Pre-empting the expected competition from rival video game console developers and smart TV manufacturers for dominance of the living room, Microsoft (NASDAQ:MSFT) is opening a new Xbox entertainment studio to focus on creating “interactive content” for the Xbox console.

The company announced its plans during an interview on Monday night between Peter Kafka of AllThingsD and Microsoft’s senior VP of its game division, Yusuf Mehdi, and Nancy Tellem, the company’s entertainment and digital media president as part of the website’s Dive into Media conference.

Microsoft first hired Nancy Tellem, a former executive at CBS (NYSE:CBS) and Hollywood veteran, last September as part of its drive to expand the content and services its flagship Xbox 360 video game console offers beyond strictly video games.

With Tellem helming the Los Angeles office, the newly minted “Xbox Entertainment Studios” already has over 150 employees dedicated to producing first-party “interactive” video content for the Xbox 360 and presumably its next-generation successor -- a first for the company’s dedicated gaming devices. While Mehdi and Tellem were tight-lipped on any details about what, exactly, this new content or Microsoft’s next Xbox might look like, they said that the first examples of the new “interactive content” will “hopefully” be introduced to available consoles later this year.

This was partly a strategic move as the company no doubt saw the looming competition from prospective hardware developers like Apple (NASDAQ: AAPL) introducing its own comprehensive home entertainment devices (for lack of a better term), an anxiety to which other game industry leaders like Valve’s Gabe Newell have admitted. But changing the nature of the Xbox console also reflects a strategic reframing of the console itself based on users’ own habits. The majority of the Xbox 360’s 76 million users, Mehdi said, spend far more time watching stuff on the console than playing with it -- the purpose for which the device was originally designed.

And the changes don’t just stop at the usage. While Xbox users, like all gamers, have traditionally been overwhelmingly white male teenagers, Mehdi said 38 percent of Xbox users are currently female, and 51 percent have children of their own. On an aggregate scale, the Xbox 360 offered 18 billion hours of entertainment worldwide in 2012, with users spending an average of 87 hours a month with the device. And the company already has some 46 million users subscribing to its premium Xbox Live subscribers, which will most likely be the online platform through which it distributes any of its new video content.

In some ways, then, Microsoft is facing a similar challenge to the one that Internet companies like Netflix (NASDAQ: NFLX) or Amazon (NASDAQ: AMZN) are beginning to tackle as they strive to produce first-party content or nab exclusive access to the type of video content that cable networks have historically claimed as their own. And Tellem did say that her goal is to produce “hit” programming for the company. But Microsoft is trying to meet this challenge in a unique way by integrating “interactivity” into its new content.

“Our value-add is not being just another distributor,” Medhi said. “It’s adding another level of interactivity.”

It’s tempting to see a buzzword like “interactivity” as a mere gimmick. But Tellem said: "I really don't believe in just adding interactivity for interactivity's sake," instead insisting that there are "some natural things that evolve out of it that enhance the experience."

She added that viewers will still have options for how they choose to consume the content, saying, "You can have your choice, you can either watch linear content or really interact with it.”

If nothing else, adding interactivity to television-style programming could increase both the level of user engagement and the content provider’s understanding of that same engagement -- which is promising news for a company no doubt interested in securing advertising revenue.

"Advertisers are very excited about that opportunity," Tellem said.

Microsoft shares dropped slightly in Tuesday morning trading, falling to $27.78 per share.

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