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Microsoft's Xbox Likely to Miss June Sales Goal

Thursday's price cut in Europe won't be enough.

Without a drastic cut in price,

Microsoft

(MSFT) - Get Report

is unlikely to meet its goal of selling 9 million units of the Xbox game console by the end of June.

Perversely enough, this short-range setback will actually help Microsoft's bottom line because the company loses an estimated $100 on every Xbox it sells. Nor does it derail the company's long-range plan to make Windows the dominant home entertainment platform. (Microsoft will announce quarterly earnings after the bell on April 15.)

Wedbush Morgan analyst Michael Pachter said Microsoft could undershoot its forecast for Xbox sales in the fiscal year ending June 30 by 1 million or more units. Right now, he said, a realistic estimate of worldwide sales is 6.5 million to 6.6 million, and it is likely that another million units will be manufactured as an inventory cushion. What would it take to make the target? "A much larger price cut than we expect," he said during an interview.

Indeed, Microsoft announced Thursday that it will cut prices for Xbox consoles by 20% in Europe and Great Britain. Retailers in Britain will drop the price from 189.99 pounds to 129.99 pounds, or $202 at current exchange rates.

Pachter said a cut of that magnitude in Europe and the U.K. could boost sales by a "roughly estimated" 1 million units -- not enough to erase the sales deficit. (His firm has no banking relationship with Microsoft.)

According to Pachter, Xbox sales from July to the end of December 2002 in the U.S. totaled about 2.2 million. European sales totaled 1.4 million, and 400,000 units were sold in Japan, he said.

Although Microsoft was obviously too aggressive in its forecast, and there aren't nearly as many hit games for Xbox as there are for the PlayStation 2, the Xbox is rapidly gaining market share.

Earlier this week, Microsoft grabbed second place in the video console market when Nintendo announced that it had sold only about 5.6 million GameCubes for the fiscal year ended March 31. The Kyoto-based company had expected to sell 10 million units.

First place is still held by

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Sony

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and its PlayStation 2, and no one, including Microsofties, expects the U.S. software giant to catch up anytime soon.

But it would be a mistake to minimize Microsoft's achievement in leaping to No. 2. Nintendo, creator of the hugely popular Mario and Super Mario series of games, has been in the business for years and has substantial brand equity, while Microsoft, which has a history of failures in the home entertainment market, didn't launch the Xbox until late 2001.

Although the video game market is huge -- sales of hardware, software and accessories generated $10.3 billion in the U.S. alone last year, according to the NPD Group -- Microsoft is after even bigger game. "The technology in PCs has been employed for content creation or what you might call 'lean-forward' devices," said Mark Specker, chief technologist-investment banking for SoundView Technology. "That set of technologies also makes for a good content consuming or 'lean-back' device in the living room." (SoundView does not have an investment banking relationship with Microsoft.)

Specker, of course, is talking about the much-hyped convergence of consumer electronics and consuming. That market began emerging a few years ago when kids started downloading music to handheld devices, and their parents spent serious money on DVD players and digital cameras that could upload snapshots to the Web or a home PC.

How big might that market get? "The market for conventional televisions alone in the U.S. and 19 top foreign markets is $40 billion," Specker said. "The growth potential for the convergence or lean-forward market is substantial, and Microsoft needs to be there."

Microsoft is there, despite some embarrassing early failures like its efforts in the set-top box arena. Technologically, the Pentium 3-powered Xbox is considered a very robust platform, and it generally comes with an ethernet slot and a large hard drive. Moreover, it is powered by a variant of the Windows CE operating system, making it easy to visualize other Internet-centric entertainment devices built around it.

To be sure, the company still seems a bit tentative as it sticks its toes into waters long dominated by the likes of Sony, Philips and Matsushita. "They're

Microsoft not acting like Microsoft -- they're not using pricing and cycle time as a weapon," said Bing Gordon, co-founder of

Electronic Arts

, a key game developer.

But once Microsoft gets a bit more seasoned, the game is going to get a lot tougher.