In order to keep console sales strong headed into the holiday season, Microsoft had no choice but to drop the price, says Matt Rosoff, an analyst with independent Microsoft-focused research firm, Directions on Microsoft.

Microsoft sold fewer consoles than expected in its last fiscal year, shipping 11.6 million systems at the end of June 30, instead of its scaled down expectations of 12 million consoles. At the beginning of the fiscal year, Microsoft had said it could sell as many as 13 million to 15 million systems.

"This is a crucial season for Microsoft. If you look at sales of Xbox 360 since the PS3 and Wii there has been a definite slowdown," says Rosoff. "But now that the core system is priced fairly close to the Wii, and the console has the strongest lineup of games." The Wii retails for $249.99.

Sony sold 98,469 PS3s in June , up 21% from May, said research firm NPD. Nintendo sold 381,800 Wiis, while Microsoft sold 198,400 Xbox 360s during the month. And since the new $499 price for the PS3 was announced, sales have increased more than 135% at the company's top five retailers, Sony said.

Microsoft's latest discounting effort did lose the element of surprise, however.

Online gamer forums have been buzzing for more than a week after leaked newspaper ads that touted the price cut for retailers including Wal-Mart ( WMT) and a Circuit City ( CC).

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