Will Microsoft's Free Game Offer Boost Xbox One Sales?

Microsoft (MSFT -1.84%) recently announced a promotion allowing new Xbox One buyers to choose any disc-based game worth $60 or less -- including Activision Blizzard's (ATVI) Destiny -- for free.

Source: Microsoft.

The promotion covers stand-alone consoles as well as bundles like the $399 Forza Motorsport 5 and Madden NFL 15 bundles. The offer will be valid at Target, GameStop, Best Buy, Toys 'R Us, Amazon, Wal-Mart, and Microsoft stores until September 13. The Microsoft store is offering an additional discount -- $50 off the stand-alone console, which normally costs $399.

Those steep discounts are clearly aimed at helping the Xbox One, which has sold around 5 million units, gain ground against Sony's (SONY 0.37%) PlayStation 4's market-leading 10 million units.

Sacrificing margins to gain market share
When the Xbox One and PS4 were launched last November, the problem was obvious -- the former cost $100 more than the latter, thanks to the bundling of the new Kinect. A lack of compelling exclusive games and an Xbox Live Gold pay wall for basic media apps like Netflix and Hulu also hurt sales.

In January, Microsoft offered a $100 rebate to trade-in last generation consoles like the Xbox 360 and Sony's PS3. In March, Microsoft hoped that Electronic Arts' (EA -0.54%) Titanfall would revive lagging sales. But the shooter, which was also released for the 360 and Windows, only sold 2.1 million units on the Xbox One -- clearly not enough to become the next Halo.

In May, Microsoft finally unbundled the Kinect, slashed the Xbox One's price by $100, and removed the Xbox Live Gold pay wall. But none of those desperate efforts have helped the Xbox One win over more gamers.

Software attach rate matters more than console margins
Research firm IHS estimates that the Xbox One without the Kinect costs $396 to manufacture. Under the new offer, Microsoft is giving away up to two new games for $399. By buying third party games for the consumer, Microsoft is not only spending heavily to convince gamers to buy the Xbox One, but it also gives up the 10% to 15% license fee that it gets from a publisher via a normal sale. This strategy doesn't make any sense in the long run, but the temporary promotion accomplishes two things.

First, it steals the spotlight from Sony, which has been aggressively promoting its white PS4 Destiny bundle for $450. Gamers who still haven't upgraded to an eighth generation console could opt for the cheaper Xbox One and get Destiny for free instead.

Sony's Destiny Bundle. Source: Sony.

Second, selling consoles at a loss is fine, so long as the company can make up the losses by charging the aforementioned license fees on games from third-party publishers. In addition, most new Xbox One customers will sign up for an Xbox Live Gold account, which costs $60 per year. Therefore, Microsoft hopes that sacrificing margins to gain market share will lead to more game purchases and Xbox Live revenue per console.

Microsoft is surprisingly winning in this department -- each Xbox One owner has purchased an average of 3.3 games, compared to 2.6 games per PS4 owner, according to Vgchartz. By comparison, the Xbox 360 has a software tie ratio of 10.8, compared to 10.1 games for the PS3.

Meanwhile, offering two new free games to sell a console at a near break-even cost seems like a reckless way to gain market share, but history tell us that it won't likely discourage Microsoft. Back in 2005, BusinessWeek reported that Microsoft lost $126 for every Xbox 360.

Will big Xbox One promotions slow Sony down?
While Microsoft is doing everything it can to slow Sony down, Sony seems to effortlessly move consoles off shelves without resorting to huge discounts.

Sony's $450 Destiny bundle includes a one-month subscription to the PlayStation Network, the white console and controller, and the game -- which altogether represent a minor discount of $20. Back in March, Sony launched its $570 Infamous: Second Son bundle, which included the game, an extra controller, and a one-year PS Plus membership -- which cost exactly the same if purchased separately.

By comparison, Microsoft seems stuck in the same position as Nintendo, endlessly launching big, desperate new bundles to draw new gamers to the platform.

A Foolish final word
Microsoft correctly timed its big promotion to tap into the eagerly anticipated launch of Destiny.

While the promotion could help Microsoft counter Sony's Destiny bundle, it doesn't really solve the platform's biggest problem -- its lack of big exclusive games. Destiny, like Titanfall, is really just another cross-platform, cross-generation game. Halo 5: Guardians, perhaps the Xbox One's most anticipated game, won't arrive until next fall.

That's all bad news for Microsoft, but it's great news for gamers, who can now buy the console at a much lower price than those eager early adopters last November.