Arizona State University Evolution of The Xbox Supply Chain Case Study Write-up needs to be 4 pages. You have been hired as a consultant to Microsoft (and

Arizona State University Evolution of The Xbox Supply Chain Case Study Write-up needs to be 4 pages.

You have been hired as a consultant to Microsoft (and paid big bucks!) to help evaluate their current and design their future supply chain strategy.

1. (20 points) As a software company, Microsoft does not have their own factory, and only limited supply chain talent from WPC (who needs those in a software company?), but the company has gathered an ecosystem of partners to help build the first Xbox supply chain (2001). Those partners include Flextronics, Nvidia, and Intel. You can assume they used 3PL distributors in US and Europe, their primary markets. You can also assume their customers are retailers like Best Buy and the products are not sold online.

Describe the supply chain strategy of the first Xbox in terms of:

Strategic objectives of Microsoft
Customer Value Proposition
Product characteristics (innovative vs functional characteristics)
The effects of cost, demand uncertainty, economies of scale, lead time, committed response time, and degree of flexibility

2. (20 points) What changes were made to the supply chain for the Xbox 360 and why?

Describe the changes made to the supply chain strategy in terms of the same four bullet point items in question 1.

3. (20 points) Map the new Xbox 360 supply chain strategy using a Business Model Canvas. Use the Business Model Canvas Framework introduced in this module to map how Microsoft built its new supply chain to align with the customer value proposition and the single sales channel (e.g. retailer, Best Buy). You do not need to complete the Revenue and Cost Structure sections, as we will cover this in the Supply Chain Finance module.

4. (10 points) Intellectual property (IP) ownership is an important consideration in a supply chain strategy. How was IP built or not built into each of Microsoft’s supply chain strategies? For the exclusive use of A. Alsadah, 2020.
CASE: GS-49
DATE 04/14/06
EVOLUTION OF THE XBOX SUPPLY CHAIN
With the first generation of Xbox, our ambition was to change the way people think about video
games. Starting today with Xbox 360, our ambition is to transform the way people play games
and have fun.
1
—Robbie Bach, President of the Microsoft Entertainment and Devices Division
In November 2005, Microsoft prepared to launch its next-generation video game console, the
Xbox 360. A global release was scheduled, beginning on November 22 in North America,
followed shortly by Europe (December 2), and Japan (December 10). It had been four years
since Microsoft had introduced the original Xbox. The first Xbox had hit the U.S. market a year
behind Sony’s PlayStation2, but this time Microsoft expected to beat Sony’s next-generation
system to market by many months.
The Xbox 360 would provide a substantial increase in performance for gamers. Its processors
were so powerful that graphics would appear virtually lifelike, and would run on high definition
televisions. When used with Microsoft’s Xbox Live Web service, the Xbox 360 would enable
gamers to play multi-player games online. The system could also be used as the base of a
family’s home entertainment system, taking advantage of its high definition DVD player.
Demand for the new system was expected to be heavy. The challenge would be for production
to meet the demand.
THE VIDEOGAME MARKET
In 2005, the global market for video games was approximately $27 billion, consisting of $6.7
billion in console sales, and $20 billion of software (games) (Exhibit 1). Sony dominated the
market, with cumulative sales through December 2004 of 102.5 million PlayStation 1 (PS1)
consoles and 87.5 million PlayStation 2 (PS2) consoles. Microsoft had sold 19.9 million Xbox
consoles, slightly more than Nintendo had sold of its GameCube (Exhibit 2). Of the current
1
Jay Greene, “Robbie Bach is Ready to Rumble: The Honcho of Microsoft’s Xbox 360 Heads for a Bare-Knuckles
Brawl with PlayStation,” Business Week, November 28, 2005, p. 54.
David Hoyt prepared this case under the supervision of Professors Charles Holloway and Hau Lee as the basis for
class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2006 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order
copies or request permission to reproduce materials, e-mail the Case Writing Office at: cwo@gsb.stanford.edu or
write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University,
Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a
spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or
otherwise –– without the permission of the Stanford Graduate School of Business.
This document is authorized for use only by Ali Alsadah in SCM 479 Summer 2020 taught by Gregory Collins, Arizona State University from May 2020 to Jun 2020.
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Evolution of the Xbox Supply Chain GS-49
p. 2
generation systems, which used 128-bit technology, (PS2, Xbox, and GameCube), Sony had 67
percent share, Microsoft had 17 percent, and Nintendo 16 percent.2
Several factors contributed to Sony’s dominance in late 2005. By the time the first Xbox was
released, Sony had gained a substantial head start. Not only was the PS2 available 12 months
before the Xbox in the U.S., the PS1 was also well established. As a result, there was a
substantial number of games available for the Sony consoles, compared with those ready when
the Xbox was released. In addition to confronting Sony’s substantial brand presence, the design
of the Xbox had faced resistance in markets such as Japan, where users criticized it as
unattractive and considered the game controller as too large.3 (The Xbox share in Japan was less
than 1 percent, dramatically less than its share worldwide.)
Microsoft hoped to overcome these problems with the Xbox 360. After four years in the market,
the company had established a presence, and was no longer a newcomer. Microsoft enlisted a
number of top game design firms to develop games for the new product. It had used an outside
design firm to create an attractive look for the product. Microsoft also expected that
subscriptions to Xbox Live, a Web service in which users could download games and participate
in online games, would be a highly profitable business, as many customers now had broadband
Web connections. And, it was going to be the first to market with the next generation game
console—perhaps by a substantial margin.
THE EVOLUTION OF VIDEO GAME CONSOLES
The initial video game consoles were introduced by Sony, Sega, and Nintendo in 1994. These
were based on 32- and 64-bit processors, and used to play relatively simple games. The most
successful manufacturer of first-generation video games was Sony, with its PS1. The Nintendo
64 trailed the PS1, while the Sega Saturn failed in the marketplace.
Second Generation Video Games
Sega introduced the next major technology advance in videogaming in 1999, when it launched
the Dreamcast. The system sold well initially, but sales fell rapidly when Sony introduced the
PS2, and Sega eventually exited the market. This second generation of consoles was a major
technical advance, using a 128-bit processor. Sony’s PS2, launched in March 1999 in Japan, and
in the U.S. in October 2000, sold extremely well despite production and delivery delays which
limited supply to the U.S. market. The Xbox, launched in the U.S. in November 2001, used
more advanced technology than was offered by Sony, but Microsoft did not have the established
base of games and gamers that Sony enjoyed, and Sony continued to dominate the market.
The Development of the Xbox
Microsoft’s Xbox project began in early 1999 when a group of Microsoft employees with
videogame backgrounds began to explore the possibility of creating a game console. At the
2
Christopher Russ and Andrew Kohl, “Company Note: MSFT: Assessing the Impact of Xbox 360,” Wachovia
Capital Markets, LLC Equity Research Department, May 17, 2005, p. 4.
3
Robert Guth, “It’s Xbox 360 vs. PlayStation 3, and the War Is About to Begin,” The Wall Street Journal, May 9,
2005, p. B1.
This document is authorized for use only by Ali Alsadah in SCM 479 Summer 2020 taught by Gregory Collins, Arizona State University from May 2020 to Jun 2020.
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Evolution of the Xbox Supply Chain GS-49
p. 3
time, Microsoft offered PC-based games, but personal computers had to be able to handle a wide
range of applications, and thus were not optimized for videogaming.
While the gamers were trying to get Microsoft to develop a console, Microsoft management was
also concerned that consoles such as the PS2 threatened the company’s home PC business.
Developing a high-performance console, with a considerably lower sales price than a PC, might
solidify Microsoft’s position in the home.
The group of gamers (referred to as “renegades” by Dean Takahashi in his history of the Xbox
project, Opening the Xbox: Inside Microsoft’s Plan to Unleash an Entertainment Revolution)
worked on their own to define a game console, including meeting with potential critical
component suppliers. They made their initial proposal to Bill Gates on May 5, 1999, including a
preliminary estimate of parts costs. The proposal was for a product that would leapfrog Sony,
offering superior performance, and including a built-in hard disk drive that would enable online
gaming and downloading of games and game enhancements—in contrast to the PS2, which did
not offer a hard drive, but at the time was considering one as an add-on. The console would also
include a broadband Internet connection, despite the fact that broadband was available at
relatively few homes at that time. The early plan anticipated sales of 1.8 million units in 2000,
growing to 30 million in 2005 (at which time Microsoft would have a 35 percent market share)4
The project was legitimized as a business by the appointment of an executive to lead it in July
1999.
The Xbox team included potential suppliers in its planning from the beginning. Flextronics, a
potential contract manufacturer of the Xbox, provided cost estimates and advice long before
contract negotiations began. Nvidia, a leading developer of graphics chips, also provided cost
and technical advice. In considering potential manufacturers, the Xbox team approached PC
companies, such as Dell, since the Xbox was basically a computer. Discussions with the
computer makers made it clear that the computer business model was inconsistent with
manufacturing game consoles. Console makers typically lost money on each box, but made
profits on selling games. Cutting prices on consoles made them more attractive to consumers,
driving more game sales. Computer makers, on the other hand, had to make money on hardware
sales. As Michael Dell explained:
When Sony cuts prices on its PlayStation, their stock price goes up. Every time I
cut prices, my stock price goes down. If you don’t understand why that happens,
you don’t understand the console business. I understand why [the Xbox] is
strategic to Microsoft. I don’t understand why [it] is strategic to Dell.5
Two factors were critical to profitability in the console business: driving costs down, and game
sales. Microsoft estimated that the original PlayStation cost Sony $450 when it was launched,
but just $80 five years later. Sony’s initial sales price had been about $300, decreasing to $99
after five years.6 Unlike computers, where performance typically increased dramatically, but
4
Dean Takahashi, Opening the Xbox: Inside Microsoft’s Plan to Unleash an Entertainment Revolution, (Roseville,
California: Prima Publishing, 2002), pp. 103-107.
5
Ibid. p. 168.
6
Ibid., pp. 18, 184.
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Evolution of the Xbox Supply Chain GS-49
p. 4
prices stayed relatively constant, consoles maintained constant performance while costs
decreased. As the project line matured, the loss on each console decreased, and eventually the
manufacturer generated a profit on console sales.
This model fit well with the use of contract manufacturers to produce the consoles, and
Microsoft began discussions with potential suppliers, eventually selecting Flextronics to build
the consoles.
The Xbox would have over 1,000 components, of which about 45 were critical, either because of
cost or because they were only available from single suppliers. One of the most important
choices was the graphics processor, which was essential to the product performance. Sony had
spent $1 billion to build a plant to manufacture its own graphics chip, enabling it to control its
own destiny and reap all the benefits of future cost reduction.7
Microsoft leaned toward purchasing graphics chips from Nvidia, the preferred choice of game
developers, despite a relatively high cost. In addition to considering other graphics chip
companies, Microsoft also considered having its WebTV unit license technology and design the
chip in-house. The chip could then be manufactured by a contract chip fabrication company,
allowing Microsoft greater control over costs. Microsoft went so far as to promise a substantial
investment in a new graphics chip company, GigaPixel before finally deciding to buy chips from
Nvidia. (Microsoft did follow through with the investment, however.) They chose Nvidia
because they believed that a reliable supply was more critical than obtaining the lowest possible
cost. Nvidia had the best performance, and an excellent record of on-time development and
delivery. GigaPixel was unproven, and did not have the available capacity to develop the chip.
The eventual Nvidia contract included a maximum margin per chip, and decreasing maximum
prices based on cumulative volume.8
Another critical component was the microprocessor, for which Intel and AMD were the
competitors. AMD had been the front-runner through much of 1999, as it was eager to increase
capacity, while Intel had dominated the market and took a hard line on prices. However, during
the year, AMD introduced the 600 MHz Athlon processor, which did very well in the market,
using up all of AMD’s capacity. In order to make chips for the Xbox, AMD would need to add
capacity, and wanted Microsoft to provide about $400 million for that purpose, plus a $300
million guarantee on chip purchases. AMD also increased its price. On the other hand, Intel had
available capacity, and came down in price (though not as low as AMD), with prices declining
each year. In March 2000, Microsoft signed with Intel to provide chips for the Xbox.9
In addition to manufacturing the Xbox, Flextronics also provided mechanical designers that
helped with parts specifications. Parts procurement was handled in one of three ways.
Commodity parts were purchased directly by Flextronics, which often used the same parts for
many OEM products, and thus purchased in very high volume. For some custom designed parts,
such as the controller, Microsoft negotiated the contract with the vendor, and Flextronics ordered
7
Ibid., p. 98.
Ibid., pp. 198-211.
9
Ibid. pp. 212-215.
8
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Evolution of the Xbox Supply Chain GS-49
p. 5
the parts against the Microsoft contract. For parts such as the microprocessor and graphics chip,
Microsoft purchased the parts from the vendor and delivered the parts to Flextronics.10
In December 1999, Microsoft decided that it would delay the launch of the Xbox from the fall of
2000 to the fall of 2001. A 2000 launch would force the company to use technology that did not
offer a substantial improvement on Sony’s PS2, which was scheduled for launch in spring 2000.
By waiting, Microsoft would be able to incorporate much faster graphics and microprocessor
chips, offering dramatically better performance than the PS2. The delay, however, added the risk
that Sony would solidify its position, making it harder for the Xbox to gain market acceptance.11
When the Xbox was launched in November 2001, it used Intel’s 733 MHz Pentium III chip as its
central processor, with a 250 MHz Nvidia graphics processor. The Xbox also had a DVD player,
64MB memory, an 8 GB hard drive, and built-in broadband modem for Internet access.12 The
system processed 116 million polygons per second, the critical measure of graphics performance,
compared to 66 million for the PS2.13
Xbox Manufacture
In November 1999, Flextronics recommended producing Xboxes in a plant in China in order to
minimize costs. Microsoft, however, wanted plants close to customers due to shipping
concerns—Microsoft wanted to be able to replenish supply quickly. Sony had experienced
delays in replenishing U.S. supply, which had to be shipped from Asia. In January 2000,
Microsoft reached an agreement with Flextronics to build the Xbox, using its industrial parks in
Mexico and Hungary.14
When the decision was made, Flextronics was the fourth largest EMS company with $4.3 billion
in revenue, behind Solectron, SCI Systems, and Celestica. One of Flextronics’ unique features
was its industrial park concept, which improved supply chain efficiency.15 The company
obtained land, built a production facility, and invited selected vendors to locate their facilities in
the park. Co-locating greatly reduced shipping costs to Flextronics and improved information
flow between Flextronics and its vendors.
When the Flextronics began work on the Xbox program, it had industrial parks in Hungary,
China, and Mexico. The Guadalajara, Mexico industrial park was designed to supply the Xbox
to North America, and the park in Hungary would supply the European market. In Guadalajara,
Flextronics dedicated a section of its industrial park to the Xbox. The park operated around the
10
Parts procurement by EMS companies is described in more detail in Stanford Graduate School of Business case
OIT-35: Flextronics: Supply Chain Relationships in the EMS Industry, pp. 13-14.
11
Takahashi, Opening the Xbox, op. cit. pp. 183-186.
12
Hau Lee, Microsoft—Xbox Launch and Supply Chain Readiness, Stanford Global Supply Chain Management
forum case SGSCMF-003-2003, July 28, 2003, p. 5.
13
Takahashi, Opening the Xbox, op. cit. pp. 220, 270.
14
Ibid., pp. 196-197.
15
The Flextronics industrial park model is described in detail in Stanford Graduate School of Business case OIT-35:
Flextronics: Supply Chain Relationships in the EMS Industry.
This document is authorized for use only by Ali Alsadah in SCM 479 Summer 2020 taught by Gregory Collins, Arizona State University from May 2020 to Jun 2020.
For the exclusive use of A. Alsadah, 2020.
Evolution of the Xbox Supply Chain GS-49
p. 6
clock, seven days a week to meet the production volume requirements, with supplies continually
arriving, and one tractor-trailer full of completed Xboxes leaving every two hours.16
Flextronics planned to begin production on June 15, 2001. However, the system design was not
stable enough to begin production in June. The Nvidia graphics chip had to go though several
revisions, with prototypes produced at a contract fabrication facility in Taiwan, tested and
modified in California, then remade and retested. Eventually, the chip met all specifications by
itself, but the overall system was still unstable, crashing frequently. An incorrect power supply
specification was discovered, and was readily fixed.17
As a result of design delays, production didn’t start until September 2001, with Flextronics’
Mexico plant coming on line first, and reaching capacity in just over one month. The Hungary
plant, benefiting from the Mexico experience, was at capacity within 3 weeks. Both plants
produced 175,000 units weekly, more than the original expected capacity, and sufficient for
product launch in November.18
Game Development
The other essential element was creating games, since that was the reason customers bought
consoles, and was the profit driver for console companies. Console manufacturers made money
from game sales in two ways. They sold their own games, either developed in-house or by
others (“first party” games), or independent game publishers sold games (“third party” games)
and paid a royalty for each game sold (typically about $7 per unit). Microsoft had in-house
capability, as it developed games for the PC. For PC games, however, there was no royalty,
which led to a flood of games, most of which were poor quality. Microsoft originally planned
not to charge a royalty to independent game developers of Xbox games, figuring that would
foster game development. However, developers actually encouraged royalties, as that was a way
to limit the number of games, ensure that only high-quality games were produced, and improve
the visibility of each game. Royalties also were essential to a profitable business model, so
Microsoft charged royalties for third party games.
Microsoft actively recruited game developers to create Xbox games, and bought some game
companies to make first party games. Third party game developers submitted their plans to
Microsoft, which decided which games it would license. At the U.S. launch, there were 19 titles
available, of which 5 were first party games. For each Xbox purchased between launch and the
end of 2001, consumers bought more than three games, with the best selling game, Halo, selling
over 1 million copies. There were many othe…
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