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Huge Xbox losses hidden by patent royalties, says analyst

Huge Xbox losses hidden by patent royalties, says analyst

Thu 07 Nov 2013 6:40pm GMT / 1:40pm EST / 10:40am PST
HardwareFinancial

Nomura's Rick Sherlund believes gaming business has been losing billions for Microsoft, but Android licensing fees obscure deficits

Microsoft is hiding billions in losses from its Xbox gaming business, according to Nomura analyst Rick Sherlund. In a note to investors yesterday, Sherlund laid out a plan suggesting what steps Microsoft should take to resolve its current CEO vacancy and address some key issues going forward. One of Sherlund's key points in the note is that the Xbox platform, despite being largely viewed as a success, is actually losing huge amounts of money for Microsoft, according to his own estimates.

"If we start with the overall traditional [Entertainment and Devices Division] business that actually loses money before corporate allocations and back out the nearly $2 billion 95 percent gross margin Android phone royalties, we conclude that Xbox platform plus Windows phone and Skype lose about $2.5 billion per year, and we estimate that the Xbox platform may account for roughly $2 billion of this," Sherlund said. "This is contrary to conventional wisdom, we think investors do not realize how extensive the operating costs are for this business and it is concealed by the hugely profitable Android royalties."

The Android royalties mentioned are the result of patents Microsoft holds on technology that Google infringed upon in developing the operating system. Microsoft has signed numerous licensing agreements with the manufacturers of Android and Chrome OS devices--Acer, LG, Samsung, and HTC among them--that bring in revenue while letting those companies continue using Android on their devices.

"Xbox is an orphan in our view," Sherlund said. "It is a 'cool' product line and a successful consumer franchise, but it also loses a lot of money and we think is a distraction to the more enterprise strengths of Microsoft."

As for the narrowing cast of potential CEOs for Microsoft, Sherlund said it is likely that Ford's Alan Mulally will be appointed to the position by December.

Sherlund first made headlines for advocating Microsoft spin-off its gaming business back in June.

26 Comments

Klaus Preisinger Freelance Writing

1,133 1,167 1.0
Considering how Microsoft was formerly known as the company you hated because of how well your workplace PC functioned, or rather didn't, I'd say it is still money well spent on the world's gamiest brand promotion. The overall image is still up from where it was before Xbox.

Posted:11 months ago

#1

Paul Shirley Programmers

178 150 0.8
<The overall image is still up from where it was before Xbox.>

That presupposes that the Xbox brand gloss transfers to the Microsoft brand. As far as I can see it doesn't, Xbox is a nearly standalone brand with very little mention of Microsoft in any public facing packaging or publicity. Xbox gamers are aware it's a Microsoft product but I've never seen it making a difference to how they think of Microsoft in any other scope.

Microsoft seem aware of this, with the suggestion of using the brand on PC gaming. I'd also say the overt focus on Xbox as a media hub is driven by it's dubious financial contribution as a pure gaming device.

Edited 1 times. Last edit by Paul Shirley on 7th November 2013 7:40pm

Posted:11 months ago

#2

James Prendergast Research Chemist

735 432 0.6
@ Christian:

I sort of agree with your comment but would alter it slightly:

- The XBOX wasn't successful outside of the US, I think the 360 was - but not to the extent of the PS3, of course.
- I don't think the brand (MS or Xbox itself) is a negative. I don't feel that it has any connotations (from the people I know in two-three countries) that really detract from it as a brand. However, it certainly doesn't have the brand value of Nintendo or the legacy brand value of Sony (who were huge in the 80s and early 90s).

Finally:
I would say in Europe it's the image of a brand that never delivered the same quality, commitment or value to the customers in the region compared to all the marketing materials produced for the product. The majority of their focus is always based on the US market and, since it's not 1984, the rest of the world sees those marketing materials and says: "Well, why don't we get that?"

MSes' problem, IMO, is that there isn't any balance in their focus worldwide and they only provide specialist value to one market and, instead of tailoring their product to each individual market, they just leave all the bonuses out of the other markets.

Now, it's true that Sony and Nintendo do this to an extent in their home market of Japan but there are two key differences here: 1) Most of the western world does not understand Japanese or one of its written forms and 2) The Japanese marketing is very highly contained and their US/EU features/marketing have a lot more parity as well as focus on specific markets.

This trend has continued in this latest console generation - lots of EU markets initially excluded (even after the dial back on the DRM) and even before the dial back a lot of markets had lock-in due to that DRM/credit card/account binding - which is TERRIBLE in the EU*, lots of features touted in marketing that only apply to the US or are only really effective in the US.

*Imagine not having a console work because you travelled between states in the US? Crazy for them to even ever think about having that as a requirement.

Posted:11 months ago

#3

Alfonso Sexto Lead Tester, Ubisoft Germany

820 652 0.8
Correct me if I'm wrong or if it's out of topic, but I remember this being the same in the beginning of each console cycle; Big looses in hardware and patents for the first year after you begin to get profit from the royalties you get for third party games and first party sales.
Releasing a console into the market is an investment after all.

Posted:11 months ago

#4

Alfonso Sexto Lead Tester, Ubisoft Germany

820 652 0.8
@James
Imagine not having a console work because you travelled between states in the US? Crazy for them to even ever think about having that as a requirement.
God! I had to suffer that when I moved to Germany. Microsoft seems to believe that the EU is a country instead of a conglomerate of 28 independent countries. something THE SHOULD KNOW. But hey, this applies to PS3 too.

Thankfully 360 allow the use of PayPal now and you can link all the accounts you want, you still restricted in some services but hey, at least you can buy games that way...

Posted:11 months ago

#5

James Prendergast Research Chemist

735 432 0.6
@ Alfonso - yeah, fair point. Though I never had a problem with the PS3 in moving around? Didn't try it with the 360. I was specifically referencing what they initially released about accounts being tied to the country the XBO was registered in. If you moved country you'd need a new account and thus all your games and score wouldn't go with it. I don't think it works that way for the current gen.

That was, thankfully, removed once they backtracked on the "always-on" scheme.

[edit] While searching for info I also noticed that the last confirmed reports had the XBO releasing in only 13 countries instead of the 21 that was initially stated in June.

So for EU that's UK, France, Germany, Spain, Ireland, Italy. Total = 6

Not the originally touted: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Netherlands, Norway, Spain, Sweden, Switzerland, United Kingdom. Total = 14

I hadn't even remembered this... and this won't be helping matters any in the EU.

Edited 2 times. Last edit by James Prendergast on 8th November 2013 9:42am

Posted:11 months ago

#6

Klaus Preisinger Freelance Writing

1,133 1,167 1.0
The 360 might not be the most popular console in Europe, but MS does not need to be number 1 to improve the company image. Compared to how disastrous the brand was perceived during the late 90ies and early odds, Microsoft is certainly better off now.

We also certainly know that features beyond games can be described as fragmentary at best. Microsoft having an additional paywall between online service and consumer, doesn't help make them much either. But the 360 certainly has a few video services which matter in Germany. The distinct lack of all those features in current XO announcements paints the old picture. It is a game thing with a few afterthoughts. In essence, the fist serious living room competition will curbstomp it.

Posted:11 months ago

#7

Morville O'Driscoll Blogger & Critic

1,578 1,432 0.9
Hmmm... Interesting reading this, then reading the Bloomberg article about Elop's plans should he become CEO.

Posted:11 months ago

#8

Paul Shirley Programmers

178 150 0.8
Alfonso: Correct me if I'm wrong or if it's out of topic, but I remember this being the same in the beginning of each console cycle

This is a report about current financials, not predicted next gen. The end of the cycle when those 3rd party royalties and accumulated sales should be strong. Microsoft have always organised their divisions in somewhat arbitrary ways, unless you deep dive the financials to look for what they're trying to average away (AKA hide). This is just one of these bits of sleight of hand, that hides the reality that keeping Sony at bay has been more important to the overall business than actually making a profit.

If Xbone as a media device also fails to turn a profit on their media content services things will get interesting, because that's the XBox end goal for Microsoft.

Posted:11 months ago

#9

Nicholas Pantazis Senior Editor, VGChartz Ltd

1,020 1,467 1.4
Popular Comment
As a side note of this article, how sad is it that Microsoft's only currently successful business venture is being a giant patent troll?

Posted:11 months ago

#10

James Prendergast Research Chemist

735 432 0.6
@ Paul Shirley - Even if Alfonso is wrong ( I don't think he is) the R&D costs of the XBO are a current drain.

Posted:11 months ago

#11

Iain McNulty Software / Game Developer, Yanxen

34 39 1.1
Outside the US neither the XBox nor the XBox360 were successful.
Oh really? Last time I checked both consoles were actually massively successful in the UK, unless you are counting the UK as the 51st State? ;)

Posted:11 months ago

#12

Adam Campbell Associate Producer, Miniclip Ltd

1,180 967 0.8
Is it? Outside the US neither the XBox nor the XBox360 were successful. I would say in europe the image of the brand isn't helping MS, it's the image of a brand, that - despite all the money MS is burning to keep it alive - never managed to become the number 1.
When it comes to consoles I would say in europe Sony is viewed as the cool kid on the block, Nintendo is viewed as the company you trust if your looking for entertainment that doesn't harm your kids and doesn't hurt your brain and MS is viewed as the rich uncle from overseas who is desperatly trying to buy your love with lots of money.

I don't know where you're getting your information from. In the UK the Xbox 360 is pretty much seen as the default console for core gamers, with perceptions that led the PS3 for many years.

Only now has the Xbox One dented that image, though some of it has been clawed back since policy reversals and the calming after the E3 storm. Though the 360 still continues to be that console I described for many.
Being big in the UK doesn't mean much nowadays, the console market in the UK collapsed the yearly revenues were:
So yes, the XBox360 was big in UK, but the UK wasn't big in video games,

No? The UK has been for most of the last decade at least the 3rd market by country. In 2009 we are all talking about it usurping Japan.

http://www.mcvuk.com/news/read/uk-industry-off-to-a-flyer-in-2009

The 360 also managed to overtake Wii as the number 1 UK console. Still the biggest market in the continent. I wouldn't just count it out as being irrelevant.

http://www.mcvuk.com/news/read/overall-uk-games-market-down-17-4-in-2012/0108783
http://www.mcvuk.com/news/read/uk-games-market-worth-4bn-in-2008
http://gamerinvestments.com/video-game-stocks/index.php/2010/01/06/2009-uk-video-game-industry-2nd-strongest-year-on-record-3-3-billion-in-total-revenue/
http://www.gamesindustry.biz/articles/2011-01-04-total-uk-videogame-product-sales-drop-29-percent-in-two-years
http://www.mcvuk.com/news/read/overall-uk-games-market-down-17-4-in-2012/0108783
Industries go through peaks and troughs. A wonderful British export, GTA V has lifted the UK to record growth this year and we also look forward to what will likely be record sales for next generation consoles, the highest in Europe as usual.

Edited 4 times. Last edit by Adam Campbell on 8th November 2013 9:55pm

Posted:11 months ago

#13

Adam Campbell Associate Producer, Miniclip Ltd

1,180 967 0.8
You realise, that the numbers provided in the article were for 2008 and not 2009 and that the UK video games market has crashed since 2008 (their peak year) and is today only about 40% of what it was in 2008?
That doesn't validate anything you've said, either about perception, 360 sales outside the US or the significance of the UK market globally.

Posted:11 months ago

#14

Iain McNulty Software / Game Developer, Yanxen

34 39 1.1
You said it was not a success outside of the US, except it was success in the UK. It does not matter how much it contributes to their overall global income, fact is that in the UK it was a success, if it were a failure then they would not be releasing the Xbox One over here, nor would they support the UK market in the slightest, unless they love burning money.

Posted:11 months ago

#15

Adam Campbell Associate Producer, Miniclip Ltd

1,180 967 0.8
Crashing the market within 4 years and landing at 40% of 2008's revenues tells me a lot about the significance of the UK market globally
Nearly as many Xbox 360's have been sold in the UK as PS3's in Japan. Over 8 million.

http://www.techradar.com/news/gaming/consoles/xbox-360-set-to-surpass-nintendo-wiis-uk-sales-record-1131356

http://www.eurogamer.net/articles/2012-12-13-3ds-has-surpassed-ps3-lifetime-sales-in-japan

By the end of last year PS3 broke the 5 million barrier in the UK.

http://hexus.net/gaming/news/ps3/46573-ps3-sales-break-5-million-barrier-uk/

Japan has a population of nearly 127 million, the UK just over 63 million, around half that of Japan. There's also a 2 trillion difference in total economic output. You're still saying the UK games industry is an insignificant market when looking at these consoles?

Of course, this is assuming you (like most people do) consider Japan to be a significant market. Sure, the UK games industry is smaller than it was a few years back, but as I mentioned before industries go through peaks and troughs. Sales have not been weak in the UK lately, especially as software on home consoles and 3DS have enticed people to spend.

Edited 3 times. Last edit by Adam Campbell on 8th November 2013 11:09pm

Posted:11 months ago

#16

Adam Campbell Associate Producer, Miniclip Ltd

1,180 967 0.8
You said it was not a success outside of the US, except it was success in the UK. It does not matter how much it contributes to their overall global income, fact is that in the UK it was a success, if it were a failure then they would not be releasing the Xbox One over here, nor would they support the UK market in the slightest, unless they love burning money.
Moreover, there is only an 8 million difference between 360 and PS3 sale in Europe. A 3rd of those European 360 sales were made in the "weak" UK market.

Posted:11 months ago

#17

Adam Campbell Associate Producer, Miniclip Ltd

1,180 967 0.8
Stationary consoles are dead in Japan, since 2005 Sony and Nintendo sold about 65 million handhelds, while they sold less the 25 million stationary consoles. Neither the PS3 nor the Wii were successful devices in Japan.
But you're not disputing the fact that the UK can sell enough units to swing market leadership in Europe? Which for a long while, it appears to have done just that. Insignificant markets don't sell 20+ million consoles and that's just the PS3, 360 and Wii.

Posted:11 months ago

#18

Adam Campbell Associate Producer, Miniclip Ltd

1,180 967 0.8
@Christian



I don't think your figure above is the entire product of the UK games industry, especially with the rise of on-line (and mobile and social) here. Leave out those factors from Germany and France and the figures will look different.

Posted:11 months ago

#19

Peter Dwyer Games Designer/Developer

482 293 0.6
@Christian

I read your points with interest mainly because they are pretty much nonsense. First of all the UK is a much smaller country by both population and land mass than either France or Germany yet generates an equivalent or greater revenue in console sales than Germany. Secondly there has been a world wide recession and that has caused the drop in sales not some mythical crash that you've made up.

What publication are you actually a journalist for?

Posted:11 months ago

#20

Bruce Everiss Marketing Consultant

1,692 594 0.4
@Peter Dwyer
I read your points with interest mainly because they are pretty much nonsense.
What publication are you actually a journalist for?
You are at it again. Your debating technique is to personally attack the person who disagrees with you. This is unacceptable behaviour on a professional industry forum. There are plenty of fanboy forums on which it is the norm, where you can go and be abusive if you want.

Posted:11 months ago

#21

Nick Parker Consultant

288 158 0.5
These are the physical goods software market size facts:

2008:
Global - $33.2bn
UK - Share of global sales = 11.1%
France - 6.9%
Germany - 7.2%
Japan - 10%
2012:
Global - $23bn
UK - share of global sales = 7%
France - 6%
Germany - 7.8%
Japan - 15.2%

Source: IHS Screen Digest.
Japan has grown on the back of handheld software sales (PSP/Vita and 3DS). The UK has declined in both size and market share due to a number of factors, most of which caused by recesssion (taking out key high street retailers which reduced store numbers) and gamers shift to mobile and PC social and casual at a faster rate than other markets. The UK was quick to adopt digital games sales which offset some of this packaged goods decline better than other markets so it is unfair to say that the UK video games market as a whole is in despair. The USA lost 5% market share in the same period.

Don't forget that the decline in the market was primarily down to the short lifecycle of the Wii which reached peak years in 2008 and 2009 then went into decline. The UK, having a more urban and sometime irreverent youth culture, has not always been too kind to younger family gaming experiences that Mum and Dad also enjoy.

The UK represents over 40% of the total Western Europe Xbox 360 installed base (lifetime sales) while 22% of the Western Europe PS3 installed base. The Xbox 360 has had to contend with a hostile reaction to the original Xbox on mainland Europe, something which the brand has been unable to shake off despite attempts to target younger and family demographics while PlayStation seems to enjoy a "fits all" brand loyalty on the continent.

Edited 2 times. Last edit by Nick Parker on 9th November 2013 11:10am

Posted:11 months ago

#22

Klaus Preisinger Freelance Writing

1,133 1,167 1.0
If you want to talk sales numbers across different countries, then do not forget the rising influence of Keyshops.

PC Prices for Battlefield 4 + China Rising:





Publisher health is determined by how much money they receive. Gross market size is determined by how much of the cash flow can be measured. What we are currently experiencing though, is retailers slaughtering each other and cash flow moving outside the range of observation. Publishers are more affected by the quality of their game, rather than the violent shifts in distribution. Granted, business models do play a role as well.

So is it really a recession? Is it player moving to keyshops for the same games than before? Is it players moving to games not being measured as exactly, such as mobile and f2p? Is ti publishers having the wron way of distribution for the right product? Traveling across Europe, you certainly notice the huge difference in shelf space given to PC games, PS3 games, 360 games, etc.

Edited 1 times. Last edit by Klaus Preisinger on 9th November 2013 1:39pm

Posted:11 months ago

#23

Aleksi Ranta Product Manager - Hardware

275 127 0.5
i think the biggest problem with Microsoft and their entertainment business it that they have forgotten one of the key concepts of international business, think global, act local. They are an American company that more often than not are blind to different regions in the world and their specific needs. Ill give you an example:
Here in Finland (a small market of about 5.2million people) sony has from the very beginning been selling their console roughly 2-3 times as much as the Xbox360. Why, well one of they factors in my mind has always been that localized content is nowhere to be seen and Microsoft just hasnt been able to understand how important that is to the mass/casual market. Sony has for years been pushing localized versions of their singstar franchise and microsoft isnt even able to localize the basic things in their games that are made for the casual crowd, most kinect specific games for example.

Of course at the end of the day its always a question of money but in this day and age content + services need to be tailored to the specific country or you are at a very great disadvantage from the get go. The coming Xbone generation is no different when looking at it from here in the Nordics, its an America first console + few select markets. So the cycle continues, no local content because market penetration is poor. And market penetration is poor because of mistakes made in the X360 generation. Everyone is losing out.

Posted:11 months ago

#24

Shane Sweeney Academic

392 400 1.0
Apples popularity and sinister undertones is the best thing to happen to Microsoft's brand.

Posted:11 months ago

#25

Alfonso Sexto Lead Tester, Ubisoft Germany

820 652 0.8
@Bruce
You are at it again. Your debating technique is to personally attack the person who disagrees with you. This is unacceptable behaviour on a professional industry forum. There are plenty of fanboy forums on which it is the norm, where you can go and be abusive if you want.
Really sorry Bruce, but honestly, what do you expect?

You are a professional of the industry and a veteran (not everybody has 20 years experience like you) it's because of that that most of us find unacceptable all those console-apocalypse prediction you are always talking about.

Try to see it from our point of view: each time you say that "consoles are killing creativity" and predict a big console failure and they disappearance from earth you are attacking every single professional in that particular sector. Aside from that, it makes it hard for us to have a conversation with you when you defend every article that fits your ideas but, when somebody says the opposite, we get a "YYSSW".

Finally, when we tell you why we disgree with your point of view, you label us as "unprofessionals" and blame us for "attacking you" That is also a fanboy mentality Bruce. We don't attack you (at least I don't) I discuss your ideas because consider them to be misguided and somewhat "dangerous" in some cases. but you will never, NEVER, see me insulting you or disrespecting you.

Now calm down a bit mate. We are professionals here; we will always discuss each other. the only question in that context is "why we get questioned" one can learn a lot from that.

Posted:11 months ago

#26

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