Microsoft reserves more than $1 billion for Xbox360 repairs

Microsoft announced that it will reserve between $1,05 billion an $1,15 billion to cover repairs of faulty Xbox360 consoles up until now and to extend the worldwide warranty to three years.

In a press release, the company admits to an intolerable amount of defective units.

As a result of what Microsoft views as an unacceptable number of repairs to Xbox 360 consoles, the company conducted extensive investigations into potential sources of general hardware failures. Having identified a number of factors which can cause general hardware failures indicated by three red flashing lights on the console, Microsoft has made improvements to the console and is enhancing its Xbox 360 warranty policy for existing and new customers.

Microsoft stands behind its products and is taking responsibility to repair or replace any Xbox 360 console that experiences the “three flashing red lights” error message within three years from time of purchase free of charge, including shipping costs.

The money will be taken out of the pre-tax earnings for the last financial year which ended last month.

Background

The recent debate started when technology news site Daily Tech reported that up to one third of all Xbox360 consoles were being returned to stores as defective. The site cited anonymous managers at retail outlets such as EB Games or GameStop. As unlikely as this figure sounds, other polls showed similar results.

Prior to that, the independent UK repair service Micromart had announced it would no longer accept Xbox360 consoles, calling the hardware defects ´endemic´. Company spokesman Geoff Croft told me that the main problem appeared to be the lead-free solder Microsoft used, probably in order to make production more environmentally friendly. In difference to standard solder, this one dries and gets brittle easier. This creates dry joints and the contacts on the boards become insecure, Croft told me.

Is really every third console faulty?

Of course, Microsoft is saying nothing. In the conference call, Bach only spoke of a "meaningful number" and that they "identified several factors" that contribute to the hardware failures.

But there is a way to double-check the findings of the surveys above. Analysts estimate that the $1 billion would be enough to repair around 2,5 million consoles. With around 10 million units sold, that amount would already suggest that Microsoft is counting on fixing every fourth console.

And that does not count out the possibility of Microsoft expecting an even higher number of faulty units. They simply might not want to allocate the entire amount right now, for various reasons. Either way, the estimate of ´up to a third´ of all units failing does not seem to be too far from the truth.




$1 billion hurts

Contrary to popular belief, $1 billion is a significant amount for Microsoft. For the financial year that just ended, Microsoft posted an operating income of $16,5 billion.

Here is a detailed list of the various divisions and their individual performance, prior to the internal change in the company´s operating segments and compliant with the ´U.S. Generally Accepted Accounting Principles (GAAP)´.

Division / Operating income 2006 / 2005 / 2004
(in millions)

---

Client $10.203 / $9.464 / $8.740

Server and Tools $4.323 / $3.291 / $1.474

Information Worker $8.285 / $8.025 / $7.458

Microsoft Business Solutions $24 / -$171 / -$291

MSN -$77 / $412 / $98

Mobile and Embedded Devices $2 / -$65 / -$237

Home and Entertainment -$1.262 / -$485 / -$1.337

Corporate-Level Activity -$4.988 / -$5.871 / ---

As if losses of $5 billion weren´t enough

So the Home and Entertainment division is the only one that has been consistently in the reds since 2004. In fact, it has been in the reds ever since its creation. In 2002 and 2003, that division cost Microsoft 874 and 924 million, respectively.

If you add that up, this division has incurred a staggering total loss of almost five billion dollars ($4.882 millions to be precise) since 2002.

Prior to 2002, the Xbox was part of the then Consumer Software, Services, and Devices division and even that one has been in the reds ever since 2000.

Bear in mind that an analyst already called Microsoft´s Xbox enterprise a disaster back in April, way before the scale of the console defects became apparent.

Gaming has been a disastrous endeavor for Microsoft, particularly from an investment perspective.

So the $1 billion or so discussed here will almost double the losses incurred by the Home and Entertainment division in 2006. And that sum will deduct around one sixteenth of the entire company´s operating income for that year.

Will Xbox ever become profitable?

So we just learnt that Robbie Bach´s division has now lost Microsoft a total of around $6 billion - pretty much one dollar for each person living on this planet. But when will they become profitable? Will they ever?

Bach was still pretty confident in May, speaking to eWEEK:

It's a business that will be profitable next year—we'll make money next year and that will be the first time, which is pretty exciting. And then the next two or three years are the place where you need to make tracks, and the next two or three years are where you have to make money.

The big question is whether Microsoft is still on track to reach the goal of profitability by 2008. And, perhaps, nothing has changed. The money is coming out of last year´s wallet, so to speak. The current financial year may remain largely unaffected, one might think.

But there are some things Microsoft should be concerned about. After sinking a total of $6 billion, should the shareholders not be ready to revolt by now and demand Microsoft´s withdrawal from the videogame industry? What if the allocated sum is not enough to cover the entire costs of repairs and this whole affair eats even deeper into Microsoft´s profits? What will the shareholders do then?

Of course, after investing billions and billions into an enterprise like this one, you would be desperate to see some returns. You would grind your teeth and bear it. But you would not tolerate another slip-up. I am merely suggesting this: What if this was that very slip-up?

Source: Microsoft Presspass