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KE1246 August 16, 2023 © 2023 by the Kellogg School of Management at Northwestern University. This case was prepared by Professor Mohanbir

KE1246

August 16, 2023

© 2023 by the Kellogg School of Management at Northwestern University. This case was prepared by Professor
Mohanbir Sawhney. Cases are developed solely as the basis for class discussion and are not intended to serve as
endorsements, sources of primary data, or illustrations of effective or ineffective management. This case was based
exculsively on publicly available information. For pedagogical purposes, the author may have fictionalized individuals,
conversations, and case facts. The strategies and tactics mentioned in the case do not purport to represent the
company’s actual strategies. To order copies or request permission to reproduce materials, call 847.491.5400, or email
[email protected]. No part of this publication may be reproduced, stored in a retrieval system, used
in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or
otherwise—without the permission of Kellogg Case Publishing.

M O H A N B I R S AW H N E Y

Xbox Game Pass:
Business Model Optimization and
Transformation

Phil Spencer, the CEO of Microsoft Gaming, was considering strategies for increasing revenues
and subscribers for Xbox Game Pass in 2022. Revenue and subscriber growth had fallen short of
expectations in recent years, and Spencer needed to figure out how to meet the aggressive growth
goals the company had set for the service.

In 2017, Microsoft introduced Xbox Game Pass, a subscription-based service for its eponymous
gaming console. The Xbox Game Pass service followed the trend of subscription-based services like
Netflix in video and Spotify in music, as well as Microsoft’s corporate strategy of transitioning to
subscription-based business models for its cloud-based software and services. By January 2022,
Xbox Game Pass had attracted 25 million subscribers. The service generated $2.9 billion in
revenue in 2021, accounting for nearly 20 percent of total Xbox revenue ($16.3 billion).1 It was
the leading subscription-based service in the industry, with greater revenues than similar services
from PlayStation and Nintendo.

After healthy growth during the pandemic years, revenue and subscriber growth recently had
been falling short of expectations. The Xbox team was considering three options for reigniting
growth in 2023:

• Optimize the existing business model by offering Game Pass on other platforms, building
a gaming store, modifying prices and tiers, or leveraging Xbox All Access

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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• Transform the business model by charging subscribers based on their usage

• Improve profitability by rewarding customer loyalty and reducing customer churn

Business Model 1.0: Razor-Razorblade
Microsoft had employed the “razor-razorblade” business model for the Xbox console ever since

its introduction in 2001. This model was pioneered by the Gillette company,2 which sold razors
at or near a loss and made money by selling the proprietary blades that fit the razors. In the more
generalized version of this model, a base hardware product is sold at a slim or negative margin, and
the sale of a contingent consumable or complementary product generates profits.

This model was used in the video game industry by Sony PlayStation, as well as by Microsoft
Xbox. Lori Wright, head of business development for Xbox, told The Verge that the Xbox
business was high-growth and profitable overall, but “we sell the consoles at a loss.”3 A Microsoft
spokesperson elaborated: “The console gaming business is traditionally a hardware subsidy
model. Game companies sell consoles at a loss to attract new customers. Profits are generated in
game sales.” 4

Business Model 2.0: Subscription
With the June 1, 2017, launch of Xbox Game Pass, Microsoft priced the subscription service

at $9.99 per month for users to download and play a rotating catalog of more than 100 Xbox
games. Players could also buy games outright at a discounted price. Microsoft hoped the service
would enable customers to discover and play games they otherwise would not have been willing
to purchase. Ideally, the service would also encourage the development of new and experimental
independent games that would be difficult to sell using the traditional publishing model.

Game publishers, developers, and even some Xbox executives initially resisted the idea of a
game subscription service, fearing it would devalue game purchases and lead to small usage-based
royalties. Typically, sales of all new video games dropped off rapidly; more than 95% of revenue was
generated within the first 12 months. Microsoft argued that Game Pass would rekindle demand
for older games by generating “franchise uplift,” or interest in previous game versions.

Ed Fries, a former Xbox executive, told an industry publication that the subscription model
could lead to people not buying games anymore: “Game Pass scares me because there is a somewhat
analogous thing called Spotify that was created for the music business. When Spotify took off, it
destroyed the music business. It cut the annual revenue of [that] business in half; it has made it so
people just don’t buy songs anymore.”5

When Game Pass was launched, the catalog included only games that had been in the market
for twelve months. (Microsoft shared 70% of game sale revenues with publishers.) Once the model
had proved itself, Microsoft expanded the Game Pass catalog; on January 23, 2018, the catalog
included all Xbox-developed games the same day they were offered for retail sale. Third-party game

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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publishers also began to release their new titles on Game Pass. By December 2022, the catalog
contained more than 400 games in various genres.

On June 9, 2019, Microsoft released Xbox Game Pass Ultimate, a new subscription tier that
combined Game Pass with the existing Xbox Live Gold multi-player subscription package for
$14.99 per month (vs. $19.98 per month if purchased separately). Ultimate subscribers also had
access to exclusive perks for games they owned, including in-game items such as player costumes,
weapon skins, playable characters, and in-game currency that could be used to purchase content
from in-game stores.

Xbox Game Pass in 2022
Based on presentations at the Microsoft game developer conference (GDC) in 2022, Game Pass

spurred broader adoption and deeper usage of games among its customers. Game Pass members:6

• Played 40% more titles and 30% more genres than before they had joined Game Pass

• Spent 50% more on games and 2.8 times more on in-game purchases that unlocked
specific features or gave the user special abilities, characters, or content

Game publishers also benefited from Game Pass. Existing games that joined Game Pass
increased their player numbers 8.3 times, and independent games launched on Game Pass saw a
15-fold increase in players.7

Although the Game Pass business was successful, Gaming CEO Phil Spencer acknowledged
that the subscription-based model would never become the dominant business model for Xbox. At
a Wall Street Journal Live conference in October 2022, he revealed that Game Pass accounted for
15 percent of Microsoft’s overall Xbox content and services revenue. He expected that the service
would remain around that level. 8

Subscriber growth had slowed over the previous few years. Microsoft had a growth target of
73% for the 2022 fiscal year, but actual growth was only 28%. In 2021, real growth was 37%
versus the target of 48%.9 What should Microsoft try next?

Option 1: Optimize the Current Subscription Model

Expand Game Pass to Mobile Platforms

The Xbox Game Pass service was available on desktop computers and the Xbox console.
Microsoft saw an opportunity to expand the addressable market for Game Pass by making the
service available on Android and iOS mobile platforms. This approach would echo Microsoft’s
“embrace and extend” strategy of the early 2000s of making Microsoft Office accessible through
additional web browsers such as Netscape, Mozilla, and Safari. It would also be consistent with
Microsoft’s strategy of making its popular office productivity applications—i.e., Microsoft Word,
Excel, and Outlook—available on the Android and iOS mobile platforms.

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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Console gaming was dwarfed by the size of the mobile gaming market, defined as games
designed and played on mobile devices such as feature phones, smartphones, and tablets. In 2020,
Xbox Live reported about 100 million active users.10 The mobile gaming audience in 2022 was
almost 2 billion, nearly 20 times the size of the Xbox audience. Of the $184 billion generated in
2022 by all types of games, the mobile gaming market accounted for 50% of revenues, whereas
console games had a 28% revenue share and PC games had a 21% revenue share. Mobile game
downloads surged to almost 90 billion, 6 billion more than in 2021. The average revenue per user
(ARPU) for mobile games was expected to reach $164 in 2023.11

Microsoft could significantly expand its total addressable market (TAM) by putting its Game
Pass service on mobile platforms. Mobile devices also allowed gamers to play games anywhere
without being tethered to their consoles. If Microsoft sold games through the iOS or Android
platforms, it would have to share 30% of the revenue with Apple or Google. Further, technical
limitations meant that the user gaming experience on smartphones and PCs would always be
inferior to the Xbox console. Consequently, mobile gamers were a significantly less willing to pay
than console gamers were. Microsoft would find it challenging to persuade mobile gamers to fork
over the same level of subscription fees paid by gamers who owned Xbox consoles.

Build a Next-Generation Xbox Store

Microsoft had previously revealed plans to create a next-generation game store that would
operate on various hardware platforms, including mobile devices. With its pending acquisition of
game publisher Activision Blizzard, Microsoft could scale the Xbox Store and attract gamers to a
new Xbox mobile platform, including Microsoft and Activision titles. However, moving mobile
gamers away from Google Play and the iOS App Store would require more time and effort.

Raise Prices and Modify Tiers

Since its introduction in 2017, Microsoft had kept the standard Game Pass subscription price
the same, even as streaming companies like Netflix consistently raised prices. Microsoft had tried
several times to push through minor price increases, but intense backlash from subscribers had
forced rollbacks.

Leverage Xbox All Access

In August 2018, Microsoft announced Xbox All Access, an all-in-one plan that aimed to
increase its console penetration by bundling a console with a 24-month Xbox Game Pass Ultimate
subscription. As of 2022, the Xbox All Access plan was offered in two variants: a $24.99 per
month plan with a lower-price Xbox Series S console; and a $34.99 per month plan with an
upgraded Xbox Series X console.

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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Microsoft could consider more aggressive pricing for the All Access plans to increase Game
Pass subscribers. One concern was that this approach would conflict with the vision of making
Game Pass available on all devices and platforms.

Option 2: Transform the Business Model by Moving to
Usage-Based Pricing

Usage in gaming tended to be highly skewed, with a small percentage of very heavy users. A
2015 study of the worldwide gaming market identified four customer segments based on how
much money people spent on microtransactions such as virtual goods or VIP memberships:12

• Non-monetizers: 114 million (97.91%)

• Minnows: 1.2 million (1.03%)

• Dolphins: 1 million (0.86%)

• Whales: 230,000 (0.2%)

Minnows typically spent about $1 each month. Dolphins spent significantly more, with an
average spend of $5 per month. Whales spent heavily and drove the most revenue. Although
Whales comprised less than 0.2 percent of users, they generated more than 85% of total revenue.
Interestingly, Minnows tended to play fewer times per week (an average of two) than Whales, but
they played as many as three games, whereas Whales focused most of their play and spending on
one game.

A subscription-based pricing model did not capture value from a highly skewed user base.
By charging all Game Pass customers a flat fee, Microsoft caught little of the value it created for
Whales and left little or no consumer surplus for less usage-intensive Minnows and Dolphins.
Usage-based pricing would enable Microsoft to capture more value from Whales while offering
a lower base price, encouraging Minnows and Dolphins to try the service. A consulting firm had
proposed a three-tiered pricing plan. (See Exhibit 1.)

The consulting firm hired by Microsoft to design possible usage-based pricing suggested that
such a move could generate a backlash from some Whales, who had been trained by Netflix,
Amazon Prime, Spotify, and other players in the streaming business to expect unlimited access for
a fixed monthly price. The consultants projected that 10% of current Whales would refuse to sign
up for the Platinum tier, which targeted them, and either leave the service or downgrade to the
Gold tier. They also projected that the current Dolphin segment, targeted by the Gold tier, would
grow by 10%, partly based on Whales downgrading. The current Silver tier, which focused on
Minnows, would grow 25% because of the lower price of entry.

To soften the impact of the price increase for heavy users, Microsoft could offer exclusive
“member deals and discounts” in the Game Pass store based on a player’s usage tier. (Microsoft
already offered discounts, but they were not linked to usage.) When players purchased a game,
they gained permanent access, retained their achievements, and ensured that their playing time did

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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not count toward their monthly usage. Purchases also generated revenue for Microsoft and game
publishers, who received 70% of Game Pass store revenue.

One proposal was to offer Gold Tier subscribers (Dolphins) a 10% discount and Platinum
Tier subscribers (Whales) a 25% discount. These discounts would be in addition to any existing
discounts offered by Game Pass. The Xbox team estimated that the discounts would increase Gold
Tier members’ spending from $15 to $20 monthly and Platinum Tier subscribers from $30 to
$40 monthly. The team also estimated that the additional value offered by the member-deals-
and-discounts program would increase the retention rate of Whales from 90% to 95%, and the
Dolphins segment would grow by 15% instead of 10%. The Minnow segment would still increase
by 25%.

Option 3: Improve Profitability by Increasing Usage
and Retention through a Loyalty Program

Microsoft could increase revenues and profits from Game Pass by reducing the number
of subscribers who leave rather than trying to extract more revenue from existing subscribers.
Churn was a key challenge for Game Pass in 2022, as it was for all subscription-based services.
For example, Netflix had a monthly average churn of 3.5% in Q3 of 2022, up from 3.4% in Q2
and 2.0% in 2021.13 For Xbox Game Pass, monthly subscriber churn was estimated to be 5% for
Minnows, 4% for Dolphins, and 3% for Whales.

The Xbox team proposed a loyalty program called Xbox Rewards that would link usage and
loyalty to rewards rather than to prices. Reward points would be earned in three ways:

• 10,000 “Welcome Points” for becoming a subscriber

• One “Play Point” for every minute spent playing games on Xbox Game Pass

• 20,000 “Anniversary Points” for every 12 months’ subscription to Xbox Game Pass

This structure combined mechanisms employed in the credit card business, which rewarded
customers for signing up for a product; in the airline industry, which rewarded customers for usage
(points per mile flown); and in stock options awarded by startup companies, which rewarded
employees for tenure by having the options vest over time.

Points could be redeemed for games, hardware, and other merchandise at 2,000 points per
dollar from the Xbox Store. To further encourage retention, reward points could not be redeemed
until they were “vested,” 12 months after being earned. All unvested points would be forfeited
when subscribers canceled their Game Pass membership.

The Xbox team estimated that the loyalty program would reduce monthly subscriber churn to
4.5% for Minnows, 3% for Dolphins, and 2% for Whales. This increased customer lifetime would
generate incremental revenues for Microsoft and game publishers, but these would be partly offset
by the redemption cost of reward points.

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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Conclusion
Introducing Xbox Game Pass was a bold transition for the Xbox business model in 2017,

but revenues in recent years lagged expectations. Spencer and his Xbox team needed to make a
strategic choice to meet their aggressive growth goals.

The team had researched the costs, benefits, and risks of three options: (1) optimize the current
subscription-based model by changing the pricing tiers, features, or platforms on which Xbox
Game Pass was available; (2) transform the model by moving to usage-based pricing, possibly
adding exclusive membership benefits for premium usage tiers; or (3) increase customer lifetime
value and reduce churn by rewarding subscribers for usage and tenure.

Spencer began reviewing the material to develop his recommendation.

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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Exhibit 1: Proposed Usage-Based Pricing Plan for Xbox Game Pass
[Return to text]

Silver Tier Gold Tier Platinum Tier

Target segment Minnows Dolphins Whales

% Current Xbox
subscribers)

75% 15% 10%

Average usage

level

4 sessions/wk

x 60 mins/session

= 1,000 mins/month

8 sessions/wk

x 60 mins/session

= 2,000 mins/month

20 sessions/wk

x 90 mins/session

= 7,200 mins/month

Current
subscription price

$14.99/month $14.99/month $14.99/month

Current price/
minute

1.5 cents/minute 0.75 cent/minute 0.2 cent/minute

Proposed usage-
based price

$9.99/month $24.99/month $39.99/month

Proposed monthly
usage limit

1,000 minutes 3,000 minutes Unlimited

Proposed price/
minute

1 cent/minute 0.83 cent/minute 0.55 cent/minute

(at 7,200 minutes)

Proposed price/
minute over usage
limits

0.5 cent/minute 0.5 cent/minute None

Additional benefits None; limited to 100 game
titles

Expanded catalog

Exclusive first-party titles

VIP Tier 1 benefits

Largest catalog

Exclusive first- and third-
party titles

Pre-release exclusive
window

VIP Tier 2 benefits (e.g.,
battle passes, IAP offers,
Boosts)

Support hotline

Source: Created by the author.

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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Endnotes
1 Leah J. Williams, “Microsoft Reportedly Earned US $2.9 Billion from Xbox Game Pass in 2021,” GamesHub,

October 11, 2022,
fy-2021-31135/.

2 Will Kenton, “Razor-Razorblade Model: Definition, How It Works, and Examples,” Investopedia, December
18, 2022,

3 Tom Warren, “Microsoft Would Like to Remind You the Xbox Definitely Makes Money,” Verge, May 6, 2021,

apple-epic-games-trial.

4 Ibid.
5 Andy Robinson, “Former Xbox Exec Says He’s ‘Scared’ of Game Pass’s Potential Impact,” Video Games Chronicle,

May 23, 2022,
potential-impact/.

6 Sergio C. González, “Xbox Game Pass Data Reveals Gamers Are Playing and Spending More,” MeriStation
USA, March 25, 2022,

7 Ibid.
8 William D’Angelo, “Xbox Game Pass Is Profitable and Accounts for about 15% of Xbox Revenue, Says Phil

Spencer,” VGChartz, October 26, 2022,
profitable-and-accounts-for-10-15-of-xbox-revenue-says-phil-spencer/.

9 Stephen Totilo, “Microsoft Misses Xbox Game Pass Subscriber Target for Second Year,” Axios, October 27,
2022,

10 “Number of Monthly Active Users (MAU) of Microsoft Xbox Network from Fiscal January 2016 to December
2022, Statista, accessed January 9, 2023,

11 Andrea Knezovic, “187 Mobile Gaming Statistics for 2023 That Will Blow Your Mind,” Udonis, April 12, 2023,

12 “How to Identify Whales in Your Game,” GameAnalytics, September 10, 2015,
blog/how-to-identify-whales-in-your-game/.

13 George Winslow, “High Churn Rates Hurt SVOD Sub Growth in Q3 2022,” TV Tech, November 29, 2022,

For the exclusive use of J. Ma, 2024.

This document is authorized for use only by Jiarui Ma in Xbox Gamepass Spring 2024 taught by David Kreutter, Columbia University from Jan 2024 to May 2024.

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