What Microsoft CEO Steve Ballmer did for Xbox — and what his retirement means for its future

Steve Ballmer’s decision to retire as CEO of Microsoft in the next year will have a big impact on the future of the Xbox gaming console, as he has played a key role in all of the major decisions about the company’s highly successful foray into the video game industry.

Ballmer isn’t much of a gamer himself, and he always had trusted lieutenants such as Don Mattrick (former president of the Interactive Entertainment Business division) or Robbie Bach (former president of Entertainment & Devices) to run the show. It is hard to tell what direct impact he had since he was always part of a chain of decision makers on key Xbox moves. But he was there from the start, and based on the reporting I did for two books on the Xbox, his influence was felt by those who built the business.

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In the history of Xbox, which we have chronicled extensively, his name doesn’t come up on many of the key decisions. Still, while Ballmer wasn’t a fan of the console at the start, he didn’t kill it off. He stuck with it during the worst of times, and now he can look back on how it has been built into a gigantic success. Xbox Live online membership has grown to 50 million, Microsoft has sold more than 70 million Xbox 360s, and the Xbox line is now consistently profitable.

The early days of Xbox

When Xbox was getting off the ground in 1999, Bill Gates was chief executive and Ballmer was president. Gates had the vision to make an outstanding product for consumers, but Ballmer was a foil to that dream. During the discussions, he focused on whether Xbox would be a good business, rather than whether it would be a cool product. That kept the Xbox team grounded in reality, but it also held it back in a number of ways.

“In the early days, Bill was our biggest advocate, and Ballmer was our biggest enemy,” said one Xbox founder, who asked not to be identified. “He thought a subsidized piece of hardware was bad for business.”

But in video games, consoles are typically sold at cost or at a loss, and companies made money on the software — the games. It’s the classic razor-and-razor-blades model — one that was new to Microsoft. Gates had seen failures from many half-steps into gaming, so he wanted to focus on making the coolest product that would grab market share rather than short-term profits.

It’s not clear when Ballmer came on board with that idea. But Gates was the boss.

Ballmer appointed Rick Thompson, then head of Microsoft’s hardware division, to explore the possibilities of how Microsoft could enter the games business in a meaningful way. When Thompson balked at first, Ballmer called him into his office. Ballmer was swinging a baseball bat into his own palm, trying to hammer home a point about how important the job was. Thompson accepted, and he went around to the different game companies, asking the likes of Nintendo and Electronic Arts if they wanted to be acquired. As it performed this due diligence, Microsoft lost critical moments in the market as Sony raced ahead.

Thompson concluded that the first Xbox would likely lose up to $900 million over eight years and would be a “Hail Mary” play. But Gates and Ballmer decided to go into the business anyway because it was strategically important to Microsoft’s future, and it would stop others like Sony from taking over the living room and supplanting the PC as the key entertainment device in the home. Ballmer also insisted from an early stage that the Microsoft executives find a path to profitability. The reality of entering the industry was far more costly than expected as the first Xbox lost somewhere around $3.7 billion over the first four years.

But Ballmer and Gates viewed the toehold they grabbed in the games market as a strategic success. They had diversified Microsoft beyond the Windows and Office franchises and overtook Nintendo in the numbers of console units sold in their first attempt. Gamers loved titles like Halo: Combat Evolved. While Ballmer wasn’t a gamer, he and then chief Xbox officer Robbie Bach had provided the backbone and credibility of Microsoft for gamers, developers, and publishers to believe that the company was in the console business for the long term.

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That was critically important in the early days as the Xbox started as a rogue effort within Microsoft by a few game “green berets” who didn’t have much clout otherwise within the corporation. Ballmer and Gates encouraged founders Seamus Blackley, Kevin Bachus, Ted Hase, and Otto Berkes to continue building the platform, and they gave their blessing as the project won support from former head of Microsoft Game Studios Ed Fries and former MS Office head Robbie Bach.

Some of the Xbox founders recalled how, even though Microsoft had billions in cash, they had to find a way to make money. So Microsoft chose to keep the Xbox expenses under control. The company grew the division quickly, then cut back once the scope of the business became clear. Even though Microsoft had all the cash in the world, it had to use it to deal with different enemies — Google and Apple — and so appeared to be outspent by Sony and Nintendo on games.

“Ballmer was the skeptic to Bill’s optimist,” said one longtime Xbox member. “He was as far outside the gamer culture as Microsoft had among its executives, so he didn’t have the emotional angle to understand why we thought it would work.”

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This meant that Ballmer had blind spots. There were times when Microsoft appeared to be stingy. At one point, it was cutting back on the staffing at the Xbox. At the same time, Sony was building an internal organization of game studios that had twice as many people as Microsoft did. Ballmer’s instincts were as a business person. He was not a product guy, like Bill Gates or Apple boss Steve Jobs.

“The only credit Ballmer can take is not killing it,” said another Xbox team member. Others are more generous: “Ballmer and Gates were one of the best business teams of all time, each complementing the other’s strengths and weaknesses,” said Fries. “They both deserve credit for building one of the most successful and profitable companies in the world.”

Other executives would have thrown in the towel after the financial disaster of the first Xbox. But Microsoft was printing money in other areas, and it stayed the course. It even stayed with it during the launch of the Xbox 360, when quality problems meant that as many as one out of every two systems sold were being returned.

Because Microsoft rushed the Xbox 360 to market, it ran into big setbacks at the outset. Bach made the decision to proceed with the launch in 2005 and go forward with production despite a number of manufacturing problems, as we noted in our 10,000-word story on that in 2009. Ballmer backed him up on that, and for a time, Microsoft clearly wasn’t doing the right thing for its customers. It eventually offered to replace the consoles for free and take a $1.1 billion write-off, but that was many months after continuous complaints from gamers. In that respect, Ballmer was as deaf to consumer complaints as anyone else running the business.

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But in its final years, Xbox 360 grew faster than Nintendo’s Wii and Sony’s PlayStation 3. Now Microsoft is reaping billions in profits in games. It took more than a dozen years for that to happen, but Ballmer deserves credit for having the backbone to enter the market — or at least not jump out of it.

Along the way, there were amusing Ballmer stories. When former Sega executive Peter Moore (now COO at Electronic Arts) joined the company, Ballmer got so excited about the Xbox business that he was pounding a table with his fist, yelling “Xbox! Xbox! Xbox!” He accidentally hit a Polycom conference phone and broke it. Another time, when Blackley and Bachus were standing in line in the cafeteria, Ballmer came up behind them and shouted, “You’re going to make us a lot of money!”

What lies ahead

Microsoft has gone through huge changes in recent months. Mattrick always wanted to test the potential of the Xbox. He wanted to spin the division off as a separate company. But Ballmer as CEO wanted Microsoft to reap the rewards of an integrated Windows and Xbox company, fulfilling the long-held dream of a single operating system running across the office, home, mobile, and games. When the time for a reorganization happened, Ballmer chose to elevate Julie Larson-Green above Mattrick, putting a single leader in charge of Windows and Xbox. Mattrick left to take the CEO job at social-games publisher Zynga.

The reorg was consistent with the way that Microsoft designed the upcoming Xbox One: It has the Metro interface, it integrates other Microsoft products like Skype, and it has plenty of entertainment services beyond games. In other words, the Xbox One is about more than just games.

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While readying the launch of its next-generation game console, Microsoft stumbled out of the gate with its announcements in May and June. Mattrick was behind many of the decisions that were unpopular: changing the way the way used games worked, requiring the console to be always connected to the Internet, and having vague privacy policies on the Kinect motion camera. After Mattrick left, Microsoft changed those policies. But the damage with gamers had been done. Sony now carries the flag on behalf of consumers and indie game developers, and Microsoft is trying to fix its reputation on those fronts.

Ballmer’s choice of Larson-Green raised a lot of eyebrows, as it meant a non-game executive would run…well, games. But Microsoft executives have always had varying degrees of experience on the gaming side. Some of the most successful — Ed Fries and Robbie Bach — had no game chops at the outset.

Ballmer will be on board for as much as a year, which means he’ll be around for the launch of the Xbox One this fall. That offers a reasonable degree of stability for Microsoft, its partners, and its customers. After that, we’ll see how Ballmer’s successor does. But one thing is clear. Even if there are many layers of management in between, the next CEO of Microsoft will have a profound impact on shaping the future of the Xbox platform and the games that we’ll enjoy in the future.