Microsoft Shifts to Make More of Its Own Video Game Software

Company will open new game studios or acquire them, Xbox chief Spencer says

Microsoft's Bet on Xbox One X

As Microsoft Corp. begins selling a new Xbox console, the focus of its video-game unit is shifting toward software and services.

The company plans to increase investment in developing in-house video games, including starting or acquiring studios to do so, Xbox chief Phil Spencer said in an interview last week. That’s an about-face from its approach the past several years, during which Microsoft has shuttered studios, cancelled games, and faced criticism at an industry conference from gamers for its lack of hot first-party titles.

“We need to grow, and I look forward to doing that,” Spencer said. “Our ability to go create content has to be one of our strengths. We haven’t always invested at the same level. We’ve gone through ups and downs in the investment.” Microsoft on Tuesday will start selling the Xbox One X, a high-end console targeted at hard-core gamers. 

Historically some of Microsoft’s biggest sellers for Xbox have been games the company published itself, including the “Halo” and “Gears of War” franchises, but in recent years it has scaled back some in-house development, said Spencer, a 30-year Microsoft veteran who has spent the morning sipping tea from a “Gears of War” pint glass. A year ago, Microsoft shut down two studios, Lionhead in the U.K. and Press Play in Denmark. 

The renewed investment marks an increasing focus on the Xbox business as a whole, while just a few years ago Microsoft viewed the unit as a sideline. In September, Spencer was promoted to report directly to Chief Executive Officer Satya Nadella and now sits on the senior leadership team. Restoring gaming to the forefront at Microsoft required winning over Nadella and the board – initially to get them to agree to acquire cult favorite Minecraft in September 2014 , and more recently to change directors’ mindset about gaming overall, Spencer said. In July 2014, Nadella declared gaming an important market, but one that was not core to Microsoft’s mission. 

As Microsoft’s Xbox devices continue to be outsold by rival Sony Corp.’s PlayStation, the Redmond, Washington-based company is also changing the way it measures success in the Xbox business away from console revenue and unit shipments toward more closely watching sales of games, subscriptions and related services—not just on Xbox machines but on iPhones, Android devices and personal computers. The company now tracks monthly active users and revenue from software and services, and is looking at opportunities such as further expansion of Xbox Live online usage, eSports and game streaming. 

“This means fundamentally rethinking how we measure progress in gaming,” Nadella said on a conference call with analysts last month. 

That changed focus lets Microsoft play to recent strengths—Xbox software and services revenue grew 21 percent last quarter, while console hardware sales dropped. Hardware sales will rise this quarter, owing to the new, $500 Xbox One X model, and profit margins will narrow again because of the impact of the new hardware, the company forecast. 

While software and services are becoming more important, the console isn’t near death yet. It’s still best for gamer enthusiasts and the top games, and will remain so for quite some time. But Microsoft will probably debut a streaming service that doesn’t require a console for some types of content in the next three years, Spencer said. A 2012 trial of such a service inside the company was too costly and never made it to the market, but Microsoft’s progress in Azure cloud services over the past few years is changing the economics and quality level, he said. 

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