The general knee-jerk reaction to Microsoft's $99 Xbox plan is that it's crazy, odd, a bad deal.
But the move is really the latest in a long line of similar efforts to get consumers to plunk down cash for things they would otherwise be unwilling to pay quite so much for.
The subsidization model does a few things well. Most obviously, it keeps prices low, reducing the barrier for entry and opening up and increasing the revenue streams elsewhere. We've already seen this on multiple fronts, from free-to-play games like Angry Birds and Team Fortress 2, to, most notably, the smartphones industry.
Even Amazon introduced a similar effort last year when it announced the Kindle with Special Offers, an ad-subsidized version of the device that ran for $25 less than the ad-free version. The idea? Amazon takes a hit on the Kindle sale, but gets to put advertisements in front of far more consumers. (Kobo also tried something similar.)
Video game consoles have run on a less overt subsidization model: Sell consoles at a loss and make up the cash on games sales. The $99 Xbox deal pushes that a bit further, cutting the entry price by a significant margin to attract new buyers. The difference here lies in the contract, which binds the consumer to Microsoft for two years. This, as ZDNet's Mary Jo-Foley notes, makes it more likely that consumers will opt into other purchases.
And then there are the cell phone carriers, which take a hit on cell phone sales in exchange for two-year contracts. Not that it's been entirely rosy here. Subsides are notoriously disastrous for the profit margins of the cell phone carriers: The more smartphones Verizon and AT&T and Sprint sell, the more they have to shell out to subsidize the purchases. (See: the ongoing snafu over the iPhone.)
This reality prompted T-Mobile Chief Marketing Officer Cole Brodman to publicly decry the carrier subsidization model that his industry has come to rely on. “It actually distorts what devices actually cost and it causes OEMs, carriers — everybody to compete on different playing fields,” Brodman said last month.
Clearly, subsides have been a major double-edged sword for carriers -- not that that will prevent other industries from also experimenting with them.
These kinds of subsides work by pushing the complete financial picture far into the general haze of the future, where short-term benefits far outweigh long-term costs: Be happy now, worry about consequences later.
With the $99 Xbox deal, this means that consumers ultimately pay more for something that they can get for a lower price now. But here's the thing: Most consumers aren't going to run those calculations; they'll only see the $99 price tag. And the price difference after two years? That simply becomes the cost of financing.
That's why subsidies work for both consumers and companies, and also why the model seems like a logical next step for other device's and industries. Assuming that Microsoft's $99 Xbox test works out, it's likely that we will end up seeing similar efforts with the next Xbox as well. And the sky's the limit from there.