[Justin Buser]

Online Focus

Even before the launch of the Xbox 360, Microsoft was the most aggressive of the console makers in championing online gaming. More than 150 games for its original Xbox, launched in 2001, allow gamers to play against each other online as long as users pay the Xbox Live subscription fee.

The appeal of online play is that users can quickly find human competitors -- whether they're friends or strangers -- without having to gather in someone's living room. For instance, a user wanting to find a competitor in Electronic Arts Inc.'s Madden football game late at night easily can log on to Xbox Live and find a foe within seconds. Each player would coach a virtual team in the same game.

More than two million users of the original Xbox have subscribed to Xbox Live, or about 10% of the customer base. Adoption has been "much faster than expected," said Aaron Greenberg, Microsoft's group marketing manager for Xbox Live, who declined to say whether the service is profitable. With the Xbox 360, Microsoft hopes to persuade 50% of users to hook up to the Internet, he said.

One of Microsoft's strategies to garner more online users is to make it easier to sign up. Unlike with the original Xbox, users of the Xbox 360 don't have to buy a special online kit at a store. If they get the $400, premium version of the new console -- or pay for extra memory for the $300 core model -- they get a free subscription to a service called Xbox Live Silver. It lets players buy and download certain games and send text or voice messages to other users. If they want to compete against others online, they must upgrade to the pay service, known as Xbox Live Gold.

Users pick a nickname -- called a "gamertag" -- that identifies who they are in any game they play on the Xbox 360. This makes it easier for other users to find them and communicate, and it allows Microsoft to offer features in the Gold service such as a tool that assigns a rating to players and pairs them with competitors of similar skill levels.

High Stakes

Mr. Goodman, the Yankee Group analyst, estimates that Microsoft spent more than $200 million just to develop Xbox Live. Mr. Pachter, of Wedbush Morgan, estimates the company has spent more than $1 billion total on the service, including marketing costs. Microsoft won't disclose the cost, though Mr. Greenberg said it has made "a huge investment" in Xbox Live. Microsoft pledged in 2002 to spend $2 billion over five years to beef up its Xbox business, including the development of Xbox Live and the Xbox 360.

The Xbox Live service is part of an entertainment division which includes the Xbox console, as well as PC games and interactive TV products. The division reported an operating loss of $391 million on $3.24 billion in revenue for the fiscal year ended June 30, 2005. Microsoft expects a wider loss for the current fiscal year, because of costs associated with the Xbox 360's launch.

Microsoft's ability to convince more users to pay for the online service will play a key role in the Xbox's profitability. While online gaming is growing in popularity – U.S. revenue is expected to climb to $1.6 billion next year from $1.1 billion this year, according to Dallas research firm Park Associates -- the concept remains unfamiliar to many users of console machines like the Xbox. And while many of the most popular PC games incorporate online play, such features are often included for free. An exception is multiplayer PC games designed for thousands of players, in which publishers typically charge a monthly subscription fee of about $15.

Microsoft could attract a higher percentage of online users for the Xbox 360 than it has with the original Xbox, industry analysts said, in part because the company has positioned the console to be a one-stop digital entertainment center, allowing users to download and play movies and music and view digital photos. But some analysts said they were skeptical that interest among gamers in playing online is strong enough for Microsoft to meet its goal of getting half of Xbox 360 users to use the online service. "The market for online gaming for Xbox is maybe 20%" of users, Mr. Pachter said.

One strategy Microsoft is using to expand its audience is Xbox Live Arcade, a service geared to more casual gamers that features games that are faster to learn, and don't take as long to play. It lets users download arcade-style games for free and test them for a few days -- or for a few levels of the game. If they like a game, users pay between $5 and $15 to keep it. Multiplayer titles include Gauntlet and Joust, popular games from the 1980s.

The company also will allow players to buy add-on content for games, such as special characters and weapons, and Microsoft will share the revenue with publishers. The move could help push more publishers to make online-compatible games for the Xbox 360.

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