Microsoft is reportedly closing Massive, its in-game ad unit and company initially acquired for $200 – $400 million in 2006. When Microsoft bought Massive for this massive amount of money, in-game ads were predicted to become a $2 billion a year business.

So, what happened?

First, Microsoft did what Microsoft typically has been known to do. It bought a company for $200 – 400 million and the next thing you hear about it is when they shut it down three years later. They had the product and technology to own this space, and they didn’t.

What also happened, according to Gamespot, is that Microsoft has focused more on in-game ads in this Xbox platform (which makes sense, but why then buy Massive) and big game companies like Electronic Arts have decided to sell ads themselves within their own games, so they don’t have to share revenue with Microsoft.

The fact that the latter happened is the most obvious fact in the world. Anyone involved in this deal should have realized that if you put Microsoft, a big company and quasi competitor to EA or Ubisoft in the way, surely the big video game companies would try to serve and sell the ads themselves. With no game partners to work with, Microsoft is apparently throwing in the towel.

So what does that mean for in-game advertising and video games? EA and Ubisoft will continue to sell their own ads. There continues to be an opportunity to sell ads within download games if the game companies offer to give the “savings” back to the consumers with lower prices. And the holy grail of in-game advertising will be social games and virtual items. That is where the real money is at, as seen with last week’s McDonalds ad buy with Zynga’s FarmVille.

As for Microsoft, it’s yet another wasted opportunity to own a market they were first to jump into yet to let others more adaptive lead the way.