Inside Microsoft's Consumer Strategy

Few companies in techdom are diving deeper into consumer electronics than Microsoft. Comcast (CMCSA) recently began offering set-top boxes that run Microsoft (MSFT) software to its cable customers. The tech giant just opened the doors to its online music store and released software for portable music players that works in concert with the store. Microsoft's partners have already sold 1 million new Windows XP Media Center PCs that connect directly to TV sets to record programs onto the computer's hard drive. And consumers have purchased roughly 16 million of its Xbox game console, including more than 1 million who've signed up for the Xbox Live online gaming service.

The pace won't let up. The Colossus of Redmond just introduced a new breed of consumer-electronics products, Media Center Extenders, that let customers pull video, music, and pictures wirelessly off Media Center PCs and play them on any TV or stereo around the house. Audiovox (VOXX) just started selling a new mobile phone that uses Microsoft technology to also store and play songs. And analysts expect Gates & Co. to launch the next generation of Xbox by Christmas 2005, giving it a leg up on rivals Sony (SNE) and Nintendo, who aren't likely to match that timing.

Behind the scenes, Microsoft is busily trying to link all its consumer efforts to give it more bang for its buck. It has created something called the Consumer Leadership Team, a group of top execs including Chairman Bill Gates and CEO Steve Ballmer. The goal is to ensure that consumer innovations ginned up in one part of the company are available to execs running Microsoft's other consumer businesses.

Another team member, chief Xbox exec Robert J. Bach, is tapping Microsoft's growing consumer software expertise to build the next Xbox and expand its tech dominance beyond the workplace and home offices. Bach recently talked about Microsoft's consumer strategy with BusinessWeek Seattle Bureau Chief Jay Greene. Edited excerpts of their conversation follow:

Q: You've talked in the past about how success in Xbox would feed some of Microsoft's other businesses such as MSN or Windows Media Center PCs. Has that happened yet?

A: It's one of those things that's in the process of happening. You see the opportunities for integration coming. We're taking advantage of those. It takes time for that to take effect in the marketplace.

A digital lifestyle is developing that incorporates things you do online with things you do with entertainment, with things you do with gaming, with things you do with music, movies, TV. As that all comes together, Xbox is certainly going to play an important role. And that means it needs to integrate with other parts of Microsoft that are going to play an important role as well.

Q: Are there key products to look for from Microsoft?

A: You're going to see us take a paced approach to this. It's important at the foundation level for things like Media Center, MSN, Xbox to be successful in their own right. You're seeing with all three properties that their success is broadening. Then the opportunities to integrate them become more palpable.

The Extender product, which I use at home, is a great product and proves that integration can deliver great customer benefit. The number of people doing distributed video in the home today is not large now. It's increasing. It's a market for the future. But you're not going to see, and nobody should expect, huge numbers for that product. What they should see is a great customer scenario that proves that we're going to be able to deliver value over time.

Q: How close is the time when it will be commonplace for consumers to have networked devices in their living rooms?

A: Picking a time frame is tough, but I think you're going to see that trend over the next five years continue to accelerate. It's like PVR [personal video recording, a la TiVo]. It's like online gaming. You're going to see analysts saying it's going to happen in the next two years, and you're going to see analysts say it's not going to take place for another 10 years. And just like PVR, which is now starting to take off in a big way, nobody got the date right.

I try to think in five-year windows, and I think in the next five-year window it's going to be an important part of what people want to do.

Q: That might suggest that the next version of Xbox would need to enable these scenarios in ways that are better than the current version. Is that right?

A: Well, we haven't talked about the next version of Xbox. But people know we're working on it, and people have to assume it's going to be the world's best game console. That's the place where it needs to start.

But we do think there are going to be opportunities to enable what we've called "integrated innovation" scenarios. You can assume that everything we do -- the gaming side and things that integrate with other forms of entertainment -- is going to get better and better and better.

Q: As the next generation of consoles comes out what specific areas are you really raising the bar from where it is right now?

A: Set aside the console thing just for a second. I think you have to step back ask what are the things people want to do? I'll put on my Consumer Leadership Team hat here, instead of my Xbox hat. What are some of the scenarios that we think are powerful and rich that people are going to want to do whatever device they're working on, whether it's an Xbox, a Media Center PC, a handheld, or some other device? Four or five come to the forefront relatively quickly.

Certainly, there's the idea that you're going to want to share what I'll call for lack of a better phrase your digital memories, whether that's digital photos or digital video. People are going to want to find cool ways to share those types of things. You're going to see a lot of work across all parts of the company to figure that out, to make it a richer scenario, and to make it a lot easier.

You can think about sharing broadcast video. That's going to be a richer scenario. The work we're doing in Microsoft TV with Comcast is really good. It's well integrated. The idea that you're going to want to share that, that you're going to want to have that on a network -- that is going to happen. It's just a question of time and figuring out the process for that to happen.

Music is clearly a scenario that everyone is focused on. Certainly, Apple (AAPL) has done some good work there. But we're still very early in the curve of what's possible and what people want. The consumers we talk to in MSN or Xbox or the Windows team say music is a very essential part of what they do whether it's on an Xbox or a PC or some other device.

Communications turns out to be a very important scenario as well, whether that's chat, messaging, blogging, telephony. All those things are important scenarios, and there will be things that Microsoft will be doing to deliver those. Now in some of those, we may be an infrastructure player, rather than a direct consumer player. There are tons of ways where software can play a role.

This isn't so much about [information technology] meeting [consumer electronics] or vice versa. I'd pose it in a slightly different way. It's really [consumer electronics] meets software. Certainly, there are IT aspects to this. But the real powerful thing that's happening here is the value of software and the value of what consumer-electronics companies do are coming together. All of these scenarios I've just talked about require some hardware and some very cool software to enable them.

Q: When Microsoft first announced plans to get into the game-console business, rivals suggested it would fail because it has little consumer-electronics experience. And clearly that hasn't happened. Other tech companies -- from Apple to Hewlett-Packard (HPQ) to Gateway (GTW) to Dell (DELL) -- have gotten into this business, some with pretty good success. Does it say anything about the ability of tech companies to jump into consumer electronics?

A: It's hard to generalize. All the companies you cited are incredible companies, but they're all different. You have to go back to the general principles and say, what did Microsoft do well to enable them to be successful at this? Can other companies do those things well? Can they get in and really understand the nature of the market? Can they find a way to leverage the strengths they have -- software, in our case -- that help them in a consumer-electronics context?

Software has been a big part of our success on Xbox. Can they find a way to differentiate themselves from the existing solution, as we did with Xbox Live, because in a commodity business, the new guy has a really hard time?

Those are the kinds of lessons that people need to look at. It's not so much a more general statement about companies that you would have thought about as PC companies or as software companies suddenly making it in the consumer-electronics space. My guess is there will be examples from the whole list you gave of companies that will be successful and some that won't.

Q: Can any broad lessons be learned from tech companies getting into consumer electronics? It certainly seems like many more are doing it today than there used to be.

A: Being a consumer-electronics company today isn't just about having some cool hardware technology. iPod is a great example. The actually technology in the iPod, with perhaps the exception of the size of the hard disk -- which Apple didn't come up with, Toshiba did -- isn't very innovative. What's innovative in that product is the design, no question; the software, no question; and the way the design and the software and the hardware integrate with each other. That's the underlying thing that has fundamentally changed.

If you go back 20 years and could ask about TV design, they'd say it's just about hardware. The TV experience now isn't just about hardware. It's about software. It's about services. And the telcos and the cable companies of the world are going to be in a business that's going to involve not just hardware, not just the pipe, not just service, but software and the combination of those things.

It really is revitalizing a business, and not just for Microsoft. You could say the same thing for the consumer-electronics companies because that business has been a commodity business in many parts for a long time. There's an opportunity for them, through this change that's going on, to take advantage of that and get themselves into a more value-added business.

In a world in which everyone is beating themselves up over [traditional] TVs at $299, there aren't a lot of ways to differentiate yourself. In a world in which you're talking about a video-on-demand experience that involves high-end hardware and software and services, there are lots of ways to differentiate yourself. For us, for the cable people, for everyone in the ecosystem.

Steve Ballmer, Power Forward
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