Microsoft ( MSFT) may be a behemoth and a monopolist, but when it comes to video games, it's just an upstart.

In the latest round of the video-game wars, the company lost billions of dollars while being crushed by industry giant Sony ( SNE).

Corporate Vice President J Allard, who heads Microsoft's video-game efforts, is promising a different result this time. Under his leadership, Microsoft has unveiled its next-generation console, the Xbox 360, which the company promises will appeal to everyone from core game geeks to nongamers. Indeed, Allard has boldly predicted that a billion people will eventually play games on the new console.

But the company again faces a challenge from Sony, which is introducing its own next-generation machine. And it still has many questions left to answer that will likely determine the fate of the 360, which in turn will affect the companies developing games for it.

At the E3 conference in Los Angeles last week, I spoke with Allard about the challenges for the 360.

Q: Why do you expect the Xbox 360 to do better in the marketplace than the Xbox did?

A couple of factors: Xbox -- not only did we enter the market, what, 19 months behind Sony -- so we got a very, very late start -- but we were a brand-new team. The day we approved this project, we had never sold anything directly to Target and Wal-Mart.

We didn't have a business relationship with Electronic Arts ( ERTS). We didn't have our online service developed. We had never shipped a console game before as a company. So we were developing a lot of new competencies as a company and assembling a new team. As talented as the team was that we pulled together, we hadn't really jelled as a team yet. So we had a lot of work to do.

This time with Xbox 360, we've got the experienced team, we've shipped a lot of console games and built some incredible franchises. And we've got the relationships that we need and built out partnerships. The other material thing, obviously, is we're not going to give the 20-month head-start to our competitors.

Q: At the press event last week, you predicted that a billion people would play the Xbox 360. How did you come up with that figure?

The thing about that comment is it's really intended to be an inspirational comment for the industry. Right now, more people enjoy movies, music, television and movies than they do video games.

Our revenue growth is great, right? If you look at all the numbers, you say, "We're doing great as an industry." Well, we force everybody to go buy new hardware every five years. That helps. Our average selling point of content is $50 or $42 or whatever you want to call it. That helps, right? And the fact that we have such an enthusiast base that consumes so much, it drives up those numbers.

That's great, but how do we invite people back in and turn the world into gamers? To think that there are a billion people in the world that can read or watch movies or play music, nobody would scoff at that. But if you say, 'We're going to get a billion people to go play games,' that's a big dream.

And so, it's more a challenge to the industry to say, 'Hey, we're all going to appeal to the core gamers, but let's all do our part to take it to the next level.'

Q: Why do you think the Xbox 360 will have an appeal outside of the core gaming contingent?

Well, the first is approachability, which takes several forms. First is the device itself. The industrial design of the device really reflects the optimism that we have for the industry, and it's more inviting. We went to a wireless design. And it seems like a trivial matter from a technology point of view, but from a living-room experience point of view? Having wires strewn across your couch and across the floor is a big deal to a lot of people. So, in showing the industrial design and the wireless concept to a lot of nongamers, they say, 'Well, finally, this is a product that doesn't need to be banished to the basement.' So, I think it will get into the right place in the home and invite more family members to participate.

Another aspect of it is the community, whether it's kids or adults, and bringing the community more to the forefront of the entertainment experience. You could be watching Lord of the Rings on your 360, I could be playing Perfect Dark Zero, but we could have a conversation over voice while we're doing that. We could talk about those experiences. I could invite you in to play Perfect Dark Zero while you're watching the movie.

Then the last thing that we're really thinking about is the content itself and making it more inviting. We have this notion of Xbox Live Arcade, which is aptly named. It's like walking into an arcade, but over the network. And you'll be able to download everything from casual, time-killing games to the classic arcade games like Pac-Man.

Q: The big hit on Xbox has been the Halo series. When will we see a version of Halo for Xbox 360?

The Bungie Studios guys have had development kits for a long time now. So, they're cooking some interesting stuff for 360. I think it won't disappoint in any stretch of the imagination.

We have one formula with Halo: Ship it when it's ready. We did it with Halo 1. We did it with Halo 2. And we haven't disappointed the audience yet. That's Bungie's philosophy; that's the Xbox team's philosophy.

Q: How much is the Xbox 360 going to cost?

Not sure. It's probably about two months away before we make the decision on that.

Q: The last Xbox went out at about $300 initially. Will the 360 be priced higher, lower?

It's going to be in the neighborhood.

Q: When exactly will you release the 360?

When it's done and we've got enough of them. We're going to do something that's really unprecedented in the industry by launching the console in all three major markets for the same holiday. It's never been done before. So, that's some of the logistics that we're working through now.

The chips are in production, the machines aren't. So we've got a little bit of work left to do.

Q: Sony's planning on launching their PlayStation 3 around six months after the Xbox 360 launches. They've gotten some rave reviews for their new device. Have they stolen some of the 360's thunder?

I don't worry about great visuals that they showed that weren't actually running on real hardware. It doesn't matter. Gamers don't make their purchase decisions based on movies that were shown in May for products that come out in March. They just don't.

Q: When the original Xbox came out, Microsoft showed off what you could do with off-the-shelf, PC hardware. In contrast, you're going with customized hardware this time around. Why the change in direction?

Part of it was the necessity of getting to market quickly, we had to go off-the-shelf. There wasn't an alternative. You can't build a game console with highly customized silicon components with the time they had for the Xbox. We barely did it, in some ways, with the off-the-shelf stuff.

Part of it was our experience as well. We thought that it was very, very important to get game developers a great platform that they were familiar with.

But the thing about going to custom hardware is it will give you the best price-performance ratio. The second thing it does is it allows you to control costs.

Intel doesn't make 733MHz parts anymore -- except for us. So they don't cost reduce in the same way as custom hardware. It's very important for us to be able to manage our costs, so our price curve and our cost curve approximate one another. On this past generation, they just didn't.

Q: You've lost $2 billion or so in this division thus far. Do you expect to be consistently profitable this time? What's it going to take to do that and when will it happen?

You can't be consistently profitable, because the upfront costs are so high. So the first two couple years are pretty tough. But we intend on selling an awful lot of these things. We've really designed the business around scale this time, and I think that once we get over that initial curve, it should be a pretty healthy business for the company.

Q: A couple of reports have mentioned that the Xbox 360 games you and your partners are demonstrating are running on emulators on Apple's Macintosh computers. Did Bill Gates grit his teeth when he read that?

The Xbox team thinks different!

Q: They think different? I like that. I'm sure Steve Jobs would like that, too!

Well, I have more G5's than any human being on planet earth right now. That was the closest hardware system that was out there. Even though we're doing highly customized parts, they still are derivative of off-the-shelf parts. So we've given them a good approximation. When we get the final hardware, the performance is just going to skyrocket.

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