Microsoft has dropped Nvidia in favour of the graphics chip maker's arch-rival, ATI, as the provider of the graphics technology to be incorporated into its as yet unannounced next-generation Xbox console.
So says a report on Internet gaming-oriented web site Spong, citing "senior development sources in the UK".

Certainly Microsoft and Nvidia haven't had any easily relationship during the life of the current Xbox. The highly competitive and price-sensitive nature of the console market required Microsoft to be flexible on price. Nvidia is believed to have been decidedly inflexible when it came to helping the software giant achieve its pricing goals. Microsoft wanted to pay less for its chips than originally agreed, but Nvidia (quite understandably) stuck to its guns.

But more prosaic reasons may lie behind the decision - if such as decision has been taken. ATI has a Pentium 4 bus licence from Intel; Nvidia does not. Microsoft would undoubtedly be looking at a more advanced CPU for Xbox 2 than the current console's Pentium III, and the P4 is a logical step up.
If there is an ATI connection, then that would seem to preclude the use of an AMD chip, for which Nvidia would be the most logical partner thanks to its nForce expertise. Indeed, the current Xbox's chipset is essentially an nForce geared to work with a PIII.

ATI is nevertheless a problematic partner for Microsoft as it is already Nintendo's chosen graphics contributor for the next-generation GameCube. Or is that a problem? Spong suggests that Nintendo and Microsoft are natural allies against market leader Sony - my enemy's enemy... - and this opens the door to co-operation between the two, with ATI as a third member of the alliance.

There may well be a number of factors, other than business ones. ATI tech runs cooler and delivers more performance per Mhz. I would imagine Xbox2 with the Geforce Fx dustbuster noise would'nt go down that well in a console.

Seems a strange one as ATI are doing GameCube 2, as mentioned. Conflict of interest there perhaps ?

Microsoft are losing a fortune on XBOX - have they released a service pack yet for it ? :)

ATI shares enjoy rumors of Microsoft deal
From reuters.com:

TORONTO, June 13 (Reuters) - Rumors that ATI Technologies Inc. has been selected for a major contract by Microsoft Corp. helped push up the shares of the graphics chip maker on Friday, but analysts were not buying the rumor.
Shares of ATI rose 46 cents, or 5.8 percent, to close at $8.40 on Nasdaq. On the Toronto Stock Exchange, the stock finished 40 Canadian cents, or 3.7 percent, higher at C$11.18, while the broader information technology sector was down 2.4 percent

According to a computer games Web site, ATI is said to have been selected by the world's largest software maker to supply graphic technology for the still unannounced next generation Xbox console.
The Web site says Microsoft will dump Nvidia Corp. because of its inability to work cohesively with the chip designer.

Nvidia source confirms ATI Xbox 2 design win
From TheRegister.co.uk:

Internet gaming site Spong.com has claimed its recent story ATI will provide the chipset and graphics technology for the Xbox 2 has been confirmed by an unnamed "senior source close to Nvidia".
According to Spong.com's source, "[Nvidia] didn't want to meet Microsoft's demands for the floating design of Xbox Next. It didn't make sense to partner on the project. At this moment in time, ATI is working with Microsoft."

Assuming the source knows what he or she is talking about, the comment suggests that Microsoft did offer the project to Nvidia. After the battle between the two companies over how much money Microsoft should pay Nvidia for the original Xbox graphics and chipset technology, it was widely supposed at the time of Spong.com's first ATI/Xbox 2 story that the software giant was simply pissed off with Nvidia.
But it's clear that sound business minds prevailed, and the longer-term benefits of working with an existing partner outweighed more momentary emotional considerations.
Nvidia, however, doesn't seem to have been willing to be flexible, and now its arch-rival has the deal - if the source's comments are accurate.

ATI needs to be careful though IMHO.
This is one of the reasons why nvidia lost the graphics card lead by spending too much time & resources on the xbox, amongst other things.