Microsoft is in trouble, and this ain't no joke. Vista is a disappointment. Search is weak. Xbox is under siege from the Wii. Paul Graham recently posted that "Microsoft is Dead." Paul might have a taste for the dramatic but you can see where he is coming from. It hasn't been a particularly good twelve months for Ballmer's Boys, and recent news isn't much better. Further, it has come to light that Microsoft, in an effort to embellish its perceived momentum in gaming and its window into family rooms the world over, has been using the oldest and shabbiest of retailer tricks to juice sales figures for the Xbox 360: channel stuffing. No, you say, Microsoft couldn't be doing such a thing. This is a relic of old-line consumer products companies like Philip Morris, or fraudsters like Miniscribe who literally shipped bricks in lieu of disk drives to hit sales targets. Well, the Internet has gotten pretty heated up on this issue, particularly as the inevitable boom-bust results of this tactic are now coming home to roost. Microsoft management is being forced to walk down volume guidance, shining a bright light on the year-end spike in shipments that made the numbers look good - for a while. But that game is over. The jig is up, Softy. So whaddya gonna do now?
Why Stuff the Channel?
Because you are feeling desperate. But why? Xbox is doing pretty well, right? Well, not good enough, and giving ground fast to the Wii. Let's consider what's gone on in gaming consoles over the last two generations. Last go around Sony got the jump on Microsoft and Nintendo with the PS2, beating the original Xbox and Gamecube consoles to market by about a year. The result: Sony kicked some serious butt, selling around 100 million units to 20-25 million units each of the Microsoft and Nintendo offerings. So Microsoft thinks to itself "Ha, I'm going to pull a Sony and get a jump on these bastards for our nextgen console." So it releases Xbox 360 in November/December 2005 versus November 2006 for Sony and Nintendo, a full year jump on the competition. The results to date: 9.7 million Xbox 360; 6.6 million Wii; and 3.1 million PS3. So, the Wii has achieved around 2/3 of Xbox 360s sales volume after only four months, and this after conceding a 12 month head start. From Microsoft's perspective, this can't feel too good or bode well for the future.
Further, both empirical and anecdotal evidence point to increasing interest and resources being devoted to the manufacture of the Wii, with some of those resources coming directly out of those currently associated with the Xbox 360.
From DigiTimes 03/26/2007:
Wistron is likely to gradually discontinue the production of Xbox 360 games consoles for Microsoft in 2008, partly due to declining profits on production of the consoles and partly on market reports stating that Microsoft has added Celestica to the list of its suppliers, according to a March 26th Chinese-language Economic Daily News (EDN) report.
From DigiTimes 03/28/2007:
In order to meet demand for Wii, which presently far outstrips supply, Nintendo intends to find another manufacturer to bolster production of the console, currently being handled solely by Foxconn Precision Compotents (FPC). New manufacturing partners under consideration include Asustek Computer, Compal Electronics, Inventec and Wistron, which are all eager to land a contract with the Japanese firm.
It kind of seems like the story is that as Microsoft is cutting prices for customers and pressuring suppliers to drop their prices as well, that the Xbox 360 isn't the gravy train it was cracked up to be. And that companies like Wistron are excited to shift resources away from Xbox 360 and towards the Wii. So, when things aren't going your way and you have loose accounting practices at your disposal, what do you do? Stuff away!
How to Stuff the Channel
For those uninitiated in this time-honored practice, per Wikipedia:
Channel stuffing is the business practice where a company or a sales force within a company inflates its sales figures by forcing more products through a distribution channel than the channel is capable of selling to the world at large. This can be the result of a company attempting to inflate its sales figures. Alternatively, it can be a consequence of a poorly managed sales force attempting to meet short term objectives and quotas in a way that is detrimental to the company in the long term. Many managers will engage in channel stuffing to increase annual/quarterly sales. Even though this would hurt the company because the distributors would have to return any unsold goods back to the company, it would help the manager if his earnings was based on a sales quota.
Occasionally, distribution channels such as large retailers have been known to identify the practice of channel stuffing in their suppliers, and use the phenomenon to their advantage. This is done by holding back on orders until the end of the suppliers' quota period. The suppliers' sales force then panics, and sells a large amount of the product under more favorable terms than they would under ordinary circumstances. At the beginning of the next period, no new orders are placed and barring any action, the cycle then repeats.
Corporations have been known to engage in channel stuffing and hide such activities from their investors. In the United States, the U.S. Securities and Exchange Commission has in some cases litigated against such corporations.
None of the reasons for channel stuffing are particularly noble, glamorous or value accretive, but that hasn't stopped legions from engaging in this unethical practice. There have been some terrific posts on the topic, dating back as far as December, calling out Microsoft on their trumped-up sales figures.
From Blackfriars' Marketing 12/11/2006:
We have a game we play around the office here with Microsoft press releases. The game is, "Find the words that make the headline true." It's not always easy.
Let's start with XBox 360s. Last week, Microsoft said that it expects to sell more than 10 million XBox 360s by the end of 2006. Sounds plausible, right?
Well, sort of. Unfortunately, NPD just released their numbers for November. The outcome was pretty close to Blackfriars forecast last week:
Nintendo Wii: estimate: 600,000+, actual: 476,000
Microsoft XBox 360: Blackfriars estimate: 600,000, actual: 511,000
Sony Playstation 3: estimate: 200,000, actual: 197,000
Sounds pretty good, right? XBox 360 beat the Nintendo Wii in November with half a million units. They should be fine with the projection, right?
Well, not if you go back to Microsoft's earnings statements and notice that through September 30, Microsoft had only sold 5.9 million units according to its SEC filings. XBox 360 sales in Q3 were averaging 300,000 a month, so let's say October sales were 400,000. Adding on 511,000 for November, that brings us up to 6.8 million. Estimates are that Microsoft will sell about 1.5 to 2 million XBox 360s for Christmas. That leaves the total about a million units short of the 10 million goal.
The secret sentences in the first press release cited above that make the projection possible are the following:
That "sold" number refers to units "sold into retail," which refers to units in transit, units sitting in store inventories and machines sold to consumers.
So how can Microsoft make its stated goal? It's simple: they "stuff" the retail channel by requiring retailers to take XBox 360s over and above those they need by the end of the year.
Now some might argue that retailers won't want to take inventory they don't want this time of year. But Microsoft has a nice trump card to play here. They simply say, "Well, we have a big consumer product launch of Windows Vista and Office 2007 coming up on January 30. Those who don't take XBox 360s might have some trouble getting inventory of those products." And given that those products are pretty much guaranteed to sell in the millions of units for the year at price points of hundreds of dollars, most retailers will just take the XBoxes and call it a day.
Oof, that's brutal, and, of course, true. Carl Howe at Blackfriars' is a rock star. It's forensic analysis like this that makes those with domain experience in the blogosphere so valuable. And then the more recent post, after Microsoft uttered "no mas" and had to come clean.
From Blackfriars' Marketing 01/26/2007:
Microsoft reported earnings this evening, and with it, they announced their actual results for XBox 360 sales over Christmas. The good news: Microsoft shipped 4.4 million XBox 360 units in the fourth calendar quarter of 2006. The bad news: the company only expect to sell another 1.6 million by July 1, lowering its projection of 13 to 15 million down to only about 12 million. These numbers nicely confirm Blackfriars' earlier prediction that Microsoft was shipping excess XBox 360 consoles to retailers to make its 10 million XBox's sold by the end of 2006.
The money quote on XBox 360 sales:
"We are just being cautious about the second half," said Liddell in an interview. "There is a reasonable amount of inventory in the channel."
Second-quarter sales at the entertainment and devices division rose 76 percent to $2.96 billion, but it lost nearly $300 million.
A quick marketing hint for Microsoft: advertising sales targets is just a bad idea. Yes, you get to set expectations so you can exceed them -- but that backfires on you when you don't. And worse, it makes you do things that from a business point of view make little sense, like stuffing the retail channel with products they don't want. Further, doing silly things to make artificial goals just tarnishes Microsoft's brand -- which probably wasn't the original goal.
Well, in the end I guess it all comes out in the wash. The moral of the story: beware of headline numbers and sales projections around year-end, as hype and wishful thinking may get mixed up in a kind of toxic brew (at least to investors). Let's look at some additional perspective (with some cool and informative charts) on the channel stuffing issue and the relative performance of Xbox 360, Wii and PS3.
From RoughlyDrafted.com 03/27/2007:
Next Gen Consoles: PS3, Wii, Xbox 360
Meanwhile, despite the scorn dumped upon the beleaguered PlayStation 3, Sony has already shipped over two million units in its first couple months.
Sony, like Microsoft, announces units shipped, not actually sold. This allows both companies to advertise sales numbers based on how many units they can force retailers to accept, not on how many units customers actually buy; both have considerable market power to push excess unsold inventory into the channel.
The Wii sold 3.19 million units by the end of 2006, and is on track to catch up to and outsell the Xbox 360 by this fall. Even the PS3 looks set to pass the 360 this year; Microsoft recently dropped its June 2007 sales estimate from 15 million to 12 million.
Microsoft had announced the 15 million goal in November 2006 to distract attention away from the other consoles that were just being released. It met its earlier goal of 10 million by the end of 2006 by stuffing the channel with unsold inventory.
That move didn’t help to actually sell units; Microsoft’s SEC filings report that at the beginning of October, the company had only sold 5 million 360s.
That means that half of the world's 360s were sitting in retail shelves this holiday season, and a significant amount still are. That has pressed Microsoft to dramatically slow new shipments until the channel clears out excess inventory.
And the hard-core gamers following this stuff are none too pleased, either. Deceptive tactics like this don't play well with the intensely loyal, deeply devoted high-end crowd, and these sentiments were splashed all over the comments in a recent post at Kotaku concerning the release of the Xbox 360 Elite. So, release a high-end model extension with a jacked-up price in the wake of adverse PR around the channel stuffing issue? Great idea - not.
From Kotaku 03/28/2007:
This is a horrible deal. I just can't believe it, MS what are you doing?
I swear this feels like an attempt to stuff the channel some more and make 360 sales look better than they are. I mean, announce it 4 days before the end of the quarter, book sales of 20 units to 25,000 outlets worldwide, that's 500,000 more "sales" this quarter instead of next.
I'm just so shocked from the idea of raising the price on a console, I can't stand it. I know it brings more functionality, but still. When Sony added ethernet to the PS2 (with the Slim), did they raise the price? When the DS Lite came along with better battery life and a new display, did they raise the price?
The only time I can remember the price of a console going up is when original Xbox went from $150 to $175 right before it died. That didn't go well, does MS want to repeat that?
br549 03/28/07 1:07am
I just don't get it.
The Fall-Out
I'm sure Chris Liddell was just thrilled at having to stand up in front of the investor community and do a little tap dance around the Xbox 360 channel-stuffing issue. But, of course, he wouldn't come out and say that, but use some appropriate Alan Greenspan-like euphemisms to convey the point in more oblique terms.
From Reuters 01/25/2007:
LOS ANGELES, Jan 25 (Reuters) - Microsoft Corp. (MSFT.O: Quote, Profile , Research) on Thursday cut its fiscal 2007 forecast for Xbox 360 video game console shipments, citing unsold inventories in stores, and said it is trying to make sure its gaming division turns a profit in the upcoming fiscal year.
Chief Financial Officer Chris Liddell said Microsoft aims to ship a total of 12 million Xbox 360s by the end of its fiscal year on June 30, down from a previous target of 13 million to 15 million.
"We are just being cautious about the second half. It was always going to be a slow half. We've done very well in the first half. There is a reasonable amount of inventory in the channel," Liddell said in an interview with Reuters.
So what is a "reasonable" amount of inventory in the channel, Chris? Does it have anything to do with shipping (not selling, mind you) 4.4 million units in Q4 2006, with a projected 1.6 million units through the first half of 2007? I guess you guys just had to make that magic 10 million number by the end of 2006, didn't you? But what did it really mean? Not much, in retrospect.
Bottom line: strong companies confident in their strategy and performance don't do these things. They don't have to. What kind of a message does this type of behavior send to the investor community and, more importantly, your customers? Weakness. Fear. Short-term thinking. Nothing that represents a positive signal for a better, brighter tomorrow. Might this also raise questions around Microsoft's pushing of Vista, which hasn't exactly been flying off the shelves and has received more than its complement of negative press? There is something seriously, institutionally wrong with Microsoft. This is not the company I knew in the late 1990s. Get back to basics, boys. Because accounting tricks neither fool Mr. Market nor your customers forever.
http://www.informationarbitrage.com/2007/04/microsoft_phili.html
Why Stuff the Channel?
Because you are feeling desperate. But why? Xbox is doing pretty well, right? Well, not good enough, and giving ground fast to the Wii. Let's consider what's gone on in gaming consoles over the last two generations. Last go around Sony got the jump on Microsoft and Nintendo with the PS2, beating the original Xbox and Gamecube consoles to market by about a year. The result: Sony kicked some serious butt, selling around 100 million units to 20-25 million units each of the Microsoft and Nintendo offerings. So Microsoft thinks to itself "Ha, I'm going to pull a Sony and get a jump on these bastards for our nextgen console." So it releases Xbox 360 in November/December 2005 versus November 2006 for Sony and Nintendo, a full year jump on the competition. The results to date: 9.7 million Xbox 360; 6.6 million Wii; and 3.1 million PS3. So, the Wii has achieved around 2/3 of Xbox 360s sales volume after only four months, and this after conceding a 12 month head start. From Microsoft's perspective, this can't feel too good or bode well for the future.
Further, both empirical and anecdotal evidence point to increasing interest and resources being devoted to the manufacture of the Wii, with some of those resources coming directly out of those currently associated with the Xbox 360.
From DigiTimes 03/26/2007:
Wistron is likely to gradually discontinue the production of Xbox 360 games consoles for Microsoft in 2008, partly due to declining profits on production of the consoles and partly on market reports stating that Microsoft has added Celestica to the list of its suppliers, according to a March 26th Chinese-language Economic Daily News (EDN) report.
From DigiTimes 03/28/2007:
In order to meet demand for Wii, which presently far outstrips supply, Nintendo intends to find another manufacturer to bolster production of the console, currently being handled solely by Foxconn Precision Compotents (FPC). New manufacturing partners under consideration include Asustek Computer, Compal Electronics, Inventec and Wistron, which are all eager to land a contract with the Japanese firm.
It kind of seems like the story is that as Microsoft is cutting prices for customers and pressuring suppliers to drop their prices as well, that the Xbox 360 isn't the gravy train it was cracked up to be. And that companies like Wistron are excited to shift resources away from Xbox 360 and towards the Wii. So, when things aren't going your way and you have loose accounting practices at your disposal, what do you do? Stuff away!
How to Stuff the Channel
For those uninitiated in this time-honored practice, per Wikipedia:
Channel stuffing is the business practice where a company or a sales force within a company inflates its sales figures by forcing more products through a distribution channel than the channel is capable of selling to the world at large. This can be the result of a company attempting to inflate its sales figures. Alternatively, it can be a consequence of a poorly managed sales force attempting to meet short term objectives and quotas in a way that is detrimental to the company in the long term. Many managers will engage in channel stuffing to increase annual/quarterly sales. Even though this would hurt the company because the distributors would have to return any unsold goods back to the company, it would help the manager if his earnings was based on a sales quota.
Occasionally, distribution channels such as large retailers have been known to identify the practice of channel stuffing in their suppliers, and use the phenomenon to their advantage. This is done by holding back on orders until the end of the suppliers' quota period. The suppliers' sales force then panics, and sells a large amount of the product under more favorable terms than they would under ordinary circumstances. At the beginning of the next period, no new orders are placed and barring any action, the cycle then repeats.
Corporations have been known to engage in channel stuffing and hide such activities from their investors. In the United States, the U.S. Securities and Exchange Commission has in some cases litigated against such corporations.
None of the reasons for channel stuffing are particularly noble, glamorous or value accretive, but that hasn't stopped legions from engaging in this unethical practice. There have been some terrific posts on the topic, dating back as far as December, calling out Microsoft on their trumped-up sales figures.
From Blackfriars' Marketing 12/11/2006:
We have a game we play around the office here with Microsoft press releases. The game is, "Find the words that make the headline true." It's not always easy.
Let's start with XBox 360s. Last week, Microsoft said that it expects to sell more than 10 million XBox 360s by the end of 2006. Sounds plausible, right?
Well, sort of. Unfortunately, NPD just released their numbers for November. The outcome was pretty close to Blackfriars forecast last week:
Nintendo Wii: estimate: 600,000+, actual: 476,000
Microsoft XBox 360: Blackfriars estimate: 600,000, actual: 511,000
Sony Playstation 3: estimate: 200,000, actual: 197,000
Sounds pretty good, right? XBox 360 beat the Nintendo Wii in November with half a million units. They should be fine with the projection, right?
Well, not if you go back to Microsoft's earnings statements and notice that through September 30, Microsoft had only sold 5.9 million units according to its SEC filings. XBox 360 sales in Q3 were averaging 300,000 a month, so let's say October sales were 400,000. Adding on 511,000 for November, that brings us up to 6.8 million. Estimates are that Microsoft will sell about 1.5 to 2 million XBox 360s for Christmas. That leaves the total about a million units short of the 10 million goal.
The secret sentences in the first press release cited above that make the projection possible are the following:
That "sold" number refers to units "sold into retail," which refers to units in transit, units sitting in store inventories and machines sold to consumers.
So how can Microsoft make its stated goal? It's simple: they "stuff" the retail channel by requiring retailers to take XBox 360s over and above those they need by the end of the year.
Now some might argue that retailers won't want to take inventory they don't want this time of year. But Microsoft has a nice trump card to play here. They simply say, "Well, we have a big consumer product launch of Windows Vista and Office 2007 coming up on January 30. Those who don't take XBox 360s might have some trouble getting inventory of those products." And given that those products are pretty much guaranteed to sell in the millions of units for the year at price points of hundreds of dollars, most retailers will just take the XBoxes and call it a day.
Oof, that's brutal, and, of course, true. Carl Howe at Blackfriars' is a rock star. It's forensic analysis like this that makes those with domain experience in the blogosphere so valuable. And then the more recent post, after Microsoft uttered "no mas" and had to come clean.
From Blackfriars' Marketing 01/26/2007:
Microsoft reported earnings this evening, and with it, they announced their actual results for XBox 360 sales over Christmas. The good news: Microsoft shipped 4.4 million XBox 360 units in the fourth calendar quarter of 2006. The bad news: the company only expect to sell another 1.6 million by July 1, lowering its projection of 13 to 15 million down to only about 12 million. These numbers nicely confirm Blackfriars' earlier prediction that Microsoft was shipping excess XBox 360 consoles to retailers to make its 10 million XBox's sold by the end of 2006.
The money quote on XBox 360 sales:
"We are just being cautious about the second half," said Liddell in an interview. "There is a reasonable amount of inventory in the channel."
Second-quarter sales at the entertainment and devices division rose 76 percent to $2.96 billion, but it lost nearly $300 million.
A quick marketing hint for Microsoft: advertising sales targets is just a bad idea. Yes, you get to set expectations so you can exceed them -- but that backfires on you when you don't. And worse, it makes you do things that from a business point of view make little sense, like stuffing the retail channel with products they don't want. Further, doing silly things to make artificial goals just tarnishes Microsoft's brand -- which probably wasn't the original goal.
Well, in the end I guess it all comes out in the wash. The moral of the story: beware of headline numbers and sales projections around year-end, as hype and wishful thinking may get mixed up in a kind of toxic brew (at least to investors). Let's look at some additional perspective (with some cool and informative charts) on the channel stuffing issue and the relative performance of Xbox 360, Wii and PS3.
From RoughlyDrafted.com 03/27/2007:
Next Gen Consoles: PS3, Wii, Xbox 360
Meanwhile, despite the scorn dumped upon the beleaguered PlayStation 3, Sony has already shipped over two million units in its first couple months.
Sony, like Microsoft, announces units shipped, not actually sold. This allows both companies to advertise sales numbers based on how many units they can force retailers to accept, not on how many units customers actually buy; both have considerable market power to push excess unsold inventory into the channel.
The Wii sold 3.19 million units by the end of 2006, and is on track to catch up to and outsell the Xbox 360 by this fall. Even the PS3 looks set to pass the 360 this year; Microsoft recently dropped its June 2007 sales estimate from 15 million to 12 million.
Microsoft had announced the 15 million goal in November 2006 to distract attention away from the other consoles that were just being released. It met its earlier goal of 10 million by the end of 2006 by stuffing the channel with unsold inventory.
That move didn’t help to actually sell units; Microsoft’s SEC filings report that at the beginning of October, the company had only sold 5 million 360s.
That means that half of the world's 360s were sitting in retail shelves this holiday season, and a significant amount still are. That has pressed Microsoft to dramatically slow new shipments until the channel clears out excess inventory.
And the hard-core gamers following this stuff are none too pleased, either. Deceptive tactics like this don't play well with the intensely loyal, deeply devoted high-end crowd, and these sentiments were splashed all over the comments in a recent post at Kotaku concerning the release of the Xbox 360 Elite. So, release a high-end model extension with a jacked-up price in the wake of adverse PR around the channel stuffing issue? Great idea - not.
From Kotaku 03/28/2007:
This is a horrible deal. I just can't believe it, MS what are you doing?
I swear this feels like an attempt to stuff the channel some more and make 360 sales look better than they are. I mean, announce it 4 days before the end of the quarter, book sales of 20 units to 25,000 outlets worldwide, that's 500,000 more "sales" this quarter instead of next.
I'm just so shocked from the idea of raising the price on a console, I can't stand it. I know it brings more functionality, but still. When Sony added ethernet to the PS2 (with the Slim), did they raise the price? When the DS Lite came along with better battery life and a new display, did they raise the price?
The only time I can remember the price of a console going up is when original Xbox went from $150 to $175 right before it died. That didn't go well, does MS want to repeat that?
br549 03/28/07 1:07am
I just don't get it.
The Fall-Out
I'm sure Chris Liddell was just thrilled at having to stand up in front of the investor community and do a little tap dance around the Xbox 360 channel-stuffing issue. But, of course, he wouldn't come out and say that, but use some appropriate Alan Greenspan-like euphemisms to convey the point in more oblique terms.
From Reuters 01/25/2007:
LOS ANGELES, Jan 25 (Reuters) - Microsoft Corp. (MSFT.O: Quote, Profile , Research) on Thursday cut its fiscal 2007 forecast for Xbox 360 video game console shipments, citing unsold inventories in stores, and said it is trying to make sure its gaming division turns a profit in the upcoming fiscal year.
Chief Financial Officer Chris Liddell said Microsoft aims to ship a total of 12 million Xbox 360s by the end of its fiscal year on June 30, down from a previous target of 13 million to 15 million.
"We are just being cautious about the second half. It was always going to be a slow half. We've done very well in the first half. There is a reasonable amount of inventory in the channel," Liddell said in an interview with Reuters.
So what is a "reasonable" amount of inventory in the channel, Chris? Does it have anything to do with shipping (not selling, mind you) 4.4 million units in Q4 2006, with a projected 1.6 million units through the first half of 2007? I guess you guys just had to make that magic 10 million number by the end of 2006, didn't you? But what did it really mean? Not much, in retrospect.
Bottom line: strong companies confident in their strategy and performance don't do these things. They don't have to. What kind of a message does this type of behavior send to the investor community and, more importantly, your customers? Weakness. Fear. Short-term thinking. Nothing that represents a positive signal for a better, brighter tomorrow. Might this also raise questions around Microsoft's pushing of Vista, which hasn't exactly been flying off the shelves and has received more than its complement of negative press? There is something seriously, institutionally wrong with Microsoft. This is not the company I knew in the late 1990s. Get back to basics, boys. Because accounting tricks neither fool Mr. Market nor your customers forever.
http://www.informationarbitrage.com/2007/04/microsoft_phili.html
