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Microsoft Updates Xbox as Apple to Facebook Gain in Games

Microsoft Corp (MSFT) (MSFT). is revamping the Xbox to fend off a breed of competitors ranging from Apple Inc (AAPL) (AAPL). to Facebook Inc. (FB) Those companies were nowhere in gaming when the software maker debuted its last version five years ago.

Now these newcomers -- along with the likes of Google Inc. (GOOG) and Amazon.com Inc. (AMZN) -- are posing a threat by introducing their own software and devices that let consumers access an array of games and entertainment on smartphones, computers and home electronics.

Where once Microsoft’s Xbox had only to contend with Sony Corp. (SNE)’s PlayStation and Nintendo Co.’s Wii, there’s now a plethora of devices boasting robust graphics and computing power, capable of downloading games from the Internet and connecting TVs in the living room to gadgets throughout the house. That’s putting pressure on Microsoft to make the new Xbox -- to be unveiled tomorrow at an event in Redmond, Washington -- capable of delivering more programming, entertainment and services, moving it further beyond the gaming realm.

“This has to last them in the living room for four to 10 years,” said Brian Blau, an analyst at Gartner Inc. in San Francisco. “They have to think about what’s coming in five years and compete against the two generations of tablets which will come out during that time.”

Photographer: David Paul Morris/Bloomberg

Attendees play with Microsoft Corp.ís Xbox 360 game console during the Consumer Electronics Show in Las Vegas. Close

Attendees play with Microsoft Corp.ís Xbox 360 game console during the Consumer... Read More

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Photographer: David Paul Morris/Bloomberg

Attendees play with Microsoft Corp.ís Xbox 360 game console during the Consumer Electronics Show in Las Vegas.

The new gadget will use the Kinect sensor to recognize faces and recommend content based on a user’s interests, people with knowledge of the matter said. Due in stores by year’s end, the latest Xbox will also feature Advanced Micro Devices Inc. chips designed to make it easier for developers to create games, people said in April.

Video Calling

As it takes on challengers, Microsoft is also seeking to extend the Xbox’s two-year streak as the best seller over Sony’s PlayStation and Nintendo’s Wii. Worldwide console gaming is a $27 billion market.

The new Xbox will probably have Microsoft’s Skype, which delivers low-cost voice and video calling, and an improved Kinect motion- and voice-control system, said Michael Pachter, an analyst at Wedbush Securities Inc. in Los Angeles.

“Few people will buy an Xbox just to watch TV, but Microsoft is making the bet that enough people will want to play games some of the time and watch TV all the time,” he said.

In an indication of the changing fortunes for companies at the intersection of software and consumer electronics, Microsoft shares have risen 22 percent over the past five years, compared with a 58 percent slump for Sony. Apple’s stock has more than doubled, while Google has advanced 57 percent. Microsoft rose less than 1 percent to $35.08 at today’s close in New York.

Set-Top Substitute

Microsoft is also in talks with cable operators, including Time Warner Cable Inc., to have the Xbox replace the set-top box in living rooms, delivering some content over the Web instead of through traditional cable pipes, said Richard Doherty, president of technology-consulting firm Envisioneering Group Inc. The discussions are ongoing, he said.

“They might not even use the phrase game console this time around because they’re trying to pitch it as this incredible entertainment hub in the home,” he said.

Representatives of Microsoft and New York-based Time Warner Cable declined to comment.

As Microsoft works to beef up the Xbox, newer kinds of games are taking hold, threatening to pull gamers away from consoles. Customers are flocking to inexpensive titles for tablets and mobile phones running Google’s Android operating system or Apple’s iOS.

Downloading Gains

U.S. retail sales of packaged video games fell 21 percent last year to $8.9 billion, according to researcher NPD Group, while revenue from games downloaded to computers and mobile devices rose 16 percent to $5.9 billion.

Zynga Inc. pioneered social gaming with such titles as “FarmVille,” which lets users populate digital landscapes with virtual cows and tractors. Facebook, owner of the world’s largest social-networking service, is building its own gaming empire, announcing in March that the number people paying to play games on its service rose 24 percent from a year earlier.

Companies like Finland’s Supercell, maker of “Clash of Clans,” and Japan’s GungHo Online Entertainment Inc (3765)., which sells “Puzzle and Dragons,” are winning over customers with free downloadable games that for many are replacing pricey console titles, said Ed Fries, a former Microsoft video-games vice president.

“I don’t want to go to a store and pay 50 bucks -- that’s not how people will consume games,” Fries said. “I want that Apple-like experience of having a lot of choices and to be able to try to buy.”

Ouya, Nvidia

New entrants may challenge the Microsoft-Nintendo-Sony oligopoly in video-game devices as well. Ouya Inc., funded by Kleiner Perkins Caufield & Byers, is making a $99 game console that runs on Google’s Android. Nvidia Corp (NVDA)., maker of the graphics chips Microsoft used for the first Xbox, began taking orders this month for a handheld device called Shield.

Apple has sold more than 500 million devices with its iOS software built-in, and it has more than 175,000 games and entertainment titles on its app store and more than 200 million users of its Game Center, a hub for multiplayer games, a company spokeswoman said.

Intel Corp., the world’s largest chipmaker, is planning to introduce an over-the-Internet paid-TV service later this year. The new offering will be based around an Intel-designed set-top box that the company says will be much easier to control than existing devices from cable and satellite providers.

Even as it upgrades the Xbox, Microsoft needs to ensure it doesn’t short-change its core audience by shifting focus too much toward entertainment and casual games.

Graphics Demanded

To get hard-core gamer types to pony up for a new Xbox, Microsoft must deliver better graphics and more innovative experiences, said Liam Callahan, an NPD analyst, citing a survey. He found that general entertainment features like Netflix Inc. movies are further down the list of features desired in a new console.

“Those entertainment options are important -- in a sense they are almost a given,” he said. “But gamers won’t buy a next-generation console from Sony or Microsoft for that.”

Microsoft already offers television, movies and sports on its Xbox Live online service, through partnerships with various content companies.

The company hired former CBS Corp. television executive Nancy Tellem in September to oversee content produced for the Xbox.

Ball Kicking

With Microsoft’s smartphones and tablets barely making a dent in those respective markets, the company has also exhibited a willingness to connect the Xbox to tablets and mobile phones from competing companies. Xbox SmartGlass, an app meant to let console users view additional content and features on mobile devices, comes in versions for Android and iOS.

All the while, Microsoft will need to remain vigilant against perennial contenders Nintendo and Sony.

“Microsoft has the opportunity to really kick the ball out of the park,” said Fries, who co-founded video-game developer Airtight Games and advises game companies including Ouya. “But there are a lot of competitors they have to think about and a lot of things they have to get right.”

To contact the reporters on this story: Dina Bass in Seattle at dbass2@bloomberg.net; Cliff Edwards in San Francisco at cedwards28@bloomberg.net

To contact the editors responsible for this story: Tom Giles at tgiles5@bloomberg.net; Anthony Palazzo at apalazzo@bloomberg.net

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