IF YOU haven't heard by now, the rumour mill has it that Microsoft is working on incorporating a Blu-ray drive into the Xbox 360. Microsoft has vehemently denied everything so far but in my mind, this is definitely one feature that simply must go into the next iteration of the Xbox.

This is necessary because while the Xbox 360 had a one-year headstart, its rival the PlayStation 3 has caught up.

Market research firm NPD reported that in January, PS3 outsold Xboxes in the US for the first time - 269,000 vs 230,000. This is a trend that I expect will continue worldwide unless Microsoft does something.

The one-year headstart meant that there were a lot more games for the Xbox 360 when PS3 was launched in Singapore in March 2007. In fact, at the time, the PS3 was highly overpriced (you had to pay $900 for just the machine and two games) and it only had 10 games here, none of which seemed particularly compelling.

Things are different now. PS3 now has its fair share of tier one games and it has another trump card - its Blu-ray drive.

Even though it only has a DVD drive, the Xbox 360 is still able to offer high-definition (HD) quality games by simply offering more discs. Unfortunately, HDTVs did not really take off here until mid-2007 when prices started plummeting to amazing lows and more HD content finally became available on the goggle tube.

In other words, Microsoft could not fully take advantage of the HD movement to sell more sets.

Today, HDTVs are flying off shelves at IT shows and electronics stores. I recently paid about $1,200 for a 40 inch Samsung LCD TV after trading-in my old 34 inch CRT TV. The sweet spot for buying HDTVs is right now. With everyone buying these HDTVs, the next question they will ask is: What else can I do on my TV?

The answer: Play HD games and watch Blu-ray movies. And the problem with the Xbox 360 is that it cannot play back HD movies. It used to have an optional HD DVD external drive, but since HD DVD has lost the format war, that drive is now a lemon.

Gaming is also an issue. Games on DVDs are region locked, but not those on Blu-ray. So on the PS3, it doesn't matter whether the games released are American or Japanese versions of the PS3, all games work on all machines. The Xbox 360 on the other hand is region-locked and the NTSC-J version sold here follows the Japanese system.

Rock Band, for example, has been launched in the US but not in Asia for both the Xbox 360 and the PS3. You can find the 'imported' version of the game for PS3 at shops here, because there is no issue of region compatibility, but it would be nearly impossible to find one for the Xbox 360 since it would not work on our NTSC-J machines.

Microsoft's weapon against PS3 now seems to be its superior online experience with its Xbox LIVE service plus it still has an edge with a stable of top games that is stronger on the whole. It also helps that Xbox 360 games are about $20 cheaper a piece.

But these strengths may not be enough to stop PS3 from threatening its leadership. Microsoft needs a new Xbox - one that has a built-in Blu-ray drive without a region lock on its games. But most importantly, it needs one with a new design that can match the svelte lines and cool colours the PS3 offers. And that perhaps is the software giant's biggest challenge yet.

This article was first published in Digital Life, The Straits Times on Apr 8, 2008.