Microsoft Xbox: The damage has been done

June 20, 2013: 6:56 AM ET

However, the company's about-face on policies users found unbearable will help.

By John Gaudiosi

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FORTUNE -- Anyone who questions the power of the crowd need only talk to Microsoft.

In a stunning reversal, the technology giant made an abrupt about-face on some of the controversial features of its upcoming Xbox One console. The company scrapped requirements that would have prevented users from playing offline games and made it difficult to sell used games in response to fierce online criticism. Don Mattrick, president of Microsoft's (MSFT) entertainment unit, made the announcement in a June 19 post on Xbox.com addressed to gamers: "You told us how much you loved the flexibility you have today with games delivered on disc. The ability to lend, share, and resell these games at your discretion is of incredible importance to you. Also important to you is the freedom to play offline, for any length of time, anywhere in the world."

Michael Pachter, video game analyst at Wedbush Securities, said he not only thinks it's the right thing to do, but Microsoft is timing it well. "Microsoft was wounded by the reaction to its E3 press conference, and I think they genuinely want to do the right thing," said Pachter. "The 'always connected' requirement arose from their desire to provide instant access to games, rapid switching between games, TV, Skype, and Internet browsing, etc. However, to accomplish that, they required games to be written to the hard drive, which prompted a need to ensure that the same game wasn't copied multiple times to different Xbox Ones, hence the onerous DRM."

Pachter believes Microsoft will sell 3 million Xbox Ones by the end of this year worldwide and another 11 million consoles next year. He gives Sony (SNE) an edge in the next-gen battle with 3 million PlayStation 4s sold this year globally and 13 million next year. Short supply and the global markets will limit sales this November when the next-gen devices launch. While gamers spoke with their voices, they also voted with their wallets. Some sources point to PS4 outselling Xbox One by a rate of two to one on Amazon (AMZN) coming out of E3 last week.

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P.J. McNealy, video game analyst for Digital World Research, believes Microsoft deserves credit for responding so quickly, but this also raises the question about what has happened with pre-orders. "Pre-order numbers couldn't have been pretty," said McNealy. "And this is the most important launch in the past 10 years for Microsoft."

Jeremy Miller, video game analyst for DFC Intelligence, said that while on the surface this reversal should help Microsoft regain at least some positive sentiment from consumers, it won't completely shift the perceived balance of power from PS4 to Xbox One. One reason is because Microsoft is still selling its console for $500, while Sony's device costs $400. "Microsoft, and Sony for that matter, have more complicated stories to tell this time around about features and value propositions as compared to the Xbox 360/PlayStation 3 launches," said Miller. "Buying a new console can be a big financial and emotional commitment. Building confidence and trust in what your product will deliver is more important than ever. Microsoft's job now is to lock in the product plan and get the message out there in a consistent, clear way."

This move is good news for game rental companies like Gamefly and RedBox, which will be able to offer next-gen games alongside current PS3, Xbox 360, Wii, and Wii U titles. It's also a win for the used games market, which accounted for over $1 billion last year for top game specialty retailer GameStop (GME). In a statement, GameStop said, "This is great news for gamers, and we applaud Microsoft for understanding consumers and the importance of the pre-owned market."

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Veteran game developer Lorne Lanning, founder of Oddworld Inhabitants and creator of the PS4 game, Oddworld: Abe's Oddysee New N Tasty, said today's gamers view their game purchases as a commodity that they can use to offset the $60 price point of today's software. "It's a marketplace for individuals to trade their stockpile of games for newer titles," said Lanning. "Not listening to that audience today and trying to halt that ownership gamers feel for their games is damaging to one's own brand."

The damage has been done for Microsoft. Now it's trying to rebuild its relationship with the core gamers who are vital to the industry, even as the gaming demographic broadens with mobile and free-to-play games. Independent video game analyst Billy Pidgeon believes strong negative feedback from the gamer community directed toward Microsoft's statements regarding software authentication on Xbox One would not have significantly affected launch sales of either console, but ignoring gamer criticism could have slowed sales over 2014.

"Microsoft's failure to respond to gamer sentiment at E3 opened up a competitive advantage for PS4 that Sony was able to creatively exploit," said Pidgeon. "Microsoft's response may be a little late, but making an apparent turnaround on Xbox One's DRM and used games policy will likely gain back much ground lost to gamer dissent. Still, Sony was able to gain an edge that should boost PS4 sales well into 2014."

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