Design Management Group

Case study - Microsoft Xbox

The recent introduction of the Xbox by Microsoft is a notable example of the way in which external service providers can be marshalled to support innovation. Microsoft was not known as a hardware company although it did have a hardware division, responsible for mice, joysticks and keyboards. With the announcement of the network-enabled Sony Playstation 2 in March 1999, Microsoft woke up to the threat of being squeezed out of the living-room by Sony.

Two opposing product concepts vied for management attention: one a WebTV offering with gaming capability, the other a dedicated game console. Eventually, it was concluded that it had to be a game console, superior rather than equal to the PS2. Microsoft initially hoped that a PC builder like Dell would produce the box, but these companies were not interested. Instead, Microsoft realised it would have to deal directly with key suppliers and contract manufacturers.

By March 2000, the critical partners were signed up. Intel would provide the processor and motherboard, Nvidia would provide the graphics and multimedia chips and Flextronics would manufacture the units in Mexico and Hungary. Each would be linked by collaborative manufacturing software tools provided by Agile. The first units started coming off the lines in the summer of 2001, and the Xbox was finally launched in November 2001.

Drive to lower costs

The Xbox initially sold for $299, but the estimated manufacturing cost was significantly higher than this. (A May 2002 report by electronics systems analysts Portelligent put the cost-of-goods at $323). Losses on the hardware would however be offset by profits on sales of games, particularly the in-house games which carried a higher margin. (Console prices have continued to fall: in May 2002, Sony cut the US price of the PS2 to $199, and Microsoft followed suit. As of February 2004, the price at Amazon for both consoles is around $179.99).

In a further move to cut production costs during summer 2002, Flextronics relocated its Hungarian manufacturing operation to Doumen, China. Production in Hungary stopped on May 26. Later that year, Microsoft added a second manufacturing partner - the Taiwanese Wistron Corp, the manufacturing arm of Acer.

Xbox 2

The cost of components in the Xbox continues to be a critical issue for Microsoft. The processor chips and the two disk drives account for much of the component cost. In August 2003, it was announced that ATI Technologies were to produce components for future versions of the Xbox. And in November 2003, it was revealed that Xbox 2 would contain a PowerPC processor. A November 2005 report from Portelligent estimates the cost-of-goods at $310 for the $299 basic unit, once more showing the business model to be dependent on accessories and games.

Further reading

• Takahashi, D. (2002) Opening the Xbox: Inside Microsoft's plan to unleash an entertainment revolution , Prima Publishing, Roseville
• Carey, D. Peek under the hood: Xbox -- PC meets console , EE Times, 10 June 2002 (includes an annotated picture of the Xbox motherboard, with an estimated bill of materials. David Carey is CEO of Portelligent , a company which produces teardown reports of electronic systems).
• Official website http://www.xbox.com

Recent news articles

• O'Brien, J. The making of the Xbox , Wired, Issue 9.11, November 2001
• Shah, J. and Serant, C. Microsoft's Xbox sets supply chain standard , EBN Online, 11 March 2002
• Olavsrud, T. Flextronics relocates Xbox manufacturing facility , Internetnews.com, 15 May 2002
• Penz, B. Game Over? Xbox production heads east , Business Hungary, Vol 16 No 6, June 2002
• Carbone, J. Outsourcing the Xbox , Purchasing Magazine Online, 15 August 2002
• Becker, D. ATI wins bid for next Xbox , CNET News.com, 14 August 2003
• Inside the Xbox 360: High Technology Coupled with Low Margins , Portelligent press release, 23 November 2005 (PDF)

(Xbox, Xbox Live, the Live Logo, and the Xbox logos are registered trademarks or trademarks of Microsoft Corp.)