NEWS - Sunday, November 20, 2005

Getting Xbox 360 To Market

Mr. Holmdahl is the Microsoft vice president in charge of Xbox manufacturing. He works behind the scenes as the conductor of a global train of component suppliers, factories and distributors that are turning 1,700 different parts into what will likely be one of the hottest holiday gifts of 2005. How he and his team perform will help determine whether Microsoft can challenge Sony Corp.'s position as the world's No. 1 videogame-console maker. How they do will also be crucial to Microsoft's strategy to use the Xbox to link the Web and entertainment of all forms in consumers' living rooms. One manufacturing misstep -- a shortage of graphics chips or a recalled hard drive -- could derail those ambitions and drag Microsoft's unprofitable videogame business even deeper into the red. "With 1,700 components all it takes is one not being there and it's an issue," Mr. Holmdahl says. An assembly line at an Xbox console factory in the Pearl River Delta region in southern China. His task illustrates the fact that no matter how flashy the games and skilled the marketing, videogame wars can be won or lost on the factory floor. Within the first 90 days of the Xbox 360's launch, Microsoft executives expect to deliver as many as three million Xbox 360 consoles, putting them on track to sell up to 5.5 million units by the end of July. Hitting those numbers is critical for the Xbox 360: The more machines Microsoft can sell, the more game makers will want to design their best games for the Xbox 360, starting a cycle where better games lead to higher sales of consoles, and so on. And the higher manufacturing volume that follows typically leads to lower production costs. "The faster I can build volume, the better off I am," says Robbie Bach, president of Microsoft's Entertainment & Devices Division, which includes the Xbox business. But Microsoft's expertise is software, not Henry Ford-style mass production. When Microsoft entered the videogame console business five years ago with the first Xbox, it decided to follow industry practice and make its own hardware. That came at a huge price, though. In at least the early stages of sales, videogame consoles typically sell at a loss. As sales and production volumes grow, console makers expect to get economies of scale that will allow them to lower costs and reduce their losses. But economies of scale were slow coming to Microsoft: Miscalculations about the cost of the original Xbox's hard drive and main microprocessor have led to some $4 billion in operating losses since 2001, analysts estimate. GAME QUEST • An interactive look at next-generation videogame systems. • Tactics for Scoring an Xbox 11/18/05 • Xbox 360 Will Launch With 18 Games 11/16/05 • The Next Level: A Guide to New Games 11/11/05 While Microsoft grappled with its growing losses, rival Sony extended its already strong lead. It had proved itself with the PlayStation, which went on sale in 1994, and in launching the PlayStation 2 in 2000 had both the backing of the best game makers and the experience building smart hardware gadgets to stave off Microsoft. As previous gaming heavyweights like Nintendo and Sega lost ground, Sony was able to grab a 70% share of the videogame console market. Microsoft still holds a smaller than 20% share, according to analysts. The new Xbox represents a new generation of videogame consoles, with unprecedented levels of realism in their graphics and vastly improved online game capabilities. But this time Microsoft may have a tactical advantage over Sony, whose PlayStation 3 won't be out until sometime next year. And, Microsoft executives say, they've learned some valuable lessons from the last round. This time the company has a better lineup of games and a smarter approach to production. In the first Xbox, Microsoft used off-the-shelf chips from Intel Corp., a decision that left Microsoft a slave to the chip maker's prices. Microsoft has since teamed with International Business Machines Corp. to make the Xbox 360's core chip, giving it more control over its costs, Mr. Holmdahl says. The software maker also designed the Xbox 360 with a detachable hard drive, allowing it to lower the price of the console over time as it achieves economies of scale without concern for hard-drive prices, which tend to stay stable. Microsoft is selling two different versions of the Xbox 360 -- one including the hard drive, priced at $400, and one without, at $300. But the critical challenge comes in funneling these parts, and more than a thousand others, through a manufacturing chain that looks like a road map of Los Angeles stretched across three continents. The Xbox operation is centered at two factory sites in southern China, each run by separate contract manufacturers -- Flextronics Corp. and Wistron Corp. -- as a hedge in case one stumbles. Also near these sites are makers of many of the parts, from cooling fans to capacitors, and the 30 or so pieces of plastic that form the box. Using local suppliers means a lower risk that parts will arrive late. Local parts also eliminate the need to navigate Chinese import rules. Microsoft and IBM started production of the processor -- the heart of the Xbox 360 -- in early July, gradually increasing production over the summer. Those chips now join a parade of other parts flowing to the Chinese factories: hard drives from Japan and Korea; graphics chips that were designed by Ontario, Canada's ATI Technologies Inc. and come from Taiwan; and buttons for the machine's controller from Lacrosse, Wis. In all, 250 suppliers make parts for the machine. Some 25,000 workers world-wide have roles in making either the parts or the Xbox 360 itself, Mr. Holmdahl says. The two Chinese factories started rolling out finished Xbox 360s in August and now push out tens of thousands of units a day. After each Xbox 360 rolls off the line, it undergoes two hours or so of automated testing and five minutes of manual testing before being packed into a plane or a 40-foot-long ship's container. Back at Microsoft's headquarters in Redmond, Wash., Mr. Holmdahl keeps a database chronicling the genealogy of every Xbox 360, including where it was made and shipped and exactly which parts are in it, so that any problems can be traced quickly. The finished machines move through Hong Kong, then by boat to Chiba, Japan; Rotterdam, the Netherlands; or Long Beach, Calif. Some units reach the U.S. by air freight, landing in either Chicago or Toledo, Ohio. All U.S.-bound Xbox 360s eventually pass through a central distribution center in Memphis, Tenn., where they are packed onto trucks and trains bound for stores run by Wal-Mart Stores Inc. and Best Buy Co., among others. The system has had its glitches. Last month, on a 5 p.m. conference call with their China-based colleagues, Mr. Holmdahl's team discovered one factory wasn't producing at the level Microsoft needed to hit its holiday season forecast. Alarmed, Mr. Holmdahl soon led a team of engineers to China, where he found that certain test equipment was bogging down as production speeded up. Ten hard days of troubleshooting and writing new software ultimately fixed the problem, Mr. Holmdahl says. "We were really able to crank up the volume," he says. Chris Crotty, a senior analyst at research firm iSuppli Corp., says one potential chokehold on production is the custom-made IBM processor. Unlike the console's hard drive, which is commonly used in PCs and made by several different manufacturers, the processor is only available from a single source, though two factories make it. "If they were to suffer stock-outs, that would really jeopardize their momentum," Mr. Crotty says. Mr. Holmdahl says he's confident the chip supply will hold strong. "There will be plenty of consoles available" for the holidays, he says. Still, he says on Tuesday he'll be checking with his team around the world, even as he celebrates at an Xbox 360 launch party in Redmond. "Everybody has my phone number here," he says.

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