"You're not the champ until you beat the champ."

The entire staff of Level Up is seated in the Manhattan speakeasy Little Branch, opposite two Microsofties--one former, one current. Several drinks into a conversation about the console wars, Former has just asked us, at what point in the cycle do you think you're going to declare Microsoft the winner? Which prompts the rejoinder that opened this post. We proceed to inform him that back in 2001, as we were in edits on our story about the launch of the first Xbox, there was a line that had been cut from our piece that we wished had remained, because it would have been a very prescient quote to have on the record. The quote? "Xbox will be Microsoft's Vietnam."

At this point, Former becomes impassioned. That's not fair, he says; we always saw this as a long-term venture. To which we reply that we were talking about the original Xbox, and while other divisions of the company throw off more profits in a single quarter than the entire $5 billion or so lost in the home and entertainment division to date, the fact remains that, as we take-our-word-for-it predicted, the Xbox group has been spectacularly unprofitable for Microsoft. Hence, our heretofore unpublished Vietnam analogy. The rest of the night is a blur, but we digress.

Here at Level Up, we pride ourselves on giving good quote when asked, and our quote in yesterday's issue of USA Today that "the PS3 is sucking wind right now," seems to have delivered the goods, as evidenced by its coverage on the Internet and the emails coming across our transom. We've known USA Today's Mike Snider for several years, and have tremendous respect for his work. However, we also try to be holistic in our analysis, and there were some opinions that we shared about Sony's competitors that didn't end up in the finished copy. There's nothing sinister in Snider's decision; we completely understand that the focus of his published story was the PS3's woes, which we ourselves addressed yesterday. But we thought we'd take this opportunity to provide a more comprehensive look at the February NPD numbers for the U.S. market, and explain to Former why we don't expect to proclaim a Microsoft victory at the end of this console cycle.

Microsoft entered the month of February with many advantages. The Xbox 360 had a 12 month head start on its rivals. There's plenty of stock on store shelves. It has far more games available than either PS3 or Wii, and several of those games are available for $20 to $30. And perhaps most importantly, it has a $299 SKU that's priced $200 cheaper than the least expensive PS3, just $50 more than the Wii, and at exactly the same price point the PS2 occupied when it obliterated its competition in 2001. Yet despite those considerable advantages--and even though five of February's top ten 10 best-selling SKUs were on Xbox 360--the best Microsoft could do was outsell the higher-priced PS3 by 101,000 units, while succumbing to the supply-constrained Wii by 107,000 units. That's not the kind of performance that portends market dominance. Nor is cutting your shipment forecast through June 2007 from 13-15 million to 12 million. But Microsoft has done that too.

The reason that we spent much of last fall discussing the sluggish Xbox 360 sales with our interview subjects is because we were genuinely mystified as to why it wasn't doing better, and, more importantly, why wasn't the steadily growing number of hit titles causing a commensurate growth in the installed base? The signs of this weakness have been apparent for months, yet it went largely undiscussed--a notable exception was the forum-dwellers at NeoGAF--and when we queried industry veterans about it, they seemed genuinely mystified and would struggle to offer explanations.

In this vacuum of analysis, statements like the following went pretty much unchallenged. At this year's Consumer Electronics Show, Microsoft general manager Chris Satchell told GamesIndustry.biz, "We've sold 10.4 million [Xbox 360s], but the stat you may not have heard is that over half of those sales are from people that didn't own an Xbox 1." That statement sounds impressive--until you realize that at that point in time, Xbox 360 sell-through was still trailing that of the original Xbox. If Microsoft is getting all of these new customers--and we have no reason to doubt the veracity of Satchell's statement--shouldn't their installed base have been 1.5x that of the original, as opposed to lagging behind? (Please don't use pricing as an excuse; as we pointed out above, there' a $299 SKU that's been available since launch, and if PS2 was able to become a runaway success at the same point in its lifespan at that price point, price alone can't explain the sales gap.) In other words, if you look at the half-empty part of the glass Satchell raised, there are clearly a large number of Xbox 1 owners who haven't yet bought an Xbox 360. Why?

Part of the problem is that in the absence of a new Halo game, there's been a slower-than-expected conversion of Xbox owners to Xbox 360. As of last fall, half of the people playing Halo 2 were doing so on the original Xbox, not the Xbox 360. That's why the upcoming Halo 2 map pack will only work on Xbox 360--Microsoft needs to force recalcitrant Halo-lovers to buy their new machine. Another challenge for Microsoft may be that most Xbox 1 units sold at $199 or less; in fact, when Halo 2 shipped in November of 2004, the price of the Xbox had been set at $149 for seven months.

By contrast, PS2 held price at $299 for its first two Christmases, and $199 for the subsequent holiday. So despite the hardcore nature of many Xbox aficionados--i.e. they love shooters and they buy a lot of games--many of the gamers that made Halo 2 a phenomenon could conceivably be even more price-sensitive on the hardware side than their PS2 counterparts, and thus perceive even the $299 Core as either too expensive and/or too lacking in value compared to the $399 model. Microsoft is no slouch when it comes to market research, and if our above hunch is correct, it could finally explain why the company opted for a two-SKU strategy even though hardcore gamers loudly derided it.

The final reason why we don't expect to crown Xbox 360 the champ when all is said and done is somewhat tautological: until we see the evidence that it's capable of reaching the true mass market the way that the PS1 and PS2 did, we won't believe that it can. What the original Xbox proved, and the Xbox 360 is proving even moreso, is that Microsoft has learned how to strip-mine the hardcore gamer. (The evidence? Gears of War is one of the biggest console hits in recent history, yet the Wii is kicking the 360's ass and taking its name. And as we stated earlier, even before the Wii and PS3 launched, the 360 was steadily producing one or two hits a month, yet monthly hardware sales were consistently below 300,000 units, and were often closer to 200,000 units.)

Based on the concentric circle theory of product dispersal--at the center are a smaller number of hardcore gamers who buy lots of games; on the outside are a larger number of ultra casuals who buy fewer games, with a number of audience segments in between going from more hardcore to less hardcore--the further away you get from the hardcore center, the less evidence we've seen of Microsoft's ability to reach those broader, more casual audiences. The generals at Microsoft Game Studios have sent into the fray soldiers as varied as Fusion Frenzy, Voodoo Vince, Grabbed by the Ghoulies, Kameo and Viva Pinata. None of them got the job done.

By contrast, Sony has brands developed in each of three major territories--North America (Jak, Ratchet & Clank, Sly Cooper, ATV Offroad Fury), Europe (SingStar, Buzz!, EyeToy) and Japan (Gran Turismo, Hot Shots Golf, Ape Escape)--with demonstrated appeal to broader audiences: children, women, casual gamers. That's why the Game Developers Conference introductions of Home and LittleBigPlanet were so important: they show that Sony continues to develop products that can appeal to the parts of the market that are necessary to drive hardware sales past 26 million (Xbox 1) to well over 100 million (PS1 and PS2) once they get within striking range on the pricing. The burden of proof is on Microsoft to prove that it can deliver products with that kind of appeal, and in the seven years since it stepped into the ring, it has yet to do so.

The folks at Microsoft would like to believe that, their worse-than-ever performance in Japan notwithstanding, the only ceiling that existed on the Xbox 1's sales stemmed from their late entry to the market. They may well be right. But while Microsoft has taken advantage of its first-mover advantage--most notably the establishing of Xbox 360 as third party developers' base platform; much-improved third party support from Japanese developers; the peeling away of Sony's historic timed exclusivity on the Grand Theft Auto franchise; and the positioning of Xbox Live and Xbox Live Arcade in a way that for now neutralizes the PR value of Sony's free but less-feature-rich online service--we suspect that there are a number of other challenges that will keep prevent the 360 from breaking into the mass market in the way that the PS2 did. And the numbers thus far back us up very clearly on this point.

The worst case scenario for Microsoft, then, is one in which the Xbox 360's bid for the mass market is blocked by the Wii for the next two to three years, at which point the aging and underpowered Wii gives way to a cheaper-than-it-is-now PS3 with a selection of AAA titles that's far wider than what the PS3 has at the moment; new installments of Playstation's own popular and casual-leaning games; and a slew of new franchises from Sony's much-larger studio operation. The best case scenario won't manifest itself until Xbox 720, but there is an interim scenario that we've been trying out for size on a few people in the industry--it contains a theory that we think best explains the the current overall state of the industry--and once we have it nailed down, you, Dear Reader, will be the first to know.

Next: Kyoto, We Have A Problem, Or, What's Wrong With the Wii