Microsoft Still a Long Way From Home

"If you're an online gamer, you love it," Riley says. And "if there was no money to be had, then these manufacturers wouldn't integrate the technology into the system. There has to be demand for it."

Although Microsoft's online game offerings may be more advanced than Sony's, the Play Station 3, due out next year, may be viewed as a more cutting-edge entertainment hub than Xbox 360. That's because Sony, the world's second-largest electronics manufacturer, decided Play Station 3 will feature next-generation Blu-ray technology, which could replace DVD players with the transition to high-definition television.

"First and foremost, Sony is an entertainment company. That's part of our DNA," says Sony's Smith. "That runs deep throughout the whole organization."

Other critics think Microsoft is in dangerous territory by straying too far from its software roots. "They think this Xbox will get them in the living room," says Jane Snorek, a senior analyst who covers technology for U.S. Bancorp Asset Management. "I just don't see that."

"Why be in the hardware business? If you're going to be in the home entertainment business, why don't you just write software for a TV company or a cable company?" asks Snorek, whose firm is underweight Microsoft. She argues that a set-top box is likely to be a more powerful entree into the living room than a video-game console.

Of course, Microsoft invested billions of dollars in the cable arena well before it dived into the video-game business. But eight years after buying WebTV and investing $1 billion in Comcast(CMSCA), Microsoft is finally reporting a small following of cable operators testing and trying out its latest set-top software, called Internet Protocol Television.

Only a company like Microsoft, with a massive $40 billion in cash and short-term investments, could get away with hedging its bets by investing so much in two different Trojan horses simultaneously. But with stiff competition from Sony and slow adoption in the cable industry, even the software titan is likely to have to wait another five years or so before either gambit has a chance of capturing the digital home.

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