How Xbox changed the games industry

In late 1998, Seamus Blackley was flying home from a visit to his then-girlfriend in Boston, looking for a way to pass the time with his brand new laptop. During the flight, he wrote a proposal about how his employer could build a games console.

His motivation? A Sony advert for the upcoming PlayStation 2, claiming that the company's second console would be so powerful, it would be like a personal computer in the living room.

Blackley, who spent much of his time working around graphics and assessing future capabilities in this area for Windows, considered this to be "utter garbage." While he had no doubt PS2 would be a huge leap over its forebear, equally he had no doubt that its graphics specifications would be "easily destroyed by what I knew was coming in the same timeframe on the PC."

"The only problem with the PC is that it's this Turkish bazaar of different configurations," he says. "Furthermore, everybody built games on the PC, and then cross-compiled them over onto the PlayStation. That's where all the tools were. So, if we just had a device that had one spec, we could wreck them."

The PlayStation ad riled up quite a few figures at Microsoft's HQ. Robbie Bach, who would become the first chief Xbox officer, says the company saw Sony's promise of a personal computer in the living room as a challenge.

"Microsoft viewed itself as, 'Well, if anybody's going to put a personal computer in the living room, it's going to be us'," he tells us. "There were other people on the team who said Microsoft needed to expand in the living room just as a necessity to grow the business. And if you're going to be in the living room, a game console is the best-selling device in that space and the best way for us to participate."

Ed Fries, who had been leading Microsoft's games division since 1995, adds that the gaming business was, at that time, roughly 40% of all the profit Sony was making as a company. "So, when you can create a new business that attacks a big profitable part of your competitor's business, that's always good business."

So Blackley spent that flight writing a proposal for a platform that could use Intel's x86 architecture to beat PlayStation at its own game.

"Microsoft would just need to define a spec for a platform for DirectX, like a DirectX-enabled piece of hardware, a DirectX box"

Seamus Blackley

"I started thinking about it with its ramifications for tools and the empowerment of developers, and how easy it would be. We'd instantaneously have every developer know how to develop for our platform, whereas Sony had to train people. Microsoft would just need to define a spec for a platform for DirectX, like a DirectX-enabled piece of hardware, a DirectX box."

By the time it launched on November 15, 2001, 'DirectX box' had been shortened into what stands as one of the biggest brands in gaming history.

Enter the Xbox

So how do you build a console that beats the PlayStation 2? Blackley believed the machine itself was not the priority but the combination of machine and tools that would enable developers to easily make new titles for the platform.

He also believed Sony was taking a "brute-force approach" to graphics, because Japan didn't have the "long tradition of academic computer graphics" found in the US -- pointing to Nintendo's collaboration with Silicon Graphics for the Nintendo 64 as a prime example.

"The approach that ATI or NVidia or 3dfx took to making graphics hardware was an approach informed by decades of research in rendering, and it was very mature, and very beautiful," he says. "The scenes you could draw were more efficient and more beautiful because it was a sophisticated architecture based on an understanding with the problem of rendering. It wasn't a brute-force approach, which is what the Japanese had taken, based on just pushing as many pixels as possible.

"How many lighting effects you could get on a polygon, and how many of those polygons you could put through in an average scene... If you were a Sony developer, you had to build your own infrastructure for doing all of that. On the PC, of course, it was all sitting there in front of you."

This gave Microsoft a very subtle but huge advantage in Blackley's eyes. He was so excited that he sent the proposal to his friend and colleague Kevin Bachus, group product manager for DirectX as soon as he landed. In the following discussions, Bachus brought in his superior Ted Hase while Blackley recruited Windows' lead developer for graphics Otto Berkes. The quartet began inviting themselves to meetings in order to find support for the proposal within Microsoft.

"It's not like there's a process inside a company for submitting a console design," he says. "And Microsoft is a software company, not a hardware company. They had some mice, and they made a keyboard, but that was a relatively tiny part of the business. At that time, Microsoft Office was the most profitable business in the history of the human race. It's not like people were bringing proposals for hardware. This was a crazy thing to come up with.

"I basically ignored my job for six months. I should have been fired. I didn't do anything on my job. I was going around, finagling my way. Me, Ted, Kevin and Otto would invite ourselves to any meeting in any building at Microsoft run by anyone that we saw who had anything to do with anybody making hardware, full stop."

He continues: "People thought it was insane. But it was intriguing at the same time because most people didn't understand how fast the games industry was growing and what a big business Sony had... There was a terrific amount of resistance."

Eventually it got in front of Microsoft co-founder Bill Gates, won the support it needed, and the Xbox division was formed.

This caused excitement at the company and folks from other divisions sought a way to be involved, although Blackley reports there was still resistance that slowed the process down.

"A lot of people came and tried to block," he says. "Or people wanted to join the team because they were very senior. People who had no idea about games, who'd never played a game before in their lives, would purchase a Dreamcast the day before, play a couple games, have a huge revelation. 'Oh my God, this hardware is so easy to use, the user experience is so great'. And then come into a meeting like they were a genius of game development and tell us all how it should be.

"It's like the Meta thing [newly-renamed Facebook's video concept of the metaverse], where anybody who's ever played a game can look at that Meta plan and be like, 'Oh God, this feels like the first thing any idiot thinks of before they know anything'. And here it is with all this money behind it."

Bach adds that there was "huge executional risk" in creating the Xbox business, and the short timeframe in which Microsoft planned to catch up to Sony just added to the pressure.

"We gave ourselves 18 months from a standing start with 20 people, and our job was to build the world's most powerful video game console. And, oh, by the way, we had to build a games portfolio for consoles, a retail sales group, a supply chain and manufacturing process. So, the first challenge of this whole process was nothing to do with our competitors, it was, 'Oh my gosh, can we actually do this?' 15 months into the process, it wasn't clear we were going to get it done."

"People thought it was insane. But at the same time because most people didn't understand how fast the games industry was growing and what a big business Sony had… There was a terrific amount of resistance"

Seamus Blackley

Sony already had a head start, with the PlayStation 2 due on shelves in early 2000 and hotly anticipated thanks to the ongoing success of the original. With no internal hardware processes in place, Microsoft turned to manufacturing partners to help build the Xbox -- but this added further limitations to its debut console.

"You can't custom make anything in 18 months," Bach says. "So everything in Xbox was basically off the shelf, which meant when it came time to cost-reduce it, it was really difficult for us to do that. We were stuck in this position of having to match Sony on price, but being unable to keep up with them on cost. And that is how you lose $50 to $75 per console at the gross margin line -- without paying for marketing or any of the other overhead costs."

Fries says the chance to get into the growing games business was just the sort of opportunity Microsoft needed at that time.

"One problem the company had was most opportunities we looked at weren't big enough relative to things like Office and Windows to be worth the time of the company... I saw this as a chance to take our PC platform, PC games that had been doing really well, and move into the console world and expand our game publishing business.

"Plus, there had been no American company in the console business for almost 20 years at that point, since the meltdown of the game business in the early '80s. The Japanese took control of the console business. And it was great content, but where was that voice that you saw from American game developers, American RPGs, something from Bioware for example, which was very different from Japanese RPGs? It was on PC, but where was that kind of content in the console world?

"It was a big, crazy thing to go take on the Japanese and the three parties there. It was definitely a daunting thing."

Harvey Eagle -- then advertising manager for EMEA, now director of Azure Gaming -- says creating a new games console would also solve a fundamental problem for retailers. Nintendo was struggling to keep up with Sony and its GameCube looked unlikely to change that, while Sega's ambitious Dreamcast did not get off to the strong start that many had hoped. PlayStation's dominance was undeniable.

"We felt retailers in particular were keen to have another strong player in the market so they weren't so tied to the success of any single platform," says Eagle. "And in those days retail was your only direct sales channel."

The Xbox takes shape

After referencing the console in an interview towards the end of 1999, Bill Gates officially unveiled the device during his GDC 2000 keynote. The move made quite the impression; Peter Moore -- at the time, senior vice president of marketing at Sega -- was pleased not only to see another company joining the console space but particularly a Western company.

"But I thought it privately because I was about to go into competition against the Xbox with the Dreamcast," he tells us. "I thought it was very much a good thing for the industry. The more players in there, the more capital that's invested in building games, the more game studios that would be created and funded, the more opportunities for you to develop for different platforms. Publicly, I wouldn't say that because I was at Sega."

It wouldn't be too long before Moore was working closely with Xbox. The two companies had already collaborated on Windows CE, a version of Microsoft's operating system that could run on Dreamcast, and after Sega discontinued its final console in 2001, a partnership began to bring Sega titles like Crazy Taxi, Sega Soccer Slam and its NBA and NFL titles to Xbox in its second year.

As for Moore, who had risen to president and COO at Sega of America, he joined Microsoft as corporate vice president of retail sales and marketing in January 2003, helping to guide Xbox through its first and second generations.

"The one thing that I learned once I went there as well is just the sheer willpower of a company at that scale, that belief, and that focus, and the desire to make sure that Sony didn't own the living room."

The prototype Gates showed off at GDC 2000 was a quite literal X box that, like the PS3's boomerang controller after it, was great for grabbing attention but was redesigned to something more conventional by the time it launched. Even then, the original Xbox -- a hefty black slab with an embossed X on top -- looked somewhat unwieldy compared to the understated and sleek PlayStation 2 and the stylish Nintendo GameCube it was launching against.

"The original Xbox at a design level was not the prettiest thing," Bach admits. "It was, 'We've designed the inside, we've got to put some plastic around it.' And nobody cared because they could play Halo. Does anybody care what their home projector looks like when they're watching home videos? The answer's no. What they care about is what's up on the screen."

"I'm not going to lie to you, that's what happens when a bunch of people who really have never played a console game before, from a big PC software company, design what they think is cool," Blackley laughs. "But you make trade-offs. I knew that if the games were good enough that people wouldn't really care what the console looked like, and we might get a pass on that."

He adds that this is not as true for the controller, a design he fought against. Interestingly, it was a petition from Japanese developers that led to the creation of the Xbox Controller S, a smaller, more manageable gamepad that became the standard for all subsequent Xbox generations (albeit with a few tweaks each time).

As both Bach and Blackley say, it's games that drive a console's success and Xbox got off to a strong start in November 2001. The launch line-up included 20 games, including familiar names like Dead or Alive, Madden and Tony Hawk's, an exclusive Oddworld title (then a PlayStation-centric franchise), and first-party titles like Fuzion Frenzy and Project Gotham Racing. Oh, and something called Halo, a new sci-fi shooter from recent Microsoft acquisition Bungie.

"We were stuck in this position of having to match Sony on price, but being unable to keep up with them on cost"

Robbie Bach

Again, given Microsoft's lack of experience in the console world, Fries was pleased with how the first wave of titles shaped up: "We really didn't know what our launch line-up was going to be. There were all kinds of things we tried that went absolutely nowhere, and other things that worked great. Even before we started working with Bungie, we teamed up with Lorne Lanning. That was a double win: to take the Oddworld franchise away from PlayStation and put it onto the new Xbox was good."

As with getting the console approved internally, forming a launch line-up met with resistance. Blackley recalls nearly getting kicked out of EA's headquarters by Don Mattrick -- who, ironically, would also later join the Xbox team -- until he called through to Bill Gates' office to prove Microsoft's console plans were genuine.

"That was the level of scepticism we faced everywhere, because the idea of Microsoft doing a game console in 1999 was absolutely ludicrous. It was ludicrous. It seems obvious now, but it was a big job to convince people and to be credible."

Credibility was perhaps the biggest challenge Microsoft faced in launching its first console, especially one trying to take on the market-leading PlayStation. As Bach observes, the company had long since proved itself in the business world, but in the gaming scene it was up against some very established players.

"Sony had earned its credibility with PlayStation 1, Nintendo had long-term credibility, and so just getting people to say, 'Okay, Xbox is real, they're here, and they get it,' was not an obvious thing for us to achieve," he says. "And in certain markets, like in Japan, it's not clear we ever achieved that.

"The combination of Halo Combat Evolved and Xbox Live, that was our one-two punch that broke through the barrier and got us credibility."

Part of the pre-launch credibility came down to marketing, Eagle's domain. Recalling the early campaigns, he says Microsoft "definitely had to earn its birthright."

"I certainly recall at the time that, despite the success Microsoft had in the PC gaming space with titles like Age of Empires, it lacked the credibility to successfully challenge the other console players. We definitely had to earn our birthright.

"PlayStation's marketing had become very dark and obtuse -- they had the David Lynch-directed Welcome To The Third Space campaign for the PS2, if you remember. We wanted our brand to be very much the opposite of that, we wanted our brand to be welcoming and celebratory. That led us to our brand strapline: life is short, play more."

Watch on YouTube

The ad went viral -- albeit as an email attachment, since this was pre-YouTube and social media -- and even sparked enough complaints in the UK that it was banned. "Which, of course, only added to its notoriety," Eagle adds.

Xbox was well received in the UK, where consumers' tastes are similar to those of the US, and Eagle's team found success getting attention in the Nordics and Netherlands. However, the PC-dominated German market and PlayStation-leaning Southern European territories were harder to break into.

"The biggest challenge we had at the time was our pricing," Eagle continues. "We had to cut the price pretty dramatically just a few weeks after launch in order to stimulate sales, which was a really tough decision at the time. The console did sell well, we were very fast to get to one million units worldwide, but the business model was not working because we were selling every console at a loss and our software attach rate was not strong enough to offset that. Not many companies would have stuck with it at that point."

While Microsoft did persevere, the console was short-lived, replaced by the Xbox 360 just four years later -- driven in no small part by that loss suffered for every unit sold. PlayStation was built to be reduced as technology became more affordable and multiple chips could be replaced with fewer.

Since Xbox was built on PC architecture and Microsoft did not own everything inside its own box -- the Intel x86 chip, the Nvidia graphics card -- that was not possible. This was partly attributable to how quickly the original Xbox had been put together. Re-engineering it would have been expensive, so it was deemed less costly to build a replacement.

The Xbox effect

Even though the Xbox was only available for four years -- a remarkably short lifecycle, especially compared to the eight years of its successor -- the impact it had on the industry was undeniable. As Bach described it, that one-two punch of Halo and Xbox Live changed the console space forever.

All of the Xbox alumni we spoke to said the same thing, almost word-for-word: without Halo, Xbox would not have survived. Which came as something of a relief to the team since, as Fries explains, Microsoft had no idea whether or not it would sell.

"The business model was not working because we were selling every console at a loss and our software attach rate was not strong enough to offset that"

Harvey Eagle, Microsoft

"There was always a cloud hanging over Halo," he says. "We were PC gamers at heart, and networked first-person shooters were the hottest thing in PC gaming at that time. But they didn't really sell at all on console. I mean, there was Goldeneye but you can't compare that to a modern dual-stick first-person shooter. It really hadn't been done before. The first thing the marketing group does is look for comparables. You couldn't find a comparable for something like Halo. So, we didn't know."

While there had been single-stick shooters on consoles before -- the aforementioned Goldeneye, Medal of Honor, Turok -- Halo's introduction of the dual-stick control scheme set a standard the genre is still following today.

"It really created this bridge between the innovation that was happening in PC games into the console world," Fries adds. "I think that's probably one of the most important things from a game creator's point of view. If you look at some of the biggest genres right now on console, you have Call of Duty, say. That's PC-style gameplay right there."

Perhaps the biggest impact Xbox had on the console industry was Xbox Live. The subscription-based online service that powered multiplayer games was the brainchild of J. Allard and his team, who worked on the console's system software. While Xbox Live didn't launch properly until a full year into the console's life, Fries says it was something Microsoft was counting on from the beginning -- again, based on how popular networked PC gaming had become.

This influenced crucial decisions about the console's functionality, with Microsoft eschewing a modem in favour of an ethernet port, firmly believing the then-minimal broadband penetration would dramatically improve in the company years.

"Halo Combat Evolved and Xbox Live, that was our one-two punch that broke through the barrier and got us credibility"

Robbie Bach

Attempts at bringing online gaming to consoles had been made in the past; as recently as the ill-fated Dreamcast, but even as far back as Nintendo's Famicom in Japan. Xbox, Fries says, was "the machine with the right hardware at the right time, and that's when innovation happens."

The success of Xbox Live and online gaming on console was particularly validating for Peter Moore, who had been pushing this during his Dreamcast days.:

"We just didn't have the install base when we needed it," he says. "Sega didn't have the financial wherewithal that was required then, and certainly times ten now, to launch a console in the face of strong opposition."

But Microsoft had that financial resource, as well as the technology and back-end infrastructure to make it happen. Moore describes Xbox Live as a "very important differentiator" for the console, especially as rival Sony was slower to move into this area.

"We believed in Xbox Live," he says. "We invested enormously, capital, people, technology, that we could bring to bear from the broader Microsoft, which Sony didn't have. They were very much then a hardware company, and a brilliant hardware company, in TVs and cameras, and obviously video games. We were a software company, and as software started to make a real impact in the way that people played our games, and wanted to play online... That really played into our hands."

Microsoft was so confident in Xbox Live, it charged for it -- one of the first entertainment service subscriptions to hit the market. While most consumers today pay a monthly fee for access to music, TV, film and games, in 2002 this was beyond rare. Eventually Sony began charging for its own PlayStation Network, midway through the PS3 generation, and even Nintendo now has an Xbox Live-style subscription for Switch.

"You get what you pay for, right?" says Moore. "We felt we had a superior service, and it was. It propelled hundreds of millions of gamers into doing something that they don't think twice about. There are millions of people playing online as you and I are talking right now... You can look back and thank the very talented team at Microsoft that started building out that infrastructure. And you can look back a few years earlier and thank the belief of Sega of Japan that online was where it was at. I've often said I felt that Sega passed the baton to Microsoft in online gaming."

Bach points to Xbox Live as something Sony "struggled to compete with for a long time."

"Xbox Live hit that great experience at the perfect time, just as broadband was expanding. Everybody forgets that when Xbox launched, broadband was nothing... Everybody basically said, 'Look, this is going to fail.' Oh, and then, by the way, we're going to charge $39 for it. And people went, 'Well, now it's really going to fail.'

"$39 for a gamer is nothing, as it turns out. It's the cost of a single game. And so, if you think, 'Well, I can play that, and now I can play multiplayer on this game forever, and I can play multiplayer on any game,' things start to get super interesting.

"Today, it's the heart and soul of the business, and I don't mean the service necessarily, but the games on Xbox Live and the full experience it delivers is really at the centre of what they do."

"Xbox lost a substantial amount of money - but we helped make Sony's life more difficult, and create a beachhead for us in a new market that Microsoft is still in twenty years later. So, I think it was money well spent"

Ed Fries

Xbox's legacy can be found elsewhere across the industry. It was the first console to include an internal hard drive, allowing users to download demos, additional content and even rip music from CDs to listen to while playing. Again, a hard drive is a standard feature for almost all consoles that have followed since.

But it's the broader impact Blackley points to. While the original PlayStation is credited for taking console games mainstream, more so than they had been before, the first Xbox played its own part in this.

"It legitimised games in a big way because here's Microsoft, this big respected publicly traded company, big global company, that's not an entertainment company, and they've decided to move into this space in a big way," says Blackley. "And it makes everybody who's a gamer feel a little bit more legitimate."

Fries adds: "It was seen as a success, even though financially we forecast that the Xbox would lose a substantial amount of money -- and it lost that amount and then some. But what did we get for that money? We helped make Sony's life a little more difficult, we helped create this new brand, and create a beachhead for us in a new market. A new market that Microsoft is still in twenty years later. So, I think it was money well spent."

Moore believes the Xbox revitalised the competition in the console space and in doing so brought value for money to gamers.

"If there's a single player that's dominant, and I'm not accusing anybody of anything, but then pricing can get out of hand because you don't have that hardcore competitor," he concludes. "It's great to have multiple players competing, fighting, investing enormously in the industry. What we see today here in 2021, the seeds were sown with the original Xbox and Microsoft coming into the marketplace.

"Since that day, tens of billions of dollars have been invested in building out the Xbox brand, the Xbox platform with Xbox Live, and the industry everywhere has benefited, including Sony, including Nintendo. A rising tide lifts all ships, and Microsoft contributed heavily to that rising tide."