Ever since Microsoft ( MSFT) became a player in the video-game business, the game console has been portrayed as a Trojan horse built to take charge of the digital home. But despite the hype surrounding the Tuesday launch of Microsoft's Xbox 360, the video-game console isn't yet ready to become the centerpiece of the high-tech living room. "Everything is
ultimately going to converge," says Mark Demos, an analyst for Fifth Third Asset Management, which holds Microsoft shares. That would mean -- eventually -- a single system to run all technology in the home: video games, the Internet, music and software applications. But "we're not there yet," adds Demos, who predicts such convergence will arrive in five to 10 years. ( TheStreet.com also looked this week at how Microsoft's rivals will cope with the ballyhooed rollout; and what the new games and new game machines mean for investors. ) The Xbox 360 does take some concrete steps toward that realization. "One of the big things we started thinking about in planning in 2003 was making sure that Xbox 360 was going to be a console that played well with other devices," explains David Reid, director of platform marketing for Xbox. To that end, Xbox 360 has three high-speed USB ports to connect to a variety of digital music players and cameras. And, of course, like the first-generation console, Xbox 360 can play DVDs. But you still need to connect Xbox 360 to a special Media Center PC to make it a more powerful hub complete with live TV, photo albums and movies on demand. But even Microsoft's new-fangled console can't overcome external obstacles that continue to exist. For example, some people simply don't want to surf the Internet or send email from their TV in the living room because it's not private, notes James Lin, managing partner of video game consultancy Simba Group. Moreover, the Internet hasn't developed enough to fully reach convergence, says Chris Bonavico, a portfolio manager with Delaware Investments, which holds Microsoft shares. "We're just starting to see the trend of downloading one show at a time," he notes. "It's a very long-tailed trend toward computing involvement in television entertainment."
But that hasn't stopped Microsoft from adding new features to its online-gaming platform, Xbox Live, to move closer toward the single-device ideal. Among them: a new marketplace for online commerce and the ability to handle micropayments for features that gamers can build onto their games. To date, however, online gaming has attracted a small audience. Xbox Live counts only 2 million subscribers, or about 10% of total Xbox owners. Although Xbox Live is widely viewed as a more powerful platform than rival Sony's ( SNE) online gaming effort for Play Station, Sony's has far more users, with 2.5 million registered in North America alone. While the larger number of Play Stations sold partially explains this difference, there's another key difference between Microsoft and Sony's online strategy: Microsoft has been charging $49.99 for an annual subscription to Xbox Live while Sony has offered its online platform for free. "Certainly what we found in our research is that cost was a huge barrier to entry," says Molly Smith, senior director of brand development and communication for Sony Computer Entertainment America. Microsoft apparently came to the same conclusion, as it's adding a free "silver" tier of Xbox Live to the $49.99 gold membership, which offers additional content and the multiplayer online gaming. It's still a subject of debate, however, whether online gaming will move beyond a niche market that attracts only hard-core gamers. Wedbush Morgan analyst Michael Pachter argues that playing video games is primarily a solitary activity, like other forms of entertainment, such as reading a book and watching TV. "You don't want to interact with other people -- we do that all day long," Pachter argues. "Microsoft is wrong: Everybody doesn't want to be online all the time." But David Riley, senior marketing manager for NPD Group, disagrees. A recent NPD survey of gamers found that they're spending more time playing online compared with last year, and they're more willing to pay for online play. In particular, NPD highlighted an increase in woman and teens playing Xbox Live.
"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.