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Microsoft threatens to eat the whole gaming industry.

Microsoft threatens to eat the whole gaming industry. They have been in gaming from the early days, starting off with Microsoft Adventure in 1979. They really put their foot into gaming with DirectX, and later with the Xbox. These days, when you say the words Microsoft and gaming, people think of Xbox consoles.

That will not be true forever.

Microsoft is not the 12th largest company in the world for nothing. They have not been around for almost 50 years for no reason. And Microsoft is not in gaming as a hobby. They do not stay in a business unless they see a future in it. Their history is littered with products and divisions that they canceled. Microsoft clearly sees gaming as part of their long-term future, but they do not view Xbox as their end-goal in gaming. They are looking to profit from streaming and their cloud business as an end goal, as these are more in line with their core business.

Background

Let’s cover some background before we get to how Microsoft is looking to eat the gaming industry.

Microsoft and Antitrust

Microsoft’s history is varied. They started in software, then moved in the OS game with MS-DOS. Throughout all of this, they have kept an eye on expansion. Not always through savory means. Microsoft had a strategy known as EEE: Embrace, Extend, and Extinguish. They would first embrace a technology and create their own software to support it. Then, they would extend the technology with new features and functionality, pushing people to use their version of the software. For example, they embraced the web browser by creating Internet Explorer, which directly competed with Netscape Navigator, the dominant browser of the time. They then extended Explorer with technology that would put it ahead of Navigator. The last E is extinguish: once the Microsoft tool becomes the de facto standard, they look to force out their competitors entirely. In the case of their battle with Netscape, Microsoft bundled Internet Explorer for free with their operating system. They used EEE to take over industries that they saw as threats this way, and it got them in trouble during their antitrust lawsuit.

Left: Jonathan Kanter, Right: Gary Reback. Leaders in the opposition to Microsoft in the antitrust case in 1998

Microsoft had a dominant place in the industry built on a one-two punch: Windows and bundled software. Microsoft used their control of Windows to reduce the effectiveness of their competitor’s software while leaving their own intact. This forced Netscape out of business and got the US government on their backs. Microsoft lost that anti-trust lawsuit and had to stop making their competitors crash. They didn’t stop EEE, though. They shut Lotus out of the spreadsheet market and got sued in another anti-trust suit from WordPerfect. It looks like they’re trying to do it to this day.

Azure

In modern day, Microsoft also has their hands in many pots. They still have Windows, the dominant OS. They have Office; both Outlook and Excel are big money-makers for them. One growing business for them is Azure, their public cloud service. The public cloud has gained a lot of ground in the last decade. Amazon is best known as an online shopping platform, but they make most of their revenue from their public cloud offering, AWS. Microsoft has seen growth from the public cloud as well.

Early on, Microsoft saw Azure as an extension of Windows in the cloud. They even initially named it Windows Azure, and later renamed it to Microsoft Azure. They made a custom version of Windows to run in the cloud and launched it as a niche tool. To compete with Amazon and Google, Microsoft had to change strategies. They started to Embrace both Linux and Open-Source Software with Azure. They moved past Windows as their primary OS in the cloud and started adopting new industry standards with Linux, Apache and Kubernetes, among others.

Their forays into Linux go beyond Azure now. Microsoft integrated the Linux kernel into Windows. They have contributed to Linux development, and to cloud development. It looks like Microsoft is at the Extend phase with Linux. It shows that they not only still hold onto their old strategy, but also that they are not afraid of working with old competitors.  

Xbox

Microsoft waited a while to get into the console space. Before the original Xbox came out, both Sony and Nintendo, Microsoft’s modern competition for the console space, had consoles under their belt. Microsoft came up with the DirectX Box, a PC running Windows 2000 with console features. Thankfully, they settled on the name Xbox, and released it in 2001. Xbox was meant to compete with PS2 for control of the TV. Microsoft saw the PS2 as a threat to the PC as an entertainment device. The Xbox took a lot of the features of the PC and put them in a console, so that Microsoft could retain control of the living room.

The Xbox lost that battle. They lost $4 billion on the Xbox. It outsold the Nintendo GameCube, just barely, but did not come close to the PlayStation 2. Microsoft still saw Xbox as being worth the investment, so they continued the Xbox line.

The original Xbox lost $4 billion

Microsoft has started to embrace cross-platform. They were the first to dip their toes in with crossplay between Xbox and PC. They tried with Games for Windows Live. The service did not work well, but that did not deter them from working with PC games later. Microsoft decided to put all of their first-party games on PC as well as on Xbox, and to offer a cross-buy program where you can buy a game on Xbox and get it on PC as well. They were the first of the major console manufacturers to move on crossplay between consoles in 2017. Mike Ybarra, VP of Xbox, argued “it’s more about gamer choice, more about making an IP on our platform last longer. I don’t care about where they play, I just want people to have fun playing games because that’s just better for the industry.”

They continued moving in that direction with Xbox Game Pass. They created a subscription service, like Netflix, for games, and they offered it cheap: $10 a month. Game Pass was and is also available on PC (on the same subscription). Game subscriptions were not new, but what was new was the number of games you could get for a low price. Game Pass now sits on roughly 25 million subscribers.

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Microsoft’s plans in gaming

Microsoft is deemphasizing Xbox consoles

Microsoft is deemphasizing their console business. In 2020, Phil Spencer, head of Xbox, said that they don’t see Sony and Nintendo as their competition going forward. He said “That’s not to disrespect Nintendo and Sony, but the traditional gaming companies are somewhat out of position. I guess they could try to re-create Azure, but we’ve invested tens of billions of dollars in cloud over the years.” They have moved to leverage their cloud investment in gaming further with Xbox Cloud Streaming.

Xbox Cloud Streaming is doing well (up 1800% in minutes played this year) for a few reasons. First, it is very cost effective for consumers. Xbox is spending heavily on IP to make Xbox Cloud Streaming and Game Pass good value options. Second, the technology behind Xbox Cloud Streaming is solid. Microsoft’s cloud expertise shows in the quality of the experience. Who is Xbox competing with in cloud gaming? Google, with Stadia. Amazon is moving into the space with Luna. Microsoft is not interested in selling Xboxes; they are trying to control the market.

Azure is a massive part of their business

The public cloud makes up a lot of Microsoft’s revenue. In Q4 of fiscal year 2022, the intelligent cloud was Microsoft’s highest revenue segment, beating out their productivity and business software that used to be their cornerstone. Compare that to earnings from 2010: then, the highest revenue segment was office software, followed by the Windows operating system. Microsoft is moving a lot of their attention to the cloud, and deemphasizing some of the old cornerstones of their business. 

The Intelligent Cloud (Azure) made up over 40% of Microsoft’s revenue FY22 Q4

One of their other old cornerstones was Windows server. In 2010, the third highest revenue segment was Windows server and its associated tools. Microsoft has moved away from this altogether. Azure fulfils the role that Windows Server used to fill. Microsoft used to have a lot of control over websites and servers. Now, Microsoft is able to retain control of part of that industry by pushing Azure. These days, Azure makes up 21% of the public cloud market share , and it’s rising. Microsoft is looking for ways to expand Azure, and to create another solid foundation for their future. They could have another Office or Windows on their hands.

Azure has potential in gaming

Microsoft is looking to push Azure in different parts of gaming.

Back in 2019, Microsoft partnered with Sony in cloud gaming. Sony was planning to use Azure as their cloud provider to set up their future cloud gaming efforts. This makes sense with Microsoft’s other statements and plans. They don’t have to lose out to Amazon or Google on cloud infrastructure for cloud gaming. Cloud gaming is very taxing, and this would be a boon for Microsoft’s competitors. It is also rumored that Nintendo is using Azure for their cloud gaming forays. This opens Microsoft up to control game streaming.

Kenichiro Yoshida, President and CEO, Sony Corporation (left), and Satya Nadella, CEO, Microsoft

They aren’t the only ones to see the potential of the cloud in gaming. Google has been trying to get into cloud streaming games for years. They have Stadia, a game streaming platform, which has not been doing very well as a standalone product. However, Google is pivoting the technology to sell as a B2B cloud gaming platform, very similar to how Microsoft is working with Nintendo. Amazon has also partnered with Nintendo in the past to help with cloud infrastructure, and with Luna, they could look to sell cloud streaming infrastructure as well.

Microsoft is further diversifying by partnering with Unity. Unity is a generally popular engine, but it is especially dominant in mobile gaming. Microsoft has not had a lot of success on mobile, but this would be a way to extend their cloud business into mobile. Overall, Microsoft has a lot of options to leverage Azure outside of Xbox.

The whole picture

Microsoft’s gaming strategy has evolved over the years with their company. They have had massive failures, like the original Xbox and the Xbox One, and massive successes, like the Xbox 360. Now, they are one of the most sophisticated companies in gaming, and they are looking to profit in as many ways as possible. Overall, Microsoft is approaching gaming in two major ways:

  1. As a B2C company. Microsoft uses Xbox to sell games and consoles to players, and they are expanding to other markets using Game Pass and Xbox Cloud Gaming. Over time, they will look to deemphasize Xbox as a console, and shift it more towards being a brand. They see more revenue in being a streaming service and a game producer than in being a console maker.
  2. As a B2B company (their primary business), they are expanding their cloud infrastructure offerings through Azure. They are also using their development tools, like VS and Playfab, to profit on game development regardless of platform. 

Microsoft has moved aggressively to embrace gaming, and they have been working hard to extend many parts of gaming. Time will tell if they succeed in extinguishing the competition, either on the consumer side or the infrastructure side.

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