With all of the discussion around Microsoft's dramatic turnaround with its last price cut, there is one important fact that was kind of lost in the excitement.

The 360 Arcade became a legitimate product.

History:

Microsoft launched the 360 with two models: the Premium and the Core at the price points of $400 and $300 respectably. The Premium was an instant hit while the Core was left to be rediculed by the gaming community and had measly sales.

Even when Sony launched the $600 PS3, and the Core was only half its price, nobody was buying it. In mid 2007 Microsoft tried to revive the Core by renaming it Arcade and bundling a few games with it. Still, there were almost no takers. Even when the price was lowered to $270, nobody paid any attention to this disk-less machine. The only legitimate offerings from Microsoft were the Premium and Elite models.

When Sony dropped the PS3 price to $400, Microsoft was in a bind. It was really struggling in the market with the value proposition of the $300 Premium vs the $400 PS3. It seemed like for just $100 more you get Blue Ray and so much more. And indeed, after the Halo3 boost was over, the PS3 started making rapid gains in market share.

But then came September 2008 with the dramatic price cut of the Arcade from $270 to $199. And WOW! Suddenly the sub-$200 price tag grabs everyone attention. Microsoft soon reported a 600% increase in the sales of the Arcade model. Yep, it started selling like pancakes.

The lowly Arcade suddenly got the limelight. It became the banner for Microsoft price differentiation compared to the PS3 (and to a lesser degree the Wii). Suddenly it was all about the $199 vs the $399 price gap. Half-Price! Wow! This  led a huge reversal in market position and the Arcade became a major seller for Microsoft.

Analysis:

Why is this important? Because in the process the Arcade became a legitimate product, worthy of consideration. From now on it is not the PS3 vs the Premium anymore. It is the PS3 vs the Arcade. This is the price comparison in everybody's mind (unless you are a hardcode PS3 fan).

Moving forward, it is the PS3 that is in a bind. A $50 price cut is just going to make it a $349 vs $199 comparison. It does not move the needle much. Only a $100 price cut may significantly change the market perceptions. But can Sony’s cost structure afford it without suffering a red-ink bath? I doubt it.

Legitimizing the Arcade was a brilliant move by Microsoft. How will Sony get out of this jam?

Bundles. One thing consumers love about buying stuff is all the "free" stuff they think they are getting. I put up a post not-too long ago about a 450 dollar xbox that includes eight games. The 399.99 PS3 is just that, a PS3. No games, one controller, no HDMI cables. Its your bare minimal system. So often compare this to the arcade.

I can't compare it to the pro because the pro comes with 2 games, and is 100.00 dollars cheaper, the elite also comes with 2 games currently. At the same price.

So why compare a 80 gig PS3 to the Arcade Xbox 360? Because the bundle is at its very bare minimal. For both systems it seems although Sony and Microsoft ripped everything extra outta the box to dwindle the price down. The big difference between the two is obviously the 80 gig hard drive. But honestly, 80 gigabytes now-a-days should be cheap. Most 80 gigabyte hard drives are less than 50 dollars if even that.

The other difference is the blu-ray player. But thats another story.

The people they are attempting to appease to with the arcade (and by way of bundling Legos Indiana Jones and the such) isn't the same people who would really want online and downloading stuff. So, for what its marketed for, the arcade works fine.

i thought this thread was going to be about the XBLA

Sony's best strategy would be to use the weak points of the Arcade as it's strength. Start running adds about the 360's lack of a hard drive (of course not mentioning that it's only an arcade problem) and the limits it sets on online experience if there's one thing people hate it's buying the inferior system and missing out on the best experience they'll probably never use.

Also multi-pack bundles would be a great idea, a PS3 with a game and a couple hot BluRay movies should help justify the extra expense.

The real question is what they do with the Arcade in the future!

I can see 3 good choices.

1. Do nothing, it works why change it?

2. Put an SD card slot. You can grab a 4gb SD card for like $10, but they lose the HDD upgrades. They could do this if they intend to drop the price of the Premium but not the Arcade, otherwise it wont make sense.

3. Install a small flash HDD like Nintendo does, possibly a combination with 2. It doesn't have to be much, but 4gb would allow people to say download Live Arcade games and stream netflix which should help them sell Live content and Live Gold subscriptions.

So essentialy you are suggesting that Sony will try to de-legitimized the Arcade model again. Questionable startegy. Using your airtime to discuss the competition is something that draws attention away from you. The results are also questionable. Microsoft is openly positioning the Arcade as a "starter" system. Sony can only re-enforce the same message, but can hardly chip at the system credibility with the Arcade current positioning.

There is something pretty smart about what Microsoft is doing here: When you want to push a system, make sure to position it as the "moderate priced" or the "mid-level". Microsoft Microsoft wants to push the Pro, so indeed they have a cheap model (Arcade), a medium price model (Pro) and share with Sony the expensive ones (Elite and PS3).  This way Microsoft is covering both the low-end of the market with the Arcade and offering the Pro to the masses of "risk avert buyers" - the ones who are afraid to buy the cheap system (because they may miss something), and will also avoid the higher end systems (becuase they don't think themselves as rich and they don't want to overpay).

By establishing these three tiers, Microsoft pushed Sony to be in the "luxery" department. And the luxery products rarely get mass market adoption.  

BTW, the arcade is lacking a hard drive, but it is not lacking a full on-line experience.

Squilliam said: The real question is what they do with the Arcade in the future! I can see 3 good choices. 1. Do nothing, it works why change it? 2. Put an SD card slot. You can grab a 4gb SD card for like $10, but they lose the HDD upgrades. They could do this if they intend to drop the price of the Premium but not the Arcade, otherwise it wont make sense. 3. Install a small flash HDD like Nintendo does, possibly a combination with 2. It doesn't have to be much, but 4gb would allow people to say download Live Arcade games and stream netflix which should help them sell Live content and Live Gold subscriptions.

I vote for (1). Microsoft is comfortable with the Arcade as a "starter system". They want to see customers buying accessories or electing to buy the Pro for more features. Upgrading the Arcade might just takes sales away from they other higher margins SKUs without any revenue increase.

The Arcade is doing its job perfectly.

Yeah, on top of that. The biggest difference between the arcade and the pro is the hard drive. Simple solution to increase arcade sales even further is to drop the price of the 60 gig hard drive. Or begin to market the 20 gig hard drive again at retail stores for 39.99. It won't be part of the packaged deal, but if people can buy a cheap system with a cheap hard drive as a option to them. I'm sure a lot of people will be interested in the arcade as the "casual" xbox 360. It seems that microsoft is trying that approach anyway.

 They are. You can get a refab 20GB drive directly from Microsoft for $20. Good deal.