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From Mary Jo Foley's blog: Xbox Live does not run on Windows Azure; it runs on its own servers in Microsoft's datacenters.

This may be Azure as a service vs. Azure as a platform.

I'd be very surprised if there were 300,000 physical servers.

Sure. But if XBox Live machines are in the same datacentre as the Azure ones then you would be crazy not to use Azure as the platform for your apps.