Microsoft’s Savvy or Setback? The $1 billion writeoff, 3-year “Red Ring of Death” Warranty Enhancement

[UPDATED 8 Jul 07: Transcript of MS’ conference call on 5 Jul 06 with Robbie Bach is HERE.  “Open Letter” from MS’ Peter Moore to the Xbox 360 community explaning the new warranty terms HERE.]

By now the news has coursed across the globe, Microsoft Corp. announced on Thursday, 5 July 07, that it would take a $1.05-$1,15 billion earnings charge, reported in fiscal year 2007, to repair and replace consumers’ consoles suffering “red ring of death” (“RROD”) problems with the Xbox 360 console, retroactive to the console’s release in December 2005. The console’s now one-year warranty, with respect to RROD problems, is now extended to three years from date of purchase (again, retroactive to Dec 05). MS games chief Peter Moore released a letter on Thursday to Microsoft employees, available HERE, explaining the move.

For those of you not “in the know,” the RROD is a defect affecting some Xbox 360 units that renders some systems non-functional, and requires return to Microsoft for repair or replacement. Microsoft has now announced it will reimburse customers who have already paid for repairs related to the RROD problem, as well. Microsoft cited “an unacceptable number of repairs to Xbox 360 consoles” as impetus for the latest move.

There’s been much debate as to the meaning of this over at Dean Takahashi‘s and Mike Antonucci‘s blogs. Good question: just what does it mean?

As you know, I suspect the putative “30% failure rate” is overblown, though that same “anecdotal evidence” leads me to suspect also that the actual failure rate is still likely higher than the 5% industry standard. This isn’t to doubt the size of the problem: even if the failure rate was, say, 10& to 15% of the 11.6 million 360’s sold, that would be 1.1 to 1.7 million defective units. Clearly, many were upset by MS’ both not addressing the problem more firmly and more quickly, and appearing to dodge the issue in interviews. Acting on the swell of discussion on the internet and needing facts, any facts, to fill their stories covering the emerging story at the beginning of July, the media made quick headline with the 30% story, without solid facts or investigative journalism to support that figure. A quick Google search of news on the topic should make this pretty clear to any amateur investigator out there.

The “30%” “news” story in fact emerged in the past week or so from interviews of approximately three individuals–and apparently interviews of no one high-ranking in the organizations, but of three (count ’em) former retail employees of EB Games and Best Buy. Read one of the stories citing the “anecdotal evidence” over at PC World HERE. But I don’t think the real issue, at this point, is the actual failure rate: MS has clearly taken a more customer-centric tack with its Xbox 360 and Zune hardware platforms, modeling itself self-consciously on the Apple hardware paradigm, and despite the slow pace of change, Mcrosoft’s trajectory is generally correct, and more pro-consumer than any time in recent memory for the company.

Despite claims floating around the internet that this is in fact an “admission” of a 30% or even higher failure rate, I think it’s no such thing.

The truth is, Mr. Moore’s letter and the newly extended warranty are no more an admission of any truth behind anecdotal evidence of the purported 30% failure rate than O.J’s acquittal is of his innocence. There’s proximity, but the truth requires a little deeper digging.

What’s really going on here is good business sense (after a long failure to more adeptly address the perceptions of hardware problems).

There’s three possibilities:

1. The hardware failure rate is really 30%, and MS is making good.
2. The hardware failure rate is less than 30% but equal to or more than the typical 5% failure rate of consoles, and MS is making good.
3. The hardware failure rate is lower than the average console failure rate, and MS is making good.

We can write off #3, because MS would have released the failure rate if it was lower than the industry average. That leaves #1 and #2.

Consumers should be happy with either possibility, because it insulates them from expenditures to repair their consoles for 36 months, and the warranty itself is free. This is a victory for 360 users who have the “red ring of death” problem. Moreover, it’s a leg up on the console competition, which even assuming they only experience the industry average console failure rate, don’t offer a similar 36-month warranty coverage.

Wii and PS3 don’t offer an equivalent warranty. The 5% (give or take–we’re doing averages here) of Wii and PS3 owners who suffer system failures won’t be covered when their consoles go belly-up. Using total sales figures from Swivel.com, that’s currently 292,000 Wii owners, and 275,000 PS3 owners that’ll be SOL when their consoles die.

Xbox 360 owners who suffer a similar hardware failure, in contrast, would be protected. I suppose the bottom line is, all things being equal, would you (the gamer) prefer to have to purchase another $200-$600 console, or prefer the inconvenience of being without a console for a week while it’s being repaired, free of charge?

I suspect that #2 is the actual situation: the failure rate is likely less than the 30%, but probably something over the industry average, which MS didn’t want to release to the public, knowing any admission would stick with to the console like glue. MS chose the path of least resistance: in return for refusal to make an explicit admission, MS offered anyone who actually suffers the (anecdotally overblown but real) “red rings” problem a sweetheart deal.

My prediction: we’ll see this come out in the laundry. By next year, we’ll see the charge-off was an over-estimate. MS will be able to report to investors that it (1) took care of its customers fully and allayed any concerns about out-of-pocket expenditures, and (2) ended up spending far less than its charge-off for repairs, reimbursements, and shipping costs. These two facts (I predict) will inure to MS’ favor, and also prove that the actual failure rate was far less than 30% (more like 5-10%). MS then wins: it doesn’t admit the actual failure rate now, and when the figures for repairs come back, MS will have repaired consoles at a far lower-than-30% failure rate. At that point, even if the failure rate was above the industry average, MS will have scored a consumer-affairs victory.

Time will tell.

Lime out

See also:

• Newsweek’s N’Gai Croal’s excellent 6 Jul 07 interview of Peter Moore