Does this mean X-Box is pulling out of the console race?

No it means what a game console is is changing. 

Just like what a cell phone is today is radically different from what it was even 6-7 years ago. 

Even Nintendo has moved past the "game-only" console aspect. 

The next XBox will just push that further, so will the next Playstation (say hello to GoogleTV). 

I don't think they'll go beyond a 2 year subscription and generally most things top out at 2 years for subsidised products like phones or 1 year with things like cable/internet etc. I do think however they can get it much cheaper than $299 I would say minimum you'll get the same $200 discount on the console with the $15 per month deal so the minimum price ought to be around $99-199 depending on the base price of their cheapest console. Sometime between now and the release of the Nextbox this year they'll turn that $15 per month subscription into more than just an extra big Live payment.

They released the Xbox 360 core for $299 + Memory card or about ~$340 U.S.D so considering the fact you can buy 64GB of 50MB/S flash memory for $40 retail they could easily ship with that as the minimum spec for the console at $299 w/o Kinect with say a base of 64GB of removeable storage. The total silicon budget is likely going to be less than the 500mm^2 the 360 shipped at and saving money on packaging/shipping and using commodity parts whenever possible should help too.

A 260mm^2 main die + say a 200mm^2 'interposer with 64MB of eSRAM/IO chip/ROP (South/Northbridge) with 8GB of stacked DDR4 leveraging development from both AMD and another 3rd party company for the interposer/DDR4 interface ought to be a cheap and effective design. 

So a Smart Console

It could work if they have a fairly expensive subscription with cheap hardware (e.g. $30 per month, $99 console) and if they offer a lot of content (and I do mean a lot!). Stuff like game streaming, some specialised channels. They could effectively go the full cable route and have different prices depending on what package you want (maybe even streaming Fifa games + actual football TV channels as part of the same package). There's a lot of potential.

They could go the cable route and make it so that every game is free and content is paid for by playtime/advertising revenues as well as additional content sold. It'd be an interesting scenario say for instance to charge $300 a year (price of 5 games) to be able to play every console game ever released in a Netflix type scenario.

Edit: Would you pay $25 a month to play all you want on a console? Cable subscriptions can easily cost twice that.

The difficulty would be how the publishers/developers get paid and how much they get paid.

Payment based on how much your game is played? That would ruin a lot of shorter single player game devs.

Is that supposed to be a bad thing? I would love for next-gen consoles to be able to do half the things I do on my laptop. Of course it should be a games console first and that's what it should be promoted as.

sounds logical for MS., and offering it as a different type of device would put nextbox in an even bigger market, if MS are looking at this the way you are, but i think it's to ambitious for either manufature to try. or they'll make a gradual move towords this direction.

Those days are over even Nintendo admits it.

Multi media machines are the future.  And the OP is right.  MS wants to own the living room in every way.  That is the purpose of the Xbox brand

Damn, can't wait till E3 or Microsoft's own press conference type show presentation thingy that they'll probably have. The company is just to big to not have it's own show. I'll probably watch it on youtube or something because I live in Australia.