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March 10, [The Wall Street Journal Interactive Edition] ------------------------------------------------How Four Renegades Persuaded Microsoft to Make a Game Machine By DEAN TAKAHASHI Staff Reporter of THE WALL STREET JOURNAL The battlefield of Nintendo, Sony and Sega gained a big new combatant Friday when Microsoft Corp. officially announced one of its most unusual forays ever: a plan to build a video-game machine called the XBox. Created by a renegade group of Microsoft engineers who spent months lobbying the software giant to branch out, the X-Box is a simplified version of a personal computer. It has a hard-disk drive and graphics that claim to be three times faster than those of other game-machine makers. The world has known sketchy details of the X-Box since last fall, when news of its existence surfaced in the media, but Microsoft hasn't divulged specifics until now. Does the world [Go] Join the really need another Discussion: video-game console? What do you That question can't think of be answered until Microsoft's after the fall of 2001, recent moves? when Microsoft plans to start selling the X-Box. In any case, the long lead-time will provide plenty of opportunity for defensive moves by the Japan's Big Three: market-share leader Sony Corp., No. 2 Nintendo Co. and No. 3 Sega Enterprises Ltd. Sony officials decline to comment on the XBox, but they note that they have the advantage of 70 million current customers and a long history in consumer electronics. "We're totally aware that we face some incredible competition," says Microsoft's Bill Gates in an e-mail interview. The entry of Microsoft into game-machine making is a sign that the electronic-games industry has come of age. Last year sales hit $6.9 billion, just shy of movie box-office receipts of $7.3 billion. And the industry is expected to outpace other types of entertainment as a new generation of consoles takes off. With Microsoft entering the fray, "this is the beginning of a battle for the living room that is going to last 10 years, starting with games and then going into all forms of entertainment," says David Cole, an analyst at DFC Intelligence in San Diego, Calif. Microsoft is already a big player in computer games, and its "DirectX" software is widely used to create PC games with intense 3-D graphics. The company sells games like "Age of Empires" and "Flight Simulator," makes such game hardware as "Sidewinder" joysticks and has a side deal to supply game software to Sega. It also runs the MSN Gaming Zone, an online games Web site with millions of players. But Microsoft has never built a computer for sale, and in February 1999 it certainly had no official intention of making a game computer. Nonetheless, on the company's campus, in Building 27 and Building 5, a "garage-shop" game console was taking shape in the spare time of four engineers, Seamus Blackley, Kevin Bachus, Ted Hase and Otto Berkes. Existing machines from the likes of Nintendo were custom-made for games. The four engineers were designing a PC stripped of everything game playing didn't require. That would let Microsoft exploit the huge economies of scale of the PC industry, using the same hardware components as PCs and the same game-programming software, Microsoft's DirectX. This strategy would also make it easier for software makers to adapt computer games to run on the new machine. The four men soon obtained permission from their bosses to work on the box full-time. They began showing their early work to some higher-ups in March 1999. The X-Box idea might have stopped there but for something Microsoft was just starting to perceive as a threat: the Sony PlayStation 2. Video-game consoles were never much of a concern for Microsoft, but after Sony unveiled plans for its new machine in March, it became clear that the machine could act as a Trojan Horse, putting Sony into living rooms: It was a game machine, but also a DVDmovie player and an Internet-access device. "We were thrilled when we heard about the Sony plan," says Mr. Blackley, a graphics specialist and game programmer. "It was really good for us because it brought validity to the games market. It was our big motivator and helped us get noticed within the company." Still, top Microsoft executives didn't know about the X-Box project when they met with Mr. Gates at a resort near the Canadian border for an annual brainstorming session in midMarch. The sessions split into eight possible new product areas. Mr. Gates attended the discussion about games because Sony's announcement had riveted executives' attention to that market. Mr. Gates and other senior executives concluded that they needed to move beyond the PC and offer something new to gamers. Part of their rationale was that video-game players have traditionally been the earliest adopters of new technology. After the retreat, Craig Mundie, a Microsoft consumer-electronics executive, acted on the group's decision by forming a task force on games. He was still unaware of the X-Box project, but found out about it quickly when the box's builders showed up uninvited at a meeting scheduled to iron out Microsoft's game-computer strategy. "They were going in the right direction," says Robert Bach, the vice president now overseeing the X-Box, and the four quickly got approval to keep going. The first big conflict flared in May. In a meeting with the X-Box team, Mr. Gates agreed with a demand from Ed Fries, general manager of Microsoft's game division, that unlike competitors' game consoles, the machine should have a hard drive. He argued that it was a strategic feature that could make games designed for the X-Box richer in terms of animation, audio, speed and expandability. Opponents responded with the classic arguments: A hard drive is a liability because it introduces complexity, cost and reliability problems. The group decided to keep the hard drive, but it had to continue to justify its presence at each contentious product meeting. Rick Thompson, head of Microsoft's mouse and joystick hardware division, became project head on July 21, and he shifted 20 people from his hardware group onto the X-Box team. By then he had the backing of Microsoft President Steve Ballmer. But Mr. Thompson still encountered skeptics in the company. They were worried that Microsoft might lose hundreds of millions of dollars in the venture. Mr. Thompson eventually got a boost from J. Allard, a programmer famous for writing a memo in 1993 that motivated Mr. Gates to get serious about the Internet. Mr. Allard was on leave from Microsoft, looking for a chance to either "go home or go big." When he heard about the X-Box from a friend, he decided to join up, convinced, he says, that "the X-Box is going to change the world." As head of the X-Box's software effort, Mr. Allard chose to use a bare-bones version of the software behind the Windows 2000 operating system, known for its stability, as well as the DirectX software. But the system was going to avoid the quirks that lead to frequent PC crashes by running games that were specially designed for the X-Box. By this time, the X-Box was pulling in Microsoft people from all divisions, though Microsoft won't say how many eventually joined the group. Then the outside evangelization began. In the fall, Messrs. Bachus and Thompson courted game developers intensely, soliciting opinions on what would make the best box. "We were very enthusiastic about the technology that they were coming up with last fall," says Tom Dusenberry, president of Hasbro Inc.'s games division. "As they gained feedback from developers, they adjusted their targets on the hardware." Hardware-component vendors vied to be designed into the box. Nvidia Corp., for example, won the contract to supply the graphics chip only after multiple rounds of talks. Then a potential show-stopper hit. The plan was to have PC makers build and sell the Microsoft-designed box. In September, though, Mr. Thompson came back from a trip with news that PC makers were declining the job, seeing it as a money-losing proposition. Console makers, after all, typically make most of their profit on game software, not hardware. The news came as a relief. Mr. Thompson realized Microsoft would have to make a bigger bet and take on the risk of manufacturing, but he believed this would make it easier to match the prices of rival consoles and keep the whole project coordinated. So the group decided to hire a manufacturer to build machines that would carry the Microsoft nameplate. Microsoft hasn't said who the manufacturer is. On Dec. 21, the X-Box group went to Messrs. Gates and Ballmer with two options: launch a less-sophisticated machine in 2000 or a more ambitious one in 2001. Mr. Gates told the team that Microsoft's machine had to provide several times the performance of the PlayStation 2. "We weren't aiming to build a parity product," Mr. Gates said. He told the team to wait until 2001, which would let it use a Nvidia chip that operates at a trillion operations a second, as much as three times as fast as the Sony machine. At the end of the same "go or no-go" meeting, Mr. Ballmer said, "You're asking me for a decision on this with a Big 'D,' not with a little 'd,"' meaning that it was a long-term bet. Then Mr. Ballmer turned to Mr. Thompson and boomed: "Go!" After Friday's announcement comes the hard part. Microsoft must formalize licensing arrangements with software makers, focus on cutting manufacturing costs to the bone, and contemplate further the "killer" game that the company knows it will need to succeed against its entrenched rivals. The delay may give Sony a chance to cement its hold on the market with the PlayStation 2. But Microsoft's early announcement could lead some consumers to wait for a machine with more advanced features. The common high-tech tactic, branded "vaporware" by rivals, has angered antitrust regulators in the past. "We made a big bet with Windows, a big bet with the Internet," says Mr. Bachus. "We're making a big bet with games." Write to Dean Takahashi at [email protected] ------------------------------------------------------Copyright © 2000 Dow Jones & Company, Inc. All Rights Reserved.