Microsoft expects to take an earnings charge of over $1bn for the quarter that ended in June related to expenses it will incur fixing faulty Xbox 360 machines.
On Thursday, Microsoft said it will expand its warranty coverage to Xbox 360 customers who have a certain type of hardware failure. The new programme is a result of an "unacceptable number of repairs to Xbox 360 consoles”, Microsoft said.
Customers who have a general hardware failure that is indicated by three flashing red lights on their consoles will now be covered by a three-year warranty starting on the date of purchase. Microsoft will repair or replace the console, including cost of shipping, within that time frame. The company will also reimburse customers who have already paid for the repairs.
Microsoft also said that sales of the Xbox 360 had fallen short of expectations. It had hoped to have sold a total of 12 million at the end of June, the close of Microsoft's fiscal year, but finished the year with 11.6 million, said Chris Liddell, senior vice president and chief financial officer at Microsoft, during a conference call to discuss the new warranty and earnings charge.
Microsoft expects to take a $1.05bn to $1.15bn pre-tax charge for its quarter ending June 30 because of expenses related to repairing and replacing consoles as well as repairing or writing off consoles that are made but not yet sold, Liddell said.
Customers have been reporting hardware problems since the consoles first hit store shelves in 2005, said Billy Pidgeon, an analyst with IDC. However, Microsoft argued that isn't so. "For the first year plus, this was something that was not on our radar," said Robbie Bach, president of Microsoft's entertainment and devices group, during the conference call. "In the last couple of months we started to see a significant increase in repair requests ... so we geared up to respond to that appropriately," he said.
Although Microsoft isn't disclosing the exact failure rate, it's high, Bach said. "Suffice it to say that with a $1 billion charge ... it's a meaningful number and one that we take seriously and clearly has our attention," he said.
The executives also wouldn't describe the exact problem but said it is a combination of issues for which Microsoft, and not any manufacturing partner, is to blame. "It's our responsibility, not anybody else. ... We understand the issues and have made changes to dramatically reduce the problem going forward," Bach said.
Because Microsoft is taking the charge during its fiscal 2007 year, the company still expects to turn its first profit in its entertainment division, which includes the Xbox, for 2008, Liddell said. Offering this enhanced warranty should give customers confidence in the product, he said.
Analysts agreed that the new warranty offer was something Microsoft had to do. "I think it's a very smart move on their part to shore up loyalty," said Pidgeon.
Such loyalty is very important for Microsoft because of its plan for making a profit from the Xbox. "From a business perspective, Microsoft has to do this. If the failure rate is high, it means a lot of unhappy customers, but more importantly, customers who aren't buying games," said Matt Rosoff, an analyst with Directions on Microsoft. Microsoft sells the consoles at a loss, making a profit from the games that users buy.
He's not convinced the new warranty can keep sales up for Microsoft. Gamers who may be deciding between a new Sony PlayStation or an Xbox may worry about this hardware problem. "Even though [Microsoft has] said, 'don't worry, we'll replace it for you,' it's that perception of quality, and it's hard to reverse once it's out there," he said.