Toshiba executives have revealed that Microsoft is planning a new version of the Xbox 360 gaming console to try and beat Sony PlayStation 3.
The new model is to offer a built-in HD DVD drive, a "large" hard drive and new entertainment software, the sources say.
Microsoft currently offers an external, add-on HD DVD drive for the Xbox 360 but sales have apparently not been strong for this product.
A new console with an internal HD DVD drive would provide stronger next-gen competition against Sony's PS3 which includes a Blu-ray player.
"An Xbox with a built-in HD DVD drive is critical", a senior Toshiba executive said.
"They and we are working on it. It also has to be more than a gaming machine. Microsoft recognize this. A version of the device may also be sold under the Toshiba brand name."
Other plans for the new device could include dual TV tuners, a docking station for MP3 players, and the possibility to make the console designed to slot into HD TV screens over 40-inches.
The sources indicated that an Xbox 360 with HD DVD is expected to launch in late 2008, or in time for the 2009 Consumer Electronics Show in Las Vegas.