Three flashing red lights are joining the blue screen of death atop the list of things that Microsoft Corp. customers dread.
Troubled by an "unacceptable number" of malfunctions in the Xbox 360, Microsoft said Thursday that it had set aside more than $1 billion to take care of customers who suffered from the "three flashing red lights" error messages.
"This is the largest warranty extension of its kind, ever," said Richard Doherty, research director at Envisioneering Group, a consumer electronics consulting firm in Seaford, N.Y. "In dollar terms, there's been nothing like this before -- not for television sets, not for DVD players, not for home stereos."
The admission of hardware problems also could prove costly to Microsoft's reputation. The software giant is counting on the Xbox 360 to help it establish as big of a beachhead in the living room as the company now has in the office, with its dominant Windows operating system.
With 11.6 million Xbox 360s sold, Microsoft is the early leader in the current generation of game consoles, letting its customers not only play games but also surf the Web, buy movies and communicate via television. But the glitches could provide an opening for its powerful rivals, Sony Corp. and Nintendo Co.
Microsoft said it would repair or replace all game systems that go on the fritz and reimburse customers who had their broken consoles fixed. It also plans to extend the warranty, from one year to three, for broken consoles.
"This problem has caused frustration for some of our customers, and for that we sincerely apologize," said Robbie Bach, president of Microsoft's entertainment and devices division.
As a result, Redmond, Wash.-based Microsoft plans to take a financial charge of as much as $1.15 billion for its fiscal fourth quarter, which ended Saturday.
The sum dwarfs the $429 million that Sony reserved last year to recall 9.6 million laptop computer batteries that could catch fire when overheated. Microsoft says the consoles pose no safety hazard and is not recalling them.
Microsoft declined to say how many of its consoles could be affected by the glitch, which causes the machine to freeze. But some analysts say the sizable financial charge indicates that Microsoft is expecting a high rate of failure.
"With the amount of money they're putting in reserves, it looks like they're expecting 1 machine in 4 to fail and require a warranty," Doherty said.
Analysts said the warranty-and-repair program essentially added $100 to Microsoft's cost for each of the consoles sold since the Xbox 360's debut in November 2005. Microsoft sells its consoles for $299 to $479, depending on the size of the hard drive.
Because the charge is being taken during the company's just-ended 2007 fiscal year, Microsoft still expects its Xbox division to be profitable in the current one.
Its shares fell 3 cents to $29.99 in regular trading, then slipped to $29.88 in extended trading.
"Microsoft has a lot of inventory in the channel, and all of it is probably subject to this failure," said Van Baker, vice president and research director at Gartner Inc.
Analysts chalked it up to an expensive learning experience for Microsoft, which rose to prominence in the high-tech industry by making software, not hardware. With the exception of mice and keyboards, Microsoft started manufacturing computing hardware only when it launched the first Xbox in 2001.
"This is the problem of a company that has not been historically a large-scale manufacturer of a consumer electronics product," said Michael Pachter, an analyst with Wedbush Morgan Securities. "These are the growing pains that you have when you're learning how to do that. It's good they're facing the issue head-on and not running away from it."
Richard Mitchell, lead writer for the Xbox 360 Fanboy blog, said concerns about the "three rings of death" had kept some gamers from buying the console. "The three-year warranty will go a long way toward assuaging their fears," he said.
But some Xbox owners aren't fully appeased, including Dustin Burg, a 21-year-old from St. Cloud, Minn. He is on his third Xbox 360 console -- the first succumbed to the flashing three red lights and the second had a faulty hard drive.
"I really do think Microsoft is trying their best to make things better for their customers," said Burg, who said Microsoft replaced both consoles and paid for the shipping charges. "At the same time, I feel they're not being 100% upfront about telling us what's wrong with the box."
Peter Moore, vice president of Microsoft's interactive entertainment business, declined to describe the cause of the problems other than to say that they involved a number of issues with the hardware.
Microsoft said Xbox 360 owners with questions about the warranty program could call (800) 4-MY-XBOX (469-9269) or visit www.xbox.com.