Microsoft’s Xbox advertising ambitions

Last week, Insider reported that Microsoft is in the exploratory stages of establishing an advertising platform for its Xbox console. According to the reporting, Microsoft would allow select brands, via a Private Marketplace, or PMP (effectively an invite-only auction), to advertise in free-to-play games on the Xbox console. Details about the platform are currently scant.

(Note that in the tweet thread above, I mistakenly use Morgan Stanley’s ticker symbol, $MS, in place of Microsoft’s, $MSFT. Mea culpa.)

That Microsoft would seek to introduce ads to the Xbox environment is not altogether surprising: I posited back in January that, if an ad network were introduced to it, Microsoft’s proposed acquisition of Activision could spawn a considerable content fortress, consisting of a substantial content portfolio spanning mobile, desktop PC, and console, all supported by a premium subscription product on Xbox, the Xbox Game Pass, with 25MM active subscribers. Such a large, contextually-homogenous yet platform-diverse pool of content creates the conditions for efficient cross-promotion and augmented monetization efficiency through personalization (eg. sales and special offers) using first-party data. But an advertising platform is needed to unlock this functionality.

I use the phrase ‘advertising platform’ here purposefully ambiguously to mean two related but distinct things:

  • The tools and targeting logic required to deliberately and conscientiously serve specific content to specific users at specific moments in specific placements;
  • The infrastructure required to allow advertisers to purchase inventory in designated advertising placements.

The existence of the first bucket of functionality doesn’t necessarily imply the existence of the second; this is the underlying distinction between a content fortress and a walled garden, as I explain in this piece:

Ultimately, a Content Fortress fits into the post-ATT reality by subsuming third-party content interactions into a first-party setting. Note that a Content Fortress is different from a Walled Garden: a Walled Garden engages users with (often user-generated) content and monetizes that engagement by allowing advertisers to purchase ad impressions that lead the user to an external destination…But this dynamic ended with ATT, at least on iOS. ATT prevents user-level data transfer between an ad platform and an advertiser’s property: ad platforms aren’t allowed to observe the actions that users take following an ad click…A Content Fortress sidesteps this restriction by bringing the third-party content that previously existed independently onto the advertising platform as a native experience.

A content fortress allows a publisher to maximally capture engagement across its content portfolio by using its first-party access to user data to efficiently route users throughout its portfolio or to personalize in-product experiences. The transformation of a publisher, platform operator, or walled garden into a content fortress can unlock value in and of itself without requiring that ad inventory be sold to external parties, as I explain here.

I make a similar point in Netflix already operates an ad network. Next stop: Content Fortress., in which I argue that, rather than selling advertising inventory, Netflix should utilize its growing, multi-property content portfolio and existing personalization technology (“ad platform”) as a content fortress to improve user growth and engagement (for a sharp and well-reasoned argument in the opposite direction, read Ben Thompson’s piece on the topic).

Why would I advocate for Netflix to avoid selling inventory to external advertisers while championing Microsoft’s ambitions to do so with Xbox? Because the respective business models are entirely different: the Xbox operates a storefront that allows developers to sell their products directly to consumers, and Netflix is a curated content service. Both platforms feature a subscription product, but the Xbox Game Pass simply makes some content available for free when a developer opts into doing so (which not all developers do), and Netflix gates all of its content behind the subscription, with content producers being paid a flat licensing fee. Content creators for Netflix are not compensated based on engagement, but Microsoft uses a hybrid model for Xbox: game developers can generate revenue through (1) direct sales on the storefront, they can (2) participate in a usage-based royalty structure through Game Pass, they can (3) sell their content to Microsoft for a one-off fee for inclusion in Game Pass, or they can (4) negotiate some combination of these revenue models (Microsoft also more details in this interview with Xbox chief Phil Spencer).

Because of this hybrid-model structure, I believe Microsoft should both create the infrastructure to allow for personalization and cross-promotion for its own first-party content and give developers the ability to leverage that infrastructure to auction their inventory to external advertisers. Ultimately, creating a personalization engine available for use by developers and pairing that with a proprietary Xbox ad network incentivizes developers to go Xbox exclusive and to participate in the Xbox Game Pass. If Xbox’s personalization engine is made available to game developers, then those developers are better able to monetize their games’ DLC on Xbox relative to other platforms. And if developers can make money from their games on Game Pass through advertising, they are more inclined to participate in that program, and ultimately, to shift their games’ commercial configurations to free-to-play, which can create much more favorable unit economics for games and lead to revenue outcomes that are preferable to both developers and consumers.

Many developers view Game Pass and other similar programs as a race to the bottom: once developers begin giving away content, customers become accustomed to not paying for content, and so all content must be given away. That’s only problematic when the only revenue model is content licensing or platform-dictated, usage-metered revenue share agreements. If developers can manage and optimize their own revenue outcomes through platform-specific personalization tools (for maximizing DLC revenue) and through selling ad inventory, then a system like Game Pass becomes much more amenable to developers. It absolutely makes sense for Microsoft to develop a personalization engine for the Xbox: to utilize within its own content portfolio, and to use as a carrot to encourage developers to participate in Game Pass for their own benefit.