Microsoft moves into chip world with Xbox

There's a multibillion-dollar company moving into the chip business: Microsoft.

According to sources, the Redmond, Wash.-based software giant will more actively participate in the design of the brains for the next version of its Xbox gaming console, tentatively called Xbox Next. By switching from using relatively standard parts to more customized silicon, the company can better optimize its game console, due in 2005. At the same time, the move potentially gives the company a toehold in a completely new market.

"It is clear that Microsoft wants to get a lot of their DNA into it," said Richard Doherty, director of research company The Envisioneering Group. One reason for that involves hacking incidents. "They sure don't want to have a situation where an Xbox can be turned into a PC," Doherty said. Another is that Microsoft can squeeze better performance out of chips by being involved on the front end of the design process.

For the original Xbox, Intel and Nvidia sold chips to Microsoft that were largely identical to semiconductors the two chipmakers have also sold to the general PC market.

With Xbox Next, Microsoft is licensing graphics technology from ATI Technologies, processor technology from IBM and chipset technology from Silicon Integrated Systems (SIS). Microsoft will then work with these companies to fashion customized chips, sources said.

The arrangement will likely mirror Sony's relationship with IBM and Toshiba to create the Cell processor slated for use in the next big release of the PlayStation game console, said analysts and sources close to the companies.

Microsoft will likely ink deals with one or more semiconductor foundries to manufacture the chips for the new Xbox design, said people familiar with the deal. "Manufacturing is not part of the agreement yet. It is up to them what they do with manufacturing," an IBM representative said.

Microsoft, which announced the IBM and SIS deals last week, refused to comment further on its plans. Chairman Bill Gates is expected to discuss Xbox plans at the CES show in Las Vegas this January, Doherty said.

Although chip customization can create risks, it will enable Microsoft to optimize performance inside the console. The company has also been wrestling with Xbox hackers, who've been able to turn the $179 console into a fully functioning computer.

In a sense, "Microsoft is becoming a fabless semiconductor design firm," said Peter Glaskowsky, editor in chief of The Microprocessor Report. These companies--without their own chip-fabrication factories, or "fabs"--design their processors but outsource manufacturing to foundry companies. They also often license design expertise and intellectual property from others. Microsoft "had very little to do" with silicon design for the first Xbox, said Glaskowsky.

Commercially, Microsoft will differ from other fabless companies, such as Transmeta, in that its main customer will be itself. Still, Microsoft could conceivably leverage its investment by using the chips in many products, similar to what Sony plans to do with Cell.

"Microsoft could in principle take the technology they have licensed for Xbox and create hybrid systems," said Glaskowsky, referring to products that combine computing technologies with consumer electronics.

The details on how these different chip agreements will work remains vague at this point. Nonetheless, some of the semiconductor companies working with Microsoft have stated that their Microsoft relationship does not fit into the ordinary dealings between chipmaker and box maker.

"It (the Microsoft arrangement) is different than our normal. It is a technology development thing for SIS," said Brad Walker, director of business development for SIS. Typically, SIS develops chipsets on its own and then seeks out customers later.

The deal with ATI is similar to the relationship ATI has with Nintendo for providing graphics to the GameCube, said Chris Evenden, director of PR for ATI. ATI designed a customized chip for the Japanese giant, which then took the blueprints and found a manufacturing partner. In turn, ATI receives royalties for each GameCube console sold and royalties on the sales of Nintendo games.

With Microsoft, ATI will provide customized graphics technology for "future Xbox services and products" and in exchange will receive royalties. Royalty deals are an exception for the company. ATI mostly earns revenue by selling chips. Nvidia's Xbox revenue came from selling chips.

One of the major open questions, of course, is how different these chips will be from the semiconductors IBM, SIS and ATI will sell on the open market.

The IBM representative acknowledged that Microsoft is looking at the company's PowerPC technology, the underlying architecture behind the chips in Apple computers. PowerPC concepts will also be the basis of the Cell processor, which will contain multiple chip cores that handle a variety of tasks.

Sony, Toshiba and IBM, however, have been working on Cell since 2001, and it won't come out until at least late 2005. Doherty speculated that Microsoft's IBM-flavored processor probably wouldn't represent as radical a departure as Cell, but the chip would differ from the silicon found in Macs.

"They are going to make sure that it is not a rubber stamp of someone else's," Doherty said.

ATI's Evenden said, "you want to leverage as much of your intellectual property as possible" from the PC market in making game console chips. There are, however, substantial differences. With a PC chip, users want to adjust the resolution and other factors. In consoles, companies don't have to worry about those issues.

Manufacturing is also uncertain. Although no deal has been signed with IBM, it is inevitable that Big Blue will make some of the chips, said Glaskowsky. IBM embarked on a strategy in 2002 to sign intellectual property and/or manufacturing contracts with high-profile chipmakers.

Some of its clients include Advanced Micro Devices and Analog Devices. IBM also upgraded its East Fishkill, N.Y., fab to handle some of this work.

Microsoft, though, will have options. Chartered Semiconductor, a Singapore-based foundry, is redesigning some of its fabs with IBM's cooperation so they will be virtually identical from a manufacturing standpoint, as IBM's. Typically, Asian foundries charge lower fees than IBM.