I give anextra welcome to those of us joining via the web. My name is John Ellis I work atMicrosoft Investor Relations as does my colleague Emily Zander in the back. She recently joined thegroup and helped coordinate this event. We’re of course joined today by Robbie Bach, president of our Entertainmentand Devices Division and Mindy Mount, CFO of our Entertainment and DevicesDivision.
We’re going to follow thesame format as we have in the past, Robbie’sgoing to make a fewintroductory remarks and then we’ll spend thevast majority of our time answering your questions. Should you ask aquestion, consider this as implied consent to have your voice or likenessincluded in ourwebcast, both live and recorded along with thetranscript of this session atthe Microsoft investorwebsite.
Continuing ina similar vein ofdisclosure, please beaware that today’s presentation may include forward looking statements based onour current expectations and assumptions about thebusiness and aresubject to risks and uncertainties. Ouractual results could differ materially because of risk factors we may discusstoday and have identified inour most recent 10Q and 10K filings.
You should also note that we areright in front of ourearnings release, we arein our quiet period, sowe will not talk about business results of theDecember quarter outside of what was discussed last night in the keynotespeech.
Additionally we won’t beupdating any financial guidance today, as much as you may try. With that I’d like to thank Rob and Mindy fortheir time and I turn thefloor over to Robbie.
Thanks John. Thankseverybody. I thought what I’d dois spend as little time as possible reviewing what we did last night but just doit incase people didn’t seeit and just summarizewhat we discussed last night and then try and turn itover to you for questions on any number of directions you want to go.
Basically what Bill and I tried to dolast night was lay out two levels of things going on. Thefirst is his long termvision for how he seesthe next digitaldecade laying out, what arethings he thinks areimportant and thedirection we’re going. We saw thatcertainly in thefirst part of his speech where hetalked about itdirectly and then you saw itat theend of the speechwhere we did the demo usingthe new work from theMicrosoft research group, talk about how mobile phones, cameras and otherthings might beinvolved in thebusiness in thefuture.
Thesecond thing we wanted to dois talk a little bitabout things that areevolving in thecurrent business. Whether that bethings we’re doing in theonline space, we did avery nice demo on Windows Live last night, we talked about how Live is going tobe acentral part of theservices we deliver and thework that we do goingforward. We also showed some technologyduring the eveningaround new ways of interfacing with technology whether that was thetouch work we did on Surface, or whether that was thevoice work you saw us dowith Tellme and in theMicrosoft Auto case was also quite exciting. And then you saw talk from atechnologies perspective thework we’re doing around social interactions with what we’re doing with Zune andZune social and how that plays out.
There were also anumber of announcements made on content partnerships, certainly animportant part of thework we do. I’ll highlight theMSN NBC announcement around theOlympics as being aparticularly important one. Both our MSNbusiness and our online business as awhole in thebusiness I manage, theannouncements with Disney and ABCfor their television content and MGN for themovie content, certainly were highlight announcements.
We also wanted to highlight some business results andperformance from theprevious year. I talked quite abit about metrics around Xbox, some of which you had heard during thepress release a fewdays before, some of which was through last night. I think notable amongst that arethree data points. One, the17.7 million consoles sold thus far [life] to date. Thesecond, and I think aphenomenal number, is the10 million members on our Xbox Live service, about sixmonths in advance ofwhen we were anticipating reaching that number and we’ve seen certainly in the months of Novemberand December a rapidacceleration on that service, very excited about that. And then thethird number was thenumber we talked about interms of revenue and we took theUS market, where we have thebest data because of MTDand through the monthof November, Xbox hasbeen about a $2.5billion dollar business, that’s about $1 billion ahead of Nintendo and about $2billion ahead of where [the seat three hasbeen]. Certainly, Nintendo does betterthan that in units,because their price-points arelower and their attach on games is significantly lower than ours as well. Our view is we should belooking at theentire business, theecosystem we’re building, since that’s what’s going to determine how things aregoing to happen in thefuture.
We also talked acouple of other metrics around businesses, 1 million TVs on our Media Roomservice, that is adramatic increase. I’m not sure I couldhave quoted you anumber last year, sothat’s a bigstep up in thatbusiness, we see rapidacceleration there. Media Center, wemade several announcements there around support from Samsung and HP, theimportant point being there that theeasier we can make itto get digital contentto the television, themore effective we’re going to bein theconnected entertainment space. And if wecan do that ina way that doesn’trequire yet another box connected to aTV, all thebetter. That’s why it’s very exciting tosee HPbring their media smart TVs with extended technology actually built into theTV, with a networkconnection built into theTV as being avery important step forward inthat area.
You saw theAuto demo was I think indicative inpart of the naturalinterface work that I talked about, but also indicative of anice new relationship we have with anew industry that I think we can growover time. In the grand scheme ofour business, it’s not ahuge business in thegrand scheme of E&D, but on theother hand, from atechnology and customer perspective, it’s actually quite abig business andimportant part of what we’re doing with connected entertainment.
Sowith that, I think I will pause and we’ll turn itover 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’tanswer a question andJohn will give me asignal and we’ll go from there. Questions,either person in thefront go ahead. Please wait till we passthe mic for people whoare listening on theweb.
Ben Schachter – UBS
Thelast thing you mentioned almost inpassing a deal you didwith BT around turningthe 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 strategythere? And thesecond question, if you could just give ageneral thought on theidea of console cycle.
Ben Schachter – UBS
Something about thelength, how is itdifferent now than what we’ve…
Sure, solet me talk about theBT announcement. Last year atthis time, we showed Xbox 360 acting as aset-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 theworld. BTwill be thefirst one to offer Xbox 360’s, basically you would go buy anXbox 360 from T, that box would function just like aregular Xbox 360 would, and inaddition would have theclient’s software on itto run as a set-topbox from BT Visionservice. That enables them to delivervideo on demand, DVRfunctionality and other functionality to their customers.
That’s anexciting step forward for us ina number of ways. For us, itmeans deeper penetration of Xbox, from our customer’s perspective it’s one lessthing connected to theTV, from BT’s perspective, it’s effectively aset-top box they don’t have to subsidize because there’s actually realfunctionality built into theset-top box that people would actually bewilling to payfor. Soit’s a nicewin-win-win around and for customers they just geta better integratedexperience.
So, that will rollout at BT, we aretalking to other network operators about that functionality and have been. I will tell you that for agood portion of 2007, network operators said that’s something we definitelywant to do and rightnow we want to work on scaling our implementation of Media Room, both thework with Microsoft we’re doing as well as thework they were doing in the back office and intheir installation work.
Clearly this is new businesses for them sothey’re gearing up and getting that figured out. What you now see, I’d sayin this last quarterof work is, we’ll pass those hurdles now and now they arelooking beyond how to expand thebusiness, so I thinkyou will see uscontinue to build new opportunities with other network operators beyondBT. But BTwill be thefirst.
To your second question about thelifecycle for this generation of consoles, I’d saythe following, I thinkcertainly as you’ve seen with DS2 and themidlife of that product, there should beevery expectation that thelife cycle of a 360will be certainlylonger than an Xboxlifecycle was. And theXbox case, we artificially shortened that lifecycle because of theeconomics on thebox. Consuming that lifecycle wasn’tbeneficial from aP&L perspective. Inthis case because of theway we built theeconomics into theconsole, we’d be muchmore in aposition to extend thelife even if after some date we come out with another console.
Soindependent of predicting thecycles of the industryper se, you shouldthink of Xbox as having aslightly longer lifecycle this time than itdid last time, certainly more of atale in terms of ourability to continue to sell inthat marketplace. Nothing specific interms of years or dates or anything like that, but this is ageneral philosophy inhow we’ve approached thebusiness, that’s theway we think about thebusiness cycle forward. Otherquestions? I’ll come down therow next.
Rick Schilling – Galiant Group
Rob, could you talk about margins interms of the -- Idon’t want to talk about this past quarter -- but with Halo 3 I’m sure it’sgood, but with thedirection going forward now that you’ve got thesoftware ramped up and thevolumes where they are, how would you think about volumes over thenext couple years.
You mean on theXbox business or just overall?
Rick Schilling – Galiant Group
Well, I’m thinking theXbox business but I think that kind of drives theoverall business.
Well itdoes and itdoesn’t. Let metalk about E&D first then I’ll come down to talk about Xbox. E&D on amargin level, if you think Microsoft hasgotten a littlecomplicated on amargin level, E&D on amargin level is actually quite complicated because of thenumber of businesses we’re inand the differencebusiness models that each of them hasand so none of themargin structures for any of those businesses arethe same.
We have some businesses that arepure package goods retail software businesses, like MacOffice, which has acertain margin in thestructure associated with it, we have businesses that arepure hardware businesses, like my keyboard which hasa completely differentmargin structure associated with it, we have businesses that areroyalty businesses, like Windows Mobile business, that is yet another marginstructure associated with it.
If you take Xbox Live, just as anexample, within theXbox, you have anadvertising business, adownload business and asubscription business allbaked into one, sothat has anothermargin business. Media Room, you shouldthink about as being aclient-server model, much more like our sequel server business, sothat has yet anotherclient license, server license, maintenance model that goes with it. Atthe E&D level, itmakes doing a marginanalysis, I’ll say, quite complicated. You do have to atsome level break itdown into some of thecomponent businesses to actually have areasonably intelligent conversation about how itgoes and I know that makes modeling for you guys that much morecomplicated.
Theother thing to remember about that margin discussion is theway money goes from revenue to contribution margin of profit is different ineach of those businesses as well. Someof them are lowrevenue businesses but high margin, soit makes top line andbottom line quarter to quarter alittle tricky. Managing that makes that alittle tricky.
Relative to Xbox, I’ll just saythe following interms of how we think about this. Themodel continues to drive theconsole itself to neutral and gross margin and dothat as closely as we can and like I said before sometimes we’ll beright side up on that, because we’ll beat apoint where we haven’t lowered prices but consoles costs have come down andsometimes it’ll be theother way around, but over time you should seethat level itself off. This is absent thewarranty currency charges that we took last year, but that’s anadditional added component to what we did.
And then, on themoney is in games,peripherals and Xbox Live, Xbox Live, I would have said in the first generationof Xbox, neither here nor there on theT&L, Xbox Live today, with 10 million members and 3 different businessmodels, you know actually hasa meaningful impact onwhat we do, thebusiness we can track and measure and seeprofitability and all thebusinesses.
So, that’s kind of theway you have to think about thecomponents, then within thegames business you have to divide itinto a coupledifferent components, there’s third-party business, which is again aroyalty business and then there’s our first-party business, some of which isinternally developed titles, some of which is stuff we publish outside. Sothat’s kind of thetour Rick, I don’t know if that helps, that’s kind of thetour. Interms of trend, with theexception of what I highlighted with Xbox Live as its continued growth hashelped contribute. I don’t think there’s alot to change sortof trend perspective.
I think most of it’s sort of what we’ve been saying for awhile, certainly very different from Xbox1, that I would say, themargins are actuallyquite different from Xbox1. We had aquestion down the aislefrom Rick, so…
Maybe we could just dig into theXbox Live number there alittle bit. Partly, how areyou monetizing, you’re monetizing mainly thesubscriptions I imagine atthis point, could you also dosome color on the 10million users, I’d imagine Halo had abig effect on that, areyou seeing differences in the subscription ratesand do you have newgoals now for year end?
Let’s drill down alittle bit on what we seegoing on Xbox Live. Certainly thelargest form ofmonetization is subscriptions. Predominately that’s $49 ayear, there’s a fewother plans that you can beon, but most, the vastmajority of people who aresubscribers, what we call GoldMembers are on a$49 a year plan. I will saythat the mix ofbusiness that is download and ad based is growing, percentage base it’s growthquite big, percentage interms of the totalstill quite small, but we dosee that taking abigger piece of thepie over time.
I think for theforeseeable future subscriptions is still thepredominate form ofmonetization there. But I dolike having thebalance of the three, itenables us to make offers and reach aset of customers that we could not reach with asubscription offer, because asubscription offer is amulti-player gaming offer and that reaches acertain set of customers. What’s niceabout the ad supportand download business is itenables us to reach people who aremaybe gamers, but they’re probably more casual gamers, abroader audience, maybe alittle less engaged, but still want to have afun experience. SoI think from that perspective, it’s actually quite good.
Thesecond part of your question was? Ohyeah, context of the10 million people. I think asignificant amount of that growth happened as, sort of thetriple play, if you will, of our price cut, Halo 3 and agreat content line up in the fall holidayperiod and I’ll comment on itjust because it’s in thenews. That actually left ussurprised. Thegrowth was much faster than we expected.
As I said, we were expecting 10 million members by theend of the fiscalyear, we had 10 million members by theend of December, we did have some challenges on theservice, keeping the servicerunning at thescalability we did. We had concurrencyrecords almost everyday for several weeks during theholiday period, sothat’s been a pleasantchallenge in thesense of success and unpleasant challenge for our customers. We tried to dosome things to thank them for their patience and obviously on top of thatproblem, getting theservice back to its usual high-uptime standards.
But again, from alonger term business perspective, we’ve seen alot of growth from those titles, ithappened more quickly. Now, just becauseits title driven I don’t think itactually means allthose are subscribers,some of them arecertainly, but thefact that we’ve driven alot of new consoles brings people into theenvironment and a lotof them start as Silver subscribers first before they decide to doa Goldsubscription and themultiplayer option.
So, I think we’ve finally seen agood mix of all of theabove in what we’vedone and in terms ofprojections for thefuture, frankly, we haven’t had thetime to digest what happened atthe holiday toactually assess what’s going to happen over time and how we seethat happening over thenext six months andwe’ll do thatwork. One thing we have been thinkingabout Xbox Live just ingeneral is, as we’ve gotten to thescale of the number ofusers we have and theamount of content we have on thedownload side, we have to dosome work to make iteasier to find things. Theuser experience of finding things ina longlist box is not super satisfying, your thumb gets alittle sore on thescroll button. So, we’re going to haveto do some work tohelp program the side alittle bit, bring some things to thetop, make it easierfor people to find thebest content and thethings they’re looking for, things like that.
It’s allgood design work that we know how to do, but, just from thecontext of, wow this is really scaling, we’re increasingly thinking ofourselves as being in aprogramming the siteenvironment as opposed to just putting things there in the marketplace andletting people go shop and browse. Otherquestions? Yeah? Down in the front.
Brent Thill – Citi
Yeah, Brent Thill with Citi. Robbie can you elaborate on your internal content strategy, now lifewithout Halo kind feeds back to Rick’s question on margins. That seemed to bethe biggestcontribution, themargins are now withHalo and perhaps other content disappearing like Mass Effect.
Well lets talk about that in the followingcontext. First of all, we should beclear, Halo didn’t go anywhere. SoMicrosoft owns all theHalo IP, we can dothat Halo work with theBungee team going forward if we want. Also, if we want to doit with another team,internal team or some other team, we can dothat, so Halo didn’tgo away, the franchisevalue we have in thatdidn’t go away, themargins structure of that doesn’t go away, you should think of that as stillbeing a greatbusiness. Bungee wanted to have moreartistic freedom and theability to work on some projects outside of Halo and sothat’s why we’ve developed thestructure we have enabled them to dothat. But infact they’re still in thesame building they were intwo years ago, they’re still working on things for us related to Halo, as wellas some other things, so, don’t take that too far interms of how you think about theanalysis.
Interms of other things that aregoing on in thefirst-party business, you know you aregoing to see us as wehave always in thebusiness, move contentout of theportfolio. We’ve had apretty dynamic mix of things that aredeveloped by Microsoft employees and third-parties, I think you’ll seethat continue. Mass Effect is afabulously performing product, but given theway the ownershipstructure has changed,it may not make sensefor us to be thelong term caretaker ofthat, we’ll evaluate that, we talk to EA about itall thetime. SoI think there’s good ways for us to evolve that portfolio, you should think offirst party as being on theexactly the samestrategy as its been on for awhile, which is A wehave to do agood profitable business there, Bwe have to show off and showcase theplatform. Itdoesn’t mean we’re going to doa ton of titles, wewon’t, but we will do bigtitles, we’ll dotitles of high quality.
If you look atthe quality ofMicrosoft Game Studios titles, it’s phenomenally hotas an average inthat [inaudible]. Look atthe Metacriticnumbers, it’s amazingly consistent how well we do, now, we don’t doas many titles as some other guys doand so that means wehave less volume, but thequality is there and theunits per title issubstantially higher. I think you’ll seethat continue. Yeah? We’re going to need to try themicrophone…
What doyou think you and your competitors will start mounting thenext strategy consoles acouple years from theinitial launch and second, what areyou plans for aportable gaming system?
First question is pretty easy to answer, I don’t know. Certainly don’t know what my competitors areplanning to do. That’s along game theoryexercise that a lot ofpeople will start thinking about, but we don’t certainly have anything tocomment on that, and relative to our own plans, we’re doing what we always dowhich is, we’re constantly scanning thetechnology and looking for things that could bebreakthroughs for next generation work, but there isn’t anything that would bemeaningful to discuss there. There is aton of business to bedone this generation and aton of work to enable that business, that’s where allthe resources of theteam are focused.
Interms of your question about portable gaming, there’s kind of three ways youcan think about portable gaming. One,you can think about what’s going on incellphones and we’ve dabbled inthat a little bit,we’ve licensed some of our intellectual property to people to dothings on cellphones. I haven’t seen itas a bigstrategic initiative for us, nor have I seen itas a bigprofit driver for us, sowe’ll do some thingsprobably opportunistically there. Maybethere’s things we should bedoing in theWindows Mobile space, but even there I haven’t seen thecustomer demand or desire yet.
Itturns out that that business is from afinancial structure, atough business for us to bein because it’s avery cost sensitivebusiness and you have to drive high volume across alot of platforms for itto make sense and being abatch shop to convert games from one cellphone architecture to another isprobably not a greatbusiness for Microsoft to bein.
Then thesecond thing you can sayis gosh you have this portable media device called theZune, Apple has aniPod they have games on theiPod, we could have games on theZune, again, something intheory we could do, thecontrol mechanisms for theZune would actually bebetter for gaming than thethumb methodology on theiPod, but we haven’t seen alot of traction inthat space around gaming and theZune team is super focused on music and video, soI think you’re not likely to seea lot of activitythere.
Thefinal thing is, would you want to go to compete with DS and PSP and I’ll saythe same thing I’vebeen saying for a longtime on this, I’m really like being focused on Xbox 360, I think that hashelped us a lot, Ithink trying to get in the portable gamingmarket would be avery, very tough battle, Nintendo is very good atit, I think it hashurt Sony to be inthat space just because they’re fighting on multiple fronts and I don’t thinkyou can do itas something you port from Xbox or from any other platform,
I think you have to have aunique concept design for aportable which means it’s afull new business, afull new investment, afull new set of hardware, it’s not something you can just sort of inch your wayin. So, for me, we don’t seethat as a bigarea of focus for us or astrategic focus for us. Yeah?
John Difucci - BearStearns
One question on Xbox and two on Xbox Live. The17.7 million units shipped was Xbox, can you give us any gauge on what kind ofshape the channel isin, since theholidays.
Actually channels in the right shape, Iwould say probably,how would I qualify that? We had placesgetting right to theend of holiday where we were starting to run alittle thin, so Ithink we finished up theholiday right where we wanted to. I feellike we’re in good positionthere. Obviously varies alittle from country to country, so, theUS is alittle different from theUK which is alittle different from Spainwhich is a littledifferent from Australia. But, as anoverall place we’re quite comfortable with where we arefrom an inventoryperspective. Was there asecond segment to that…
John Difucci - BearStearns
Yeah, acouple on Xbox Live. 10 million XboxLive users, it lookslike you’ve consistently hit anattach rate of about50%, I’m just wondering how you seethat as evolving, I would assume that would probably start to trail off alittle bit, but it’s held up pretty steady.
You seeMindy and I laughing because you know everytime we think we know that, thatnumber is going to go up or down we’re wrong and thenumber has been prettysteady, actually for quite awhile and we said, gosh, in the period before Halowe think gosh it’s going to bea little slow duringthat period, we’re getting out of thehardcore gaming, the bigbulk of the hardcoregamers had come first, then itwould go down a littlebit, then it wouldcome back up with Halo, well itdidn’t follow that track atall, it was avery steady ramp.
I think one of thethings that helps with consistency on that, I will say, is that thesubscription is ayear-long subscription, sofor the people who areGold Members, theystay on a year-longbasis and that gets you through troughs where maybe there isn’t exactly thecontent they want but three months later there’s apiece of content they want sothey want to keep thesubscription current and you’re not asking people every month to think aboutwhether I’m going to getcharged another $7 for my Xbox Live subscription.
I think from abusiness model approach, that actually helps us and keeps that relativelystable. I think also theother thing that confounds us alittle bit is thecontinued advance of broadband and its ubiquity in the home and as thatbecomes more ubiquitous it’s just easy to connect. Alright and that ease of connection reallyhelps us, especially with Silver Members who arejust logging on to look atthings, share information, dosome downloads, download some trailers, et cetera. Of course we can work to monetize thosepeople outside of asubscription which is great for us.
John Difucci - BearStearns
Okay and just finally, you mentioned some of theissues you had with Xbox Live inyour infrastructure, you did dosome things to try and satisfy customers that might haven’t been to happy aboutit. Areyou well positioned to avoid those issues in the future and I stillsort of heard some issues might beout there.
Yeah let mejust tell you, I can give you probably afuller update. Sothis started to happen on 23, 24 December and then through that first three orfour days after Christmas, there were times when itwas very difficult to geton the service, we hadtrouble with people logging inand it wasn’t tenminute periods of time, itwas reasonable chunks of time and reasonable numbers of people. That part, we’re well past now.
Thepart that you call the, gosh we just don’t have scale available to managethat. There arestill, as you correctly report, some spot issues that we have and we’retracking those down and pushing those out. From anarchitectural perspective, we should bein good shape andcertainly inside thecompany we have thecapability to just scale well beyond where we arenow, think about what we doon Hotmail and Messenger, we shouldn’t have ascalability issue.
I think thething that I take away from this is more of aplanning exercise with thedevelopment team and with theservice team, because we’re going to have to think more about capacity planningin aslightly different way. Shame on us forhaving things advance faster than we expected and not being ready for it, butwe’re going to have to step up and put alittle more capacity inand build some headroom on thearchitecture side sowe just don’t have these problems, because we’re going to need theheadroom eventually anyways and it’s aneasy investment to decide to make, because of thepace of growth with our hardware, with our service we’re going to need morespace anyway. Trying to run ittight isn’t actually very smart because you’re going to have to make theinvestment anyway.
That was my take-away from this is we should plan alittle further out and leave ourselves more room because there’s no businessreason not to dothat. Yeah, in the middle. You have to wait for my people on therecording…
It seemslike one of the bigthings this year is trying to connect theTV to theinternet, lots of people would love to doit, seems like ingeneral the way whereif you architected abrowser properly you could really push Live Search and Live services, on myXbox I’d love to have it, curious why you haven’t gone that direction.
Yeah, I think, thinking through browsing on anXbox is something we doperiodically. It’s ahard problem because one of thethings people love about Xbox Live is it’s avery managed ecosystem and avery managed service. So, you have, thiswill sound funny, thebenefit of not being able to go anyplace you want, sothere’s a little bitmore structure and therecent outages notwithstanding, alot better reliability and consistency of theexperience you have.
There’s also dramatically higher security as aresult of that because theservice is a verythick service and we can manage thesecurity in avery tight way that makes thecontent partners actually quite happy and quite comfortable. So, that’s really thereason we haven’t gone that way and thereason we haven’t pushed allthat hard. We also don’t get, frankly, alot of requests from customers to browse, which is interesting, but we don’tactually getthat. Now, to your more general point,about getting content to theTV, I actually dothink that’s animportant point.
Xbox is one way to dothat, the thing Iwould highlight for you is to think about aneven better way, Xbox is away to reach TVs that exist today, but theTVs that are comingnew into themarketplace, boy there is going to bea host of turnover inTVs in people’shouseholds over thenext five to tenyears. Having those TVs come networkready is super important. And I thinkyou will see that as atrend in theTV space ingeneral. Theability to plug innetwork connections directly into theTV and theability to have that inour case be CDextender ready is very important. That’ssomething we’re going to work on and try to make that work.
Thereason that’s important for meis because otherwise you have to assume that thecustomer has abox that has thatspecific software and technology init, which means you either have to sell alot of Xbox’s, given thenumber of TVs, you’ve got to sell anawful lot of Xbox’s to beextenders for that, or you got to convince people to spend somewhere between$199-$299 on a boxthat does nothing more than pass video through, across anetwork from an Xboxto a TV. I think there’s some people who would buythat certainly for pre-existing TVs, but thebetter way to getcontent there directly is to have itbe part of theTV, when you buy the TVyou get itand you plug it inand you’re on the homenetwork and ultimately on theinternet. And certainly given what’shappening in chiptechnology, the costof Ethernet connections and aTV, that whole coststructure is coming down, I think that’s certainly areasonable thing to expect, it’s why you seeHP making anearly move inthat direction. Other questions? Yeah.
Robbie can you comment alittle bit about theEuropean business with Xbox, what you seeas far as penetration into Continental Europe? And how Xbox Live differs in the European marketrelative to the NorthAmerican market.
Sure, if you look atall of our territories,they’re all alittle bit different. I will saythat Europe isn’t Europe,certainly not in thegaming business. Soit varies actuallyquite widely by regions. We’re verystrong in theUK and ingeneral in northern Europe. We’re alittle less strong in themiddle of Europe and thesmallest part of our performance is insouthern Europe.
Alot of different reasons for that, it’s been that way historically, I thinkwe’ve improved in eachof those territories since Xbox1, but you still seean asymmetry in the business between thethree territories. Sothe places where wehave the most work to doin Europe would bein Italy, Spain and thesouthern part of Europe, alittle bit also inFrance and Germany, thenorthern part of Europe continues to perform exceptionally well. Likewise if you went around theworld, Australia, New Zealand continue to bevery strong markets for us, infact most of southeast Asiais actually quite strong for us, Korea is aplace where Xbox1 did very poorly, it’s doing alittle bit better now, not abig console market ingeneral, but Japan is aninteresting place to talk about briefly.
Thenumbers are no bigper seand so they don’t changethe financialstructure of thebusiness very much, but we areperforming better inJapan and I would describe theXbox1 Japanese business as starting here and going up for two weeks and thendown and then flat at avery very low levelfor the rest of thecycle. What you seewith Xbox 360 is you’re starting from afairly low level, but anice steady engagement of thebusiness and a steadyrise in thebusiness.
Still small share numbers but atleast the foundationfor future success and we aren’t getting much better support from Japanesethird parties this generation than we did last generation, you seesomeone working from Capcom done inparticular I’d highlight as great work they’ve done on theplatform both in Japanand in theUS and Europe, so, give you some idea of theway the differentregions breakout.
Oh, sorry, second question was about how Live differs, and Ithink up until very recently Live differed inone important way, which was we didn’t have Video Marketplace inEurope compared to theUnited States. That’s now starting to changewith France, Germanyand the UKgetting Video Marketplace this holiday you’ll seethat start to grow. Theother way it’s different and itactually doesn’t differ by country itdiffers by language.
You have to recognize that Live is, communication is such animportant part of Live and voice communication is such animportant part of itthat the communitydoes tend to breakout by people who speak English versus people who speakGerman, people who speak French, Italian, Spanish et cetera, itprobably contributes alittle to the factthat we don’t do quiteas well in southern Europebecause those language communities aresmaller, where northern Europe, English, works pretty well even incountries even where it’s not thenative language, so weget alittle more Live engagement innorthern Europe probably than we doin southernEurope. SoI’d say maybe asmall but acontributing factor to some of theregional differences that you seein thedifferent places. Because Live is avery cultural place thedifferent cultures and thedifferent parts doeffect it.
Last thing I’ll sayabout Europe, themarket that is kind of thehardest to figure out is Germany. Leave aside our own performance there, videogame consoles as awhole have not done super well inGermany and so thegrowth there is probably alittle behind what we would seein therest of Europe, both for our business and for theindustry as awhole. It’s much more of aPC gaming market, alittle bit like Koreaand China inthat respect. Different size style of games,but similar phenomenon. Lets go to themiddle, a couple backhere…
Just to step back, just abig picture question, in the fourth quarterthrough the holidaysand post holidays, just theUS consumer ingeneral, you sell a broadrange of products from mice and keyboards through Xbox’s, and areyou seeing certain segments that aremaybe more, if there is any sort of slowdown, more resistant to theslowdown vis-a-vis other segments which aremore 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 acrack at them and youtalk about it alittle maybe. We haven’t seen ingeneral much impact on our business that we can tell thus far. I think theeconomic questions, part of that is I think questions have risen in the last few weeks andI think holiday kind of washes over allof that, so it’s alittle tough to see.
Theother thing I’ll sayis many of thebusinesses, not all ofthem, many of thebusinesses we’re inhave one of two characteristics. Either,they are things thatpeople use when they decide to spend less on other things, sotake video games, video games historically have done well independent ofrecessions, because when people doless travel, they doless discretionary spending, they want to have things they can doat home, you can callthat a cocooningeffect, but they want to dothings that are closeto home and video games is agreat place for them to invest some money to beable to do that andthey’re usually spending iton the kids, which issomething they want to, sort of thelast place where they tend to cut back. So, one characteristic is businesses that have that effect.
Theother characteristic is businesses that have aunique cycle to them independent of theeconomy. Video games hasa little bit of thatattribute to it, I’d saythe Media Roombusiness is going through that right now, just because of anew business that effectively bring on new customers, people aremoving from satellite to cable and other places, soit’s a substitute forthem in many ways atthis stage. And sopeople were spending themoney anyway they’re choosing to spend itin adifferent place soit’s not as effected by theeconomy as you might think. Anotherexample would be our MacOffice business, where with therelease of a newproduct, you have awhole new cycle that again is kind of independent of what’s going on in the broadeconomy. I don’t know, have you seenanything else in thenumbers to add to that?
No I’d sayat this point wehaven’t seen anything; as of right now we haven’t seen any signs.
Questions, other questions, yeah we’ll doone down here.
Can you talk about theJapan consolemarket and what areyour plans there, doyou have to wait until thenext generation of Xbox to make adent?
I’ll saya couple things about theJapan consolemarket. First of allin general themarket has, there’s less growth, leave Microsoft aside for asecond, there’s less growth inthat market in theconsole side than there is in the world. Soand the fact thatdepending on what period you look atwe’ve seen some decline in the Japan market as awhole, much of that moving towards cellphones and to some extent portablegaming, so, as ageneral statement, Japan is probably nominally slightly less abigger portion of total than itused to be.
For us inparticular, I think we’re on theright strategy with Japan. I don’t think we’re going to wait to makesome progress, we’re going to continue to make progress, it’s going to bea market that we’regoing to have to be atfor a while for itto be asignificant effect on theP&L and the [inaudible]business, but because of theopportunity there longterm and because of thepresence of so manythird-parties there, it’s animportant market for us to keep after. Icertainly don’t think of itas waiting, nor do Ithink of it as thereis some big surprisearound the cornerthat’s going to make itsimply a much biggersuccess than it istoday.
We’ve got resources established there, we’ve got resourceswe’re investing there, it’s on acertain level and we’re going to keep pounding on that and we continue to seea nice steady rise,I’ll be ahappy guy. And then, whenever thenext generation comes around we’ll look atthat again and sayokay how do we getit to bump up to thenext level. Another question in the middle.
Thank you. Can youtalk a little bitabout the Zune deviceand how it hasdone relative to your expectations and also atthe same time with theiPod Touch out there, how dowe see this deviceevolve over time and what else can you…thank you.
Sure. Sowe look at theZune business as having done exactly what we expected to do, let metalk about that in acouple of different parameters. Thefirst thing I’d sayand the most importantthing is, we have areally great product. I’m happy to take theZune hardware, the[unintelligible] and thedevice, the[unintelligible] and thePC, our market place and who’s social, compete with Apple head up and review, Ithink we’ll win somepercentage of those reviews and I think if we getan objective hearingwith people who don’t look atthe fact that Apple hasa biginstall base and a bigmarket share, theproduct is very, very competitive and you can only seethat increase. We’ve got avery smart team of people who areworking on that so Ithink you’re going to seesome great things from theproduct.
Thesecond thing I’ll say, we think we know some things we can doto help differentiate it, we talked about one of those last night, ZuneSocial. We think changesthe way people thinkabout music as being more than just atrack, but as anexperience that involves more than just listening to thesong but doing things with your friends, sharing themusic, understanding theartist, those types of things, we think that’s quite powerful and building, ifyou will, theequivalent of what we’ve done on Xbox around gaming, doing thesame thing around music, we think is actually animportant opportunity for us.
Interms of market share and unit numbers, themix has been alittle different than we expected. We’vehad better performance on the80 Gig than we expected and alittle less on the 4and the 8 Gig than weexpected. We also think there’s been alittle bit of cannibalization from the30 Gig because of theprice point that hasbeen at, that’s made the4 and the 8 look alittle less attractive. As theinventory on the 30Gig has gone down in the channel you’veseen the 4 and the8 Gig come up, so Ithink we know there’s some substitution effect that’s going on atthat price point.
Interms of perception and this will bemy final point here, I think there’s no question that when people look atit, in theUnited States, that’s theonly place we’re in themarket just yet, when people look at, alright who arethe two guys who aregoing to be legitimateplayers in this goingforward, I think you have to certainly put Apple inthat camp and put us inthat camp. And then we’ll see, Europe,just to comment on that, is actually quite different from amusic devices areactually quite less popular there, cellphones aremuch more popular there as music players, Sony Erickson hasparticularly done very well selling phones there that arealso media devices, there’s some unique differences they have intheir cellphone market that makes that possible because things aresubsidized, you buy itretail, it’s very different, avery different environment. Sowe’re going to continue to evaluate what we dooutside of North America, decide how we want to approach theEuropean market, you saw our acquisition of [Muse You Wav], not abig financial number interms of theacquisition but interms of strategic importance, it’s animportant part of what we’re doing with our Windows Mobile side of thehouse. Sowe’re starting to lay thegroundwork for understanding how we pursue music inthat broader marketplace. Yeah, rightnext to you, then I’ll come over on this side.
Yeah, two questions. First of all, just when you look atyour third-party relationships, last year I think there was some talk cominginto the year that thethird-party publishers may have to decide where they’re going to focus theirdevelopment efforts, which platforms, et cetera, I know it’s early but doyou see any movementtoday among publishers talk that you know they need to bevery proactive about how they actually take atitle to market, whether it’s on Microsoft first or Microsoft and Sony first,Nintendo, et cetera, areyou seeing any movement atthis point, I know it’s early, going into ’08?
Sure. I think theonly comment I’d beable to make on that is we’ve seen acontinued strong pursuit of our third-parties doing Xbox 360 from thebeginning and as thenative, if you will, formof develop, consistently we hear that our platform is easier to develop on,certainly the PS3,people tend to start there and port PS3 sometimes itmeans they’re doing [inaudible], mean there’s atime difference, it’s sort of anironic way sort of thereverse of what we had in the Xbox PS2generation and I haven’t seen any changein that and evenrelative to Wii’s success.
What we’ve seen there is people just saying, hey, there’ssome specific content I have that makes sense on theWii, I’ll probably still do it on the360, but it’s going to have more important for meon the Wii justbecause it’s thenature of the content,but in thebroad portfolio of their product, we haven’t seen much difference there eitherand in generalthird-parties haven’t been super successful on theWii, so it’s notclear, development doesn’t costvery much, we should saythat, costs are lessbut the upside issignificantly less too because their penetration hasbeen mostly with Nintendo titles. Yeah,question in theback. Quick follow up, okay.
If you look atjust in theindustry there’s some interesting M&A deals having been done in the past year, coupledwith you’ve got Halo 3 that just made itvery well, I guess where doyou prioritize building more [unintelligible] through acquisition, maybe also,hammering thecompetition in themarketplace at thesame time by taking titles that would have gone on to peer [unintelligible] tonow owning itoutright.
Yeah itgoes back to what I said earlier about our first-party strategy ingeneral and that strategy hasn’t really changedwhich is, there’s acertain number of titles and acertain type set of genres taking advantage of certain features of thesystem that we’re going to want to produce and we’re going to make money doingthat. You will seea constant shift ofstuff that goes from pure first-party back and forth between licensed publishedbusiness let’s call that, occasionally we’ll doan acquisition, Iwouldn’t rule that out, we did one last year, certainly possible we could doone this year, but there isn’t a, oh gosh we need to go atcapacity initiative underway.
Infact I don’t, I’ve, in the time I’ve beenhere, we’ve ever had that initiative underway. Final thing I’ll sayis even if we wanted to domore first party work, more likely way for us to doit as opposed to anoutright acquisition would beto work with somebody on apublishing relationship, make sure we’re comfortable with thedevelopment team and theintellectual property, build itthat way then acquire as aresult of that. That hasbeen our traditional M.O. ithas worked quitesuccessfully historically.
Somuch of buying stuff inthis space, you buy ITbut you also buy talent and you better know thetalent you’re buying and soit’s easier for us to work with someone for aperiod of time before we take, let’s saya bigger jump from anacquisition perspective and having them part of Microsoft company. Now, to theback.
Yeah, just aquestion on blue-ray versus HD, just your thoughts on that and is Xbox Livegoing to make theargument moot?
Yeah, let’s talk about, I’ll sorry of handle thenarrow topic and thebroad topic, I think there’s both.
On thenarrow topic of HD-DVD and blue, theinterest we have, certainly we’ve been asupporter of Toshiba and HD-DVD, thepredominate reason for that hasbeen the investment wehave made in somethingmost people don’t seecalled HDI, which is theinteractive software that enables people to create interactivity into these newdisks and one of thebenefits of new high definition disks, both blue-ray and HD-DVD is thisopportunity for internet connectivity and interactivity and you need anauthoring layer for that. HD-DVD choseour HDI technology for that, BD chose ajava basedimplementation. So, from abusiness perspective you should understand that that’s really theprimary business engagement we actually have inthat space and it’s important for us to continue to support Toshiba and we’ll dothat and continue to support our partner inwhatever direction they choose to go, but infact as a percentageof our business from aneconomic perspective it’s asmall percentage of our business.
Interms of how iteffects Xbox, because HD-DVD is aperipheral for us, if HD-DVD somehow is successful, that’s fine for us we have theperipheral. If for whatever reason andmaybe the Warnerannouncement is thething that moves itthis direction, itbecomes a BD world,it’s an accessory forus, our involvement is still as anaccessory, again it’s asmall part of thebusiness, it’s not anaccessory that has bigattach for us so it’snot a bigeconomic [unintelligible]. I think mostgamers buy game consoles to play games and if they can dosome other things with it, fine, some of them decide to just buy theaccessory, but I think as hasbeen demonstrated in themarket, people who don’t want to pay$50-$100 more to have theaccessory included and I think we would seethat continue.
Now that sort of specific thing, let’s talk alittle more generally about where we seethat going, because there is atransition happening in the space and I thinkwe’re kind of two transitions going at the same time. Thefirst transition is in the disk space worldwhere we’re moving from DVD to ahigher definition DVD and I think that’s areal transition and there will be a shift up to thatboth on the hardwareplatform and on thedisks themselves. I don’t think it’sgoing of the scale andfrankly I don’t think anybody else thinks it’s going to beof the scale of VHS toDVD, because thedifferences in qualityjust aren’t as high, there’s not quite as compelling areason to shift and you’re certainly not going to back catalog rush that yousaw with VHS to DVD. Nevertheless Ithink the shift isreal, I think people will buy high definition players of one formor another and I think you will seedisks, a migrationhappen there, sohopefully for the movieindustry and our partners in the movie industrythat will be apositive thing for their business.
Now having said that, I also think there’s asecond shift going on, which you alluded to, which is to direct digitaldistribution. Inour case today that’s on Xbox Live Video Marketplace, there’s other places it’shappening, either from producer’s own websites or through other services that areoffering, Amazon and other people have services in the space. I think that’s also areal transition, I think itwill happen concurrently with this disk transition and you’ll end up ina world inwhich video will bedistributed from direct online and some through disks and hopefully again for theindustry the total isbigger than it istoday, that would be thegoal. I don’t think by theway, those two things arein any kind ofconflict. I think they can both happen,both be successful andboth work. Certainly for Microsoft, wehave more vested interested in the digitaldistribution side of that, it’s much more software intensive, it’s aplace where online services come into play in a better way and soyou’re likely to seemore of our engagement with thestudios be on thatpart the business thanit is to beon the disk part of thebusiness. Like I said we can dosome software work on thedisk part of thebusiness but it’s not ahuge play.
Final thing that HDI technology that I talked about can workon disk or online. Sofor us from aninvestment perspective we want to add interactivity to thecontent whether of how itgets delivered and sothat technology is important for our future either way. Is that helpful to you, some context ofwhat’s going on there? Otherquestions? Got one way in the back and then I’llcome back down to thefront.
My apologies, you might have touched on this, but just on theIPTV relationship and theemerging model that you’re building there, could you talk alittle about how thecarrier economics versus theMicrosoft economics aregoing to play out if that gets deployed across thevarious markets?
IPTV or Media Room as awhole, I think theeconomics arerelatively straightforward in the sense that there’sa businessrelationship between us and theoperator, they license our software, they commit as aclient-server plus maintenance business model very similar to what we doin our server side ofour business and infact we use much of our [inaudible] technology actually inthat part of thebusiness and we benefit from volume, themore volume the operatordoes the more businessfor us.
Likewise from theoperators perspective they obviously benefit from volumes because they’re ableto go sell the serviceto their customer base, soinitially for theoperators they’re allmaking pretty biginvestments in thenetwork infrastructure to enable itto happen, AT&T hascertainly made itclear that they’re making abig investment here, Ithink British Telecom, Deutsche Telecom, others would saythe same thing, and,oh the Xboxspecifically you should think of this as agood opportunity for both of us, I think it’s anopportunity for us to seesome consoles sold to people who might not start with console sale but whomight say hey I’mgetting a set top boxanyway I should get theconsole then I have gaming as well.
Sowe think of it as veryincremental to our business, we’ll seehow big itis, I don’t actually have a good sense yet for how much of anincrement it is, wedon’t think it’s asubstitution effect, frankly, we think it’s mostly anincremental business. For theoperators it’s good economics for theoperators because theset-top box is a partof the coststructure, it’s theleast exciting part of thecost structure forthem because they’re not super powerful boxes, there’s not aton you can do with themby design and so theyend up either subsidizing or having theeconomics be kind oflukewarm for them. Gives them achance something where customers really engage and bewilling to pay for thebox in addition.
Robbie, can you talk about parts of your business where youstarted to or integrate some of thead services businesses in, especially in the IPTV, could theother parts made acquisition on thegaming side?
Sure. Theadvertising you’ll seetoday in two predominatein my business. First is on Xbox with thework we’re doing, we’re doing there, we’re starting to see, I say, nice solidtraction there, actually I should point out that actually ithas two components,one is the work we dowith in gameadvertising on Xbox Live and ingame itself, the otheris work we do with ourcasual gaming services, which is business we’ve had for tenyears, that’s not anew phenomenon, you should think of that more like anMSN property and acasual business that goes along with Pogo and anumber of other people inthat space.
Then theother place where you’ll seemeaningful advertising work from us is in the cellphonebusiness, where over time, I showed alittle bit of that last night, with theads from Paramount forthe movie Cloverfield. I think you’re going to seesome opportunities there. I think thechallenge there is understanding thenature of how theadvertising model works and sorting that through. I think everbody believes as doI that advertising is something that can bevaluable there, figuring out how to fit through theform factor and theuser experience is theissue, I don’t think it’s as simple as, oh you have search on thephone therefore there’s advertising based search, I don’t think it’s quite thatsimple. I don’t know Mindy is thereother stuff we should add from theadvertising?
Theother thing I probably should point out, across E&D, I would have said ayear ago that we had agap inboth of our product and business plan around advertising and that we hadn’tthought about itenough. We’ve now thought about ita lot. Soyou’re going to seemore from us in thatspace in general, Idon’t think thepredominant form ofmonetization in verymany places but I dothink a formof monetization that’s important for us and we’ve probably missed afew opportunities in thepast 12 months by not being more deeply engaged and we have addressed that.
Robbie I’d like to bemindful of your schedule, probably two more questions.
Alright I owe one down here in the front and then I’mgoing to grab one right there. Sogo ahead.
Comment on thepotential for motion sensitivity in the Xbox and thenseparately on China, talk about thepotential for an Xboxconsole market there and also anything culturally or why doyou think micro-transactions areworking so well inChina versus other areas.
Sure, motion sensitivity, I’ll rephrase because you werebeing nice, motion sensitivity, areyou going to dosomething like Wii does for theXbox 360? We’ve looked atdifferent mechanisms for input both historically and since theWii came out, we’ll continue to look atit, maybe there will bethings we’ll dothere. I don’t think for us it’s abig part of what wedo, frankly we look atNintendo and the Wiias, in one way,competition certainly, but inanother way, almost complimentary because they provide afairly different experience than what we provide on Xbox 360 and partly it’s adifferent customer.
If you were doing themathematics Ven diagram of our two businesses and added Sony, you’d have twocircles with Microsoft and Sony that were very close to each other and you’dhave a third one thatcut into those circles in the sense that theyoverlap, but would have awhole set of things that were different from that, we joke but I think it’s thereality I think there’s going to bea lot of Wii 360households in theworld. And sowhile we look at itand think about it Idon’t know that it’s aparticularly bigstrategic thing for us to focus on.
Your second question was on…yeah China is atough interesting market, let mesay itthis way, it’s defiantly amarket we’d like to bein, certainly hasscale, it hasa couple thingschallenging about it, one is just thepiracy issues and that. I actually thinkwe can work through that, I don’t think that’s thebiggest barrier actually, I think we can find ways around that, complicated butI think we could find ways through that.
Thesecond is it’s ahighly regulated market. That makesentry difficult from anumber of different perspectives interms of partnerships you have to have, support from thegovernment you have to have and figuring out which part of thegovernment actually hasto support you is complicated, there’s atleast three ministries who think it’s their job to approve whether aconsole comes into China, sothere’s actually some real complexity there.
And then thethird thing you have to think about, it’s aPC gaming market. And that’s good forus. Microsoft likes PC gaming markets,that’s very positive for PC sales, as PC sales become more and more legalizedthat is happening. Gaming is agreat application for thecompany, so ina way I could say,yes, we want to be inChina and we’realready there and our job is now to monetize those PCsin abetter way. I don’t know whether consolegaming will be bigin Chinaor not, if and when we getin there or somebodyelse does.
From abusiness perspective thecountry is big enough,but even if it was asmaller percentage of gaming itstill would be agood investment if we could figure out away to do it, soI’m not saying one way or theother about what we’re going to do, but just in the grand scheme ofthings you should think of that more as aPC gaming market and think about thepositive impact that hason our business in on thePC side as opposed to some bigengine that’s going to changethe way we think aboutXbox.
And micro-transactions arepopular there because of theeconomics, the way theeconomy works, people have less disposable income and sothe ability to dothings in smallerchunks [unintelligible]. They may end upspending just as much money but I think because it’s done inthat way I think itactually supports better interms of what theculture.
One last question here and then we’ll wrap up. I know you guys areeager to tromp back to theconvention center.
Just as afollow up on theadvertising question, you think about themobile platform and how bigthat opportunity gets, how areyou guys thinking about ittwo years out, how bigis mobile advertising?
Yeah, here’s what I would sayabout that, I think, well thedata, the analyst datawhen you roll itup to 2011, it’s about a$10-$11 billion industry inadvertising. Now, I’m not exactly surehow people come up with that number because I’m not sure anybody really knowshow advertising is going to work on aphone, so alittle bit of that is anexcel extrapolation I expect. But even solet’s say it’s off by10-15%, it’s a bignumber. If it’s off by 20%, it’s still abig number, sowe think it’s absolutely aspace worth investing time and energy into.
Thethings that we focused on for when those mobile is making sure we have theright infrastructure for theOS for it, making sure we have theright relationships with operators and theOEMs to make sure that works well and to make sure we’re doing thesoftware work that does innovative ways to expose advertising, this is workaround location based services, it’s work around search [unintelligible] inparticular, audio search as opposed to text search, ways to enable people to getthings done on the go ina world inwhich they don’t have abig keyboard and abig browser and abig screen but stillwant to get thingsdone.
I think there is room for innovation there, I think it’scompletely open market, I think there was some people when Google announced [AdSense]they said, oh wow they’re going to make alot of money because they monetized this through advertising et cetera, maybe,but it’s not clear what assets that they bring to thetable other than having been engaged inadvertising in generaland we probably have more assets inmobile, well I know we have more assets in the mobile space thanjust about anybody interms of trying to figure out how software as aservice work.
SoI think we’re actually very well positioned there for us now it’s aquestion of execution and making sure we execute well. I want to thank you guys for being agood audience, being patient and I appreciate you coming out and I hope youhave a good rest of theweek at CES. Thanks very much.
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