Monday, July 09, 2007

What did they know, and when did they know it?

The focus of my initial post on the latest Xbox fiasco was primarily on the seemingly endless trail of management incompetence. In thinking about the issue further, I'm not sure that's enough. In fact, I'm wondering if this situation isn't potentially far more serious, possibly even actionable. I'm also wondering if my initial inclination to discount calls from commenters for an SEC investigation was right, and whether that may not be a possibility after all - or at least a risk.

It's one thing to stonewall and put a positive spin on bad news. We might disagree on the extent to which that should be condoned, but it's not illegal per se and is unfortunately commonplace. It's another thing entirely, however, for the executive officers of a public corporation to knowingly make false statements to media and analysts, attempt to conceal material information from shareholders and possibly even from reported financials, or remain silent while seeing others engage in that behavior. At best, it is unethical/unacceptable and risks a shareholder lawsuit. At worst, it raises the specter of a full SEC investigation and resulting charges/fines/restatements if found guilty - not to mention shareholder lawsuits.

Determining which we're dealing with here, seemingly hinges on answers to a relatively short list of questions, none which MSFT has addressed publicly, but all of which the Board could easily determine (more on that later). They include:

  1. What is the overall Xbox 360 failure rate due to manufacturing defects/design shortcomings?
  2. When did it first become "unacceptably high"?
  3. What was the "acceptable" threshold and how does it relate to industry norms?
  4. If it is significantly higher, what is the justification for the delta and who authorized it?
  5. To whom was the abnormal failure rate information communicated and when?
  6. What actions were taken to address the problem, by whom, and when?
  7. Were any of the subsequent remedial changes recommended during the initial design and/or manufacturing process? If so, which ones, why were they ignored initially, and who authorized it?
  8. Was proper accelerated life testing done before launch? If not, why not? (FWIW, Bach says it is being done now).
Here's a very cursory and incomplete review of event chronology:

November 2005: Xbox 360 is launched

  • Shortage of available units is blamed on insufficient manufacturing ramp up time. Others later charge that this was a result of - or at least exacerbated by - low yield, which itself should have acted as a warning of future problems.

  • Articles detailing how to fix the overheating problems begin to appear almost immediately.

  • MSFT's own Mini-Microsoft does a post on the topic of overheating and red circles (later called Red Ring(s) of Death or RRoD), which turns out to be rather prophetic.

  • MSFT responds with:
The vast majority of Xbox 360 owners are having an outstanding experience with their new systems.

December 2005

  • Robert Byers, a Chicago man who purchased the Xbox 360, files suit in a federal court accusing Microsoft of selling a defectively designed product.
September 2006

  • September 22, 2006, MSFT admits to problems with some early units, waives the cost for repairs on all Xbox 360 consoles made before January 1, 2006, and refunds any fees already paid.
  • By this point, MSFT has a full page dedicated to the issue on its web site, and RRoD is one of the command prompts on the support line.

June 15, 2007

  • Todd Holmdahl, Microsoft’s corporate vice president of Gaming and Xbox Products Group, does his best to deny there is any abnormal failure rate, claiming the issue is limited to a "vocal minority".

July 5, 2007

  • MSFT admits the problem, calls the number of failing units "unacceptable", changes the warranty for RRoD specifically, and takes the $1B+ financial charge.

  • Peter Moore, Corporate Vice President, Interactive Entertainment Business, Entertainment and Devices Division, indicates that they began investigating this just "weeks ago".

  • Robbie Bach, President, Entertainment and Devices Division, states that:

For a little over the first year this problem, or this set of issues, wasn't visible at all.

  • MSFT adds that:
The majority of Xbox 360 owners are having a great experience with their console...

[Hmm...that last one sounds familiar somehow. Only "vast" got dropped from majority, and "outstanding" is ratcheted down to just "great". Is MSFT legal doing some advance damage control?]

Given the scope of the problem, resulting financial charge, and potential risk of future legal and/or SEC exposure, common sense - not to mention fiduciary responsibility - argues that the Board of Directors get involved to satisfy themselves that appropriate, defensible answers are forthcoming to the questions above. And not wrt word-games about the meaning of "minority", or wasn't visible for "this set of issues". But on the core topic of overall reliability vis a vis industry norms, and MSFT's resulting actions. Specifically, Moore is quoted stating that:

The information that we knew we had a bad box, we kept shipping it. That’s completely wrong.

The Board needs to determine if that is accurate, using generally accepted industry standards for failure rates as the hurdle. If it is, great. Although by way of full disclosure, I should add that I'm beginning to seriously doubt that is the case. Even if it is, there seems to be no interpretation under which Holmdahl isn't guilty of being hopelessly deceitful when he made his statements defending Xbox reliability three week ago. As such, he needs to be severely reprimanded or fired.

If, on the other hand, those acceptable answers aren't forthcoming, then it's very serious. Under that scenario, imo, every senior manager who knowingly tried to conceal the problem, made false and misleading statements, and/or stood by while they were aware of others doing so, should be fired - period. If that includes Ballmer, he should step down. If charges should have been taken earlier, or shouldn't now be taken as special one-time ones, then bite the bullet and restate/change future guidance accordingly.

Shareholders deserve a clear assurance that management acted appropriately in this matter and can be trusted. The current leadership word-games, unwillingness to detail the specific nature of the issues, and refusal to confirm whether overall failure rates are at or below industry norms, is not providing that. Will the Board act to fill the gap?

: Related.

Update #2:


  • answers to a relatively short list of questions might also include:

    Who received what MSFT or $$$ incentives related to the Xbox 360 program?

    What volume T&C's (including penalties & indemnities) exist with XBox 360 mfg suppliers and sales partners, who awarded/approved them, and were any incentives involved?

    What XBox 360 related legal actions/threats/complaints have been brought against MS, when, and if/how settled?

    By Anonymous Charles, at 5:55 AM  


    What's interesting is the timing. Are the retooling costs hidden in the $1 billion red ring of death writedown announced last week? The migration to smaller chips was planned, so that doesn't seem like it should go into the extraordinary writedown category.

    Also, what took so long to upgrade to the new chips?

    Was Microsoft waiting for chip producers, or was it holding back on the next iteration because it wasn't meeting its version one sales targets?

    By Anonymous Anonymous, at 9:35 AM  

  • Few people are getting the full implications of the announcement of the Microsoft Development Center in Vancouver, British Columbia. For those not aware of it: that is the Vancouver in Canada, north of Seattle, not the one down theI-5 in the way to Portland, Oregon.

    Microsoft is not only solving the problem of thousands of Indians, Chinese and other immigrants that currently are almost at the end of their H1-B period and have no hope of getting a green card. Microsoft is also paving the way to massive savings that probably would compensate for the aQuantive, Xbox and Great Plains/Navision mistakes in the long run.

    Microsoft was fighting a lost battle against Silicon Valley and the “Seattle Valley” to get talent at huge cost. Now, instead of paying U$80K to get a junior developer in Redmond, what about paying CAD80K (Canadian Dollars) for a top Software Engineer in Vancouver?

    Also, think about the consequences for the Redmond region: instead of more and more people competing for houses that get farther each day, now there will be at least 2 thousand people leaving probably in the next 2 years. Pop!Was that the house market in Redmond or Sammamish? Boom! Was that the explosion of house prices in the distant Duvall?

    By Anonymous Anonymous, at 1:13 PM  

  • "Few people are getting the full implications of the announcement of the Microsoft Development Center in Vancouver"

    I don't know what that has to do with my post. But I couldn't figure out another to shift it into and didn't have the heart to round file it. WRT the Vancouver center, I have no problem with it (beyond my oft repeated concerns of MSFT's bloat), and am for anything that cuts costs w/o impacting effectiveness. BTW, CDN $ and US $ are pretty close these days. So the savings there are probably minimal vs say health care costs.

    By Blogger MSFTextrememakeover, at 1:34 PM  

  • While we're thinking about the SEC... how about the timely sell-off of stock by robbie (and lisa) in advance of the notice?

    By Anonymous Anonymous, at 10:13 AM  

  • Hey, you really might want to listen to the speech Peter MOore and Robbie Bach gave to financial analysts yesterday, it;s linked from the MSFT investor relations site.

    They gave a lot of reasons why they're certain Xbox will be profitable in 08, and they're not at all backing down from this. Curious about your take.

    By Anonymous Anonymous, at 10:56 AM  

  • "Curious about your take."

    WRT FY08 profitability: With the recent $1B+ charge now neatly tucked away in FY07 and their reputation - and possibly career -on the line, they'll likely find some way to accomplish it, albeit probably marginally so.
    WRT the call generally: Amazing - and not in a good way.

    By Blogger MSFTextrememakeover, at 2:46 PM  

  • is there a transcript of this conference call?

    By Anonymous Anonymous, at 12:33 AM  

  • And... just in - Peter Moore leaves Microsoft to go to EA! Is Robbie next?

    By Anonymous Anonymous, at 3:31 PM  

  • I'd say that Moore leaving is a good start. Now for Bach.

    By Anonymous Anonymous, at 3:43 PM  

  • Well, looks like Peter Moore is getting an opportunity to "explore other opportunities":

    Could he be the first of many?

    By Blogger James, at 3:48 PM  

  • I could care less if Bach goes now or later. Sure the $1B charge is hard to swallow but that pales into insignificance with what Ballmer has cost the company in the last 5-6 years in terms of lost opportunities.

    Start at the top, get rid of Ballmer, find a true leader and get this company back on track. Isnt this obvious to every shareholder - obviously not :(

    By Anonymous Anonymous, at 4:08 PM  

  • Microsoft's Bach sold more stock before Xbox news:

    "But according to the filing Monday, Bach had sold just more than $3 million worth of company stock on May 1. Microsoft spokesman Eric Hollreiser said that the additional $3 million in sales were not registered in a timely manner with the SEC "as the result of an administrative error.""

    Administrative error. Golly. Who knew?

    By Anonymous Charles, at 11:12 AM  

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