If Microsoft (NASDAQ:MSFT) wants its Xbox One to beat Sony's (NYSE:SNE) PlayStation 4 in the console wars -- at least in the United States -- than it has to unbundle its Kinect motion sensor from the gaming device, which would theoretically allow Microsoft to sell its console at the same retail price as Sony's. Xbox One currently sells for $499 while PS4 retails for $399.
Xbox One is not sold without the motion sensor, but Kinect is sold as a stand-alone device to pair with Microsoft's previous generation console, the Xbox 360, at a price of $99.
A preview of a new research report from International Data Corporation shared with GamesIndustry International, predicts that PS4 will have sold 51 million units globally by 2016. The report forecasts that Microsoft will take the lead in North America and be a closer competitor globally only if it unbundles Kinect.
"The presumed unbundling of Kinect and Xbox One, which should facilitate rough price parity between it and the PS4, should lead to a spike in Xbox One sales; assuming the console and sensor are unbundled in 2015, IDC expects Xbox One to recover and emerge with the largest installed base of any console in North America by the end of 2016," the firm told the gaming news website.
Why has Microsoft kept Kinect?
Microsoft does not want to simply win the console war, it wants to be the entertainment center for the family with control of the living room. Kinect and its voice and motion controls are a key piece of that strategy, or so the company believes. On the Xbox page the company touts the virtues of "voice-controlled entertainment" as offered through Kinect.
"Combine Kinect with Xbox LIVE, and you can kick back and enjoy your favorite shows on ESPN, HBO GO, Netflix, and Hulu Plus in a whole new way. With Kinect, you can play, pause, and rewind the action -- all with the sound of your voice."
Those features were also very prominently touted during the Xbox One introduction press conference, and in theory they are very cool. In reality they don't work that well and a big question remains as to whether consumers want them.
The Boston Globe's Hiawatha Bray reviewed Xbox One at the time of its release and while he was complimentary about the console's overall appeal as a home entertainment hub, he questioned some of the Kinect-specific features. He explained how the voice commands worked and laid out their shortcomings in his review.
You can control the experience with voice commands, sort of.... But you've got to use exactly the right words. Say "Watch CNN" and up it comes, but say "Turn to CNN" and the Xbox is clueless. Nor can you ask for a particular channel number, like Channel 7 or 25. And if the TV's volume is fairly loud, voice commands won't work at all.
He was also critical of how the hand commands work.
The Xbox One also responds to hand gestures, but it's a dicey system that only works if you hold your hands just so. It's easier to grab for the cable remote — even with the Xbox One hooked up, the remote still works. And if you've got a digital video recorder in your cable box, you'll reach for the remote again. For now, the Xbox One isn't compatible with DVRs, though Microsoft plans to change this with a future software upgrade.
Microsoft can theoretically improve these things with software updates, but as Apple (NASDAQ: AAPL) has shown with its Siri voice assistant, people might like the idea of voice commands more than the reality. I know I question whether an Xbox will respond correctly to my voice commands when my iPhone calls my friend Bob every time I ask it to call "mom." If Kinect's voice and gesture commands worked, they might be a neat way to flip between games, TV channels, and other content but it's not like using a remote control is some sort of horrible chore.
The market Microsoft and Sony are going after
Neither Sony nor Microsoft makes any significant revenue from selling game consoles. The real money comes from the sales the companies can make once they have gained a customer. Game sales are an important piece of revenue, which should only increase going forward as the IDC report sees sales of physical games at retail as being in decline.
"Given current trends, more than 50% of total game and direct app/service spending across all consoles will come through digital channels by 2019 (just over the edge of our forecast window)," said Lewis Ward, IDC research manager.
That is potentially huge news for Microsoft and Sony as not having a retailer taking a piece of each sale leaves more money for the companies and possibly their partners. Having games sold digitally also removes retailers like Gamestop (NYSE: GME) from the used game sales loop, allowing Microsoft and Sony to take a piece of those sales too.
The console makers are also looking to make money by selling apps and subscription services like Netflix (NASDAQ: NFLX) or Hulu of which the "store" typically gets a 30% cut (though deals can vary greatly). Microsoft has the added sales channel that it requires an Xbox Live subscription, which costs $60 a year for customers who pay for 12 months up front, to view premium apps like Netflix and Hulu.
For Microsoft and Sony having a console powering the main TV in the house will increasingly become like having a store located in millions of living rooms.
Unbundle Kinect or give it away
Sony has been winning this generation of console wars so far and if nothing changes it will be winning a few years from now. Microsoft needs to make Kinect an option or -- if the company truly believes Kinect will lead to more sales once a customer buys an Xbox One -- just lower the price and take the hit. The last Microsoft console, the Xbox 360, was released in November 2005 and it's still growing strong so it's reasonable to think it will have remained a major player for at least 10 years. There is no reason to believe the same won't be true for Xbox One.
A teardown of Xbox One done by research firm IHS in November 2013 pegs Microsoft's cost to build Kinect at $75. If that number holds true and the company dropped Xbox One's price to $399 and gave away the Kinect in order to grow from around 5 million units sold to 50 million it would be a $3 billion-plus giveaway. But if the company sells 10 million more Xbox Live subscriptions, it makes back $600 million each year it has those added subscribers -- keep them from 2016 through 2021 and the deal is roughly break-even on that revenue alone. Add in game sales, app revenue, cuts from subscription services, and that $3 billion invested between now and 2016 could be a sound investment for Microsoft if the company believes the Kinect is ultimately integral to the success of Xbox One.
IDC might predict a global lead for Sony but Microsoft has the money to make a move this bold, and it's hard to argue that PS4 is a better console than Xbox One if both are the same price and Xbox One throws in Kinect for free. Whether it makes Kinect free or unbundles it from Xbox One, it's clear the time for Microsoft to make a move with Kinect now before Sony builds too big a lead.
Editor's note: Since this piece was written, Microsoft has announced on its blog that it will be unbundling the Kinect from Xbox One and dropping the requirement that Xbox users have an Xbox Live Gold Membership to use apps including Netflix and Hulu.
Daniel Kline is long Microsoft. He wants an Xbox One but his lack of success at Xbox 360 games has caused him to delay that purchase. The Motley Fool owns shares of GameStop 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.