Advertisements may become a larger part of the Xbox gaming business in the long-term future.
Over the past few months, we've talked a lot about how the Xbox business could evolve. At $16 billion dollar in annual revenue, Microsoft's video games unit is clearly able to make strong earnings...but what about profits? Recent testimony from Microsoft CFO Amy Hood discussed Xbox's profit margins but these values were predictably redacted.
How can Xbox continue to grow when it is 3rd place in the console market, spending big on Game Pass, and also invested in costly and unsuccessful attempts like Project xCloud? The games unit will need to find new ways to monetize its platform of 120 million monthly active users, and advertising revenue could be the next big step.
We've seen Microsoft make big power plays into subscriptions in the last few years. In 2017, the company disrupted the video games market (and its own gaming business) with the advent of Xbox Game Pass, a transformative new subscription that promised day-and-date releases of its first-party games. The introduction of gaming's first multi-game content library subscription shook the status quo and introduced a new "cannibalistic effect" whereby consumers could purchase access to games far cheaper than they could than actually buying a more permanent license of the game.
While Xbox Game Pass is profitable, the Xbox business as a whole is not growing as much as Microsoft's board of directors would like. Records indicate that in FY22, Xbox missed its internal estimated revenue targets by over $780 million. Xbox gaming CEO Phil Spencer indicates that Game Pass may be reaching saturation levels on consoles, and he's said that console gaming is not growing. The biggest opportunity for Game Pass, Spencer says, is on PC. This is a big reason why Xbox Game Pass subscriptions are raising in price on consoles, but not on PC.
Fast-forwarding to the present FTC v Microsoft case, and we see an interesting internal Microsoft document that was shared in the public docket (before being removed). Since the document is no longer public, we will not publish portions of it, and instead reference it along the way.
This document is very illuminating and gives a closer look at the Xbox business. Xbox is a separate and independent operating unit that's nestled under the Microsoft Plus CSA, or Customer Solutions Area. Microsoft's operating divisions have a hierarchy where the CSAs are split into different parts.
In this internal report, Microsoft outlines some of the targeted growth vectors and LKGs, or Last Known Goods, a term used in Windows to denote what is currently successful.
Xbox gaming's LKGs include:
- Build out xCloud and drive Game Pass adoption and monetization
- Add differentiated Content experiences
- Evaluate a range of both inorganic and organic moves
Advertisements were mentioned specifically in multiple parts of this document as it pertains to the Xbox unit.
"Expanding our advertising capabilities will provide developers with more monetization offerings and reduce barriers to entry in emerging markets, broadening the Game pass funnel," the report reads.
Another section reads:
Business Model Diversity: Empower creator success and reduce access barriers for players by offering full breadth of business models, across transactions (Store), subscriptions (Game Pass), and advertisements.
It's possible that Microsoft could enable some sort of in-game, or in-service advertising within Xbox Game Pass or titles made available on the Xbox Store in the long-term future.
This aligns with previous predictions from games industry experts including SuperData founder Joost van Dreunen, who forecasted that Microsoft and Sony could create lower-cost, ad-supported tiers of their subscription services to drive adoption and open new revenue streams.
In the past, Xbox gaming VP Sarah Bond has also alluded to the possibility of including adds in Xbox games.
"We've talked about how we're experimenting with other models, like what does it mean for advertising in games which is more prevalent in mobile - are there models of that that work well in PC and console?
"Are there other models where you might have timed slices of games and stuff like that? Providing creators with options and choice enables them to experiment and do what they like, and actually create more immersive and creative experiences without having to fit into a mold."
There have also been previous reports from Business Insider that Xbox was experimenting with potentially adding advertisements in free-to-play games.
I have personally posited that ads would represent part of the next phase shift for Xbox Game Pass, with the subscription service moving into what I call Phase III Maximizing Returns. In this phase we would see things like increased Game Pass pricing (which is already happening), the elimination of Xbox LIVE Gold as a potential subscription option, and a move towards ad-supported subscription options and/or in-game advertising.
There's no telling exactly what Microsoft will do, but one thing remains clear: Xbox is not hitting its performance metrics and the board of directors wants continued growth. Xbox is no stranger to innovation and experimentation, and we could see ads becoming an important part of the business model going forward.