the ad support and download business is it enables us to reach people who are maybe gamers, but they’re probably more casual gamers, a broader audience, maybe a little less engaged, but still want to have a fun experience. So I think from that perspective, it’s actually quite good.
The second part of your question was? Oh yeah, context of the 10 million people. I think a significant amount of that growth happened as, sort of the triple play, if you will, of our price cut, Halo 3 and a great content line up in the fall holiday period and I’ll comment on it just because it’s in the news. That actually left us surprised. The growth was much faster than we expected.
As I said, we were expecting 10 million members by the end of the fiscal year, we had 10 million members by the end of December, we did have some challenges on the service, keeping the service running at the scalability we did. We had concurrency records almost everyday for several weeks during the holiday period, so that’s been a pleasant challenge in the sense of success and unpleasant challenge for our customers. We tried to do some things to thank them for their patience and obviously on top of that problem, getting the service back to its usual high-uptime standards.
But again, from a longer term business perspective, we’ve seen a lot of growth from those titles, it happened more quickly. Now, just because its title driven I don’t think it actually means all those are subscribers, some of them are certainly, but the fact that we’ve driven a lot of new consoles brings people into the environment and a lot of them start as Silver subscribers first before they decide to doa Gold subscription and the multiplayer option.
So, I think we’ve finally seen a good mix of all of the above in what we’ve done and in terms of projections for the future, frankly, we haven’t had the time to digest what happened atthe holiday to actually assess what’s going to happen over time and how we see that happening over the next six months and we’ll do that work. One thing we have been thinking about Xbox Live just in general is, as we’ve gotten to the scale of the number of users we have and the amount of content we have on the download side, we have to do some work to make it easier to find things. The user experience of finding things ina long list box is not super satisfying, your thumb gets a little sore on the scroll button. So, we’re going to have to do some work to help program the side a little bit, bring some things to the top, make it easier for people to find the best content and the things they’re looking for, things like that.
It’s all good design work that we know how to do, but, just from the context of, wow this is really scaling, we’re increasingly thinking of ourselves as being in a programming the site environment as opposed to just putting things there in the marketplace and letting people go shop and browse. Other questions? Yeah? Down in the front.
Brent Thill – Citi
Yeah, Brent Thill with Citi. Robbie can you elaborate on your internal content strategy, now life without Halo kind feeds back to Rick’s question on margins. That seemed to bethe biggest contribution, the margins are now with Halo and perhaps other content disappearing like Mass Effect.
Well lets talk about that in the following context. First of all, we should be clear, Halo didn’t go anywhere. So Microsoft owns all the Halo IP, we can do that Halo work with the Bungee team going forward if we want. Also, if we want to doit with another team, internal team or some other team, we can do that, so Halo didn’t go away, the franchise value we have in that didn’t go away, the margins structure of that doesn’t go away, you should think of that as still being a great business. Bungee wanted to have more artistic freedom and the ability to work on some projects outside of Halo and so that’s why we’ve developed the structure we have enabled them to do that. But in fact they’re still in the same building they were in two years ago, they’re still working on things for us related to Halo, as well as some other things, so, don’t take that too far in terms of how you think about the analysis.
In terms of other things that are going on in the first-party business, you know you are going to see us as we have always in the business, move content out of the portfolio. We’ve had a pretty dynamic mix of things that are developed by Microsoft employees and third-parties, I think you’ll see that continue. Mass Effect is a fabulously performing product, but given the way the ownership structure has changed, it may not make sense for us to be thelong term caretaker of that, we’ll evaluate that, we talk to EA about itall the time. So I think there’s good ways for us to evolve that portfolio, you should think of first party as being on the exactly the same strategy as its been on for a while, which is A we have to do a good profitable business there, B we have to show off and showcase the platform. It doesn’t mean we’re going to doa ton of titles, we won’t, but we will do big titles, we’ll do titles of high quality.
If you look atthe quality of Microsoft Game Studios titles, it’s phenomenally hot as an average in that [inaudible]. Look atthe Metacritic numbers, it’s amazingly consistent how well we do, now, we don’t do as many titles as some other guys do and so that means we have less volume, but the quality is there and the units per title is substantially higher. I think you’ll see that continue. Yeah? We’re going to need to try the microphone…
What do you think you and your competitors will start mounting the next strategy consoles a couple years from the initial launch and second, what are you plans for a portable gaming system?
First question is pretty easy to answer, I don’t know. Certainly don’t know what my competitors are planning to do. That’s along game theory exercise that a lot of people will start thinking about, but we don’t certainly have anything to comment on that, and relative to our own plans, we’re doing what we always do which is, we’re constantly scanning the technology and looking for things that could be breakthroughs for next generation work, but there isn’t anything that would be meaningful to discuss there. There is a ton of business to be done this generation and a ton of work to enable that business, that’s where allthe resources of the team are focused.
In terms of your question about portable gaming, there’s kind of three ways you can think about portable gaming. One, you can think about what’s going on in cellphones and we’ve dabbled in that a little bit, we’ve licensed some of our intellectual property to people to do things on cellphones. I haven’t seen it as a big strategic initiative for us, nor have I seen it as a big profit driver for us, so we’ll do some things probably opportunistically there. Maybe there’s things we should be doing in the Windows Mobile space, but even there I haven’t seen the customer demand or desire yet.
It turns out that that business is from a financial structure, a tough business for us to bein because it’s a very cost sensitive business and you have to drive high volume across a lot of platforms for it to make sense and being a batch shop to convert games from one cellphone architecture to another is probably not a great business for Microsoft to be in.
Then the second thing you can say is gosh you have this portable media device called the Zune, Apple has an iPod they have games on the iPod, we could have games on the Zune, again, something in theory we could do, the control mechanisms for the Zune would actually be better for gaming than the thumb methodology on the iPod, but we haven’t seen a lot of traction in that space around gaming and the Zune team is super focused on music and video, so I think you’re not likely to seea lot of activity there.
The final thing is, would you want to go to compete with DS and PSP and I’ll saythe same thing I’ve been saying for a long time on this, I’m really like being focused on Xbox 360, I think that has helped us a lot, I think trying to get in the portable gaming market would be a very, very tough battle, Nintendo is very good at it, I think it has hurt Sony to be in that space just because they’re fighting on multiple fronts and I don’t think you can do it as something you port from Xbox or from any other platform,
I think you have to have a unique concept design for a portable which means it’s a full new business, a full new investment, a full new set of hardware, it’s not something you can just sort of inch your way in. So, for me, we don’t see that as a big area of focus for us or a strategic focus for us. Yeah?
John Difucci - Bear Stearns
One question on Xbox and two on Xbox Live. The 17.7 million units shipped was Xbox, can you give us any gauge on what kind of shape the channel is in, since the holidays.
Actually channels in the right shape, I would say probably, how would I qualify that? We had places getting right to the end of holiday where we were starting to run a little thin, so I think we finished up the holiday right where we wanted to. I feel like we’re in good position there. Obviously varies a little from country to country, so, theUS is a little different from theUK which is a little different from Spain which is a little different from Australia. But, as an overall place we’re quite comfortable with where we are from an inventory perspective. Was there a second segment to that…
John Difucci - Bear Stearns
Yeah, a couple on Xbox Live. 10 million Xbox Live users, it looks like you’ve consistently hit an attach rate of about 50%, I’m just wondering how you see that as evolving, I would assume that would probably start to trail off a little bit, but it’s held up pretty steady.
You see Mindy and I laughing because you know everytime we think we know that, that number is going to go up or down we’re wrong and the number has been pretty steady, actually for quite a while and we said, gosh, in the period before Halo we think gosh it’s going to bea little slow during that period, we’re getting out of the hardcore gaming, the big bulk of the hardcore gamers had come first, then it would go down a little bit, then it would come back up with Halo, well it didn’t follow that track at all, it was a very steady ramp.
I think one of the things that helps with consistency on that, I will say, is that the subscription is a year-long subscription, so for the people who areGold Members, they stay on a year-long basis and that gets you through troughs where maybe there isn’t exactly the content they want but three months later there’s a piece of content they want so they want to keep the subscription current and you’re not asking people every month to think about whether I’m going to get charged another $7 for my Xbox Live subscription.
I think from a business model approach, that actually helps us and keeps that relatively stable. I think also the other thing that confounds us a little bit is the continued advance of broadband and its ubiquity in the home and as that becomes more ubiquitous it’s just easy to connect. Alright and that ease of connection really helps us, especially with Silver Members who are just logging on to look at things, share information, do some downloads, download some trailers, et cetera. Of course we can work to monetize those people outside of a subscription which is great for us.
John Difucci - Bear Stearns
Okay and just finally, you mentioned some of the issues you had with Xbox Live in your infrastructure, you did do some things to try and satisfy customers that might haven’t been to happy about it. Are you well positioned to avoid those issues in the future and I still sort of heard some issues might be out there.
Yeah let me just tell you, I can give you probably a fuller update. So this started to happen on 23, 24 December and then through that first three or four days after Christmas, there were times when it was very difficult to get on the service, we had trouble with people logging in and it wasn’t ten minute periods of time, it was reasonable chunks of time and reasonable numbers of people. That part, we’re well past now.
The part that you call the, gosh we just don’t have scale available to manage that. There are still, as you correctly report, some spot issues that we have and we’re tracking those down and pushing those out. From an architectural perspective, we should bein good shape and certainly inside the company we have the capability to just scale well beyond where we are now, think about what we do on Hotmail and Messenger, we shouldn’t have a scalability issue.
I think the thing that I take away from this is more of a planning exercise with the development team and with the service team, because we’re going to have to think more about capacity planning in a slightly different way. Shame on us for having things advance faster than we expected and not being ready for it, but we’re going to have to step up and put a little more capacity in and build some headroom on the architecture side so we just don’t have these problems, because we’re going to need the headroom eventually anyways and it’s an easy investment to decide to make, because of the pace of growth with our hardware, with our service we’re going to need more space anyway. Trying to run it tight isn’t actually very smart because you’re going to have to make the investment anyway.
That was my take-away from this is we should plan a little further out and leave ourselves more room because there’s no business reason not to do that. Yeah, in the middle. You have to wait for my people on the recording…
It seems like one of the big things this year is trying to connect theTV to the internet, lots of people would love to do it, seems like in general the way where if you architected a browser properly you could really push Live Search and Live services, on my Xbox I’d love to have it, curious why you haven’t gone that direction.
Yeah, I think, thinking through browsing on an Xbox is something we do periodically. It’s a hard problem because one of the things people love about Xbox Live is it’s a very managed ecosystem and a very managed service. So, you have, this will sound funny, the benefit of not being able to go anyplace you want, so there’s a little bit more structure and the recent outages notwithstanding, a lot better reliability and consistency of the experience you have.
There’s also dramatically higher security as a result of that because the service is a very thick service and we can manage the security in a very tight way that makes the content partners actually quite happy and quite comfortable. So, that’s really the reason we haven’t gone that way and the reason we haven’t pushed all that hard. We also don’t get, frankly, a lot of requests from customers to browse, which is interesting, but we don’t actually get that. Now, to your more general point, about getting content to the TV, I actually do think that’s an important point.
Xbox is one way to do that, the thing I would highlight for you is to think about an even better way, Xbox is a way to reach TVs that exist today, but the TVs that are coming new into the marketplace, boy there is going to bea host of turnover in TVs in people’s households over the next five to ten years. Having those TVs come network ready is super important. And I think you will see that as a trend in theTV space in general. The ability to plug in network connections directly into theTV and the ability to have that in our case be CD extender ready is very important. That’s something we’re going to work on and try to make that work.
The reason that’s important for me is because otherwise you have to assume that the customer has a box that has that specific software and technology in it, which means you either have to sell a lot of Xbox’s, given the number of TVs, you’ve got to sell an awful lot of Xbox’s to be extenders for that, or you got to convince people to spend somewhere between $199-$299 on a box that does nothing more than pass video through, across a network from an Xbox to a TV. I think there’s some people who would buy that certainly for pre-existing TVs, but the better way to get content there directly is to have itbe part of the TV, when you buy the TV you get it and you plug it in and you’re on the home network and ultimately on the internet. And certainly given what’s happening in chip technology, the cost of Ethernet connections and a TV, that whole cost structure is coming down, I think that’s certainly a reasonable thing to expect, it’s why you seeHP making an early move in that direction. Other questions? Yeah.
Robbie can you comment a little bit about the European business with Xbox, what you see as far as penetration into Continental Europe? And how Xbox Live differs in the European market relative to the North American market.
Sure, if you look atall of our territories, they’re all a little bit different. I will say that Europe isn’t Europe, certainly not in the gaming business. Soit varies actually quite widely by regions. We’re very strong in theUK and in general in northern Europe. We’re a little less strong in the middle of Europe and the smallest part of our performance is in southern Europe.
A lot of different reasons for that, it’s been that way historically, I think we’ve improved in each of those territories since Xbox1, but you still seean asymmetry in the business between the three territories. Sothe places where we have the most work to doin Europe would bein Italy, Spain and the southern part of Europe, a little bit also in France and Germany, the northern part of Europe continues to perform exceptionally well. Likewise if you went around the world, Australia, New Zealand continue to be very strong markets for us, in fact most of southeast Asia is actually quite strong for us, Korea is a place where Xbox1 did very poorly, it’s doing a little bit better now, not abig console market in general, but Japan is an interesting place to talk about briefly.
The numbers are no bigper se and so they don’t change the financial structure of the business very much, but we are performing better in Japan and I would describe the Xbox1 Japanese business as starting here and going up for two weeks and then down and then flat at a very very low level for the rest of the cycle. What you see with Xbox 360 is you’re starting from a fairly low level, but a nice steady engagement of the business and a steady rise in the business.
Still small share numbers but at least the foundation for future success and we aren’t getting much better support from Japanese third parties this generation than we did last generation, you see someone working from Capcom done in particular I’d highlight as great work they’ve done on the platform both in Japan and in the US and Europe, so, give you some idea of the way the different regions breakout.
Oh, sorry, second question was about how Live differs, and I think up until very recently Live differed in one important way, which was we didn’t have Video Marketplace in Europe compared to the United States. That’s now starting to change with France, Germany and the UK getting Video Marketplace this holiday you’ll see that start to grow. The other way it’s different and it actually doesn’t differ by country it differs by language.
You have to recognize that Live is, communication is such an important part of Live and voice communication is such an important part of it that the community does tend to breakout by people who speak English versus people who speak German, people who speak French, Italian, Spanish et cetera, it probably contributes a little to the fact that we don’t do quite as well in southern Europe because those language communities are smaller, where northern Europe, English, works pretty well even in countries even where it’s not the native language, so we get a little more Live engagement in northern Europe probably than we doin southern Europe. So I’d say maybe a small but a contributing factor to some of the regional differences that you seein the different places. Because Live is a very cultural place the different cultures and the different parts do effect it.
Last thing I’ll say about Europe, the market that is kind of the hardest to figure out is Germany. Leave aside our own performance there, video game consoles as a whole have not done super well in Germany and so the growth there is probably a little behind what we would seein the rest of Europe, both for our business and for the industry as a whole. It’s much more of a PC gaming market, a little bit like Korea and China in that respect. Different size style of games, but similar phenomenon. Lets go to the middle, a couple back here…
Just to step back, just abig picture question, in the fourth quarter through the holidays and post holidays, just the US consumer in general, you sell a broad range of products from mice and keyboards through Xbox’s, and are you seeing certain segments that are maybe more, if there is any sort of slowdown, more resistant to the slowdown vis-a-vis other segments which are more impacted.
You know, I should ask Mindy to comment on this as well, she’s probably closer to specific numbers and maybe I’ll take a crack at them and you talk about it a little maybe. We haven’t seen in general much impact on our business that we can tell thus far. I think the economic questions, part of that is I think questions have risen in the last few weeks and I think holiday kind of washes over all of that, so it’s a little tough to see.
The other thing I’ll say is many of the businesses, not all of them, many of the businesses we’re in have one of two characteristics. Either, they are things that people use when they decide to spend less on other things, so take video games, video games historically have done well independent of recessions, because when people do less travel, they do less discretionary spending, they want to have things they can doat home, you can call that a cocooning effect, but they want to do things that are close to home and video games is a great place for them to invest some money to be able to do that and they’re usually spending it on the kids, which is something they want to, sort of the last place where they tend to cut back. So, one characteristic is businesses that have that effect.
The other characteristic is businesses that have a unique cycle to them independent of the economy. Video games hasa little bit of that attribute to it, I’d saythe Media Room business is going through that right now, just because of a new business that effectively bring on new customers, people are moving from satellite to cable and other places, so it’s a substitute for them in many ways at this stage. And so people were spending the money anyway they’re choosing to spend itin a different place so it’s not as effected by the economy as you might think. Another example would be our Mac Office business, where with the release of a new product, you have a whole new cycle that again is kind of independent of what’s going on in the broad economy. I don’t know, have you seen anything else in the numbers to add to that?
No I’d sayat this point we haven’t seen anything; as of right now we haven’t seen any signs.
Questions, other questions, yeah we’ll do one down here.
Can you talk about theJapan console market and what are your plans there, do you have to wait until the next generation of Xbox to make a dent?
I’ll saya couple things about theJapan console market. First of allin general the market has, there’s less growth, leave Microsoft aside for a second, there’s less growth in that market in the console side than there is in the world. So and the fact that depending on what period you look at we’ve seen some decline in the Japan market as a whole, much of that moving towards cellphones and to some extent portable gaming, so, as a general statement, Japan is probably nominally slightly less a bigger portion of total than it used to be.
For us in particular, I think we’re on the right strategy with Japan. I don’t think we’re going to wait to make some progress, we’re going to continue to make progress, it’s going to bea market that we’re going to have to be at for a while for it to be a significant effect on the P&L and the [inaudible] business, but because of the opportunity there long term and because of the presence of so many third-parties there, it’s an important market for us to keep after. I certainly don’t think of it as waiting, nor do I think of it as there is some big surprise around the corner that’s going to make it simply a much bigger success than it is today.
We’ve got resources established there, we’ve got resources we’re investing there, it’s on a certain level and we’re going to keep pounding on that and we continue to seea nice steady rise, I’ll be a happy guy. And then, whenever the next generation comes around we’ll look at that again and say okay how do we getit to bump up to the next level. Another question in the middle.
Thank you. Can you talk a little bit about the Zune device and how it has done relative to your expectations and also atthe same time with the iPod Touch out there, how do we see this device evolve over time and what else can you…thank you.
Sure. So we look at the Zune business as having done exactly what we expected to do, let me talk about that in a couple of different parameters. The first thing I’d say and the most important thing is, we have a really great product. I’m happy to take the Zune hardware, the [unintelligible] and the device, the [unintelligible] and the PC, our market place and who’s social, compete with Apple head up and review, I think we’ll win some percentage of those reviews and I think if we getan objective hearing with people who don’t look atthe fact that Apple hasa big install base and a big market share, the product is very, very competitive and you can only see that increase. We’ve got a very smart team of people who are working on that so I think you’re going to see some great things from the product.
The second thing I’ll say, we think we know some things we can do to help differentiate it, we talked about one of those last night, Zune Social. We think changes the way people think about music as being more than just a track, but as an experience that involves more than just listening to the song but doing things with your friends, sharing the music, understanding the artist, those types of things, we think that’s quite powerful and building, if you will, the equivalent of what we’ve done on Xbox around gaming, doing the same thing around music, we think is actually an important opportunity for us.
In terms of market share and unit numbers, the mix has been a little different than we expected. We’ve had better performance on the 80 Gig than we expected and a little less on the 4 and the 8 Gig than we expected. We also think there’s been a little bit of cannibalization from the 30 Gig because of the price point that has been at, that’s made the 4 and the 8 look a little less attractive. As the inventory on the 30 Gig has gone down in the channel you’ve seen the 4 and the 8 Gig come up, so I think we know there’s some substitution effect that’s going on at that price point.
In terms of perception and this will be my final point here, I think there’s no question that when people look at it, in the United States, that’s the only place we’re in the market just yet, when people look at, alright who arethe two guys who are going to be legitimate players in this going forward, I think you have to certainly put Apple in that camp and put us in that camp. And then we’ll see, Europe, just to comment on that, is actually quite different from a music devices are actually quite less popular there, cellphones are much more popular there as music players, Sony Erickson has particularly done very well selling phones there that are also media devices, there’s some unique differences they have in their cellphone market that makes that possible because things are subsidized, you buy it retail, it’s very different, a very different environment. So we’re going to continue to evaluate what we do outside of North America, decide how we want to approach the European market, you saw our acquisition of [Muse You Wav], not abig financial number in terms of the acquisition but in terms of strategic importance, it’s an important part of what we’re doing with our Windows Mobile side of the house. So we’re starting to lay the groundwork for understanding how we pursue music in that broader marketplace. Yeah, right next to you, then I’ll come over on this side.
Yeah, two questions. First of all, just when you look at your third-party relationships, last year I think there was some talk coming into the year that the third-party publishers may have to decide where they’re going to focus their development efforts, which platforms, et cetera, I know it’s early but do you see any movement today among publishers talk that you know they need to be very proactive about how they actually take a title to market, whether it’s on Microsoft first or Microsoft and Sony first, Nintendo, et cetera, are you seeing any movement at this point, I know it’s early, going into ’08?
Sure. I think the only comment I’d be able to make on that is we’ve seen a continued strong pursuit of our third-parties doing Xbox 360 from the beginning and as the native, if you will, form of develop, consistently we hear that our platform is easier to develop on, certainly the PS3, people tend to start there and port PS3 sometimes it means they’re doing [inaudible], mean there’s a time difference, it’s sort of an ironic way sort of the reverse of what we had in the Xbox PS2 generation and I haven’t seen any change in that and even relative to Wii’s success.
What we’ve seen there is people just saying, hey, there’s some specific content I have that makes sense on the Wii, I’ll probably still do it on the 360, but it’s going to have more important for me on the Wii just because it’s the nature of the content, but in the broad portfolio of their product, we haven’t seen much difference there either and in general third-parties haven’t been super successful on the Wii, so it’s not clear, development doesn’t cost very much, we should say that, costs are less but the upside is significantly less too because their penetration has been mostly with Nintendo titles. Yeah, question in the back. Quick follow up, okay.
If you look at just in the industry there’s some interesting M&A deals having been done in the past year, coupled with you’ve got Halo 3 that just made it very well, I guess where do you prioritize building more [unintelligible] through acquisition, maybe also, hammering the competition in the marketplace at the same time by taking titles that would have gone on to peer [unintelligible] to now owning it outright.
Yeah it goes back to what I said earlier about our first-party strategy in general and that strategy hasn’t really changed which is, there’s a certain number of titles and a certain type set of genres taking advantage of certain features of the system that we’re going to want to produce and we’re going to make money doing that. You will seea constant shift of stuff that goes from pure first-party back and forth between licensed published business let’s call that, occasionally we’ll doan acquisition, I wouldn’t rule that out, we did one last year, certainly possible we could do one this year, but there isn’t a, oh gosh we need to go at capacity initiative underway.
In fact I don’t, I’ve, in the time I’ve been here, we’ve ever had that initiative underway. Final thing I’ll say is even if we wanted to do more first party work, more likely way for us to doit as opposed to an outright acquisition would be to work with somebody on a publishing relationship, make sure we’re comfortable with the development team and the intellectual property, build it that way then acquire as a result of that. That has been our traditional M.O. ithas worked quite successfully historically.
So much of buying stuff in this space, you buy IT but you also buy talent and you better know the talent you’re buying and so it’s easier for us to work with someone for a period of time before we take, let’s saya bigger jump from an acquisition perspective and having them part of Microsoft company. Now, to the back.
Yeah, just a question on blue-ray versus HD, just your thoughts on that and is Xbox Live going to make the argument moot?
Yeah, let’s talk about, I’ll sorry of handle the narrow topic and the broad topic, I think there’s both.
On the narrow topic of HD-DVD and blue, the interest we have, certainly we’ve been a supporter of Toshiba and HD-DVD, the predominate reason for that has been the investment we have made in something most people don’t see called HDI, which is the interactive software that enables people to create interactivity into these new disks and one of the benefits of new high definition disks, both blue-ray and HD-DVD is this opportunity for internet connectivity and interactivity and you need an authoring layer for that. HD-DVD chose our HDI technology for that, BD chose ajava based implementation. So, from a business perspective you should understand that that’s really the primary business engagement we actually have in that space and it’s important for us to continue to support Toshiba and we’ll do that and continue to support our partner in whatever direction they choose to go, but in fact as a percentage of our business from an economic perspective it’s a small percentage of our business.
In terms of how it effects Xbox, because HD-DVD is a peripheral for us, if HD-DVD somehow is successful, that’s fine for us we have the peripheral. If for whatever reason and maybe the Warner announcement is the thing that moves it this direction, it becomes a BD world, it’s an accessory for us, our involvement is still as an accessory, again it’s a small part of the business, it’s not an accessory that has big attach for us so it’s not a big economic [unintelligible]. I think most gamers buy game consoles to play games and if they can do some other things with it, fine, some of them decide to just buy the accessory, but I think as has been demonstrated in the market, people who don’t want to pay $50-$100 more to have the accessory included and I think we would see that continue.
Now that sort of specific thing, let’s talk a little more generally about where we see that going, because there is a transition happening in the space and I think we’re kind of two transitions going at the same time. The first transition is in the disk space world where we’re moving from DVD to a higher definition DVD and I think that’s a real transition and there will be a shift up to that both on the hardware platform and on the disks themselves. I don’t think it’s going of the scale and frankly I don’t think anybody else thinks it’s going to be of the scale of VHS to DVD, because the differences in quality just aren’t as high, there’s not quite as compelling a reason to shift and you’re certainly not going to back catalog rush that you saw with VHS to DVD. Nevertheless I think the shift is real, I think people will buy high definition players of one form or another and I think you will see disks, a migration happen there, so hopefully for the movie industry and our partners in the movie industry that will be a positive thing for their business.
Now having said that, I also think there’s a second shift going on, which you alluded to, which is to direct digital distribution. In our case today that’s on Xbox Live Video Marketplace, there’s other places it’s happening, either from producer’s own websites or through other services that are offering, Amazon and other people have services in the space. I think that’s also a real transition, I think it will happen concurrently with this disk transition and you’ll end up ina world in which video will be distributed from direct online and some through disks and hopefully again for the industry the total is bigger than it is today, that would be the goal. I don’t think by the way, those two things arein any kind of conflict. I think they can both happen, both be successful and both work. Certainly for Microsoft, we have more vested interested in the digital distribution side of that, it’s much more software intensive, it’s a place where online services come into play in a better way and so you’re likely to see more of our engagement with the studios be on that part the business than it is to be on the disk part of the business. Like I said we can do some software work on the disk part of the business but it’s not a huge play.
Final thing that HDI technology that I talked about can work on disk or online. So for us from an investment perspective we want to add interactivity to the content whether of how it gets delivered and so that technology is important for our future either way. Is that helpful to you, some context of what’s going on there? Other questions? Got one way in the back and then I’ll come back down to the front.
My apologies, you might have touched on this, but just on the IPTV relationship and the emerging model that you’re building there, could you talk a little about how the carrier economics versus the Microsoft economics are going to play out if that gets deployed across the various markets?
IPTV or Media Room as a whole, I think the economics are relatively straightforward in the sense that there’s a business relationship between us and the operator, they license our software, they commit as a client-server plus maintenance business model very similar to what we doin our server side of our business and in fact we use much of our [inaudible] technology actually in that part of the business and we benefit from volume, the more volume the operator does the more business for us.
Likewise from the operators perspective they obviously benefit from volumes because they’re able to go sell the service to their customer base, so initially for the operators they’re all making pretty big investments in the network infrastructure to enable it to happen, AT&T has certainly made it clear that they’re making abig investment here, I think British Telecom, Deutsche Telecom, others would saythe same thing, and, oh the Xbox specifically you should think of this as a good opportunity for both of us, I think it’s an opportunity for us to see some consoles sold to people who might not start with console sale but who might say hey I’m getting a set top box anyway I should get the console then I have gaming as well.
So we think of it as very incremental to our business, we’ll see how big it is, I don’t actually have a good sense yet for how much of an increment it is, we don’t think it’s a substitution effect, frankly, we think it’s mostly an incremental business. For the operators it’s good economics for the operators because the set-top box is a part of the cost structure, it’s the least exciting part of thecost structure for them because they’re not super powerful boxes, there’s not a ton you can do with them by design and so they end up either subsidizing or having the economics be kind of lukewarm for them. Gives them a chance something where customers really engage and be willing to pay for the box in addition.
Robbie, can you talk about parts of your business where you started to or integrate some of the ad services businesses in, especially in the IPTV, could the other parts made acquisition on the gaming side?
Sure. The advertising you’ll see today in two predominate in my business. First is on Xbox with the work we’re doing, we’re doing there, we’re starting to see, I say, nice solid traction there, actually I should point out that actually ithas two components, one is the work we do with in game advertising on Xbox Live and in game itself, the other is work we do with our casual gaming services, which is business we’ve had for ten years, that’s not a new phenomenon, you should think of that more like an MSN property and a casual business that goes along with Pogo and a number of other people in that space.
Then the other place where you’ll see meaningful advertising work from us is in the cellphone business, where over time, I showed a little bit of that last night, with theads from Paramount for the movie Cloverfield. I think you’re going to see some opportunities there. I think the challenge there is understanding the nature of how the advertising model works and sorting that through. I think everbody believes as do I that advertising is something that can be valuable there, figuring out how to fit through theform factor and the user experience is the issue, I don’t think it’s as simple as, oh you have search on the phone therefore there’s advertising based search, I don’t think it’s quite that simple. I don’t know Mindy is there other stuff we should add from the advertising?
The other thing I probably should point out, across E&D, I would have said a year ago that we had agap in both of our product and business plan around advertising and that we hadn’t thought about it enough. We’ve now thought about ita lot. So you’re going to see more from us in that space in general, I don’t think the predominant form of monetization in very many places but I do think a form of monetization that’s important for us and we’ve probably missed a few opportunities in the past 12 months by not being more deeply engaged and we have addressed that.
Robbie I’d like to be mindful of your schedule, probably two more questions.
Alright I owe one down here in the front and then I’m going to grab one right there. So go ahead.
Comment on the potential for motion sensitivity in the Xbox and then separately on China, talk about the potential for an Xbox console market there and also anything culturally or why do you think micro-transactions are working so well in China versus other areas.
Sure, motion sensitivity, I’ll rephrase because you were being nice, motion sensitivity, are you going to do something like Wii does for the Xbox 360? We’ve looked at different mechanisms for input both historically and since the Wii came out, we’ll continue to look at it, maybe there will be things we’ll do there. I don’t think for us it’s abig part of what we do, frankly we look at Nintendo and the Wii as, in one way, competition certainly, but in another way, almost complimentary because they provide a fairly different experience than what we provide on Xbox 360 and partly it’s a different customer.
If you were doing the mathematics Ven diagram of our two businesses and added Sony, you’d have two circles with Microsoft and Sony that were very close to each other and you’d have a third one that cut into those circles in the sense that they overlap, but would have a whole set of things that were different from that, we joke but I think it’s the reality I think there’s going to bea lot of Wii 360 households in the world. And so while we look at it and think about it I don’t know that it’s a particularly big strategic thing for us to focus on.
Your second question was on…yeah China is a tough interesting market, let mesay it this way, it’s defiantly a market we’d like to be in, certainly has scale, it hasa couple things challenging about it, one is just the piracy issues and that. I actually think we can work through that, I don’t think that’s the biggest barrier actually, I think we can find ways around that, complicated but I think we could find ways through that.
The second is it’s a highly regulated market. That makes entry difficult from a number of different perspectives in terms of partnerships you have to have, support from the government you have to have and figuring out which part of the government actually has to support you is complicated, there’s at least three ministries who think it’s their job to approve whether a console comes into China, so there’s actually some real complexity there.
And then the third thing you have to think about, it’s a PC gaming market. And that’s good for us. Microsoft likes PC gaming markets, that’s very positive for PC sales, as PC sales become more and more legalized that is happening. Gaming is a great application for the company, so ina way I could say, yes, we want to be inChina and we’re already there and our job is now to monetize those PCsin a better way. I don’t know whether console gaming will be bigin China or not, if and when we getin there or somebody else does.
From a business perspective the country is big enough, but even if it was a smaller percentage of gaming it still would be a good investment if we could figure out a way to do it, so I’m not saying one way or the other about what we’re going to do, but just in the grand scheme of things you should think of that more as a PC gaming market and think about the positive impact that has on our business in on the PC side as opposed to some big engine that’s going to change the way we think about Xbox.
And micro-transactions are popular there because of the economics, the way the economy works, people have less disposable income and sothe ability to do things in smaller chunks [unintelligible]. They may end up spending just as much money but I think because it’s done in that way I think it actually supports better in terms of what the culture.
One last question here and then we’ll wrap up. I know you guys are eager to tromp back to the convention center.
Just as a follow up on the advertising question, you think about the mobile platform and how big that opportunity gets, how are you guys thinking about it two years out, how big is mobile advertising?
Yeah, here’s what I would say about that, I think, well the data, the analyst data when you roll it up to 2011, it’s about a $10-$11 billion industry in advertising. Now, I’m not exactly sure how people come up with that number because I’m not sure anybody really knows how advertising is going to work on a phone, so a little bit of that is an excel extrapolation I expect. But even so let’s say it’s off by 10-15%, it’s a big number. If it’s off by 20%, it’s still abig number, so we think it’s absolutely a space worth investing time and energy into.
The things that we focused on for when those mobile is making sure we have the right infrastructure for the OS for it, making sure we have the right relationships with operators and the OEMs to make sure that works well and to make sure we’re doing the software work that does innovative ways to expose advertising, this is work around location based services, it’s work around search [unintelligible] in particular, audio search as opposed to text search, ways to enable people to get things done on the go ina world in which they don’t have abig keyboard and abig browser and abig screen but still want to get things done.
I think there is room for innovation there, I think it’s completely open market, I think there was some people when Google announced [AdSense] they said, oh wow they’re going to make a lot of money because they monetized this through advertising et cetera, maybe, but it’s not clear what assets that they bring to the table other than having been engaged in advertising in general and we probably have more assets in mobile, well I know we have more assets in the mobile space than just about anybody in terms of trying to figure out how software as a service work.
So I think we’re actually very well positioned there for us now it’s a question of execution and making sure we execute well. I want to thank you guys for being a good audience, being patient and I appreciate you coming out and I hope you have a good rest of the week at CES. Thanks very much.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!