In a stunning reversal, the company announced that the system would no longer require an Internet connection to play offline games (beyond an initial period when users first set up their system), dropped all restrictions on trading and loaning games to friends and did away with region-locking restrictions.
Citing "feedback from the Xbox community," Microsoft unveiled the changes late Wednesday.
"We appreciate your passion, support and willingness to challenge the assumptions of digital licensing and connectivity," said Don Mattrick, president of Microsoft's Interactive Entertainment Business in an open letter to gamers. "While we believe that the majority of people will play games online and access the cloud for both games and entertainment, we will give consumers the choice of both physical and digital content. We have listened and we have heard loud and clear from your feedback that you want the best of both worlds."
Analysts quickly cheered the move.
"This is the fastest Microsoft has reacted to anything in quite some time," said P.J. McNealy of Digital World Research. "It's a credit to them but it also underscores how critically important this launch is for Microsoft as a company. This is the largest hardware product launch at Microsoft for the last 10 years and it sets up the next 10 years."
Microsoft had previously announced it would require Xbox One users to check in online every 24 hours or games would cease to function-even in single-player modes. The company also noted today that downloaded games would be playable offline-a key concession, given the growing emphasis on online distribution in the next generation.
With the announcement, Microsoft hopes to nullify some of the damage the company did to its reputation with gamers at E3 and the weeks leading up to it. Sony undercut the Xbox One's price by $100 at E3, but the real reaction was for its clearly stated policies on used games (which would work the same way they do this generation) and mandatory Internet connectivity (there was none).
During the show, Amazon polled customers to see which next-gen console they planned on preordering. The results were staggering, with the PS4 outperforming the Xbox One 18 to 1-garnering 94 percent of the vote before the poll was taken down.
(Read More: E3's Winner: Xbox vs. PlayStation )
The news is also a potential big boost for GameStop, whose stock has suffered as investors worried about the fate of its used-game business. In its most recent fiscal quarter, 28 percent of the company's overall sales were from used video game products-bringing in $496.3 million. Used games represented more than 48 percent of GameStop's gross profits.
GameStop shares were up more than 6 percent in after-hours trading Wednesday.
The announcement could also benefit third-party publishers, including Electronic Arts, Ubisoft, Activision-Blizzard and Take-Two Interactive Software. Not only does it make the Xbox One a better bet at retail, increasing the potential reach for their titles, it relieves them of having to decide individual policies on used games. (Previously, publishers would have been able to block used games on the system).
"It was clear after E3 that [Microsoft] had to react, and reacting now is a heck of a lot better than reacting in September," said McNealy. "They were getting killed on the PR front by Sony, and this allows them, from their perspective, to put the issues to rest."
By changing stance on its controversial digital-rights-management stances, Microsoft can now focus on arguing the value proposition of its higher price. Before this, that argument would have been obfuscated by the controversial policies, says McNealy.
"It isn't just about price, it's about value," said Yusuf Mehdi, vice president of marketing and strategy for the Xbox division at E3 last week. "We believe we have incredible value for the price we're offering our system. And I think it's unmatched compared to other things."
While the $100 price difference is still a hurdle that must be cleared, both publishers and analysts say it will be much easier to accomplish that now that Microsoft has bowed to public pressure on its most controversial practices.
And with nearly six months remaining before the new systems launch, there's still time for Microsoft to either bundle games with its system or secure subsidies from partners that would allow it to lower the Xbox One's price.
"We're just putting our shoes on to get to the start line of a long-distance race," says Peter Moore, chief operating officer of EA. "I think you're going to see creative pricing models that would let the consumer, in their mind, make a commitment."
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image: © Nils Geylen