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June 23, 2006

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Ed Felten

I'd bet that among potential Xbox customers, game players probably outnumber would-be Linux users, perhaps by a large margin. If so, then Microsoft's profit-maximizing strategy might still be to price the Xbox at (about) $150. That's the socially efficient result too, assuming the Linux users value the Xbox at more than the marginal cost of producing it.

Xcott Craver

We could apply the same reasoning to people who enter a retail store and only buy the one item advertised on super markdown---foiling the business model of using a loss-leader to entice customers to buy other things.

And we could similarly conclude that those people will raise sale prices and price other consumers out of the market. But does that actually happen?

In practice, I figure that people who are savvy enough and determined to exploit loss-leaders are just not that numerous.

Xcott

saul levmore

I think it is even more complicated because we do not know how many Linux users would buy Xbox (or Xbox games or XboxLive)if they could not gain from hacking hacking. More generally, it's hard to think about the welfare of those who would pay more than marginal cost when something is rented, and the cost is really the cost of capital or the gain of using a substitute. So if a squatter or other "trespasser" moves into an empty apartment, we might say this is efficient because the marginal cost to the landlord is close to zero, but in reality some trespassers would, if effectively barred from free use, join the market for renters and make some of these empty apartments full or provide a higher return to capital in the industry. Isn't the same true for Xbox. We might think of all the users as renters, but some are asked to make a fixed payment upfront.

Tim Lee

Wouldn't an easier way to accomplish the same goal be through bundling? i.e. require the purchase of two games with your XBox. Linux users who valued the XBox at more than $200 would buy the XBox and throw away the games. Linux users who valued the XBox at less than $200 would be deterred from purchasing it.

Also, it seems like Apple is pursuing the exact opposite strategy. They seems to be charing high prices for the razors (iPods) and low prices for the blades (iTunes).

Doug Lay

Why doesn't Microsoft just bundle the XBox with enough games to cross the break-even point? What class of users loses out here? I suppose the users who have enough money to buy the console but not even a couple of games. It's hard to imagine this class is very big. The console also becomes slightly less attractive to the Linux users - unless the Linux users also want to use the XBox to play games, which many of them probably do.

As usual, what irks me about your analysis is that you seem to place no value whatsoever on the freedom of users to tinker with their own property. The only personal freedom I see valued in your analysis, in fact, is the freedom to contract away your rights as simply and conveniently as possible.

...oh, I see Tim Lee beat me to the punch regarding bundling. I'm not surprised :)

Roach

This is all very interesting, but can someone explain to me why Ghost Recon 2 is so much worst than the original Ghost Recon. This makes no sense from any economic incentive standpoint.

Bruce

Fascinating post. There's another interesting wrinkle here, which is that Xbox 360 games are somewhat different from Gillette blades because Microsoft doesn't actually make or sell most of the games. See this site:

http://www.xbox.com/en-US/games/xbox360games.htm

Instead it appears to get revenue from non-Microsoft games by entering into a license with game publishers. But that raises a question in my mind: What forces publishers to buy a license? Microsoft asserts that all Xbox 360 games require a license -- see the text at the bottom of this page:

http://www.xbox.com/en-US/dev/regdev.htm

But saying that doesn't make it so. Gillette no doubt would like to license generic blades. I can't tell what Microsoft's licensing "hook" is -- what the asserted IP is that must be used by a prospective developer/publisher. I found an old version of the Xbox Publisher License Agreement here (which has been jumbled with some Nintendo language):

http://contracts.corporate.findlaw.com/agreements/bam/xbox.license.2000.11.28.html

It seems the only things being offered are an opportunity to enter a Software Development Kit license (2.3) and the ability to use Microsoft trademarks (3.1.1). Perhaps marketing a compatible game without using the Xbox logo would be too difficult, and/or perhaps the SDK is such a time-saver that most developers feel compelled to use it to keep costs down.

But if Microsoft's licensing "hook" is not an insurmountable impediment to developing Xbox games, then a game developer could make games without paying Microsoft anything -- in which case the loss leader would turn into a plain old loss.

Patrick Dunn

Isn’t it a bit inconsistent to cite Rooster Teeth Productions as a prime example of technological or aesthetic innovation three days after supporting a copyright licensing system for YouTube that, if applied to online content generally, might well have had the potential to stop that innovation back in Burnie’s drunkgamers.com days?

Accepting the economics above for the sake of argument, is there any reason to believe - strictly looking at the segment of artists/pirates rather than general video game playin’ utility - that the marginal increase in the number of potential content-transformers through market efficiencies will outweigh the increase in the costs of creating such transformed content through potential liability for hacking, installing new software and hardware, or generally monkeying about? What happens when innovators don’t get permission from Microsoft (or Bungie)?

PS: For my two cents, the Ghost Recon 2 story revolves around a growing incentive to channel production values toward online multiplayer content, where player interactions provide not only revenues for the entity providing connectivity but also better reasons for players to purchase add-ons, to create and maintain a group, to enjoy replay experience, and to put forward the game-specific capital that might justify the current pricing scheme. Also, you’ve got to think Ubisoft wanted to respond to market demand for a simplified command system, despite the accompanying degree of control loss.

Brent Tubbs

Bruce: A couple months ago my law school (USC) had a guest speaker, a lawyer (Barry C Seaton) who works in the video game industry, speak to us about the questions you raise.

From his comments, and my own speculation, I think there are two things compelling game developers to pay the license fee. (1) Given how few players there are in the industry, they want to stay on good terms with each other. (2) Consoles will only run code that is digitally/cryptographically signed, and if you hack that signature, you might be violating the DMCA.

Bruce

Thanks Brent; that's helpful. Re: point 1, that's a good point, and probably explains why no one with substantial resources (or who wants to have substantial resources) would do an end-run around MS -- as long as the royalty being charged is not too onerous, anyway. Re: point 2, I've been wondering when that's going to come up in litigation as the sequel to Sega v. Accolade and Sony v. Connectix -- pre-DMCA console/game reverse-engineering cases from the 9th Circuit. (Davidson was not that sequel.) I think in many cases the game publisher would have a good 1201(f) argument -- but it has yet to be tested. And, reverse engineering is hard.

Xcott Craver

Another matter that determines if companies take the license agreement: how much does it really matter to them either way?

In Sega v Accolade, Accolade bypassed the license agreement because Sega wanted certain exclusive rights over the games. IIRC, Accolade wanted to port over their existing games, a plan which was incompatible with Sega's license terms. Basically they could reverse-engineer the console or hit the road.

If MS is only asking for money, and not enough money to really stress game companies, they may never consider doing it the hard way.

Jhn'1

Well if your bundling were to include a single game, it would be transparent for the Xbox gamer. They have to aquire (presumably buy) at least a single game to upgrade from ottoman to a game console. It would change the advertised price from a "bare" console up to a console and basic game. I doubt that many purchasers never buy a single game, and by tour model, Microsoft doesn't want them as customers anyway.

Steve R.

Fascinating discussion. My feeling are along the lines of Xcott and iTunes. In a capitalistic system, if you do not effectively price your product, too bad.

To explain further; once the product is "sold", the manufacturer should have no further interest in how the product is actually used. Unfortunately, we are moving in the direction of asserting that products are no longer sold but are actually licensed to be only used under certain conditions unilaterally imposed by the manufacturer. This is wrong.

Former Chicago student

I think one aspect you failed to take into account is that public policy also needs to recognize probable future outcomes.

The reality is that the Xbox will be hacked. There is no way to prevent this from happening...nothing Microsoft can do will really prevent it. What Microsoft and the government can do is reduce the probability that such a 'hack' becomes widespread.

There are several famous quotes from technology executives to the extent of "People don't hack hardware", which have been proven to be dead wrong. Even for obscure products, like Transmeta's Crusoe processors, this was wrong. Clean room reverse engineering is rather easy with current tools...it's something almost any EE graduate student can do in a relatively short period of time.

A reasonable debate should be predicated on probable outcomes. I'm not sure that is really the case currently, since it appears that most law makers don't have a bloody clue.

Also, while US policy may prohibit it, foreign laws likely won't (think China). Uneven global enforcement of such laws may be functionally equivalent to no enforcement (i.e. a market for modded Xbox's imported from China will likely develop).

Ultimately, this seems like a problem that can only be partially solved by legislation. A real solution would require appropriate pricing by microsoft and legislation.

Also, there are actually two separate issues here. The big problem with folks hacking the Xbox is that they can then pirate games easily. A lesser problem is installing Linux on the xbox. One is probably an order of magnitude (or more) greater than the other.

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