As a quick followup to my previous post about Microsoft selling the Xbox 360 at a loss, I thought that I’d post a link to this article on Xbox economics. While it dates back to the release of the original Xbox in 2002, the main line of reasoning applies equally well to the current situation. The main difference is that Microsoft got the Xbox 360 on the market ahead of their competition this time, meaning that they’ll be able to control the pricing of their hardware for awhile before a price war breaks out. Anyway, the article argues that attempting to subsidize hardware manufacturing costs with software sales is a bad idea. Clearly, the article was off base in predicting that the original Xbox would get killed by lower priced competition, but it does make some interesting points. And besides, Microsoft has incredibly deep pockets, so they can afford to operate at a loss to gain a foothold in (if not total control of) pretty much any market.
Update: It may cost even more than previously thought to produce the Xbox 360.