Last week’s $50 price cut on the Xbox 360 console illustrates the delicate pricing balance act that catalyst businesses have to play to keep their key customer groups engaged.

Game console companies make their profits from royalties they get from game publishers or from the sales of games they produce themselves. They seldom price the console at more than the cost of manufacturing it and often much lower. As Hagiu, Schmalensee and I explain in Invisible Engines: How Software Platforms Drive Innovation and Transform Industries the console companies do that because publishers will invest more in developing games for a larger base of consoles. Publishers will also sell more games and thereby increase the amount of royalties the console makers get.

Microsoft’s price cuts were as much aimed at publishers as at end users. The software giant has been battling it out with Sony for the better part of this decade and looked like it was going to take the lead when Sony flubbed the last cycle of competition. Then Nintendo’s Wii unexpectedly made the game business a serious three-way competition. So Microsoft has been faced with price-cutting competition from Sony and innovative competition from Wii. So the lower price helps persuade consumers to buy its box. That’s a drain on the bottom line initially. But it could more than make up for itself come holiday time in a few months if more consumers have more Xboxes to buy games for. More importantly, if the price cut attracts more end users game publishers will put more resources into games for next year.

Whether this effort to stoke a catalytic reaction helps put Xbox into the black remains to be seen.