Microsoft corporate vice president Peter Moore

Sometimes, it just doesn't pay to be first. Microsoft's Xbox 360 videogame console beat its competition--Nintendo's Wii and Sony's Playstation 3--to the market by a full year. And despite the Wii's explosive start, Microsoft is still clinging to its global lead, while former market leader Sony struggles to catch up. But a growing problem whose existence had been mostly confined to the videogame intelligentsia--the three flashing red lights indicating that one's Xbox 360 has completely malfunctioned (also known as the "Red Rings of Death")--burst into the public eye Thursday afternoon. After the market close on the East Coast, Microsoft announced that it would take a charge of $1.05 billion to $1.15 billion to cover the costs associated with the Xbox 360's "unacceptable" failure rate; specifically, for extending its warranty period from one year to three [for three flashing red light failures only], and to reimburse those who paid for repairs after their one-year warranties expired. We spoke with Microsoft entertainment and devices corporate vice president Peter Moore on Friday, and though he was candid throughout, the big question--what exactly is the problem?--remains unanswered. Asked whether the issue is a single problem with the cooling design--as several armchair engineers and numerous gamers believe--Moore stated, "I'm not going to pretend to be technical on this issue, but it's been a multitude of problems. There's no one specific factor we can point to." Yet Moore insists that the problem is not systemic, and he refused to say whether the flaws lie in design or manufacturing.

Nevertheless, the amount of money that Microsoft has set aside, when divided by the 11.6 million Xbox 360s that Microsoft has shipped, comes out to roughly $100 per unit sold, an amount that industry veterans say is right around what it would cost for shipping, handling, labor and replacing the entire motherboard for a console of that complexity. Excerpts from our conversation:

All right. You're live and direct.

OK. Let me take you though what we've just announced about 15-20 minutes ago. You know about the fundamentals. Business is strong; we're going to have a good E3, but to cut to the chase, there's something we haven't done so well, and that's that the rate of repairs that have been coming in showing the three-flashing-red-lights error message has been, quite frankly, unacceptable to us. So we've decided to take some steps to take care of that.

Firstly, we're making improvements to the console itself that will reduce the occurrence of these issues. But perhaps more importantly, we're implementing an enhanced warranty program to cover the general hardware failures, the ones that are indicated by the three flashing red lights. So we're announcing a specific warranty coverage extension to three years for any console that displays the three-red-light error message. If you get that, we'll repair the console, free of charge, including shipping, for three years from the purchase date. And perhaps equally important, for the people who have already paid us to get it fixed out of warranty, we're going to retroactively reimburse any customer that's had that problem and has paid us to fix their box--from the get-go. So we will be able to take care of everybody that's had this message from launch onwards. And the three-year warranty will be in place immediately, and will cover every box that's been bought or is about to be bought.

There's obviously no safety issue here, and this decision to do this is voluntary on our part. It obviously comes with a cost, and we're going to be taking a $1.05-$1.15 billion pretax charge to earnings for the quarter that's just ended, our fiscal year Q4 for FY07. That will cover the cost of being able to put this program in place. We continue to stand by the product, as you know, and we'll hopefully be able to take care of some people that we haven't done a good job with over the past few months.

The word that you used is that the rate of repairs for Xbox 360 consoles showing the three red lights was "unacceptable."

Yeah.

When did it cross that threshold? Walk me through the stages from awareness to growing concern to unacceptable.