Microsoft believed in HD DVD but last generation their biggest issue was bringing down the cost of the original XBox. This is the biggest reason why they did not put HD DVD into the 360. Microsoft stated many times when they started the generation that they wanted to give consumers choice and did not want to force this cost on them.
If they did, Sony would be in 2nd place this generation right now and not 360. A huge reason why Microsoft is maintaining 2nd place is because Sony has been unable to move on price. Giving HD DVD capability to 360 was a hedge bet. If HD formats would have taken off, they would have one on 360. But, because the adoption of both HD formats ended up being so slow they decided it wasn't worth it to continue once blu-ray one the war.
As for digital distribution, Microsoft has simply responded to market demand. The popularity of Steam is forcing consoles to go this way.
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