The X Factor

With last week's price cut now in force, Microsoft's one-year headstart in the console race has shown itself once again. The Xbox 360 is now far enough into its lifespan for significant price cuts to start filtering through, and as a result, the Xbox 360 Arcade system is now the cheapest current-generation console on the market in both North America and Europe.

Admittedly, the 360 Arcade remains a pretty disappointing prospect for most consumers. With the forthcoming Xbox 360 firmware update set to introduce hard drive installation for games, the drive's importance to the system continues to grow - it's already essential for many game demos, for the Xbox movie rental service, and even for some Xbox Live Arcade titles.

As such, the appeal of the Arcade model is limited - speaking personally, the only people I know who have bought Arcade systems did so in order to replace broken 360s, popping their existing hard drives onto the new machine as soon as it was unpacked. This isn't to say that the system doesn't sell to new consumers as well, of course - simply that it remains disappointingly limited compared to Microsoft's other SKUs, which will restrict its potential audience.

For Microsoft's purposes, however, the Arcade delivers a powerful PR message. The Xbox 360 is the cheapest home console on the market - cheaper than the Wii, whose massive success so far has totally eclipsed the race between Xbox 360 and PlayStation 3. Perhaps it's even cheap enough to pick up some punters from the real budget end of the market, which remains dominated by the venerable PlayStation 2.

The inevitable sales spike from this price cut is already being hailed, unsurprisingly enough. However, as with any price cut, the really important aspect is the long term effect, not the immediate spike. The spike simply represents pent-up demand from consumers who were already committed to a purchase, but had waited for a lower price point. The question now is whether uncommitted consumers will be swayed by the new price tag.

With Christmas approaching, that question is absolutely vital for Microsoft's ambitions. 2008 has by no means been a terrible year for the Xbox 360 so far, but to some extent the console's fortunes have been treading water since last Christmas. The Wii's sales lead over the 360 has grown rapidly - there's now a ten million unit gap to fill - and despite the dire predictions of some within the industry, the Wii is still constrained by supply rather than demand. The 360's own lead over the PS3, meanwhile, has been slowly eroded - PS3 is between 1 and 1.5 million units closer to the 360's installed base today than it was at the start of the year.

Microsoft will be hoping that the strong retail presence afforded by being the cheapest console on the current-gen market can form the centrepiece of a raft of initiatives designed to drive the Xbox 360 forward once again. The forthcoming Dashboard update, introducing Mii-style avatars and a brand new interface, is part of that drive. So too is family-friendly software like the Lips karaoke game, or Rare's Banjo-Kazooie: Nuts & Bolts - while Gears of War 2 will provide the heart of the console's offering for existing hardcore fans.

Neither Nintendo nor Sony faces an untroubled path in the coming months, of course. Sony's price point looks even worse in the face of Microsoft's latest cuts, and while there are several other promising titles appearing on PS3 in the coming months, the vast bulk of the company's eggs appear to have been placed in one LittleBigPlanet-shaped basket.

Nintendo, meanwhile, needs to update the market about upcoming first-party software - without a steady flow of big titles, the core gamers who keep the firm's attach rate looking respectable will be increasingly tempted by offerings from Microsoft and Sony. The world's biggest installed base becomes less meaningful if everyone is buying software for other consoles instead.

It's Microsoft, however, that has the most to prove this Christmas - and the company knows it. The race against Sony remains Microsoft's to lose, and having watched the Xbox' lead being eroded this year, the industry will be focused on this battle for second place in the coming months for an indication of how 2009 and 2010 will look. Meanwhile, Microsoft itself will want to provide a clear signal that the Wii is not going to "win" this generation totally unopposed in the casual space.

Microsoft started out this generation a year ahead of its rivals, and has gone on to deliver a great software line-up and a superb online service. It has learned many lessons from its first stab at the console business - but it's not out of the woods just yet. Many consumers still haven't forgiven it for the "Red Ring of Death" debacle, and many others aren't yet convinced that the console's appeal extends beyond young, male fans of shooters and racers.

The next few months will see the company competing aggressively with the price point, the software line-up and the feature-set that should finally redress that balance. The Xbox 360 should enter 2009 with a much better trajectory in the market than it displays today - if it doesn't, however, expect tough questions to be asked about the company's whole approach.