LAS VEGAS -- Robbie Bach, president of Microsoft's Entertainment & Devices Division, was gearing up for last night's Consumer Electronics Show keynote when I spoke with him yesterday at the company's booth at the show.

He addressed a wide range of topics, including how the economy is affecting his division and future plans for Windows Mobile and Zune. I also quizzed him about the iPhone, Blu-ray, last week's Zune problems and the impact of the auto industry's troubles on the company's automotive technology unit. Read on for excerpts from the interview.

Q: The undercurrent here is a lot about the economy. In what ways are you seeing the economy affect the Entertainment & Devices Division?

Bach: We actually sold a lot of Xboxes, so I don’t think we’ve seen a lot of effect on console sales itself. Where we have seen it is if people were buying four games when they bought a console, maybe now they only buy three games, and you do see little things where people are being a little more value conscious, a little bit more thoughtful, maybe spreading out their purchases a little bit more. 

That’s the place we’ve seen it most in the entertainment space. On the PC side, you see mix shifts between high-end PCs and more value-priced PCs. Generally I think people, at least for this holiday, still wanted to buy. But they were very deal-conscious and value-conscious, and I think that’s completely logical. I don’t think that’s a big surprise.

Q: That’s obviously the revenue side.  There’s also then the operating expense side. In what ways are you pulling back in the E&D Division?

Bach: We don’t have anything specific to announce. We do what we always do, which is make sure we’re investing our dollars and our people, talent, in the right places. Every year, independent of the economy, we go through a strategy review process where we look at the whole strategy and we say, OK, do we have our resources deployed in the right way. We’re doing that again this year, and we’ll go forward from there. 

There’s a gentle balance. You have to balance between the short-term challenges of the economy and the economics that creates, and the long-term need to continue to drive innovation.

Q: To ask this specifically, in the short term, do you expect to need to make layoffs?

Bach: Well, we just made a decision that, because there’s so many random rumors, we’re just not going to comment.

Q: It’s been a year now since Blu-ray won the next-generation DVD format wars. When are you guys going to drop the “digital download” line and say, “Let’s just put the technology in the Xbox.”

Bach: We have no plan to do that.

Q: Why not?

Bach: A lot of reasons. It’s not a feature we get a ton of requests for. We really don’t. When you ask people the list of things they want to see us spending time creating in Xbox, Blu-ray is way, way down on the list.

The second thing is, from a technical perspective, it doesn’t help us in the core of what Xbox does, which is in gaming. We can’t have publishers produce games on Blu-ray disc.  Because then they won’t play on the 28 million Xboxes we’ve already shipped. So it doesn’t help us in the core gaming space.

The third thing, and this maps to all three of those, is that it costs a lot of money. And so the scenario is, OK, let me get this straight: I’m going to add something to the product that’s going to raise the cost, which means the price goes up, consumers aren’t asking for it, and by the way, my game developers can’t use it.

Oh, and by the way, I have an even better way for you to get high-definition content straight to your TV, between the combination of what we’re doing with Netflix, what we’re doing with (video on demand), we have a great Xbox Live solution. In a way it’s a little bit of a technology looking for an answer. We just have no plans in that space.

Q: Do you own a 30GB Zune?

Bach: I do, actually. It turns out my daughter has it, and she didn’t have it with her on the 31st. So it was fine.

Q: There are people who look at that last week and then make the connection to the Xbox 360 problems, and say, “Do these guys really know what they’re doing in consumer electronics?” What do you say to that?

Bach: I say to it, look, it’s an unfortunate thing that happened, we’re certainly not excited about it. It’s the type of thing that can happen in a complex product. You wait a day, and it’s fine. The two things aren’t even vaguely related.

Q: No, except for the fact that Microsoft is coming out with both of these products.

Bach: The issues we had with Xbox were very deep, complicated, hard-to-find interactions. This is a very simple mistake, and it’s an easy one to address and fix.

Q: Well the funny thing about this one was that it was a software mistake.

Bach: The irony is it’s not our software, but that doesn’t change anything. We’re responsible for everything that’s in the product. It doesn’t show up in any other version of the product. All of the other devices are fine. It’s just that first Zune 30, which was done through a different process.

Q: Steve Ballmer has talked about the notion of extending the Zune capabilities to Windows Mobile. What are those plans, and could it go further to other areas of Microsoft’s portfolio.

Bach: You should think of Zune as being certainly important for the product it is. But you should also think of it as being important for the software and services that it represents. Today, we have people who use Zune who don’t own Zune devices. They download the player to their PC and they like the player. And they love Zune Social. They may have a portable device, they may not.

All I would say on that topic is you have to think of Zune as a great piece of hardware that we’re going to develop, as well as a great set of software and services assets that we intend to fully utilize.

Q: I went to Macworld right before this, and one of the things that struck me was the energy around the iPhone app ecosystem. It actually reminded me, frankly, of Windows. How are you going to deal with that on the Windows Mobile side.

Bach: It’s one of those ironies. We have a great app ecosystem. There’s something like 20,000 apps on Windows Mobile. So it’s not for lack of applications. The thing that Apple did – which we did on Xbox, so it’s not some big, new thing – is they created a specific marketplace for people to buy apps in.

That’s work we have to reflect on and decide how to address it going forward. We have a very vibrant development environment. That’s not the issue. It’s ease of purchase that is the difference between the two things, and that’s something we have to address.

Q: With the iPhone, Apple is combining the music side with the phone side. It’s all becoming one big offering. How are you going to counter that?

Bach: Those are things I can’t talk about.

Q: Are you going to try, or do you think you have what you need with what you have now?

Bach: Let me say it this way: I think certainly, when it comes to competing with iPhone, RIM, others in that space, I think we absolutely have the assets we need. Putting those together in the right combinations for consumers, that what’s fun.

Q: In the Microsoft job listings, there’s a reference to a position to work on a ‘Zune Xbox.’ What in the heck is that?

Bach: You know, I maybe should be ashamed to say I don’t know. I couldn’t tell you. To be fair, independent of whatever the job listing was, I don’t know what it was, but we do Zune integration with Xbox today. So we have to test all the Zune work we do today in any event.

Q: How do you expect the turmoil in the auto industry to affect your automotive technology business?

Bach: Well, I don’t think it will have a big impact on the business because the auto industry wants to sell cars, and we can tell you today that, if you take two Ford cars, one with Sync and on without, I promise you which one will sell more faster. The Sync one sells more faster.

I think the automakers are going to look for ways to differentiate, and to make sure volume keeps moving. And certainly Sync and what we do there with Ford, and Windows Automotive with what we do with other people is absolutely the way to drive that differentiation.