Sometimes, you just make the wrong call and must admit it. Now, it is my turn to do that. Microsoft’s (NASDAQ:MSFT) strategy for its Gaming division is far more shortsighted than I had initially believed.

A new round of layoffs and studio closures undercut the division’s growth opportunities at a time when the company should be capitalizing on its successes. Four studios, with a mix of recent successes and failures under their belts, were either shuttered or dismembered in the layoffs. Today, I’ll look at the three biggest and how these layoffs undermine Microsoft’s future in the video game industry.

Back in March, I wrote an article titled “MSFT Stock: Microsoft’s Gaming Strategy Is AAA.” At the time, it appeared that Microsoft had a long-term strategy in place for its Gaming division. The short of it was that, despite some relatively small job cuts at the start of the year, the division was consolidating its gains from the Activision acquisition and focusing on what mattered: The games. I wrote: “Now, Microsoft’s strategy is to simply be everywhere with the biggest titles.” And ultimately, I concluded this strategy would create an unusually stable and profitable revenue stream for MSFT stock in a notoriously unstable industry.

That prediction, however, was faulty. Microsoft seems determined to act in the same shortsighted manner that the rest of the industry’s most prominent players have embraced.

ZeniMax/Bethesda Softworks: Fallout

Most of the studios affected by this round of layoffs were under the ZeniMax umbrella. ZeniMax is a holding company for Bethesda Softworks and a now dwindling number of other studios.

Last week, Microsoft began “offering voluntary severance agreements to producers, quality assurance testers and other staff at ZeniMax,” per Bloomberg’s Jason Schreier. The timing on this round of layoffs for ZeniMax is particularly strange since the video game holding company’s largest publisher, Bethesda, was making headlines with one of its flagship franchises: Fallout.

The Amazon (NASDAQ:AMZN) produced Fallout show reignited many gamers’ interest in the series. On Steam alone, every single one of the franchise’s games saw at least a 20% increase in 30-day player counts. Fallout 4, a nine-year-old game, saw a massive 299% increase in April and hit a peak of 186,746 players. Even the newer but critically maligned online service entry, Fallout 76, saw a 331% increase in players.

The show was also a massive success with both fans and critics alike. It is important to note that Bethesda was directly involved in the show and not just lending its IP to Amazon. The game studio’s legendary game director, Todd Howard, served as an executive producer on the project.

Both Amazon and Bethesda are working on sequels to their respective Fallout endeavors. The latter is already notorious for taking a long time on its projects. While it is unclear exactly how Bethesda will be affected by these layoffs, ZeniMax is shedding a significant number of support staff, including quality assurance (QA) testers. Poor QA testing and a lack of resources from parent ZeniMax would likely just make Bethesda’s development issues worse. The troubled development of the aforementioned Fallout 76 title should’ve been a lesson on that.

Tango Gameworks: Hi-Fi Rush

This relatively new studio was only acquired by Microsoft in 2021 and was the first Japanese studio in Microsoft’s portfolio. Last year, it delivered Hi-Fi Rush to both critical and player acclaim. The game had the bonus of being simultaneously released on Game Pass, which boosted subscriber numbers. According to publisher Bethesda, the game peaked at about 3 million players.

As of last week, the studio was closed without any specific explanation as to why. Microsoft’s Vice President of Xbox Games Marketing had publicly praised Hi-Fi Rush last year and seemed pleased by its financial performance:

If Microsoft’s strategy was to “be everywhere with the biggest titles” in both a literal and metaphorical sense, closing its first Japan-based studio with a very successful and recent title under its belt (not to mention its three other critically successful games) is shortsighted at best.

Microsoft needs breakout hits like Hi-Fi Rush. We know because the company said so in a town hall the day after closing Tango Gameworks: “We need smaller games that give us prestige and awards,” said Microsoft’s game studio chief Matt Booty during the event.

Hi-Fi Rush and its parent studio did exactly this. The brand-new IP won numerous awards, including a Game Developers Choice award and a BAFTA.

Arkane Austin: Redfall

The last major studio closed by Microsoft last week is less of a surprise. Arkane’s Redfall had not been a success and flopped with critics and players alike. However, as with Tango Gameworks, Microsoft executives had publicly stood by Arkane despite the trouble. When asked last year in an interview with Axios whether the studio would stay open, Booty said: “That is the plan.”

The studio was also reportedly in the process of pitching another entry in the very successful Dishonored series.

MSFT Stock: Microsoft’s Gaming Strategy Is Shortsighted

In retrospect, Microsoft’s January Gaming division layoffs should’ve been more of a warning of what was to come instead of an act of “strategic discipline,” as I called it back in March.

Layoffs have been rampant in the industry, especially over the last three years. According to one source, this year’s industry-wide estimated total of 9,700 employees laid off has already nearly exceeded last year’s total of 10,500. And as the source stipulates, these are “best estimates.”

Microsoft didn’t provide clear reasoning behind the specific studios’ closures. In an interview with Bloomberg, Xbox President Sarah Bond gave a non-answer on the matter. Executives like Booty blamed a lack of resources and trade publications blamed the executives. The contraction within the video game and broader entertainment market is undeniable.

Yet little within Microsoft’s recent quarterly earnings for 2024 suggested the division was in financial trouble. In fact, it appeared to be doing quite well:

“Xbox content and services revenue increased 62% (up 61% in constant currency) driven by 61 points of net impact from the Activision acquisition.”

The devil could very well be in the details, but a misallocation of resources is a failure of management, not the hard workers in the studios that are shuttered. Losing those studios means losing the talent they brought and cuts short any opportunities to create the video games that make Microsoft a key player in the industry.

This ultimately leads to a shortsighted focus on the bottom line. With fewer studios making fewer (but still big-budget) successful titles, this becomes a vicious cycle of “cost-cutting.” On average, this will mean fewer successful games. The company will ultimately report a smaller top line and be forced to repeatedly recycle IPs and overtax its remaining studios.

Thus, without fresh talent and IPs, Microsoft’s offerings will become increasingly stale, and gamers will go elsewhere. For investors looking for stable, long-term exposure to the gaming industry, Microsoft has made it clear that MSFT stock isn’t the answer.

On the date of publication, Andrew Bush held a LONG position in AMZN stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.