Microsoft has announced that the Xbox 360 will have backwards compatibility but it may be very limited in the number of games that are compatible. Peter Moore, Microsoft’s vice president, announced at E3 that the "top-selling games" for the Xbox will be backwards compatible. Of course, the meaning of "top-selling" is vague.
When Sony first introduced the PlayStation 2 with backwards compatibility, it was simple for them to create. They just put the necessary chips from the PlayStation into the PlayStation 2. Nearly ninety-nine percent of the games were compatible.
Yet, the process is more difficult for Microsoft. The Xbox and the Xbox 360 are not based on the same chipsets. They aren’t even using the same company for the chipsets. The Xbox 360 uses an IBM PowerPC based CPU with three symmetrical cores running at 3.2 GHz each. A custom ATI Graphics processor for the GPU is also being used. The Xbox used a NVIDIA-based GPU and an Intel-based CPU on the Xbox.
In order to make the games backwards compatible, Microsoft may have to pay a small sum to NVIDIA for every Xbox 360 sold if it were to include it’s chip on the system. But right now, Microsoft is working to emulate the Xbox games onto the Xbox 360. The emulations would be stored on the 360's hard drive. A certain number of games can be shipped with the console, and more can be released online or through Xbox Live.
Because of the difficulty of transitioning Xbox games, don’t expect many compatible games at the 360's launch. Yet, it seems that the collection of compatible games will continue to grow.