Rafi Mohammed

Microsoft Blew It on the Price of Xbox One

Posted on June 17th, 2013 (0 Comments)

Reprinted from the Harvard Business Review website. 

UPDATE: On June 19, 2013, Microsoft announced that it would reverse its highly restrictive digital rights management policies on the Xbox One. That being said, the author still stands by his argument that the price is too high.

At last week’s Electronic Entertainment Expo (E3) conference and show, both Microsoft and Sony unveiled their new gaming consoles which will be released this holiday season. While both systems support a wide variety of games, they each have unique differentiating features. Microsoft’s Xbox One, for instance, provides strong integration with television, Internet, and Skype. Sony’s PlayStation 4 (PS4) is less restrictive in its digital rights management, which makes sharing games easier and renting games possible.

The most striking difference, however, is their prices. Perhaps feeling cocky because its sales consistently trump those of the PlayStation, Microsoft set the Xbox One’s price at a 25% premium over the PS4. The Xbox will sell for $499, while the PS4 has a retail price of $399.

Now for the folks at Microsoft, here’s a brief pricing history refresher:

  • King C. Gillette started selling razors and razor blades in the early 1900′s. To get razors in the hands of consumers, Gillette set prices low and made his profit from the ensuing sales of high priced blades. This pricing strategy has been successful and emulated by many other products (printers and cartridges, for instance).
  • Facebook is the indisputable champion of social networking. How did it gain over a billion members to use its site monthly? It made the price of entry cheap — in this case, free.

Why remind Microsoft of these strategies? Like the Pledge of Allegiance, these two stories should have been recited before every meeting that discussed the price of the Xbox One. The foundation for the battle of the next generation of console-based gaming will be set by this holiday season’s sales, and lessons from each example above reveal the importance of setting a relatively low price for the system in order to maximize overall profits.

Due to the make-or-break importance of these head-to-head initial sales, there are two key reasons why Microsoft should lower its Xbox price, matching or even beating the price of the PS4:

The Razor/Razor-Blade Pricing Strategy. Game console manufacturers have long followed King Gillette’s pricing strategy: They create game customers by selling consoles as cheaply as possible and then profit from game sales. In fact, consoles are often sold at a loss on the faith that manufacturers will reap hefty profits from the licensing fees they charge game manufacturers to run games on their hardware. On a game created by an outside developer that retails for $60, for instance, it is estimated that the console manufacturer receives a $7 platform licensing fee. Since the profit comes from games and ancillary sales, the pricing strategy is straightforward: Set prices low to get consoles in the hands of gamers. The more consoles purchased, the higher the potential profit upside.

Role of Price in Creating a Network. A growingly important decision factor in selecting a console is the breadth of its associated online community. Both Xbox and PlayStation have closed networks — meaning that if you own an Xbox One, you won’t be able to play online against others (friends, expert players, etc.) who have a PS4, and vice versa. In these types of closed networks, the more people who join, the more valuable the network becomes. At a 25% price premium, Xbox is not doing itself any favors in terms of growing its gaming network.

Console prices will drop over time. It’s standard practice for new technology to start prices high and then discount in the ensuing months and years. But this strategy may not work for the Xbox. Its premium price is receiving so much publicity that the notion of “it’s too expensive” is becoming embedded in consumers’ minds.

I get that Microsoft believes its new Xbox provides more value, and hence deserves a higher price. But historically, consumers haven’t been willing to pay a premium for the “razor,” even if it ultimately provides higher value. In 2007, for instance, Kodak bet the company on a new printer pricing strategy. While Kodak charged a premium for its laser printers, the upside for consumers was that ink cartridge refills were priced at $9.99. While a seemingly attractive value proposition, the strategy did not catch on with consumers; in 2012 Kodak filed for Chapter 11 bankruptcy.

The Xbox One is already starting at a disadvantage: A recent poll by Amazon.com found that over 94% of respondents favored the PS4 over Microsoft’s gaming console. This sentiment, coupled with the backlash from its premium price, has created a pall of gloom that Microsoft needs to overcome. The good news is there is still plenty of time to gracefully lower price (or offer a discounted version with less functionality) before consoles go on sale.

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