A knockout at the XBOX-ing ring of death

**Akshara** (0:04)
In today's episode, we'll break down two important stories. First, we'll talk about a knockout at the Xboxing ring of death, and then we'll talk about the anatomy of an AI bubble. Welcome back to The Daily Brief by Zerodha, where we cut through the noise to help you understand what's actually happening in the most important stories from business and markets. If you're listening to this on your commute, on a walk or at the gym, you can also find The Daily Brief as an audio podcast on Spotify, Apple podcasts, or wherever you listen to your podcasts. If you prefer reading, check out the newsletter using the link in the description. I'm your host Akshara, and today is Monday, 20th July. Coming to the first story. We can finally say that we got a gaming industry story on The Daily Brief before GTA 6 And it's been one hell of a year for Microsoft Xbox, one of the top three video game consoles in the world. And we're still half a year away. So Microsoft is letting go of 3,200 employees across the Xbox division, the biggest layoff in Xbox history. The company is also shutting down or selling off multiple loss-making game studios. And this decision came only a few months after Xbox got a new CEO, Asha Sharma, who previously led Microsoft's core AI division and was COO of Instacart before that. Now this brutal restructuring points to an undeniable truth. Microsoft's gaming strategy has misfired badly. Over the last few years, the tech giant went on an unprecedented acquisition spree and introduced Netflix-like subscriptions to gaming. So why is one of the wealthiest tech firms on earth retreating from a war it just spent billions of dollars to win? So there are plenty of reasons and missteps. We won't be able to cover all of them, but hopefully with this story, you get enough of a glimpse into how much their own DNA as a software company mattered to this point in their life cycle. Now, before we look into Microsoft Xbox standalone, it's worth zooming out into the game console industry as a whole. In 2001, Charles Herald, a video game journalist, summarized the history of this industry in one succinct but scary sentence. Historically, whenever three consoles have competed, one has died. Whenever a fourth or fifth major console manufacturer has entered the frame, one has eventually been bled dry and forced out. In the 1990s, for instance, when 3D graphics became popular, there were five to six players who tried to cash in on this wave. And out of this, only three remained. Sony, Nintendo, and Sega. And then a few years later, Microsoft nudged out Sega, which had already lost tons of money in the first 3D graphics war. But why is this the case? Why does the market reset to this equilibrium so often? So the video game console business is a two-sided market platform. On one side are gamers, and on the other side, game developers. Gamers will only buy a console when it offers a solid catalog of games, and developers will only make games for the system where there are enough gamers. More competitors fragment the user base and also increase costs for developers since they have to tweak their games for multiple systems. So, the goal is to start a feedback loop where more consoles sold leads to a larger user base and therefore more developers come in and so on and so forth. Now, to kickstart that feedback loop, console manufacturers often price their devices aggressively even at net operating loss. They offset this by charging game developers high royalty fees on each copy of a game sold. Now, this model was first truly popularized with the Razer and Blades, as the competitors of Gillette wanted to steal market share from the Pioneer.
Much like the Razer, the console hardware is sold at a loss. The actual profit comes entirely from the Blades, and in this case, royalty fees from each copy of a game sold. Any company that enters the console business has to ace both software and hardware, which is where Microsoft has a far more unique story in comparison to its competitors.
Think about it. Microsoft built its empire on the back of software alone. Unlike, say, Sony, it had little to do with manufacturing devices until the Xbox. Microsoft's entry into the gaming market was motivated by Bill Gates' fear that home consoles would eventually encroach upon the PC business. So Gates approved the original Xbox project with the intention of building a PC in a box. And Microsoft's software dominance helped it move fast. The company leveraged DirectX, its dominant programming interface for graphics processing, and built the console around it. And this made it incredibly easy for PC game developers to transition to the new platform, allowing them to develop games for the first Xbox much faster.