Heres a trade secret that Microsoft is unlikely to publicly acknowledge.
Sonys cutting the price on the PlayStation 3. How will Microsoft react? Well find out soon. But a key part of the strategy is going to be a project code-named Falcon.
Falcon is the name for the latest internal electronics in the Xbox 360. It will have an IBM microprocessor and an AMD/ATI graphics chip that are manufactured in a 65-nanometer production process. These are cost-reduced chips that do the same thing as their 90-nanometer predecessors, but theyre smaller.
With smaller chips, Microsoft gets a bunch of benefits. They wont generate as much heat. So the risks of overheating one of the main reasons behind Microsofts billion-dollar write-off for repairs and extended warranties are much lower. The chips may also cost half of what it took to make them before because they use less material and fewer manufacturing steps to produce.
Everyone knows that console makers cut the prices and costs on their consoles over time. But you may not be aware that the primary chips microprocessor, graphics, and the Ana video processing chip are the bulk of the cost of the machine. Microsoft started making the Xbox 360s in August, 2005, with a 90-nanometer process. It is overdue to switch to the newest technology, 65 nanometers, but that day has finally come. It may be some time a year, maybe two before it moves on the a 45-nanometer process.
But its worth it. I recall that Ken Kutaragi said that by moving along the semiconductor manufacturing cost curve with the PlayStation 2, Sony was able to reduce the size and therefore cost of the PlayStation 2s original chips to just 13 percent of the original over the life cycle of the PS 2.
If you cut the costs on the chips, you can cut the overall cost of the system. You get ancillary benefits such as using a smaller motherboard, more air flow inside the console, and the ability to take the big giant power supply in the Xbox 360s power brick and put it inside the console.
Microsoft is in the process of qualifying the new Falcon chips and motherboard this summer. I expect it will launch Xbox 360s with the new Falcon innards this fall. That is why the company has been able to say that it has solved its manufacturing quality problems. Microsoft is likely to spend a little more money on heat sinks to make sure that the overheating problem doesnt resurface with Falcon.
The good thing about the smaller chips is that they will likely be easier to make in mass quantities and they shouldnt fail as often. Quality should automatically go up. Thats what folks said about the 90-nanometer generation. But the 65-nanometer production process is a known quantity at this point at places such as IBM for sure and possibly at other suppliers such as Taiwan Semiconductor Manufacturing Co. So rather than fix the problems with the 90-nanometer machine, Microsoft has the easier problem now of getting a 65-nanometer machine to work right. I suspect that is why Robbie Bach, president of the Entertainment & Devices group, said on Thursday on a conference call with analysts that the company has its hands around it at the engineering level.
But once this machine is in the field, Microsoft will have a few options. It can take the power brick and put it inside the same chassis. It can also make a smaller version of the core, but this involves considerable redesign and retooling resources. And it could also beef up the console and make room for more costly things as it did with the Elite.
Its anybodys guess as to what Microsoft will do with the Falcon as its base platform going forward. But Sony had better watch out. Microsoft is moving ahead of Sony on the cost-reduction curve. It would be risky for Sony to get into a price war with Microsoft.
Now its easier to see why Microsoft still expects to be profitable in fiscal 2008 with the Xbox 360 business. In this fiscal year, Microsoft will introduce a major cost reduction with the Falcon platform. It will launch Halo 3. And it has already written off in fiscal 2007 the costs of repairing consoles for the next few years.
Falcon is a fundamental part of the strategy that Microsoft is using to try to beat Sony. Is it going to be good enough to beat Nintendo on costs? Very doubtful. Nintendo can play the cost-reduction game just as Microsoft can. Falcon certainly means that Microsoft can afford to cut the price of the Xbox 360 going forward. Whether it does so depends on how aggressive it wants to be at winning the lead market share in the business. But everyone knows that if you cut your hardware price too much, you lose money. After all, Microsoft lost an estimated $3.7 billion on the original Xbox.
When I asked David Hufford, a Microsoft spokesman, about Falcon on Friday, he said I was telling him something new. When I asked Peter Moore, head of games at Microsoft, about Falcon on Thursday, he said, We have a bunch of different projects that cost reduce and improve quality as you find issues, as does our competition. Once you get millions in the field, you learn about the box under all kinds of different circumstances, you can adjust and tweak what you do accordingly.
