There are three ways to make money on an Xbox. Generally it's not on the hardware itself; we'll probably be gross margin neutral on that over the life cycle of the product and try to break even on that.

The second thing you try to do is you make money on the games themselves, and there are two models there. One is first-party games that Microsoft produces. The other is games that Electronic Arts or an Activision produces, and we get paid a royalty on those games.

The third place you make money is on Live, and where we actually have a very nice service that's scaling very well, and that is a business model that's subscription, ad-based, and download-based. It kind of has the full gamut of business models associated with it, and I think you're going to continue to see that grow.

And then the final place you make money is on peripherals, so game controllers, cameras, steering wheels, a whole other set of things.

Right now we're doing a pretty good job. We're humming pretty well in the business. Our costs are a little higher than we'd like, [but] we're pushing those down; there are good initiatives underway to drive that. Game attach rate [is at the] highest level in history for a game console at this stage in the life cycle. The same with our peripheral attach rate. Xbox Live has over 6 million members.

The pieces are in place to drive the proverbial billion dollars. Specific date—oh, that's going to depend on what happens in pricing, which partly we control, partly we don't. You know what happens in component costs—mostly we have pretty good influence over that, but there are places where we don't. Pricing on memory goes up and down seemingly like a yo-yo, so [we have to manage] through that.

So, it's a business that will be profitable next year—we'll make money next year and that will be the first time, which is pretty exciting. And then the next two or three years are the place where you need to make tracks, and the next two or three years are where you have to make money.

What about the Zune? What's the opportunity there been like?

Well, … people always want to say, gosh, Apple has such a big lead, what are you going to do, how do you possibly compete with that, and why would you bother? And part of my response is, you know, they've sold 100 million devices. So, let's just do some math. You and I can do this. How many people are there in the world? Five, six billion. Let's call it five—it's a round number. Of those 5 billion, every single one of them has a music experience. Music is the most ubiquitous entertainment experience in the world. So, there's a music experience for all those people.

Let's say half of them are never going to have a digital music experience and never have a chance to have a digital music experience, so lop off 2.5 billion people.

Now let's just for yuks, because 2.5 billion is too big a number to deal with, lop off another billion people. Now you have a target audience of a 1.5 billion people. Not everyone is going to want a digital device; we can go through the yak-yak around that. But the audience is huge, and we are really early in what's going to happen in the music space. And the music industry is … in the process of reinventing itself.

And so for us, A) there's a big market; B) we think the opportunity is just beginning; and C) if you want to be in what we call connected entertainment, you have to be able to connect movies and video with music, with games, with communications technology to be able to do that. You can't not have a player.

To read a review of the Zune, click here.

So, early phases of this, we're about 10 percent market share in the category we're in, which is the hard disk. That's a good first step. Like Xbox was before it, the first step is what it is, it's nice, it's not perfect. People have commentary and questions and things we can improve, and we would say, yep, you're right. And we're not stupid, we see all those things, and we're good developers, and we know what we need to do. And you're going to see the product get better and better and better. You're going to see us be relentless in marketing. And you're going to see us expand into other parts of the category beyond the hard disk space. And I think we can be successful; I think we can build a nice business.

Click here to read Part 2 of the interview, including Bach's comments about the community that has developed around the Zune.

This article was originally published on eWeek.com.

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