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Microsoft (NASDAQ:MSFT) currently offers three Xbox 360 models. The Arcade, with no hard drive. The Premium with a 20GB hard drive. And the Elite with a 120GB hard drive. This is all going to change, to much bigger drives, and there are four reasons why.

Firstly there is the business model of the hard drive manufacturers. They compete mainly not on price, but on disk size instead. They are constantly driving up the capacity of their drives (by 40% a year compound) using technology whilst trying to keep prices constant. So the cheapest drive to buy is the one they are currently making most of. This will usually be cheaper than a smaller capacity drive. Just now top end hard drives for home and office PCs are one terabyte (1,000 GB) with 4 terabytes on the way, so they have left the Xbox 360 way behind. Interestingly, a quick price search shows that 250 GB drives are currently cheaper than 120 GB drives. And as for the 20GB drive that Microsoft use in the Premium, in this industry that is pretty much a fossil. So it isn’t even going to cost money to give us bigger hard drives.

The second reason is the demise of HD DVD. This was the high capacity content delivery system for the Xbox 360. Now that it has gone Microsoft say that they are not going to switch to BluRay, instead they are going to concentrate on downloading content. This is only bringing forward the inevitable. The problem with downloaded content is that you have to store it somewhere, and HD movies take up a lot of disk space. As such, huge hard drives are essential to get the machine to do what the customer wants it to do. The whole Microsoft business model for the Xbox 360 now depends on this.

The third reason is profit. The more storage space someone has, the more content you can sell them. And there is vastly more profit to be made from selling the content of a hard drive than there is from selling the hard drive itself. Microsoft know that the bigger the hard drives, the more profit they will make. This gives them the incentive to go for the biggest hard drives possible.

The fourth reason is competitive advantage. By switching to downloadable content instead of physical media for distribution Microsoft can be seen to be more advanced than Sony (NYSE:SNE). Also far more customer friendly. You will be able to have the content you want when you want it. The PS3 currently comes in 40GB and 80 GB (NTSC only) models. By offering vastly bigger hard drives Microsoft can be seen to be offering a better product. And because the 360 hard drive is easily removable existing owners can easily upgrade to take advantage of the bigger drives. One advantage of the RROD episode is that Microsoft have learned how to transfer a customer’s content from one drive to another.

So there are compelling reasons for Microsoft to go as big as possible as soon as possible. The 120 GB model was introduced in August 2007 and already, when you look at the reasons above, it is looking small. The 20GB Premium model is difficult to justify. So expect a realignment of the model range and their hard disk sizes this year. Also look for the Xbox 360 to have terabyte range hard drives within the next couple of years.

Source: 4 Reasons for Microsoft's Xbox to Go as Big as Possible, ASAP