CASE REPORT

Executive Summary Our team recommends that Microsoft develop the software for non-gaming set-top boxes and partner with a hardware company. This option is likely to produce the greatest ROI for Microsoft because Microsoft’s core competency is developing operating software and this option carries the least amount of risk.
Background
The consumer demand for the ability to seamlessly integrate and connect devices and data that they use in their daily life is growing rapidly. The ability to connect mobile phones, television sets, tablets, and personal computers has provided consumers with an unparalleled opportunity to the access to information (I), communication (C), and entertainment (E), collectively known as ICE. The struggle amongst Microsoft and archrivals like Apple and Google is to develop the “must-have” product that would redefine the way content is consumed in the living rooms around the world. While streaming content via game consoles has been on the rise, the introduction of streaming content via non-gaming set-top boxes has become increasingly popular. Microsoft must choose how to position itself in this rapidly changing market so that it does not render itself irrelevant and so that it can capitalize on this shift in the way that content is being consumed. Ultimately Microsoft can make one of four choices. Microsoft can: (1) keep the status quo, (2) develop the software for non-gaming set-top boxes and partner with a hardware company, (3) develop a Microsoft branded non-gaming set-top box, or (4) introduce new technology. Our team recommends that Microsoft choose option 2 and develop the software for non-gaming set-top boxes and partner with a hardware company. We have arrived at our decision by conducting a number of analyses to include: PESTEL (Political, Economical, Social, Technological, Environmental, and Legal), Porter’s 5 Forces (Bargaining power of suppliers, Bargaining power of buyers, Rivalry, Barriers to Entry, and Substitutes), and a SWOT analysis (Strengths, Weaknesses, Opportunities, and Threats).
Analyses
PESTEL
Political
The political landscape in which a company operates has a huge impact on its performance. With regards to Microsoft and Xbox, political interference or regulation relating to the gaming industry, set-top box related services, or cable/satellite service providers can have huge impacts on the performance of the company. An example of the aforementioned is the Anti-Trust laws in the United States. Another challenge is the political will to reduce piracy both product as well as Intellectual property rights. If Microsoft wishes to benefit from the major markets of Asia and Latin America where these issues have traditionally been the largest, then this political challenge needs to be addressed. In addition to the points above, we must note that the latest Xbox offering, Xbox360 was sold in 36 countries. While the major markets of Europe, Americas and even Asia seem stable, the company must tread carefully in the regions of Middle-East and North Africa due to recent political unrest.

Economical
The non-gaming living room space can be defined under the discretionary spending of a household. In the aftermath of the Global financial crisis, sales of discretionary items such as gaming consoles were negatively impacted. Even traditional non-discretionary sales of Microsoft’s software and IT services were impacted due to companies’ being careful about their spending. With its worldwide operations, currency fluctuations can also have a huge impact on Microsoft, as can tax policies and any import and export barriers of other countries. The battle for the living room, or customers’ decision with regards to what product to place in their living room to achieve entertainment, is extremely sensitive to market fluctuations. Therefore, Microsoft upper management must be aware that during times of economic downturn, they should expect a steeper decline in sales for more expensive items than they would see in their decline of sales for less expensive items.
Social
The social environment in which Microsoft is operating in is changing radically. The world has seen dramatic changes in social behavior in the last 2 decades. Microsoft must be aware that social tastes and preferences are changing at much faster rates than during the days of its inception. For example, the age group of customers purchasing game consoles could be shifting. If the aforementioned is true, this would require Microsoft to develop a different marketing strategy, as well as introduce new product features to cater to this change in the demographic of Microsoft’s customer base. According to Casual Games Association, women form 51% of the casual players demographic and consumers over the age of 35 comprise the majority of players compared to younger consumers. The report also cites that the main reason for playing casual games is stress relief. These figures were not what one would expect a decade ago.
Additionally, Microsoft must be aware that we are experiencing an aging population. In 2009, persons 65 and older represented 12.9% of the U.S. population. However, by the year 2030, this age demographic is projected to comprise 19% of the U.S. population. The implications of this shift in demographics means that there will be an increased number of persons who are unwilling to work, in higher need of living room entertainment, yet looking for products that are easy to use and not technologically complicated. An older population is also less likely to be interested in a gaming console, and more likely to prefer a less expensive device by which they can access entertainment.
Another change in social trends is the rise of health consciousness to engage in physical activities. This can be juxtaposed to the gaming console, which is often criticized for providing an invitation to sit and stare at a television for hours on end. Consumers are more likely to view a device with strictly non-gaming capabilities as less intrusive on the effort to become health conscious. These social changes have impacts on Microsoft’s Xbox business and must be addressed in forthcoming strategies. Hence, Microsoft must continually be aware of the social preferences of its customers as well as the general social environment.
Technological
Though investing in research and development to keep up with changing preferences of its customers is prudent and indispensable in any business environment, Microsoft should also keep in mind the high costs involved with introducing new innovative technology to secure more customers and the speed of such innovations being copied by competitors. Innovation in the gaming industry can be very time consuming and the resulting ROI can have high recovery risks associated with it. However, the operating software (OS) for set-top boxes and smart TV’s isn’t as restrictive, due to the fact that software development is a core competency for Microsoft. In 2012, 2011, and 2010, Microsoft’s R&D expense was $9.8 billion, $9.0 billion, and $8.7 billion, respectively. These amounts represented 13%, 13%, and 14%, respectively, of revenue in each of those years. In 2011, Microsoft had the 5th largest expenditure on R&D, only to be beaten by companies in the automobile and pharmaceutical industries. Microsoft spent the most amount of money in the ‘technology’ industry, yet some industry gurus still feel that despite the large R&D spend, the company’s technological updates were not nearly as innovative as they should have been for the amount of money invested into the R&D. Being a technology leader has always been one of Microsoft’s defining traits, however Microsoft seems to focus on maintaining current products and services as opposed to innovating path breaking new ones. Competition from companies like Apple and Google who have cemented their reputation for innovation, warrants a reformed strategy from Microsoft to compete to be technologically dominant.
Environmental
Microsoft is committed to being environmentally conscious in its operations and take corporate environment sustainability seriously. In fact, recently in May 2012, the company announced its commitment to make its operations carbon neutral. They follow an internal carbon fee model. This charge-back model places a price on carbon and makes the company’s business divisions responsible for the cost of offsetting the carbon emissions associated with their electricity use and air travel. These initiatives, besides being good for the planet, also help the company gain respect from the industry as well as its consumers. The gaming console and set top box industries don’t seem to have any major environmental concerns besides the growing consciousness among the consumers for their purchases to be environmentally friendly. Microsoft, by adopting carbon neutral measures and working with its partners to solve growing environmental concerns, it is fulfilling its responsibility as a responsible corporation. It could only add to this by investing in innovative environmentally friendly packaging as well as asking creating recycling programs for its customers to recycle their products.
"Microsoft is working with our partners, customers, governments, and leading environmental organizations to bring the power of information technology and cloud computing to address the world's environmental challenges." - Rob Bernard, Chief Environmental Strategist
Legal
As mentioned as part of the political analysis, certain regulations and legislations can have devastating effect on Microsoft. An example would be the 1999 antitrust case, in which a coalition of 19 states in the United States sued Microsoft, resulting in the trial court ordering Microsoft to split into 2. However, the Court of Appeals overturned that decision and the government and Microsoft came to a settlement agreement outside of court. The set-top box industry could have legislative interference in the form of requiring cable firms to lease set-top boxes that put security and encryption in a separate removable electronic module. This would allow consumer electronics firms to put cable TV "conditional access" technology in their products. If this occurs, the need for set top boxes would be diminished as soon as T.V. makers produce next generation T.V.s with the technology to access cable T.V. without the need of a set-top box. This change can have an impact on Microsoft should it choose to go into the set-top box industry, but only if it chooses to produce its own hardware. Should Microsoft choose to produce only the Operating Software, then this could still be a viable business, as consumers would change but the need for such software would remain. That being said, we don’t anticipate this legislation, proposed by the Federal Communications Commission (FCC), to be passed as it has been thwarted by Congress in the past. Lastly, being such a large company, Microsoft must constantly minimize its risk and exposure to legal disputes from outside parties, or even its stakeholders. The threat of large multi-billion dollar lawsuits, like the suit filed against Alcatel-Lucent in 2007 for infringement of audio patents worth $1.52 Billion, has lasting impacts on the company’s financial statements.

PORTER’S 5 FORCES
Bargaining power of suppliers
The bargaining power of suppliers is weak, as Microsoft is one of three gaming console manufacturers, and the market leader in operating software development. Because Microsoft retains control over most of its complex processes, suppliers have little power over Microsoft and it would be paramount to most of the suppliers’ businesses to avoid losing a large customer like Microsoft.
Bargaining power of buyers
The buying power of buyers is moderate. The customers do have other brands to buy their gaming consoles from, but the Xbox is on par if not better than the other two competitors and can attract the buyers by deploying many strategies. The buying power of customers (set-top providers or T.V. manufacturers) for the set top boxes is high, as customers have many options to choose from.
Rivalry
Rivalry in the gaming console market is high, with the rivals being Nintendo and Sony. The gaming industry is oligopolistic in nature and due to the innovative nature of the industry, product differentiation is necessary on a regular basis. The rivalry in the set-top box industry is moderate, as there are plenty of suppliers and the market for cable T.V. services is much larger than the gaming console industry, resulting in reduced jostling for customers.

Barriers to entry
The barriers to entry in the gaming console market is very high. The 3 companies in this market are large enough to invest in the infrastructure required to perform in this industry. In addition, each company releases consoles compatible with products authorized by them, hence creating high barrier to entry. The set-top box hardware and services market has moderate barriers to entry. The product offered can be produced by other large companies without much need for R&D or balance sheet crippling infrastructure. The T.V. manufacturers have proven that by adding proprietary systems to their T.V.’s, even they can enter this market.
Substitutes
The threat of substitutes is high for the Xbox. Consumers can opt to engage in outside sports, play games on their computers or phones, use hand-held gaming devices, use a tablet to stream entertainment and play games, or engage in other forms of entertainment. The threat to the set-top boxes software is moderate, as consumers (service providers, T.V. manufacturers etc.) can opt for Linux, Android or their own proprietary systems.
SWOT ANALYSIS
Strengths
* The success of Microsoft’s Windows OS and the brand loyalty in generates. * Microsoft has built strong distribution channels, both with suppliers and buyers and can capitalize on that when required. This has also led to a development of a world class project and supply chain management ability to rival any manufacturing company. * Microsoft is the preferred Operating Software with businesses and office workers due to the ease of use of Microsoft office suite. * The acquisition of Skype has been a huge success for Microsoft in terms of revenue growth. Most of its big-ticket acquisitions have been successful, with a few failures as well. * Microsoft’s core competency is developing Operating Software, which is extremely relevant if it decides to venture into the set-top box market. This core competency is also of important relevance if Microsoft wishes to partner with TV manufacturers who are currently using a variety of OS, ranging from proprietary systems to Linux and Android. Microsoft can definitely tap into this market if it moves fast. * The reputation created by Microsoft as a market leader in Operating Software and distribution will allow it to find reliable cable T.V. partners with companies like Samsung, Roku, Comcast etc. * Game development teams, either in-house or third party, that Microsoft deals with for its Xbox offerings are a great technological resource.
Weaknesses
* Microsoft has been known to be a slow innovator. Microsoft does have some great innovations, but they are few and far between, for example the Xbox Kinect. * Microsoft has found success difficult in many consumer products besides their biggest hit – the Xbox. Their efforts to launch the portable media player, Zune or the Window’s phone or even the Microsoft Kin, have achieved less than desirable results. * Microsoft finds itself in a mature PC market and to a certain degree, a mature gaming market. * Microsoft must constantly deal with criticisms over the security flaws in its software. * Microsoft does not seem to find much success in hardware offerings as opposed to software. We find that this is its largest weakness. “At its heart, Microsoft's devices and services model is very much a software model. But as we move to a ubiquitous computing world you can't deliver software without hardware, and you can't use software without services. That means that Microsoft has to change, shifting from its traditional platform model — and from its Windows-centric way of looking at the world.”
Opportunities
* The opportunity to benefit from providing operating software to set-top providers, cable/satellite service providers and T.V. manufacturers. * Cloud services can be enhanced to tap into a market with only a few providers.
Threats
* Competition from Apple and Google, in OS for set-top boxes as well as PCs. * Competition from Sony and Nintendo in the gaming market. * The changing consumer needs are a big threat to any major innovation which might take a few years to complete. * Change in legislation such as the one proposed by the FCC as mentioned in the document earlier. * Any potential lawsuits. In 2011, Microsoft had around $2 Billion in contingencies for potential lawsuit claims in its notes in the annual report. These threats have negative impact on investor perception.
Recommendations
Our team has been commissioned to advise Microsoft with regards to its best strategic move to win the “Battle for the Living Room.” Ultimately Microsoft can make one of four choices. Microsoft can: (1) keep the status quo, (2) develop the software for non-gaming set-top boxes and partner with a hardware company, (3) develop a Microsoft branded non-gaming set-top box, or (4) introduce new technology. Option 1: keep the status quo. If Microsoft were to keep the status quo, this would require X-box to attain “Input 1 status”, meaning that most people never switch away from this input. Our team does not recommend that Microsoft simply stay its course. If Microsoft chooses to do so, it risks losing its reputation as a market leader. In addition, to achieve “Input 1 status,” this would most likely require a complete rebranding of X-box. Our team believes that a rebranding of X-box would be necessary to invite consumers to view X-box as a machine that can do anything and everything. A rebranding would be necessary to combat against the consumer who simply isn’t interested in a gaming console, which is of rising importance with the aging population. However, a rebranding is extremely risky and we do not recommend such a strategy. A rebranding could not only be unsuccessful with regards to gaining new customers, but could also cause existing customers to lose respect for the X-box as a gaming console and drive them to fulfill their gaming needs via Nintendo or Sony. Option 2: Develop the software for non-gaming set-top boxes and partner with a hardware company. Our team recommends that Microsoft partner with an existing Internet set-top box provider, such as Roku or Samsung, or with the cable providers’ set-top boxes to provide the Operating Software for the set-top box. This option is probably the least risky of all. This is an attractive option because Microsoft’s core competency is developing Operating Software. This would require a much lower investment and no investment with regards to implementing new infrastructure. The increasing demand for seamless connectivity in the living room is too rapid to ignore and Microsoft must address it.
This option is best protected against times of economic down turn. If anything, economic down turn could result in increased sales of a relatively non-expensive non-gaming set-top box because consumers seek to find replacements for their families for activities such as going to the movies. This option is attractive because it should attract more users through the product’s ease of use, as well as a smaller investment that is simply an addition to the living room, rather than requiring a complete restructure of the infrastructure of the living room. Additionally, teaming with a partner to create a non-gaming console is likely to align more closely with recent efforts of consumers to be health conscious, as consoles with a gaming component can often be viewed as an obsession rather than a recreational activity.
We suggest that Microsoft team with cable companies to provide the software component for the non-gaming set-top boxes that can directly enable consumers to enhance their ICE experience. Specifically, we advise partnerships with market leaders: AT&T U-verse, Comcast X-finity, Verizon Fios, Time Warner Cable, and Charter. These companies have important resources, such as existing loyal customer bases and distribution channels in place. However, some cable companies may not want to partner with Microsoft and in that case, we recommend looking to the Satellite providers to develop partnerships.
Option 3: Develop a Microsoft branded non-gaming set-top box. Microsoft could follow Apple’s lead and choose to launch its own Internet set-top box. However, our team does not recommend this option, primarily because hardware has never been Microsoft’s core competency. Additionally, there is far more risk associated with this option and would require a larger investment to include hardware, distribution, and new marketing campaigns. Option 4: Introduce new technology. Microsoft could introduce new technology, such as a smart T.V., but our team does not recommend that Microsoft do so. The upside to this approach would be to gain reputation as an innovator in the market and maintain a competitive edge against competitors like Google and Apple. This would be the riskiest investment of all the options and has proven to be unsuccessful by Microsoft in the past. In addition, the innovation for such projects is so time intensive that with a rapidly changing environment with ever-changing consumer preferences, the technology could be rendered obsolete before it is even introduced and Microsoft is able to realize a profit. This type of product is likely to be an extremely large expense for consumers, and would likely require a complete change of infrastructure with regards to the individual consumer’s living room.
Conclusion
Microsoft must address this “Battle for the Living Room” and in order to do so, our team suggests that it develop the software for non-gaming set-top boxes and partner with a hardware company. This option provides the greatest ROI, the least amount of investment, and comes with the least amount of risk in the context of Microsoft’s internal and external business environments.

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