Microsoft's (NASDAQ:MSFT) Xbox One has trailed Sony's (NYSE:SNE) PlayStation 4 in sales since the two next generation consoles launched. One of the key reasons is that Sony's console had a pricing advantage.
Now, that advantage has essentially disappeared as major Microsoft retail partners have effectively dropped the price for the Xbox One below that of its rival.
What exactly did Microsoft do?
Without any fanfare or advertising Wal-Mart (NYSE:WMT), Best Buy (NYSE:BBY), and Amazon (NASDAQ:AMZN) are offering an Xbox One bundled with the highly anticipated game Titanfall for $450. That's a huge price break as the Xbox One costs $499 on its own and the game retails for $60. That makes the effective price of the console $390, below the $399 for a PS4.
David Dennis, a spokesman for Microsoft, said the price drops were the decision of its retail partners, The New York Times reported . "This is a special promotion offered by Wal-Mart and Best Buy stores in the U.S.," Dennis said in a statement. "Microsoft sets a suggested retail price, but specific pricing and offers vary by retailer."
Dennis also told the Times that Microsoft did not drop the wholesale price to the retailers.
It's also important to note that Wal-Mart and Best Buy are somewhat masking the price drop on their websites. In order to see the $450 price for the bundle, customers must add it to their cart. Both stores are also selling the bundle for $450 in their physical stores, where you can assume a price is listed. Amazon is making it even harder to find the $450 price, according to Engadget -- customers add the bundle to their cart then use promo code "xiamazon."
Why would Best Buy, Wal-Mart, and Amazon do this?
If history holds true for the current generation of consoles, retailers make very little money selling them -- instead profiting on games and accessories (and perhaps incidental sales due to added store traffic). Technology website DailyTech broke down the retailer costs, retail prices, and profit margins of some of the last generation of consoles in October 2006. At the time retailers paid $237.50 for Nintendo's Wii and sold it for $249.99; Microsoft's Xbox 360's most basic version cost reailers $292.09 and sold for $299.99. That's a scant 2.6% profit margin for the retailer and 3.9% margin on the Wii.
While retailers do not generally disclose their margins on individual items, these would be very low. Essentially the stores are selling the consoles as a way to get customers to buy games and accessories, which can carry margins in excess of 50%.
Given the manufacturing cost of the Xbox One, which AllThingsD reported as $471, and the PS4, which the tech site has at $381, it seems like the retail margin remains very low unless Microsoft is selling the units to stores at a loss. For Best Buy, Wal-Mart, and Amazon to cut the price -- likely below what they are paying for the bundle -- appears to make little sense.
Retailers sometimes sell items as loss-leaders as a way to get customers into their stores. Perhaps these three retailers believe that capturing customers will lead to future sales that they actually make money on, but it seems like an odd strategy. If the sale price was only offered online by Best Buy and Amazon, there might be some logic as the greatest barrier to future sales is registration. If a customer registers with a site to get a special price, he may come back because he's already done the hard part.
Both chains also offering the price in their physical stores makes less sense because a customer shopping a brick-and-mortar store due to price is not likely to return unless the experience is better than the one where they normally shop. The deal at Amazon makes even less sense -- by only offering it via secret code, the company risks angering customers who buy an Xbox then learn of the deal and demand a refund of the difference.
Microsoft must be behind this, right?
While Microsoft denied lowering its wholesale price for Best Buy and Wal-Mart, I can't help but think that the company is somehow behind these price cuts. Perhaps Microsoft paid Electronic Arts for copies of Titanfall in order to lower costs for select retailers, allowing them to drop the price of the Xbox One without losing their already skimpy margins. Maybe Microsoft hired someone really charming to talk the retailers into the price cut. Maybe the company employed voodoo.
It doesn't matter as long as the retailers sell the console at the lower price. This move is great for consumers who were on the fence about buying an Xbox One and it should provide data for Microsoft to know if the reason PS4 was outselling the One was purely price. If it is, then the company -- which can afford to take a loss on console sales in order to profit down the line -- can make the price cuts permanent. If a lower price does not sell more Xbox One consoles, Microsoft knows it's facing a different issue and can direct its attention properly.
Daniel Kline is long Microsoft. He owns an Xbox 360 and a PlayStation 2. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.