In my opinion problem with Microsoft is (besides the fact that they are they own enemy

) that they are too big. In the world where you need to earn more money year over year you have too big expectations. They could have played in the same game as Sony and in a way Nintendo (but they are a bit different) and I bet that Xbox would be close to PlayStation or maybe even above it by now. But they weren't happy with this type of revenue, they wanted more, much, much more. This lead them to many bad decision which also were poorly executed. Because of that they are where they are. It's not the fault of competition, it's their own doing.
Now I'm not sure if they go full 3rd party right of the bat and dump Xbox hardware. I think that wouldn't be smart but we are talking about MS here everything it's possible. I do believe that they still are into Game Pass but they can't expand it with the 'tools' that they have. They may aim at streaming from any device you want but it's a song of the future. Today they need consoles and it doesn't have to be their own console. Some are saying that GP should be launched on PlayStation and Switch - if Japanese are smart they won't do that, it's stupid thing to do. It would be like letting your competition to take your user base by free. Sure MS would need to pay for that for some time but that's the thing - in the long run they don't want to share.
What MS can do is to act as a 3rd party publisher and still have GP. They can wait for the future of streaming to come, probably they would try to speed it up, but i think it wouldn't end well. The thing is that they would need to be patient and I doubt that MS can be that (the whole Xbox is an example for that).
What I would do? What they were doing in the first half of X360 era. I would let go off people that are in charge of the division now and hire some fresh faces for the new start for Xbox. They should say that they are committed to the platform, they want the Xbox to be a success. To do that they need to make some hard decisions because mistakes were made. Then they should backtrack on day one GP releases, maybe even PC releases (it's probably less harmful but still it should be considered). They should focus on making great games for Xbox. Because they bought two publishers that made games for many platforms before they should say that they cannot make only exclusives from those publishers. They should say that it'll be decided title by title (for real this time). Games like Starfield, Elder Scrolls, Diablo, Call of Duty - IP that were multiplaform and sold well on Playstation or Nintendo should stay this way (at least for now). But the same time they could make some exclusive new games. GP would be there but mostly for smaller games and mobiles with some older gamers added after some time (like PS+). By doing this I think that they could rebuild Xbox brand in one generation. After that maybe they could think about some changes in favour of GP but it'd be mostly tied into streaming capabilities.
In short - take your time. Don't be hasty, in the end Xbox is in the market for more then twenty years and by now it could have been in much batter shape.
Now I don't think that all of this will end well for the industry. I'm afraid as I was at the beginning of GP that it'll have it's consequences for the industry. I don't want to say that Xbox is doomed for sure but it can go wrong in so many ways. Like I think that devs under MS should be afraid. It'll have an impact on Sony as well. They already have their own problems. In the end consoles are still needed because most of the casuals won't play on PC, they will go elsewhere (Nintendo, Steam Deck, mobiles). Also the developers and publishers still need consoles or else they'll need to completely change. Someone has to buy their games and PC is only a part of that model. In fact PC can also be affected by this.