Microsoft (NASDAQ:MSFT) could be developing a cheaper Xbox built for cloud-based games according to Thurrott.com. The console, codenamed Scarlett Cloud, will only stream cloud games instead of processing them locally.

This wouldn't be a new strategy, since Sony's (NYSE:SNE) PlayStation Now delivers cloud-based PS2, PS3, and PS4 games via a subscription service on the PS4 and Windows PCs. NVIDIA's GeForce Now service also streams cloud-based PC games to low-end PCs and Shield devices.

Two people play video games.

Image source: Getty Images.

However, Microsoft's rumored console could be built from the ground up as a cloud-based console, one without enough horsepower to run games locally. The report also suggests that Microsoft will launch "Scarlett Cloud" alongside a new next-gen Xbox console that can run games locally and stream cloud-based games.

Scarlett Cloud is reportedly further along in the development cycle than its pricier next-gen Xbox counterpart, but both consoles could launch in 2020 to coincide with the rumored launch date for Sony's PlayStation 5. But will a market for cloud-only consoles exist by then? Let's take a closer look at the market to find out.

Understanding the cloud gaming market

"Cloud gaming" generally refers to games which are run remotely on high-end hardware, then streamed back to a gamer via an interactive high-quality video. This process requires a high-bandwidth connection, but it allows high-end games to be played on low-end hardware.

However, the creation of a true "Netflix of gaming" remains difficult thanks to bandwidth issues for many gamers. Microsoft already lets gamers stream Xbox One games to Windows 10 PCs over local networks, but that process is far less demanding then streaming full games over the internet.

Microsoft also offers Xbox Game Pass, a subscription-based service that lets gamers download (but not stream) a library of games to their consoles. It also uses its Azure cloud platform to stream assets into certain games like Crackdown and Rainbow Six: Siege.

Back in 2014, reports indicated that Microsoft was developing an experimental cloud gaming platform called DeLorean that could "predict" a gamer's next move to reduce lag on slower network connections. In 2016, various reports claimed that Microsoft was developing a streaming device codenamed Hobart, which could play media and Windows Store games on TVs. However, the device was reportedly cancelled later that year.

A graphical representation of cloud computing.

Image source: Getty Images.

This March, Microsoft launched a dedicated cloud gaming division led by company veteran Kareem Choudhry. At the time, Choudhry told The Verge that cloud gaming could eventually reach two billion gamers worldwide, but didn't reveal any details about its long-term plans. If the reports about Scarlett Cloud are accurate, it could represent the division's first major effort to reach all those gamers.

But Scarlett Cloud could face other competitors

Microsoft's approach sounds interesting, but other big tech companies are also gearing up for the rise of GaaS (gaming as a service).

Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) is reportedly developing a new GaaS platform and cloud gaming console, according to a recent Kotaku report which cites five anonymous sources. If Google leverages the strength of its Google Play Games ecosystem to launch cloud-based games, it could reach more gamers than Microsoft or Sony.

Meanwhile, Sony remains far ahead of Microsoft in cloud gaming with over 500 games in its PS Now library. Sony is probably taking losses on PS Now, but it's well-poised to dominate the cloud gaming market if more gamers decide to stream games instead of buying them. Sony could also easily replicate Microsoft's rumored strategy and launch a cheaper PlayStation designed specifically for PS Now games.

Putting the Xbox in the cloud

The idea of a cheaper cloud-based Xbox is intriguing, but the cloud gaming market remains a niche market that hasn't roped in enough mainstream gamers. But if cloud gaming finally gains steam, as Netflix did in videos, Microsoft could start generating higher cloud-based subscription revenues from the Xbox -- which complements its long-term strategy of becoming a "cloud first" company.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Netflix, and Nvidia. The Motley Fool has a disclosure policy.