The New Xbox and Apple's Big Decision

I mentioned last week that I was expecting the other shoe to drop this week at the Game Developers Conference 2005. That shoe was the next generation of the Xbox game machine, and it dropped like an atomic bomb. The collateral damage from the resulting explosion could be extensive. It may even take out Apple (Nasdaq: AAPL), forcing the company to exit the PC business.

The New Xbox

We suddenly know a lot about the next generation Microsoft (Nasdaq: MSFT) gaming platform. We know that there will be a heavy focus on collaboration. Collaborative tools will allow players to match up online with others of similar skill levels, identify "griefers" who spoil games for new players, and customize game elements.

Recognizing that many people have already begun to sell, for real money, virtual properties they have created, Microsoft will build in a way to price and sell such game elements. If you create a really cool paint scheme for a car, a wild costume or an unusual character, you can sell it to another gamer for a mutually agreed price, and Microsoft will handle the transaction for you.

This feature recognizes that, just as in the real world, people will pay real money to have something that is unique but outside of their own ability to create. It is a reflection of just how real virtual reality is becoming.

Speaking of real, the next generation Xbox will have HD capability. I had a chance to see a nearly full-resolution demonstration of this, and the rendered scenes are almost fully photo realistic -- it is beginning to look as if you are playing with actual objects rather than cartoons. This showcases the power of the platform, and I'll bet it has a couple of Japanese gaming companies rather worried.

The Power Behind Xbox

The conference also showed that Microsoft's development platform for the product is starting to pay dividends. A tools company at heart, Microsoft has been applying this skill so that the parts of games developers don't like to create (basically the plumbing) is handled by the tool, freeing up the developer to focus on creating the elements of the game more quickly and economically. It also allows for a faster prototyping process, which should lead to the identification of bad games before large sums are spent completing them.

In some ways Microsoft is applying the collaborative development model that was created for the enterprise. In the enterprise large numbers of projects are developed in parallel, and for some time Microsoft's Visual Studio was seen as a good tool for coordinating these efforts. Games have become incredibly complex over the last several years, and next-generation systems are expected to become unmanageable unless collaborative advances are made. Visual Studio is now being co-opted by the gaming organization, and it will be integrated into Microsoft's game tools over the next 18 months.

This means that in two years games will improve dramatically in terms of time to market, intelligence and ability to model the real world. But it isn't just the tools that will help here. There is also a processor change that heralds a huge benefit for Microsoft (and likely Sony (NYSE: SNE) and Nintendo as well). The change also creates a risk for Apple.

The Cell Processor

The world of the desktop is shifting toward dual-core processors that can better deal with the massive multithreading that is being created in products such as Microsoft Outlook and Adobe (Nasdaq: ADBE) Photoshop. In Photoshop, for instance, an AMD (NYSE: AMD) dual-core offers a whopping 40 percent increase in performance compared to the same frequency single-core processor. (Dual-core processors have two processors on one chip, allowing the system to process more instructions in parallel, vastly increasing the amount of work that can be done.)

The IBM (NYSE: IBM) Cell processor is multicore. Currently with up to nine virtual cores, this processor has the capability -- especially with games and multimedia creation applications -- to dramatically increase the performance of a system.

But this doesn't come without a price. This processor is very different from current technology. To make proper use of it, the related OS will need to be largely rewritten, and the only way to run older applications will be under emulation.

The gaming industry can likely overcome the 30 percent performance hit necessary to allow old games to run on the new platforms. Because the interface in a game system is largely defined by, and unique to, the game, this isn't that big a problem. But were this a PC the porting effort would be massive, and there simply may be no way to correct the timing differences in older products without rewriting them. This is especially true of products such as multimedia creation tools that require every ounce of performance. This is what creates Apple's dilemma.

Apple's Dilemma

Apple must now realize that the PowerPC will be less interesting to IBM, which is moving its base toward the Cell. Certainly IBM will continue to produce the part for Apple, but it will ramp down development on future versions in order to work on the new Cell instead. At some point, perhaps even within 3 years, IBM will have finished migrating its own platforms to Cell, leaving Apple nearly alone on PowerPC. This is the Apple nightmare scenario.

When this point approaches, Apple will have three choices. One is to exit the computer business and concentrate on the more powerful accessories market, focusing on competing with Logitech and Creative Labs rather than with Microsoft. A second option will be to adopt the Cell architecture, but this would signal the obsolescence of the current generation of products and make it more difficult to hold customers. (Remember that the move to OS X cost them better than three quarters of the market they had before the migration.) Three is to move to x86, and rumors are once again flying that this choice is being discussed. Such a move, however, would have a dramatic and likely negative initial impact on the installed base.

A final option would be to do nothing. This was the strategy that Apple used against the inferior Windows 95 product, and it cost Apple better than 90 percent of the market share it had enjoyed before Windows 95 launched.

The most competitive path would be option number two, adopting the IBM Cell, but this choice also carries the most risk, because IBM is expected to change this product a great deal, forcing Apple to incur massive ongoing costs just to keep up. Choice three, moving to x86, is similar to what Sun is doing with AMD, but it forces them to more closely compete with companies such as Dell (Nasdaq: DELL), which are set up much better for this kind of competition.

I know a large number of folks who expect Apple will take the first option and get out of the PC business altogether in order to better focus on the new and highly profitable classes of multimedia products. Most of the people who think this way are developers, suggesting that if Apple doesn't make a clear choice, the choice may be taken away from them.

The consensus appears to be that within the next five years Apple will either move to a new processor or exit the PC business. That will not be a fun choice, but at least Steve Jobs will be able to play really cool Xbox games to take his mind off of it.