The devices and services model that shaped the Steve Ballmer era at Microsoft (MSFT 1.92%) is being phased out in favor of the cloud-first, mobile-first approach of current CEO Satya Nadella. The stated plan to move to a business structure that's less dependent on hardware once again brought the company's Xbox division under the microscope.
Source: Xbox.com.
Before Nadella replaced Ballmer, prominent company figures and shareholders had suggested that Microsoft would benefit from spinning off its gaming division and focusing on the company's vastly more profitable software operations. Many of these claims arose before Sony's (SNE 1.94%) PlayStation 4 console exploded to a significant sales lead, but Nadella has recently reaffirmed the company's commitment to the Xbox brand. Is Microsoft's gaming business a viable fit for the company as it heads in a new direction?
The beginning of the end for dedicated gaming platforms?
Heading into the current round of console hardware, there was considerable skepticism about whether dedicated platforms could replicate the successes of previous generations. The near-ubiquity of mobile devices and rise of free-to-play games significantly lowered the cost of entry for many customers seeking gaming experiences, and it was commonly accepted that the industry's established stalwarts faced greater competition than ever before.
While combined sales of the PlayStation 4 and Xbox One are outstripping the cumulative total of their predecessors at this point in their respective life cycles, there are still reasons to believe that overall hardware sales between the two companies will see substantial deterioration. If the performance of Nintendo's Wii U relative to its last-gen predecessor is included in the home console market analysis, a steep decline in the sale of gaming hardware is practically assured. In light of these mounting challenges, and numerous missteps Microsoft made in the development and marketing of the Xbox One, calls to ditch the gaming business were not without justification.
Xbox's role in the future of Microsoft
When Nadella reiterated support for the Xbox brand in a company email in July, he also indicated how the gaming brand might fit into Microsoft's new direction:
As a large company, I think it's critical to define the core, but it's important to make smart choices on other businesses in which we can have fundamental impact and success. The single biggest digital life category, measured in both time and money spent, in a mobile-first world is gaming. We are fortunate to have Xbox in our family to go after this opportunity with unique and bold innovation. Microsoft will continue to vigorously innovate and delight gamers with Xbox.
These comments suggest that Microsoft believes the Xbox brand can have an impact on businesses outside Microsoft's core focus, while also improving the strength of its most important offerings. This outlook echoes one of Microsoft's primary reasons for getting into gaming: making sure Sony didn't achieve dominance over the living room. Now, priorities have shifted, and establishing and maintaining viable positions in the mobile and cloud spheres to guard its business against the likes of Apple, Google, and Amazon.com is of paramount importance.
Is Sony ahead of Microsoft in terms of gaming and mobile integration?
Microsoft's desire to use its gaming resources for a better chance of success on mobile platforms is evident in recent updates to its SmartGlass app and its upcoming digital TV tuner, and it looks as if Sony has similar goals. The PlayStation 4 maker recently announced that its latest line of Xperia smartphones would allow users to stream games from the new console onto their phones. Sony has previously championed remote play with its PS Vita handheld and PS Vita TV set-top device, but low market penetration for these devices has limited the significance of the feature. The move enabling console-quality games to be streamed to its smartphones and played with a PlayStation brand controller is one that comes with substantial potential. It also offers a good indication as to the direction in which the console market may be heading.
Microsoft has made efforts to improve its own second screen and streaming features; however, it remains notably behind Sony on this front. With Microsoft's completed acquisition of Nokia's handset business, the company sells significantly more phones than Sony, but it has yet to deliver a strong synergy with Xbox. Increased efforts on this front are likely, as using Xbox's features and related properties on mobile devices has the potential to simultaneously improve the company's gaming, mobile, and cloud initiatives.
Foolish final thoughts
Microsoft has expended considerable resources to achieve a prominent place in the gaming market, and strong growth in the broader industry would seem to give the company reasonable incentives to maintain this position. The Xbox One and broader Xbox brand will probably continue to generate margins that cause some investors to squirm, but the company's gaming projects also have the potential to offer meaningful resources for defending and expanding its business. As Microsoft redirects its focus to cloud and mobile and faces increasingly credible threats to its core, Nadella's emphasis on utilizing these resources appears to be a smart one.
