Seasoned hardware team executed well on the original Xbox

Outsiders frequently slam Microsoft’s hardware engineers as having a software (fix it later) mentality. But Microsoft’s engineers had been trained to put quality first. Most of them had years of training. Holmdahl, for instance, had been with Microsoft in the early days of its hardware division. By the time he joined the Xbox project, he was a veteran, having worked with contractors such as Flextronics to make 20 million mice per year. Making consoles was an altogether different task, but the team had expert help through its Web TV acquisition, which brought veteran console hardware engineers aboard in 1998. One of the best at debugging was Nick Baker, one of the architects of the Xbox 360’s chips.

In 2001, the team went through the paces making sure that the original Xbox had good quality. On that launch, Microsoft was 20 months behind Sony’s launch of the PlayStation 2. Microsoft’s original Xbox team moved as fast as they could, but they took a long time defining the box and picking vendors.

By the time they hired Nvidia in March 2000 to make the graphics chip, they were hopelessly behind. Nvidia combined two different chips into one in half the time it took to design a chip, but it fell behind schedule in part because of a bug. Someone else had specified a sub-par power supply for the Xbox, and that made the graphics chip hiccup now and then. Once the team fixed the problem, they raced ahead.


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But Flextronics, the contract manufacturer, wasn’t ready. It had to build a bigger manufacturing database to accommodate the design. Microsoft had to postpone its launch by a week. It also decided to launch only in the U.S. market and would wait until the next spring to launch in Europe and Japan. No console maker had ever pulled off a worldwide launch before, and now Microsoft understood why. The delays in other territories put it even further behind Sony. Sony eventually outsold Microsoft by more than five to one — scarring into memory a tough lesson about market timing.

But the Microsoft hardware team had come out shining. Aside from a problem with a supplier’s DVD drive, the number of defective Xboxes was low. After the DVD drive issue was fixed, yields rose above 90 percent and stayed there for the duration of the manufacturing. Microsoft thus had a seasoned team to work on the Xbox 360.

Lessons of round one drove grand strategy for the Xbox 360 business

Despite the good quality manufacturing, Microsoft’s game business was deeply flawed in the Xbox generation. In the second round, Microsoft vowed to learn from its mistakes.

In the first generation, the company lost $3.7 billion over four years. Most of that was because the costs of the box — particularly its hard disk drive — were too high. Microsoft’s planners thought the hard drive would give them an edge over Sony’s PS 2. It didn’t.

Bill Gates didn’t really care about the losses in the first generation. That was simply the ante for getting into an exciting new business. Microsoft has always viewed its ambitions in the game business as strategic. It isn’t in the business just to dominate video games, but to own the living room. The game console is a kind of gateway to the Internet and all of the future entertainment services that can be piped into the living room.

But Steve Ballmer, who took over from Gates as CEO during the first generation, really wanted the Xbox business to be profitable second time around. He wanted to keep the foothold in the living room, but not at the expense of draining Microsoft’s cash, which was needed to fight Google and other rivals.

This time, Gates said he felt that Microsoft would have a fundamental cost advantage over Sony. One of the key ways Bach hoped to outwit his rivals was with speed: getting a machine to market in four years instead of five. Secretly, Microsoft had planned on selling 50 million Xbox 360s at that point.

The Xbox team met for a series of retreats. One such retreat took place in early 2004 at the elegant Salish Lodge beside the Snoqualmie Falls made famous in the Twin Peaks TV show. After that meeting, Bach, who had headed the Xbox business as its senior executive from the time of its inception, decided that company would aim for profitability with the Xbox 360. As much as possible, the machines would not be sold for a loss.

Bach believed the hardware itself should be profitable over the life cycle of the system. His planners counted on good revenues from accessories and games to ensure profits the second time around. And, in the three-page paper that outlined the grand strategy, he said that Microsoft wanted to hit the market at the same time as its rivals.

Microsoft’s best guess was that Sony would launch the PS 3 in 2005. That turned out to be a year off, since Sony ran into its own development problems related to its decision to put Blu-ray drives instead of DVD drives into the PS 3.

Microsoft had more preparation for Xbox 360

There was more time to design the box than the first-generation team had, but it was still a race. Different teams sped into planning. The different groups included chip designers, hardware planners, game designers, software operating system engineers, marketers and industrial designers.

With the Xbox 360, Microsoft was guilty of packing a little too much into its box. The company sent out its scouts in late 2002 to ask gamers what they wanted. The first Xbox came off as “The Incredible Hulk.” The second Xbox, Microsoft had mandated, had to be smaller, if only to fit in the smaller homes in Japan, a key target market. The designers thought it had to be more like Bruce Lee. Microsoft’s own user-experience team ran the show, while outside industrial design firms competed in a bake-off to define the soul of the machine.

Hers Experimental Laboratory of Japan and Astro Studios in San Francisco won the bake-off. They wanted to create something that looked elegant and iconic, qualities that were sometimes at odds with the computer that it was. Those firms gave the box its signature look — curved sides that looked as if the box were inhaling air and was about to explode with energy (that was the marketing image, anyway). There was a constant tug of war between the industrial designers, who wanted something small, and the engineers, who wanted to pack a lot of performance into the box. The more powerful the system was, the bigger the box had to be to provide air flow for heat-sensitive components.

Microsoft decided late to add a hard disk drive to most of the machines. It also came up late with a plan to add wireless controllers; all of the previous consoles shipped with wired controllers. The hard drive blocked a lot of the air flow on one side of the machine. And the wireless modules had to have enough of their own space to ensure that there was no electrical interference. In the end, the machine was a series of compromises. The gigantic power supply needed to run the machine sat outside in the power cord, while the console shell was poked full of holes on the sides to ensure air flow.

“It turned out in the end that this was all going too far, too fast,” said one source. “They were adding too many features after things were locked down. That incremental feature adding just made it fragile.”

The marketers also decided the box had to be backward compatible with the older games, including “Halo” and “Halo 2.” And they also felt the box had to have enough horsepower to make games look beautiful on high-definition TVs.

Those parameters, in turn, gave direction to the chip and hardware designers. This time, hardware chief Todd Holmdahl wanted Microsoft to have much more control over its fate. And he believed he had built up a team that could act as the “system integrator.”

Microsoft had a team of 100 chip engineers and 100 more hardware engineers between Redmond and Mountain View. They were the overseers of the integration of the parts into a working console. It was a relatively small team for such a large project compared to a hardware company such as Sony, but Microsoft had plenty of help from its partners.

In contracts with IBM and ATI, Microsoft set early deadlines for delivery of the first working chips. It also decided that it wanted to own the chip designs. That way, if it wanted to, it could take the designs and have them made by a factory of its choosing and wasn’t locked into using IBM and ATI (or ATI’s chosen partner) chip factories. The reason for this change was that Microsoft wanted to avoid dependence on its chip partners. It had learned the hard way after getting into a bad dispute with Nvidia over the prices charged for the graphics chip in the original Xbox. The case had to go to arbitration and Microsoft ultimately lost that battle. However, this was a mistake: it was now responsible for failures related to the chip.

In Microsoft’s favor this time was the fact that it had credibility among game developers thanks to hits such as “Halo,” (pictured right) which sold over 10 million units. Microsoft believed it could charge more for each machine and more for its games; and not every machine would have an expensive hard drive. In the second generation, Microsoft planned on reducing the cost of the hardware over time.

Contract manufacturing had matured since the last generation. Flextronics was willing to make each console for just $10 each, while another manufacturer, Wistron, would do the same for $7, according to sources. They hoped to make profits on large volumes of machines sold. They were also practiced in the art of reducing the costs of the components they put into their machines. Overall, Microsoft had a much more formidable hardware operation, when you consider all of its virtual resources, on the second time around. But it still wasn’t enough to do a perfect job.