With Xbox 360 Sales Slowing Down, Windows Phone Desperately Needs to Succeed

Microsoft had mostly good news to report in its third quarter earnings today, though one division stood out as the biggest loser: Entertainment & Devices, home of the Xbox and Windows Phone.

The division reported revenue of $1.62 billion, down 16 percent from a year ago. Microsoft blamed “a soft gaming console market” for the decline. Indeed, the company remains the leader in the video game console market with a 42 percent share, even though Xbox 360 sales were down 48 percent at 1.4 million units sold.

Microsoft also noted that Xbox 360 platform revenue was down 33 percent at $584 million, due to the slower console sales (and reduced Kinect sales), which was offset by higher Xbox Live revenue.

As always, Microsoft didn’t break out Windows Phone sales in the earning report, likely because there isn’t much to report just yet. But with the console market slowing down — which won’t pick up until the next generation console war begins next year (not including Nintendo’s Wii U release this Fall) — it’s becoming increasingly clear that Windows Phone will have to actually start earning some money for the Entertainment & Devices division. Microsoft can’t afford to have two major product lines sagging and bringing down an entire portion of its business.

We’re only a few weeks past the Nokia Lumia 900′s launch in the U.S., so it’s a bit too early to tell how well the phone is doing. But with multiple reports of sellouts online and in retail stores, there’s a good chance the Lumia 900 will finally put Windows Phone on the map.

At this point though, Microsoft can’t afford to take things slow with its new flagship device. It needs to work double-time on encouraging sales before Samsung’s Galaxy S III and the iPhone 5 steal all of its thunder.

According to Microsoft’s 10-Q quarterly filing today, the division’s operating income also decreased, due to payments made to Nokia (Microsoft is paying Nokia $1 billion over the next few years for their Windows Phone partnership), a 33 percent increase in R&D costs, and a 50 percent increase in sales and marketing expenses.