Microsoft might have a few surprises for the game sector up its sleeve.
January 28, 2004: 3:09 PM EST

NEW YORK (CNN/Money) – For the past two years, Microsoft has established a reputation as a follower in the video game war. When Sony acted, Microsoft reacted – especially when it came to price cuts. Things could be about to change.

Microsoft's Xbox may be on the verge of a substantial price cut, falling from $179 to $99 by Labor Day, according to P.J. McNealy, an analyst with American Technology Research.

"It is our belief that the price on the consoles in North America could see a stepped drop this year, with both the PS2 and Xbox being cut to $129 between now and the May E3 trade show, with [Microsoft] then cutting the Xbox further to $99 in the late summer," he wrote in a research note released Wednesday.

McNealy also believes Microsoft will launch its next generation console in late 2005 – a year earlier than has been previously rumored. That would put the Xbox 2 on store shelves up to a full year before Sony's PlayStation 3.

Microsoft, when asked about the report, said it does not comment on rumors and speculation.

The predictions are pretty bold – but not without merit. It's no mystery that the price of home video game machines will be coming down this year. After 2003's lackluster $20 cuts, Microsoft and Sony both saw console sales falter. Xbox hardware sales fell 18 percent in North America between 2002 and 2003. PlayStation 2 sales were off 49 percent in Holiday 2003. (Only Nintendo, which dropped GameCube prices to $99, saw sales increase.)

The price cut would result in a flood of red ink, though. When Microsoft launched the Xbox in 2001 for $299, it reportedly lost $100 for every unit it sold. Component prices have certainly gone down since then, but the console has never reached the break-even point.

But at this stage of the game (so to speak), Microsoft doesn't seem to care much about that. Deep price cuts – especially if they go unmatched by Sony – would drive up the number of people who own and begin growing accustomed to the Xbox. And having that deep installed customer base is the key to driving sales of a next generation machine.

So $99 would certainly build brand awareness as Microsoft prepares for the launch of its next machine. But I'm not sure a 2005 launch is necessarily a good move.

Xbox for $179 has not attracted new buyers.

Yes, being the first to market would let Microsoft do away with that reputation it has as a follower. It might also force Sony to either step up production of the PS3 or increase the technical specs.

But showing your hand a year before the industry's 500 lb. gorilla does carries a significant amount of risk. Just ask Sega, which tried doing that with the Dreamcast – and got booted from the hardware business as a result. Gamers looked at what the Dreamcast could do and were generally impressed – but decided to save their dollars for the PS2, since they considered it a sure bet.

Microsoft, certainly, is in a much stronger position than Sega. The Xbox's buzz factor is on the rise – and will soar higher if the company opts for a $99 price tag. But it hasn't yet established a reputation that's strong enough for it to sway Sony loyalists. (Not to mention there's a fringe faction that refuses to buy the machine simply because it's made by Microsoft.)

Certainly, it could hurt Sony during the crucial holiday sales period – both 2004 (with Microsoft offering a lower price point) and 2005 (with Microsoft offering a state-of-the-art product). But a rush to market could give Sony time to wind up for a devastating punch.

Look at the software situation. "Halo 2" – the second installment of the most popular Xbox game (by far) – is due later this year. Exactly when is a mystery – Microsoft will only offer "it will be ready when it's ready". It's possible we won't see the game until this holiday season. That would leave an insufficient amount of time to prepare another installment to launch in conjunction with Xbox 2.

Obviously, it's not essential that the system launch with its best game. And an argument could be made that holding "Halo 3" to meet the PS3 launch head on might be wise. But the Xbox has so far been unable to deliver another game line that is anywhere near as effective at moving hardware.

And the nightmare scenario in Redmond has to be releasing the Xbox 2 a year early – only to have it move off shelves at a lackluster pace.