Microsoft Corporation is bringing in a measly $28 in profits per Xbox One it sells (accounting just for components and manufacturing), according to Arik Hesseldahl of All Things D. In spite of that low number, things could be far worse. Analysts widely expected Microsoft to lose money on the console early in the game, and it most certainly will after factoring in all of the extra costs associated with selling it.
However, a big wild card to add into the picture now is how much extra money Microsoft will have to dole out for replacement consoles and free games and to fix the ones which shipped with dysfunctional disk drives. Interestingly enough, PS4 users have noted similar problems with the Xbox’s chief competitor as well.
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Nomura likes Microsoft’s new Xbox
Nomura analyst Rick Sherlund and his team ordered Microsoft Corporation (NASDAQ:MSFT)’s new Xbox One console through Amazon and reports that they received one of the ones with the bad disk drives. However, they were still able to use the console to download games and access services while they waited for the replacement.
He says overall, they like the console. In fact, before they even attempted to play any of the games, they “were drawn into and engaged with the broader functionality of the box.” He said using Hulu and Netflix, watching television shows, listing to music and using Skype all were satisfying experiences. He notes that the new Xbox One is meant to be more of an entertainment center rather than just a gaming console.
Microsoft expected to lose money
Sherlund said Microsoft Corporation (NASDAQ:MSFT) will probably lose money on the Xbox One and in its overall Entertainment and Devices Division (by its old system) in the current fiscal year. Indeed, most console makers do lose money early in the life cycle of the devices, but they usually make up for it later, particularly thanks to game sales and falling component costs.
Sony Corporation (NYSE:SNE) (TYO:6758) said in September at the Tokyo Game Show that it would sell this year’s new PlayStation 4 at a loss, although that loss will be less than it was with the PlayStation 3.
Microsoft’s profit margins on Xbox One are slim
So the red herring continues to be just how much the dysfunctional disk drivers will cost Microsoft Corporation (NASDAQ:MSFT). But currently, the company is turning a profit of about $28 per console, not accounting for payments to retailers or other costs. The cost to manufacture the Xbox One, the Kinect and the controller adds up to $471, and Microsoft sells the console for $499. But losses are still expected after the company pays other costs, including cuts for retailers, marketing, etc.
The Xbox One costs $90 more to make than the PlayStation 4, and Microsoft has priced it $100 above its competitor. Some have questioned this decision, but it seems clear that Microsoft is becoming even more serious about controlling costs.
IHS breaks down Xbox One’s most expensive components
According to IHS, at least $75 of the cost is from the Kinect sensor. The PlayStation 4 does not include any comparable device with it. In other words, if you think the PS4 is more expensive, then it really isn’t when you consider that you get more with the new Xbox. IHS says the most expensive component in the Xbox One, however, is the AMD microprocessor, which costs about $110—approximately $10 more than the AMD one in the PS4. The DDR3 memory costs about $60 and is less expensive than the higher-end memory in the PS4. The components of the console without the Kinect cost around $332.
So Microsoft Corporation (NASDAQ:MSFT)’s decision to price the Xbox as it did seems like a smart one since Sony is starting off with lower profits of $18 per console, according to IHS.
How much will Microsoft lose on Xbox One?
In Sherlund’s analysis of the Xbox One, he called it “a cool product” and provided some more details on how much Microsoft makes from game titles. It earns approximately $40 for its in-house creations and between $7 and $8 for a title made by other companies. He estimates that Microsoft Corporation (NASDAQ:MSFT) will sell 4.2 million new Xboxes during the December quarter but admits that this number may be a bit high. He thinks it could end up between 3 million and 4 million units.
He estimates that Microsoft will lose around 5% or 10% on the console, compared to a break-even to small profit on the previous model. He suspects this will also be the case for Sony’s PS4, noting that component costs fall over time and it is common for console makers to lose money early in the launch.
The analyst expects Microsoft to lose more than $1 billion on the Xbox One itself this year, including all expenses, but points to positive margins for Xbox Live subscriptions, peripherals and games.
Will Microsoft be able to leverage the Xbox One
Sherlund says the bigger question for Microsoft Corporation (NASDAQ:MSFT) is going to be whether the company can leverage the new console correctly. He continues to think the company should spin off the Xbox division to shareholders, calling it “just not that strategic” if Microsoft needs to narrow its focus and return more value to shareholders. However, he said they would be on the side of keeping the division if they “were confident it could counter the effects of disintermediation” caused by smartphones and tablets.
He also provided some alternative options for integrating the Xbox One more fully into the Microsoft picture. It could drive more usage for Bing since the search engine is included on the console. Also Windows Phones could end up being a major extension of the console, however, he doesn’t think these options will be enough to “counter the encroachment of smartphones and tablets.”