Microsoft corporate vice president Peter Moore

Sometimes, it just doesn't pay to be first. Microsoft's Xbox 360 videogame console beat its competition--Nintendo's Wii and Sony's Playstation 3--to the market by a full year. And despite the Wii's explosive start, Microsoft is still clinging to its global lead, while former market leader Sony struggles to catch up. But a growing problem whose existence had been mostly confined to the videogame intelligentsia--the three flashing red lights indicating that one's Xbox 360 has completely malfunctioned (also known as the "Red Rings of Death")--burst into the public eye Thursday afternoon. After the market close on the East Coast, Microsoft announced that it would take a charge of $1.05 billion to $1.15 billion to cover the costs associated with the Xbox 360's "unacceptable" failure rate; specifically, for extending its warranty period from one year to three [for three flashing red light failures only], and to reimburse those who paid for repairs after their one-year warranties expired. We spoke with Microsoft entertainment and devices corporate vice president Peter Moore on Friday, and though he was candid throughout, the big question--what exactly is the problem?--remains unanswered. Asked whether the issue is a single problem with the cooling design--as several armchair engineers and numerous gamers believe--Moore stated, "I'm not going to pretend to be technical on this issue, but it's been a multitude of problems. There's no one specific factor we can point to." Yet Moore insists that the problem is not systemic, and he refused to say whether the flaws lie in design or manufacturing.

Nevertheless, the amount of money that Microsoft has set aside, when divided by the 11.6 million Xbox 360s that Microsoft has shipped, comes out to roughly $100 per unit sold, an amount that industry veterans say is right around what it would cost for shipping, handling, labor and replacing the entire motherboard for a console of that complexity. Excerpts from our conversation:

All right. You're live and direct.

OK. Let me take you though what we've just announced about 15-20 minutes ago. You know about the fundamentals. Business is strong; we're going to have a good E3, but to cut to the chase, there's something we haven't done so well, and that's that the rate of repairs that have been coming in showing the three-flashing-red-lights error message has been, quite frankly, unacceptable to us. So we've decided to take some steps to take care of that.

Firstly, we're making improvements to the console itself that will reduce the occurrence of these issues. But perhaps more importantly, we're implementing an enhanced warranty program to cover the general hardware failures, the ones that are indicated by the three flashing red lights. So we're announcing a specific warranty coverage extension to three years for any console that displays the three-red-light error message. If you get that, we'll repair the console, free of charge, including shipping, for three years from the purchase date. And perhaps equally important, for the people who have already paid us to get it fixed out of warranty, we're going to retroactively reimburse any customer that's had that problem and has paid us to fix their box--from the get-go. So we will be able to take care of everybody that's had this message from launch onwards. And the three-year warranty will be in place immediately, and will cover every box that's been bought or is about to be bought.

There's obviously no safety issue here, and this decision to do this is voluntary on our part. It obviously comes with a cost, and we're going to be taking a $1.05-$1.15 billion pretax charge to earnings for the quarter that's just ended, our fiscal year Q4 for FY07. That will cover the cost of being able to put this program in place. We continue to stand by the product, as you know, and we'll hopefully be able to take care of some people that we haven't done a good job with over the past few months.

The word that you used is that the rate of repairs for Xbox 360 consoles showing the three red lights was "unacceptable."

Yeah.

When did it cross that threshold? Walk me through the stages from awareness to growing concern to unacceptable.

What we needed to do was gather data. You can't do this stuff, as you know, anecdotally. It's taken us a while. We needed to make sure that what we were able to announce would be able to improve the quality of the box by gathering the data. Also, to roll out something of this nature on a global basis requires logistics in place, as well as to calculate the costs. Obviously, this is not an inconsequential amount of money. We needed to make sure that we did this once and did it right, and so it's taken a little while. I couldn't put a specific number of weeks or months on it, but this is not something we thought about last Monday and figured we should do this week. This is something that obviously teams around the world have been working on, to make sure that: A) we take care of our customers, because they've taken care of us, and we haven't done a good job recently of taking care of them. and, B) captured all of the costs so that we could take a one-time pretax charge.

How did you determine the three-year period for the extension to the warranty?

Three years seems like a reasonable amount of time for somebody to have a piece of consumer electronics of this nature. We felt--certainly, I think it's unprecedented that someone's had a longer warranty on a console than this. I can't remember. But we felt three years--and certainly, the folks we've spoken to in the last half hour and some of the community feedback seem to think that this is more than fair. If you're a gamer and for three years we cover you, then we feel that you've gotten good value from the box. It's not an exact science. Two years, three years, it felt like fairness more than anything else for us.

If someone already has a refurbished box, is this for repair? New Xbox 360s? What is it exactly?

We're going to send you a box. I'm not going to get into details of exactly what that box is, but our goal is to take care of you. Two things here: if you paid us to fix your box, we're going to reimburse you. Simple as that. If you have a problem with your box, we're going to replace it.

Your background is in marketing. You're intimately familiar with PR. It seemed to me that while there was certainly a growing awareness of this problem online and on message boards, it seems as though the mainstream media--and I include myself--hadn't really covered this heavily. Did you feel as though on the PR side that this was coming to a head or a reckoning at all?

No.

Or did you feel like, "Hey, we've dodged a bullet on this so far—let's take care of this now"?

No. This is not about PR. This is not about making us look good. This is about doing the right thing. If you're going to worry about PR, you probably wouldn't do it five days before E3. If you're worried about PR, you'd wait until people went on vacation, I don't know. We needed to make that sure we did the right thing.

Is there any one thing that you can trace the three red lights back to? Because there's been a lot of scuttlebutt on the Internet that it has to do with the epoxy that was applied to key components; that it was either insufficient, or that it was too close to a heat-producing component that was causing that epoxy to warp and chips to come loose. Is there anything that you can say specifically about what's been causing the problem?

No, not really. And you know me; I'm not going to pretend to be technical on this issue, but it's been a multitude of problems. There's no one specific problem that we can point to and say, "That problem causes three red lights." It's different factors, different environmental issues, it's a completely different thing. As we go on in the coming weeks, there may be more information that we're willing to share, but right now, our goal is to make sure that we do the right thing as quickly and effectively as possible. And regardless of what's caused the three red lights, we're going to take care of you.

Can you say whether it was a flaw in the design or the manufacturing?

No. I can't say that, no.

In terms of reimbursing people, is that going to be a check, is that going to be Microsoft Points--how are you handling that?

[Laughs.] Not Microsoft Points. Real U.S. dollars, British pounds, European euros. Whatever it is that we charged you, you'll be reimbursed back in real currency. Not that Microsoft Points aren't real currency, N'Gai, but no, we're not going to credit your Xbox Live account with Microsoft Points.

And just to be clear, this refund program dates back to the very first Xbox [360] sold?

If you had three red lights, and you paid to fix it out of warranty--because we would have taken care of you in-warranty, obviously--then we're going to pay you back. Now that's going to take us a little while, because we've got to go through and cut checks and what have you, and it's global. But we're going to pay you back.

Did you consider a recall?

No. This is not a recall issue. This is not a systemic problem, this is not a safety issue, this is a completely voluntary action on our part. Nobody's forcing us to do anything here. We're just trying to do the right thing.

Lastly, when you realized, "This is what we're going to have to do," how did you feel?

I feel bad. I feel bad for the consumers that we haven't taken care of, because they're a really loyal and passionate bunch. You know Xbox Nation. I feel bad--more importantly, perhaps today--I feel bad for the people here in Redmond, because you don't like to do this stuff. I don't like to cause the corporation this kind of a financial hit. But it's the right thing to do. I can tell you that everybody here is very supportive of doing the right thing here, regardless of the cost. Today, I feel bad for the people who work at Xbox, because I'm sure that people are going to look at this and feel real bad about what's going on today. I'd like to think that by the time we get to E3 and we show that the business fundamentals are incredibly strong and the business is strong going forward, that people are going to feel a little better. But it's kind of a sad day here today.

Real quick: are you still going to be profitable for the next fiscal year?

Yes. sir. Yes indeed. Absolutely.

Cool, man. The pressure's on Bungie.

Yeah, there you go. Who are those guys? [Laughs.]

Thanks, Peter. I appreciate you taking the time to talk.

Not a problem. Take care.