Microsoft Corp. (MSFT) will unveil its new Xbox on Tuesday. What's underneath the hood of the latest videogame console represents a multiyear odyssey of trying to figure out how to keep the machine "cool" in the age of smartphones and tablets.
Since the last Xbox debuted in 2005, Microsoft has produced multiple prototypes for a new console and experimented with different technologies for it, said people familiar with the matter. The company has looked at streaming games from far-away servers to the latest Xbox; sending recorded videos of game exploits on the Web from the console; and including various television technologies, these people said.
In addition, Microsoft has worked to expand the ecosystem of devices and functions around the Xbox, including specialized glasses and a more advanced version of its Kinect motion sensor, said people familiar with the plans.
It is unclear how many of the prototype technologies will be included in the final Xbox. But the efforts, described by more than a dozen current and former Microsoft employees and partners, show how the company is trying to get the formulation of features right to thrust the console back into the spotlight even as consumers increasingly turn to smartphones, tablets and the Web for their entertainment needs.
A Microsoft spokesman declined to comment about technologies in the new Xbox. In a statement, Aaron Greenberg, chief of staff for Microsoft's games business, said consoles are still a thriving business, with consumers last year spending $27 billion world-wide on console gaming, or 42% of total game spending. "Gaming is healthy," he said.
While consoles like the Xbox and Sony Corp.'s (SNE, 6758.TO) PlayStation once were focal points of many consumers' living rooms, sales of the machines have contracted in recent years. Nintendo Co.'s (NTDOY, 7974.TO) newest game console, the Wii U, which debuted in November, failed to meet sales expectations and led to slashed projections. Sony in February announced its latest PlayStation, which doesn't go on sale till later this year.
Sales of new, packaged games typically played on consoles have shrunk in the U.S. for more than a year, according to research firm NPD Group. In April, packaged game sales fell 25% to $495.2 million from $657.5 million a year earlier, NPD said. Console hardware sales dropped 42%, to $109.5 million.
"We've seen a dramatic shift in the way people interact with technology, not just related to games," said Andrew House, head of Sony's PlayStation division, in a February interview. "The consumer is changing us."
At Microsoft, profits at its entertainment and devices division, which houses the Xbox and its Windows smartphone efforts, plunged by more than 66% in its fiscal 2012 year, to $364 million, below what it was in 2010. As the Xbox has aged, the number of consoles sold has also decreased, Microsoft has said in financial filings.
But the Xbox remains central to the Redmond, Wash., company's consumer-technology ambitions. "We're bigger than things like music and other forms of entertainment," said Mr. Greenberg.
Wall Street has looked kindly on game makers recently: Activision Blizzard Inc. (ATVI), Electronic Arts Inc. (EA) and Take-Two Interactive Software Inc. (TTWO) are up at least 40% each so far this year. Microsoft shares have risen nearly 30% to close Friday at $34.87.
"These next-generation consoles are going to be more powerful, and deliver more exciting and more fulfilling entertainment experiences," said Larry Probst, chairman of EA's board, on a recent conference call.
With the newest Xbox, Microsoft considered some prototypes to integrate an Xbox into a television, two people familiar with the company's plans said. One recent prototype included a plug for a high-definition video signal to be piped into the device, one of the people said.
The goal, another person said, was to make the device connect games more tightly to normal television watching. So if a customer's friend began playing Activision Blizzard's "Call of Duty," for instance, he could challenge the friend to a match, sending an invitation to the TV screen.
Microsoft also designed technology that would allow customers to plug their cable or satellite signal into the Xbox directly, one person familiar with the matter said, allowing people to watch live programming and surf channels while also being able to easily switch over to a videogame or on-demand video with the press of a button.
Microsoft also developed a companion digital-video recording technology, this person added, but has been wary of including it for fear of upsetting existing partnerships.
The prototypes also included a game-streaming service, people familiar with the matter said. That technology, which is offered by companies like OnLive Inc., allows customers to play visually intense games without the need for specialized circuitry. Instead, the game is played in a data center far away, with images and button presses streamed over the Internet.
While Sony bet on streaming technology last year when it agreed to pay $380 million to buy game-streaming company Gaikai Inc., Microsoft has been more measured in its efforts, people familiar with the matter said. Internally, employees debated whether the technology was possible given the cost of building data centers and the technical feasibility of streaming game images reliably to customers with slower Internet connections.
Still, Microsoft has continued developing the technology, other people familiar with the matter said. The company is aiming to potentially use streaming to allow gamers to play older titles made for the Xbox 360 on the newer device.
Microsoft has refined other aspects of the Xbox, other people familiar with the matter have said. Those include specialized glasses, two people familiar with the matter said. One of them noted the glasses are designed to compete with other 3-D gaming glasses, and may have functions that blend images of the real world with that of a game, known as "augmented reality.
The company has also developed a Kinect motion controller that can more precisely see a gamer's body as it moves and more accurately hear what they say. It also will include chips made by Advanced Micro Devices Inc. (AMD), similar to those used by Sony, those people said.
--Greg Bensinger contributed to this article.
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