Xbox business targeting 'expansion of operating leverage'

Xbox gaming CFO discusses the recent Activision-Blizzard acquisition and Microsoft's core business strategy with its billion-dollar Xbox games division.

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Xbox financial exec Tim Stuart explains the core heartbeat of the games business, outlining a strategy that emphasizes expansion and utilization of high-margin models.

Xbox business targeting 'expansion of operating leverage' 488

Xbox has grown tremendously over the past 10 years. To stay competitive, Microsoft has snapped up first-party studios, built its entire games business around content and services, and disrupted the market with Game Pass. This plan has seen Xbox's gaming slate expand horizontally as well as vertically, as Microsoft built and secured multiple millions-strong live service games with recurring revenue streams.

Wrap those live games alongside premium singleplayer titles into a content-delivery subscription service with a low monthly fee that's spread across multiple platforms, and you have Microsoft's main business ethos: diversity. Xbox's multi-faceted business incorporates numerous billion-dollar models centered around multi-access endpoints and digital online monetization, and after the ABK buyout, Microsoft has attained one of the highest-margin publishers on the planet.

By 2030, Microsoft aspires to be the global leader in gaming with an implied $32 billion in Xbox gaming revenues.

How will Microsoft achieve this goal? A big part of that is expansion through operating leverage, a term that mostly describes how Microsoft could spread its games to multiple platforms (think Minecraft, Elder Scrolls Online, Fallout 76, Sea of Thieves, etc) while maintaining key marquee titles to ensure Xbox console owners aren't left behind.

According to Stuart, Xbox console sales are traditionally a low-margin business--rightly so, considering Microsoft has never sold an Xbox console at a profit.

Conversely, other businesses like content & services are high-margin. This includes subscriptions like Xbox Game Pass, which are indeed expensive to maintain, and despite xCloud streaming not generating a profit, Xbox Game Pass is still a high-margin aspect of Microsoft's games unit.

Other high-margin examples include first-party game sales and monetization, which makes sense considering Microsoft keeps 100% of revenues generated on Xbox and Windows platforms, while taking a majority commission from content and games sold on PlayStation, Nintendo, Steam, and the Epic Games Store.

Xbox gaming chief financial officer Tim Stuart recently spoke about the Xbox games business at the Wells Fargo TMT Summit, outlining key touchpoints and strategies that give us a clear picture of where Xbox currently is and an idea of where it's going.

Below we have a Q&A transcript of what the Xbox CFO said at the event:

"Maybe you could help us level set first-party vs third-party, what that means for Microsoft and for investors who are trying to formulate through what Activision looked like standalone versus as a part of Microsoft.

"If you could talk about the margin size too, because, remarkably, the company has proven to be able to protect sustained margins despite all the innovation that's happening within the company. We take it for granted sometimes, but I'm sure you don't."

Tim Stuart, Xbox gaming CFO:

"I can say that's from a lot of hard work, number 1. Amy and Satya have a great focus on driving value, acquiring new customers, whether you're commercial or consumer, and driving operating leverage throughout that. Which means smart investments, targeted investments.

"At the Gaming Leadership Team, we talk a lot about resource allocation. It's one of our most important jobs. Putting the right things on the right desk at the right time. Satya and Amy are excellent at that as well.

"Pick the bets, you make sure you fund them to where they need to be funded to be successful, say no to the right things, stop doing the right things, and that's just a unique superpower, for sure, of management.

"But for us, when we think about the business of gaming as it relates to Microsoft and Activision, operating leverage and margin expansion are definitely part of that. And you know, we think of acquisition amortization separately, you can work that into your models.

"At the highest level, you go from what was a lower-margin, third-party entity that was sold on our store, to a high-margin first-party business. When you think about the Xbox component of Call of Duty, you go from again that low-margin business to a high-margin business.

"Then what you do...you also expand, and say 'we're not driving high-margin sales on PlayStation, on Nintendo.' World of Warcraft has subscription, a high-margin business.

"You're bringing in high-margin business in a traditionally lower-margin business, when you think of Xbox hardware and console.

"Where we're going in this business is really that expansion of operating leverage. Where we think about placing our bets, first-party, subscriptions, advertising, those are all high-margin businesses that we want to expand into.

"What you'll hear from us more and more is a bit of change of strategy.

"Again, I'm not announcing anything broadly here, but our mission is to bring our first-party experiences, our subscription services, to every screen that can play a game. That means smart TVs, that means mobile devices, that means what we would have thought as competitors in the past like PlayStation or Nintendo. We're going to NVIDIA, GeForce Now.

"When we think about taking our business to these endpoints, again it's that high-margin business to new gamers that really Activision allows us to do in a much more quick way to get there versus trying to build on your own."

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Derek joined the TweakTown team in 2015 and has since reviewed and played 1000s of hours of new games. Derek is absorbed with the intersection of technology and gaming, and is always looking forward to new advancements. With over six years in games journalism under his belt, Derek aims to further engage the gaming sector while taking a peek under the tech that powers it. He hopes to one day explore the stars in No Man's Sky with the magic of VR.

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