Published as part of our sister-site GamesIndustry.biz's widely-read weekly newsletter, the GamesIndustry.biz Editorial, is a weekly dissection of an issue weighing on the minds of the people at the top of the games business. It appears on Eurogamer after it goes out to GI.biz newsletter subscribers.
There has been much heat, and little light, in the media this week regarding comments made by Goldman Sachs analysts - who argued, in a note explaining their downgrading of the company's stock from "Buy" to "Neutral", that Microsoft would be best to spin the profit-challenged Xbox division off into a standalone company.
The reaction in some quarters has been nothing short of furious. It's seen by many consumers - whose attention has been drawn to it by unfairly negative coverage of Goldman Sachs' statements on various websites - as a slight on the success of the Xbox, an unwarranted criticism of the business by financial analysts who don't really "understand" the videogame market. Many calmer minds within the games business also find the proposition somewhere between simply unpalatable and outright bonkers.
Yet neither of those positions is entirely fair - and even if Goldman Sachs' statement is tough to agree with entirely, the sentiments expressed by the analysts at the firm are grounded in a pretty reasonable view of what's happening at Microsoft.
Firstly, let's dismiss the idea that this was some kind of dismissal of the success of Xbox. On the contrary, the report goes out of its way to note that very success and the rapid growth in the cachet carried by the Xbox brand. It's this very fact that leads Goldman to believe that the Xbox business has the fundamentals in place to be a successful standalone business unit.
Although the firm reckons the Entertainment and Devices division (which includes, and indeed is dominated by, the Xbox business) is Microsoft's least valuable division by quite a margin, it still estimates its worth at some $3.6 billion - hardly small change, and not an unreasonable figure for a business which despite its consumer success has unquestionably struggled with profitability over the years.
Moreover, let's do away with the widely circulated notion that this report in some way blamed the Xbox for the decision to downgrade Microsoft. On the contrary - the recommendation regarding the Entertainment and Devices division was practically a footnote (albeit a controversial one), with the clear rationale behind the downgrade being lengthening life cycles in the PC market, meaning less Windows licenses sold, along with strong evidence of tablet devices (in which Microsoft doesn't have much of a foothold) eating into sales of low-end laptops (which generally run Windows).
While we're at it, it's worth noting that the 2 per cent drop in Microsoft's stock following the release of Goldman's report was broadly in line with the movement of other similar stocks that day, suggesting that even if the report set gaming blogs the world over alight, it didn't actually nudge the stock market in any meaningful way. That's pretty much what you'd expect from a single firm shifting from Buy to Neutral based on evidence which is already out in the open and has been factored into Microsoft's share price for weeks if not months. Analyst reports rarely influence the mood of the markets in any meaningful way, and this one was far from explosive.
So Xbox is off the hook. It's not dragging Microsoft down - frankly, for all that the division wields enormous clout within the games business, it's little more than a pebble on the side of the sturdy mountain which is Microsoft's finances. Nor did Goldman's comments on the division have the slightest impact on Microsoft's share price. Calm down.
None of which is to say that Goldman Sachs' idea isn't outright fascinating. The argument they're making is straightforward. Up until this point, the Xbox division has been treated as something of an experiment by the wider company, which has - for the most part - been content to pump money into the division and its various projects, ranging from the successful (the Xbox itself) to the unproven (Windows Phone) and right through to the miserable failures (Zune).
More recently, there's been evidence of a struggle within Microsoft between two opposed camps - those who believe that the Xbox should still be treated as an experiment, or a land-grab, and thus heavily subsidised, and those who believe that the console's success means that it should now be paying its own way. The conflict between those in favour of further market growth and those in favour of monetisation has been most clearly seen in the mixed messages regarding Kinect, but it's a debate which goes to the very core of Microsoft's entire console strategy.
What Goldman Sachs proposes, in essence, is a dramatic end to that debate. By spinning off the Xbox business unit as a separate company, the division would be forced to think long and hard about profitability, to rein in its spending and start acting like a real business, rather than a costly, heavily funded experiment. It's reasonable to assume that such a move would collapse the factions within the division - while it would be a victory for the monetisation camp in principle, in reality it would force both sides to work together to find realistic ways to line up their thinking and keep the business afloat.
As a consumer or as a member of the wider games business, this is potentially very uncomfortable thinking. In theory, we'd all prefer for a platform holder like Microsoft to continue splashing cash around like there's no tomorrow. A business that's more focused on profitability is, one might argue, one which is less likely to take risks, less likely to pursue original approaches to development or new business models, less likely to subsidise new ideas in the hope of future breakthroughs.
Those fears are reasonable, and they're all solid reasons for the industry to dislike Goldman Sachs' proposal. However, there's another angle from which one can look at this suggestion - which is that there's a wealth of history to show that failing to show solid regard for profitability can result in worse products and less innovation, rather than the explosion of creativity and original thought one might expect.
Sony's PlayStation 3 is, arguably, the product of such a problem. While Sony's financial position was far from secure when the console was being developed, Sony Computer Entertainment was riding high on a wave of cash from the phenomenally successful PlayStation 2, and that created a culture which regarded money as no object - not only for Sony itself, but also, bizarrely, for its consumers. Driven forward on a wave of wealth and hubris, the PlayStation 3's development and launch were defined by a series of blunders from which a leaner, meaner, better managed and more profit-focused Sony is only now fully recovering.
In contrast, Nintendo is a standalone company, with no parent firm to whom to go running for cash. Despite decades of success and a significant pot of investments and assets, that independent status makes Nintendo into a thoroughly profit-focused firm, whose legendary creativity is both tempered by and driven by the need to make money in order to stay in business. It's a base instinct to those consumers who just want to talk in terms of creativity and artistry, but the reality is that Nintendo's status has forced it to learn how to do a lot more with a lot less.
Of course, that's a skill set which Nintendo built up over decades, especially during the lean years after the launch of the PlayStation when the firm's consoles were in the wilderness to large extent, overshadowed first by Sony and then even by the market's new entry, Microsoft. While Goldman Sachs' suggestion that the Xbox division would do well to embrace a similar approach is a solid one, the idea that this change in culture could happen overnight seems extremely optimistic.
The fact that there would have to be a major cultural change within the Entertainment and Devices Division before it could possibly survive as an independent country is only the first of what I believe are two major problem in the Goldman proposal. The second problem is not so much a flaw in Goldman Sachs' thinking, as a serious disconnect between their perspective and Microsoft's world-view.
From their report, it's clear that Goldman Sachs believes that Microsoft is, in essence, a corporate software firm. Its key business is in the enterprise sector, selling operating systems, office software, server software and a variety of supporting services to corporate clients. Selling operating systems to PC manufacturers is another facet of that business - the software ends up being used by consumers but it is still, essentially, a B2B sector.
Meanwhile, the firm has been trying very hard to make serious breakthroughs in the consumer space - the cuddly, customer-facing markets like music, games, mobile phones, search engines and so on. Goldman Sachs argues that this division of focus means that each side of the company ends up being a ball and chain for the other. It's a tempting course of logic, in some regards - one could see how the firm's corporate business holds back the cool, trendy image required by the entertainment business, while its dalliances with entertainment introduce a note of concern for the huge enterprises who place orders worth tens of millions of dollars at a time for business software.
Yet that's too facile a world-view, I believe. There's a much stronger argument - one to which Microsoft itself subscribes - which says that the two sides actually prop each other up, that being strong in consumer products and in corporate products are complementary goals rather than rival targets competing for attention.
After all, we live in a world where some of the predominant uses of technology are to distribute media, one where what platform consumers have in their pockets or under their television can crown winners and destroy losers not only in those immediate sectors, but also in development tools, in advertising, in network provision and in a host of other areas. The success of Xbox or Windows Phone, or the failure of Zune, isn't just about Microsoft's consumer division - it's got a knock-on effect on everything from the company's server business to its development tools division, and even plays into the question of whether Windows and Office can remain the dominant ecosystem for corporate clients.
As yet, that's a small effect - but Microsoft would be foolish not to have a foot in this market, all the same. Even ignoring the money to be made if the company can achieve its dream of the Xbox as the beating heart of a home's media system, the potential for knock-on positive or negative effects on the core businesses from which Goldman Sachs is so keen to separate the Xbox could potentially become significant in the coming years. Xbox may be small and expensive now, but in years to come it may well be a competitive advantage that Microsoft would dearly regret throwing away - and the same goes for Windows Phone.
Ultimately, then, I believe that Microsoft will ignore Goldman Sachs advice, and I suspect that few in the games business think otherwise. However, I'm not as convinced as some that the analysts were really being crazy about this idea. It doesn't fit with what Microsoft want to achieve as a corporation and it has serious drawbacks - but the basic observation that a little more focus on profitability could turn Xbox into a tighter, leaner and more competitive company and console is one that shouldn't be lost in our haste to deride another loony analyst report.
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