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Microsoft’s ‘Kinect’ Bet Looks to Be Paying Off

Chris Morris, Special to CNBC.com
Wednesday, 3 Nov 2010 | 7:13 PM ET

Microsoft rolled the dice when it decided to get into the video game motion control market. Nintendo, with the Wii, had certainly proven that there was an audience interested in a more intuitive controller, but with over 71 million of the consoles sold worldwide, the potential for market saturation was strong.

Kinect, the motion controller for Microsoft's Xbox 360.
Source: Microsoft
Kinect, the motion controller for Microsoft's Xbox 360.

As the company rolls out Kinect on Thursday, early signs are showing that the gamble was a wise one.

Microsoft on Wednesday lifted its sales forecast for the device from 3 million to 5 million in calendar 2010—which could add another $300 million to the company’s expected quarterly revenue. Pre-orders are selling out at game stores across the country. And the peripheral has received the ultimate marketing push: an enthusiastic mention by Oprah Winfrey on her daytime show.

Kinect is a step in a different direction for Microsoft. The $150 peripheral plugs into the Xbox 360 and allows users to play games using gestures and voice command, without the need for any sort of controller in their hand.

With it, Microsoft hopes not only to challenge the market dominance of Nintendo , whose Wii system has shown signs of vulnerability this year as saturation seems to have set in, but to extend the life of the Xbox 360 by several years.

Normally, after a video game console has been on the market for five years or so, the manufacturer begins to ramp up to the introduction of its next generation. To date, though, there has been no noise—even on the rumor mill—about Microsoft preparing to launch a new system anytime soon.

“Kinect is a major step forward,” says Colin Sebastian of Lazard Capital Markets. “It’s unique. It’s differentiated. And hopefully, the software publishers will step in line and create compelling content for it.”

The early lineup of Kinect software has been called a mixed bag. Some of the 16 early games seem little more than clones of popular Nintendo titles. But others, like Viacom’s “Dance Central” are likely to be breakout hits.

While the increased forecast could mean a short-term windfall, Kinect is still not likely to move the needle in Microsoft’s overall finances anytime soon. What some analysts are more interested in is the company’s long-term plan with the device—and they don’t think it will stop with the Xbox.

“It’s key for their entertainment and device division,” says Sebastian. “Over time, they’ll integrate other services to the platform.”

The Gain for Retail

While Kinect will help Microsoft’s hardware numbers, it may not do a lot to drive game sales immediately. And few independent publishers, like Electronic Arts or Activision , will see any benefit from it.

FarmVille
Source: Facebook
FarmVille

In fact, it might actually hurt their bottom line this holiday.

“The purchaser of a…Kinect peripheral will have… $150 less to spend on software,” says Michael Pachter of Wedbush Securities.

Publisher’s losses could be retail’s gains, though. Video game specialty retailer GameStop has seen strong demand for Kinect so far, and the spillover demand could boost Best Buy and Wal-Mart as well.

Microsoft plans to ensure that everyone knows what Kinect is this holiday season. The company has a massive marketing campaign underway with a reported budget of up to $500 million. That’s roughly the same amount it would spend to promote a new console system.

Rather than targeting core gamers using action and role-playing titles, Kinect games will revolve around fitness, dance, sports and kart racing—putting the focus squarely on the mass market.

Re-engaging that casual audience is critical for the company. While core games have continued to perform fairly well for the Xbox 360 in recent years, casual titles have lost steam, and the mass audience has several alternate options vying for their attention, including free social network games and inexpensive “bite-sized” games on Apple’s iPhone and iPad.

The mass market typically provides the majority of the video game industry’s revenues in the second half of a console’s lifespan. If Kinect doesn’t capture their attention, Microsoft may be forced to move sooner than it had planned to on its next generation device.

That won’t be a problem, though, if the early signs are correct. In addition to raising the sales estimate, Microsoft also issued a warning that it might not be able to keep up with demand this holiday.

Questions? Comments? TechCheck@cnbc.com

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