Next-Gen Price War Breaks Out

However, the timing of Microsoft's decision may well be a consequence of a looming battle - namely the release of GTA IV next month, which is widely seen as a key battleground between the Xbox 360 and the PS3. Building the installed base of Xbox 360 ahead of the launch is important, as is putting clear water between the price points of the PS3 and the 360. Having retailers putting Xbox 360 price-drop signs on their GTA IV displays won't hurt, either. This may not be the key motivation for the price drop, but it's certainly going to be in the back of Microsoft's minds.

Docking the Long Tail

It's in the long term, however, that console price cuts really make a difference. Microsoft had an early if somewhat unpleasant experience with the power of the price cut, when the original Xbox had to have its price slashed before sales could take off. It has avoided that admirably this time around (that fate, instead, arguably fell to the PS3), but it also knows that a timely price cut can have a vital effect on the curve of the installed base graph - with the immediate spike effect being, in the final analysis, far less important than the long tail.

In what is turning out to be the most competitive console battle for over a decade, Microsoft will be betting heavily on that long tail. Positioning its main SKUs at GBP 159 and GBP 199 leaves the company with little room to manoeuvre in 2008 - no further drops are likely this year, with hardware bundles being the main option left on the table if Microsoft wants to change the value proposition. As such, the firm is betting that its new prices will remain attractive - and keep pulling in new consumers - right through to Christmas.

It may well be right. Nintendo, still selling Wii units almost as quickly as it can build them, isn't going to want to drop its price any time soon - and even if it does see the Arcade starting to eat up Wii sales, it's most likely that it'll price-match Microsoft, rather than undercutting. Sony, meanwhile, remains stuck at the top of the price scale with a console that's a lot more competitive than it was at launch, but which is still expensive enough to risk being positioned as an aspirational product at a time when the market is more focused on affordability than aspiration.

Sony can, of course, play its price-cut cards - and I'd be hugely surprised if the PS3 didn't see a cut in the next six months. However, I'd be even more surprised if that cut brought the console in line with Microsoft's prices. With its cheapest SKU presently priced at GBP 300, a cut to GBP 200 would be incredibly tough for the company to justify. It's much more likely that we'll see a GBP 239 or GBP 249 console - leaving Microsoft with the edge on pricing as we approach Christmas 2008.

One thing is certain, however; Microsoft's price cut represents a very late, but very welcome, start to the next-gen price war. Thus far this has been something of a phoney war, with cuts being passed through as nebulous "changes to the value proposition". As of this week, the gloves are off.

For Microsoft, that means an immediate spike in sales as it Hoovers pent-up demand and fence-sitters, followed by a consistently stronger sales over a period of many months - and, potentially, a major boost in sales of the 360 SKU of GTA IV. As for Sony - well, the ball is now in Sony's court. It may need to respond more aggressively than it had planned if it's going to retain the strong footing it has been building up in Europe in the past year.