L.A. Times January 8, 2001

Gadgets: Unveiling the game console and Ultimate TV, the Microsoft chief is working furiously to stay relevant.

By ALEX PHAM, Times Staff Writer

    LAS VEGAS--As spending on new personal computers slows, the company synonymous with their rise, Microsoft Corp., has aggressively shifted its focus to consumer gadgetry, hoping that video game machines and high-tech televisions will keep the company on top.

    At the annual Consumer Electronics Show, which began here Saturday and runs through Tuesday, Microsoft Chairman Bill Gates unveiled the Xbox game console and Ultimate TV, a set-top box that marries a TiVo-style digital video recorder with WebTV-style interactive television.

    In so doing, Gates outlined a world teeming with personal digital devices--all running Microsoft programs and operating systems.

    It was his latest attempt to demonstrate that Microsoft is working to remain relevant at a time when the traditional functions of desktop PCs are fragmenting onto smaller, friendlier and more portable devices.

    "In the end, Bill wants it all," said Tim Bajarin, president of Creative Strategies Inc., a Silicon Valley technology consulting firm. "And it's not just the desktop or the living room. He wants your refrigerator, your toaster and, for that matter, your toilet. If it's digital, he wants his software in it."

    Key to the new direction is Xbox, a sophisticated game system that trumps competing consoles in raw computing power and is seen by many as Microsoft's best shot at breaking into the living rooms of consumers.

    The strategy is not without its risks, though. Despite earlier forays into consumer electronics with devices such as WebTV, Microsoft is a relative neophyte muscling into territory dominated by international giants such as Sony Corp., which itself is developing a range of Internet-enabled appliances and whose PlayStation 2 will compete head-on with Xbox.

    And although Gates has clearly turned his attention to new ventures at Microsoft, he was careful in a weekend speech not to undermine the personal computer software that remains the Redmond, Wash., company's biggest moneymaker.

    But with PC sales faltering in recent months, Microsoft and other computer companies such as Intel Corp. are trying to balance developing new markets against maintaining traditional cash cows.

     Gates' solution: Make the PC a gateway and data storage center for consumer electronics. That means, for example, storing digital songs on a PC that can then transmit those tunes to a stereo or a portable music player.

     In one demonstration, Gates and Microsoft technicians showed how pictures captured on a digital camera can be stored in a PC that automatically sends those images to a digital picture frame.

     "The PC plays a critical role in helping people look at, organize, edit and share data," Gates said. "It becomes the center for all digital information."

     Not everyone shares Gates' optimism for the future role of the PC. In fact, some think his view of a PC-centric world might hinder Microsoft's approach to consumer electronics.

     "If you've got a hammer, everything looks like a nail," said Chris LeTocq, research director for market research firm GartnerGroup Inc. "From Microsoft's perspective, if you've got technology, everything looks like a PC. Granted they're trying to get over that, but they have a ways to go."

     Most analysts agree, however, that Microsoft has no choice but to broaden its business. Lagging PC sales have forced a slew of computer companies such as Intel, Compaq Computer Corp., Gateway Inc. and Apple Computer Inc. to forecast disappointing financial results for 2000.

     Microsoft last month took the unusual step of warning investors that revenue would fall 5% to 6% below expectations and that the company expected to post profit of 46 cents to 47 cents a share for its fiscal quarter ended Dec. 31, lower than the 49 cents stock analysts had projected, according to First Call/Thomson Financial.

     "Microsoft is at a real crossroads," said Judith Hurwitz, president of Hurwitz Group, a market research firm in Framingham, Mass. "They've gotten to the point where people no longer have a compelling reason to upgrade their software. Consumers aren't saying, 'Gee, I can't wait to get my hands on the next operating system or the next version of Word.' So when they look at video games and hand-helds, they're saying that's where the action is. Those are huge, huge revenue potential."

     Shipments of Internet-enabled devices such as set-top boxes, hand-held computers and game consoles are projected to triple over the next five years, according to Bryan Ma, an analyst with IDC (formerly known as International Data Corp.).

     Shipments of PCs, meanwhile, are expected to grow only about 60% over the same period, according to IDC.

     Microsoft has actually been noodling in consumer electronics for several years. In 1999, Microsoft codified its efforts by changing the company's mission statement from "a PC in every home" to "empower people through great software--any time, any place, and on any device."

     Until now, though, much of its effort has been awkward and piecemeal. WebTV, Microsoft's interactive television service, has garnered just a million subscribers nationwide. MSN, its Internet access provider, languished for years as a distant competitor to America Online. And its venture into car-based PCs produced underwhelming sales.

     That hasn't deterred Microsoft. And the company seems almost giddy about Xbox. Due out in North America and Japan in the fall and in Europe in early 2002, Xbox is supported by a $500-million marketing budget and more than 1,000 Microsoft employees assigned to the project.

     The black-and-green console supports as many as four players simultaneously and will be able to play DVDs as well as games.

     Although Xbox will have the ability to be connected to the Internet at high speeds, company officials declined to reveal how they plan to take advantage of that feature. Microsoft also did not disclose the console's expected retail price.

     Microsoft showed off four games at the Consumer Electronics Show but promised more at May's Electronic Entertainment Expo in Los Angeles. Building a strong library of games is critical to the success of Xbox. "The box looks pretty slick," said P.J. McNealy, senior analyst with Gartner. "But it all comes back to the fact that it will be the games that will sell the platform--not the specs, not the shape, not the colors."

     Gates also unveiled Ultimate TV, which builds on WebTV's technology by adding the ability to record two live TV shows while watching a prerecorded show.

     Ultimate TV's connection to the Web means it can also be used to download music, movies, video games and images that can then be distributed to a PC or other devices.

     The Ultimate TV set-top box, to be released in February, will retail for $399 and carry a monthly service charge of $9.95.

     "A lot of eyes are watching how well Ultimate TV does," said Rob Enderle, analyst with Giga Information Group in Santa Clara, Calif. "This will be the first indicator of whether this market is real or that there's nothing here and we need to move on. It's a major litmus test for this market genre."