Why are Xbox 360s so cheap?

How the dismal science applies to your life.
Dec. 21 2005 1:24 PM

Xbox Economics, Part 2

More reasons Microsoft isn't charging enough for the season's hot game console.

We have an Xbox and you don't 
Click image to expand.
We have an Xbox and you don't

Last week I wrote that the shortage of Xbox 360 consoles seemed inexplicable, at least to me and my fellow economists. I invited readers to provide better explanations, and you did.

A reminder of the puzzle: Xbox 360s are the latest in a long line of Christmas products to suffer spectacular shortages. The shortage of supply isn't the puzzle; the low price is. Why doesn't Microsoft raise prices temporarily from the current floor of $300 for a basic console? Why doesn't the company auction them all on eBay, where consoles are currently reselling for $700 and up?

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If I had a dollar for every e-mail I received on the subject, I'd be able to afford an Xbox myself. Most of the suggestions I received were wrong, but a few got me thinking, and they may get you thinking, too.

The stupidest explanation came up again and again: Microsoft is holding the price low in order to grab market share and make money on selling games. This is the "cheap razors and expensive razor blades" strategy. True, console manufacturers are widely thought to be losing money on the consoles and recouping the losses on the games. But only the most idiotic of my correspondents failed to see that one traditional part of grabbing market share is, um, producing enough consoles to supply the demand you've stoked with your low prices. If you have only 500,000 consoles, you can sell them cheaply, give them away, or even pay people to take them off your hands, but in the end there will still be only 500,000 consoles to buy games for.

Many people also claimed that the seasonal shortage creates free publicity to encourage sales later, but high prices don't create publicity. I still don't believe that: Exxon got plenty of publicity by raising gas prices after Hurricane Katrina. In any case, now, not later,is the Christmas season when people want to buy it.

One reader reminded me of the "hot IPO" phenomenon of underpricing to generate interest in new shares. Maybe Microsoft was trying something similar. But I counter that Google chose an IPO auction instead of an underpriced IPO and wasn't short of publicity.

This isn't to say that Microsoft couldn't use the buzz: The console business is very dependent on expectations. Gamers buy consoles if they expect great games. Games-publishers invest in great games if they expect the console will be popular. Confidence in a console—or lack of it—is self-fulfilling. So, yes, buzz is important. But lines aren't the only way to create a buzz: Microsoft could have secured plenty of publicity (and a lot more revenue) selling a "limited edition" at auction.

Why wouldn't Microsoft raise prices to take advantage of the seasonal demand? In my original article, I claimed that Microsoft would irritate customers equally by raising prices or by creating lines, and rightly so because the typical customer is inconvenienced either way.

But more thoughtful correspondents produced good reasons why Microsoft would steer clear of raising prices.

The first is that much of Microsoft's business is nearly monopolistic: The company has no powerful commercial rivals to its Windows software or its Office products. As a result, the company has often been targeted by regulators investigating alleged abuses of its dominant position. These businesses are huge relative to the Xbox 360. High console prices might raise government suspicions. Why take the risk of antagonizing the regulators for a relatively small financial gain?

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