With Xbox, Microsoft Looks to a New Frontier: the Living Room

Microsoft Corp. is set to release Xbox, the most anticipated game system release of the holiday season — but you may not know the software giant is behind it.

The Xbox console, due out Nov. 15, is, like many teen-agers, embarrassed to be seen with its parents.

In its $500 million worldwide advertising blitz, Microsoft's name will appear in tiny type, if at all. If the software giant is mentioned, it'll be to appeal to gamers' parents, says John O'Rourke, Microsoft's director of games marketing.

It's part of Microsoft's push to build Xbox as a unique and very un-Microsoft brand — one that is cool to the 16- to 26-year-old male "hard-core gamer" whose acceptance is critical.

But don't let the deliberate distance fool you. Xbox may look and act different from Windows and Office, but executives believe it is a key to Microsoft's future.

In the last 25 years, Microsoft and others have changed the way people do business through technology, says Xbox general manager J Allard. "Now's the time for Microsoft to step up and spearhead an initiative to change the way people play through technology."

Allard and others at Microsoft see Xbox as a first step toward a broad vision of an interconnected living room, powered by Microsoft software and hardware ranging from set-top boxes to digital music and video players.

In this world, video games appear on your television screen over a high-speed Internet connection. Broadcast football games can leave reality and enter your game console with the flip of a switch. Music and videos can be downloaded or streamed into this world as well, and handheld devices and cell phones will allow you to take your entertainment with you when you leave the house.

The glue that holds this ambitious Microsoft world together will be Microsoft's Internet subscription services, called .NET, and its authentication system called Passport, Allard says. But Xbox will be the core around which other Microsoft software and hardware are built.

"(Xbox) is going to be our foundation in the home," says Robbie Bach, Microsoft's Chief Xbox Officer.

Microsoft, faced with slowing demand for personal computers and the related products Microsoft sells, has plenty of reason to look to new markets. But to enter the living room on the back of Xbox, the company is gambling on a lot of firsts.

It's the first time Microsoft is entering the hardware business, aiming a product initially only at young men and trying to sell a product that's only about entertainment, not business.

And it's the first time the traditionally staid Microsoft is using flatulent animated characters to amp up investors.

At a financial analysts' meeting this summer, Seamus Blackley — an executive who describes himself as Xbox's "head evangelist" — did just that while demonstrating an Xbox game based on the hit movie "Shrek."

It was definitely the liveliest demo of the day, but Xbox hasn't done much to animate bottom line-focused Wall Street types.

Brendan Barnicle of Pacific Crest Securities is expecting the company to lose $100 for every $300 console it sells, although its games sales will offset that.

"Ironically, the worse Xbox does the better it is for Microsoft's financials," he says.

Both Barnicle and Mary Meeker of Morgan Stanley Dean Witter believe Microsoft could eventually provide Microsoft with a strong tool for getting into the living room. But Meeker is predicting Xbox will lose about $1 billion before breaking even in the company's fiscal year 2004.

Microsoft will not say how much it expects to lose on Xbox or when it thinks it will break even.

Thanks to billions in cash reserves, Microsoft has landed hot game titles like "OddWorld" and "Halo" that are sure to entice gamers, despite Xbox's competitors' strong backlog of games.

The console also boasts extremely realistic graphics and features such as a built-in DVD player (available with an extra $29 adapter), enhanced memory and a high-speed Internet connection to be put to use sometime next year.

The unprecedented $500 million marketing campaign will do much to get games enthusiasts interested, says P.J. McNealy, a games analyst with Gartner/Dataquest. But Microsoft also has to prove it has staying power by delivering a series of games that will appeal to kids and adults, not just hard-core gamers, McNealy says.

There are other issues that may hamper the launch, analysts say, including low consumer confidence, the attention-diverting war on terrorism and the fact that the company is still involved in its federal antitrust case.

Xbox also has been plagued with talk of production problems. Microsoft denied production issues caused a week's delay in releasing Xbox. The delay, Bach says, was "just technically about getting all the components to work together." He wouldn't elaborate.

Other bumps in the road, including glitches in some product demonstrations and early inventory expectations that later proved too ambitious, have hurt the company's reputation.

McNealy applauds the software giant for learning from some of its mistakes, although he cautions that the next few months will provide the real test.

"You can only make a good first impression once," he says.