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How the wall came down between Microsoft and Xbox

Emanuel Jumatate, from Chicago, hugs his new Xbox One after he purchased it at a Best Buy on Friday, Nov. 22. (AP Photo/Nam Y. Huh)

Microsoft has been trying to take over the living room for more than a decade. It's been a years-long slog, but the release of the Xbox One seems to be the company's strongest effort yet. The console draws together a set of once-unrelated technologies and pours them all into the same bucket. With that integration, the Xbox division has come to dominate Microsoft's vision of the future in an era where the PC looks to be in a long-term decline.

The Xbox wasn't always at the center of Microsoft's strategic thinking about the consumer market. There once was something of a wall between the Xbox designers and the rest of the business. While that's since been dismantled, keeping the Xbox team separate and independent was probably the best thing that Microsoft could have done with it.

The original Xbox debuted 12 years ago last week to North American audiences. The people who put it together were a colorful bunch. Seamus Blackley, one of the lead designers, once got in trouble for equating gaming to masturbation. As part of a prank, he also reportedly paid several models to don skimpy nurse costumes, another idea that ran afoul of the brass. This kind of rebellious attitude helped set Project Midway, as it was known internally, apart from the company's other outfits.

It also no doubt helped when it came to industrial combat. Bill Gates was just starting his quest to conquer the living room when the Xbox was being developed, and Microsoft had a handful of ideas for how to do so. When another one of these projects, WebTV, sought to take over the Xbox, Blackley's team fended off the attack and wound up incorporating many of WebTV's features into the Xbox itself. Microsoft finally discontinued WebTV's descendant earlier this year, more than a decade after it bought the technology.

If this makes the Xbox division sound like a startup, you're not wrong. Blackley's team enjoyed the freedom to experiment; the business model was one of its more important innovations. As Dean Takahashi reports in "Opening the XBox," when Steve Ballmer confronted the designers about the device's high cost, the team proposed selling the console for less than it was worth. The company would make the money back by selling games. By many accounts, Microsoft's tolerance for losses here played a major role in attracting skeptical customers who may have been suspicious about Microsoft hardware.

If its laid-back instinct with the original Xbox paid off, Microsoft took the exact opposite approach with the Xbox 360, with disastrous results. Having seen the success of Microsoft's first console and with competition from other manufacturers rising, Ballmer decided that the next-generation device had to make money and that it would beat its competitors to market. It turned out to be a horrible idea, according to Takahashi. Because of the deadline, many of the 360's technical bugs were never ironed out — resulting in the unfortunate run of devices that suffered from the "red ring of death." Microsoft ultimately lost more than $1 billion on repairs and replacements for upset consumers whose consoles didn't work.

Despite that early failure with the 360, the Xbox division is still one of Microsoft's most innovative departments. Its Kinect motion sensor, released in 2010, has created a miniature renaissance in tinkering. One major snack food conglomerate is even using Kinect to power its new smart grocery shelves.

With the launch of the Xbox One, Microsoft is moving even further into the living room. Integration with Netflix and Hulu Plus make it easy to stream video, for instance. But it also reflects an Apple-like attempt at vertical integration, combining a hardware experience (Xbox, Kinect) with software (Windows 8, Skype, SkyDrive). The cloud storage integration opens up new social and sharing possibilities. Skype, which Microsoft owns, is being paired with the Kinect to allow facial recognition and automatic log ins.

In his last shareholders meeting as CEO, Ballmer recently gushed about the Xbox as the embodiment of Microsoft's new convergence strategy.

"It is a reflection of what’s possible when the company, our company, is unified under a common vision,” Ballmer said.

Whereas the Kinect was previously marketed as an addition to the Xbox, the inclusion of a Kinect with every one is another sign that Microsoft is serious about using the Xbox division as an anchor for most everything else in its business. If that's true, then Project Midway has grown up at last and arrived from out of the company hinterlands.