Microsoft And Modchips, Part II: Homebrew Software

Yesterday I mentioned Ozymandias' blog entry where he lists several reasons why an Xbox owner might want to modchip his console, as well as why he, in his own personal opinion, apart from being a Microsoft employee, could not approve of such actions.

The first was fairly clean-cut: because it enables piracy. Fair enough. Ozymandias then went a bit off the deep end on the piracy issue, which I commented on yesterday.

Another reason he says an owner might want to install a modchip would be to run other kinds of non-piracy related code on the Xbox. Some people just want to run Linux on an Xbox for the heck of it. Far more people are interested in the free Xbox Media Center software, which makes the media center features of even the newer Xbox 360, coupled with Windows Media Center edition, look like a black and white television with rabbit aerials.

Ozymandias' objection to the homebrew crowd is that it breaks Microsoft's business model. Poor Microsoft!

Click "read more" below from the front page for the entire article.

The console business is a razor/razor blade model. Hardware (the console) is subsidized (meaning Microsoft sells it at below cost) to make it easier for consumers to get it into their homes. The business then makes this up by selling you additional hardware (peripherals), software (games), and services (Xbox Live). The success of this razor/razor blade model is tracked by analysts as the "attach rate," or how many of these add-ons an average person might have per console. (The most common metric you'll see tracked is the game attach rate to a console, but some analysts also track the attach rate of peripherals and Xbox Live.)

Over time you buy games (and other peripherals and services). The revenue generated from those purchases helps to make the business a profitable one (which is the reason you see a healthy game industry, and continual investment in new features, games, and hardware). Some folks point to the fact that they bought the hardware and believe they should be able to do anything they wish with it. Unfortunately, this argument ignores the fact that they're buying that hardware at below cost, and it's the razor/razor blade model that makes it even possible to buy at that price.

Ozymandias is being factually correct here. You pay less for an Xbox 360 than it cost Microsoft to develop, manufacture, and promote it. Their only hope for being profitable on the whole enterprise is to get you to buy games and peripherals afterwards, and that the profit margins on those items will be high enough over the life of the console to recover the loss on the initial purchase.

In fact, this is one of the only areas where the manufacturer has a high incentive to make sure the hardware is reliable and long-lasting. If, let's say, Microsoft sells an Xbox 360 to you for $400, but it cost $500 to make, they've lost $100 on you if you buy nothing else. If you buy accessories and games on which Microsoft's margin equals that $100, then they've broken even, and after that, everything is gravy.

Now let's say your Xbox breaks out of warranty. You really like one of the games for it (Halo 3, let's say) so you replace it. Assuming you bought at the same price, Microsoft is now back in the hole $100 again. They can't break even on you as a customer unless you purchase additional games and accessories from them on which MS can make $100 in margin.

However, that's not the real problem with Ozymandias' point. The real problem is projecting on to the consumer some kind of moral responsibility to fulfill the expectations the manufacturer has come up with because it fits their business model. No such responsibility exists, nor can it-- nor should it. If I want to buy an Xbox and Halo 3 to play on it, and absolutely nothing else-- then Microsoft will lose money on me as a consumer, and there is nobody for Microsoft to blame for that but themselves.

What console manufacturers have tried to do since modding began is to sell their device with a license that sets out what you are and are not allowed to do. How this works, long-term, is really not clear. Historically, some intellectual property has been sold that way (computer software) and others have not been (music) while others are still working out the kinks (movies). Even so, in most cases a manufacturer, developer or publisher does not have carte blance to put anything they like in one of these agreements, so-called "shrink wrap" licenses because you can read them only after you've purchased the item and opened it, at which point they usually claim that you are bound by them immediately. Sometimes courts have judged that regardless of what is in such a license, you do have certain rights. In some cases, you may make a backup copy of a work in order to protect yourself from media failure (everybody tells you to "back up" your computer, but that makes copies of all your software, doesn't it?). In some cases, you may transfer a work to a different media format, as when you transfer a music recording from LP to cassette so you can listen in the car. The advent of digital technology in this area has many companies scared, as digital copies are longer-lasting, better quality, and more easily distributable than copies made on reel to reel or cassette tapes. But the threat that represents does not obviate the fact that as a consumer, you do have certain rights.

When it comes to modding a console, Microsoft is on much more solid ground with regards to the Xbox Live service than it is with those who, for instance, want to run Xbox Media Center (XBMC). When you sign up for XBL, you agree you won't use a modified box on the service because of the potential threat that poses for misuse to other clients. If they catch you, you're off the service. It's simple.

If all you're doing is watching your DivX collection from your computer on your TV by pumping them through your Xbox, then the situation is much less clear. Sure, Microsoft will allege that your DivX collection must contain infringing materials, because, they say, everybody's does. Whether it does or not isn't necessarily the point. It is conceivable that it doesn't. It is conceivable that such a modification has a significant non-infringing use; and as such, it is conceivable that Microsoft has no grounds on which to try to preemptively restrict you from doing so if you are not actually engaged in any other infringing activities, such as pirating games or cheating on XBL.

The other solution would be to sell the hardware at a price that covers cost and also includes a profit margin so that selling the console alone (with no game/peripheral/service sales) could be a stand-alone business. Problem is A) this model already exists (it's called a PC), and B) selling a console at PC prices (especially with the capabilities the console has in it) would simply be too expensive and no one would buy it. At the end of the day, the cost difference needs to be made up somewhere, and that's why we need to you buy those razor blades.

This really needs some refutation. The difference between a PC and a console is much, much more than the price. PCs are more or less infinitely configurable and upgradeable. Their interfaces and displays are vastly different than PCs. It is the major players in the industry who have, through their own choice, decided to pursue the business model of subsidizing hardware sales to increase installed base. Partly this is because it is true that more expensive consoles sell fewer units. Then again, how many millions of units you can sell matters little if you take a loss on every unit and cannot get the attach rate for peripherals and games high enough to compensate.

The race for bigger and bigger installed bases may also becoming irrelevant. As long as your hardware isn't so different or so underpowered that cross-platform deployments are impossible, it is likely that the really big third-party titles are going to come out for your console even if you aren't the #1 console. The Xbox benefited from this in the last round of consoles, getting a lot of the same popular games as the PlayStation 2, and getting a few exclusive hits of its own, like the Halo series. Even so, whatever "success" the Xbox might have had is not necessarily an endorsement of the subsidized-hardware business model, as aside from the quarter in which Halo 2 launched the division has yet to show a profit. As much as they are being criticized for doing so, Sony may have the right answer with their higher pricing with the PlayStation 3, even if their motivation-- the inclusion of expensive Blu-Ray hardware-- is the wrong reason.

For comparison we can look at another technical market that has examples of both business models. In the US, the most common business model for cellular phone operators is to heavily subsidize, or even give away for practically nothing, a mobile telephone to clients who sign up for one or more years of service. Contracts usually have penalties for early cancellation, but sometimes liberal policies for phone upgrades and replacements.

This is similar to the console business; the operators subsidize the phone purchase and make back the difference on service. The end-user is shielded from the high price of handsets, and in return the operator "locks in" the client against migrating to another carrier, one of the major risks inherent in that business.

It doesn't work like that everywhere, however. In other markets, end-users purchase their own handsets at full retail price, even up to $1000, and are free to choose their operator at any time. In some cases, they can easily have more than one operator and switch between them easiliy at any time. Because operators don't subsidize the handsets, they don't "lock" them into use with only one carrier. The choice of carrier can be made on a month to month, even a day to day basis, when one considers pre-paid calling cards.

This means more risk for the operator, who has to maintain good service and rates or risk losing clients to rival operators at almost any time. However, the damage to the operator should clients do so is much less, as it cost the operator less to acquire that client originally, as there was no subsidized handset.

This means that end-users trade away cheap phones for genuine freedom of choice when it comes to operators.

In the console world, it works a little differently. Console manufacturers aren't worried about so-called "churn". You can't play Xbox games on a PlayStation, or vice-versa. Xbox owners can't sign up for Sony's free online service. The hardware itself is the lock-in. The only way the manufacturer can "lose" the client over the life of the hardware is by failing to deliver compelling games and peripherals for the owner to purchase.

There is less incentive for the end-user to pay "full price" for the console, since there's no amount of freedom they can buy with it, as you can only use compatible games, peripherals, and services with your console of choice. On the other hand, there is less risk for the manufacturer in subsidizing the hardware, as the likelihood of someone spending a few hundred dollars on the box and then buying only one or two games for it over 3-4 years is relatively low.

Of course, the real reason this model persists is that any manufacturer who chose to abandon it would almost certainly have to compete against others who would continue with it, and would very likely have to cope with reduced sales figures and a lower installed base, making them less attractive to third party developers. For a manufacturer depending heavily on first-party titles, this is less of an issue; and in case somebody hasn't noticed, the #1 and #2 all-time sellers on the Xbox are both first-party titles.

Literally, the argument Ozymandias is making here against modding is that since modding allows you to run other software on your console than originally intended, it supposedly makes it less likely that you'll purchase sanctioned content, and therefore lowers the attach rate.

I can see that piracy lowers the attach rate, but I honestly cannot see how homebrew content does. I have a DLP projector that I use for playing Xbox games and for watching DVD movies. I have legitimately-purchased DVDs from all over the world, wherever I happened to be traveling: Europe, the United States, and Asia. To do this, I need a region-free player. Although I didn't, I could have modified my Xbox to perform this function. Instead, I purchased a region-free player. However, whether I'm watching movies on the Xbox or not, the fact is I'm not playing games on it at that moment. And whether or not I am watching them on a modified Xbox, an unmodified Xbox, or a different device, doesn't change the percentage of my time spent on those two activities. When I feel like playing, I play. When I feel like watching, I watch. When a movie is released that I want to see, I buy it. When a game is released that I want to play, I buy it. The balance of these two activities is affected only by the relative quality of the releases of the two kinds of content and my own personal interests. It cannot be affected by locking down the hardware to prevent certain activities. In fact, although it would not affect the attach rate positively or negatively, by allowing me to use the Xbox for these things, rather than demanding I purchase a separate item (money that ends up going elsewhere, not to Microsoft) or locking me in to an expensive and limited-value option like the Media Connector and the Media Center Edition of XP, I might very well appreciate my Xbox even more, and spend the money I saved on a few Xbox games.

The idea that limiting hardware capabilities in this way affects the attach rate is simply and demonstrably wrong, except where piracy is concerned.

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