I think their implementation of this at a hardware level is going to be a bit more elegant and technologically innovative than what you're implying. And I don't see them dropping console gaming, considering a SIGNIFICANT chunk of their overall profit from gaming comes from Xbox Live - whether it be subscriptions, DLC, etc. A model that simply does not and cannot exist on PC gaming.
Microsoft is a software company, and is intrinsically linked to computers, so it makes sense to bring the underlying feature that makes those two platforms what they are to consoles - which is inherent upgradability. I think they're going to take a calculated risk blurring the lines of PC and consoles at a software level, hoping that the former won't cannibalize the hardware sales of the former - and potentially position themselves for a net positive with the existence of a new market share to sell their games too. And if they play their cards right, they can pivot themselves to take advantage of the PC's library with respect to their home console - considering what's under the hood at a software level.
I'm not sure what you envision, but at a hardware level, I see a console as it exists today - albeit expandable during the course of its lifetime. Basically a console whose release is merely a baseline in terms of processing/graphical power. All games will be playable across all SKUs moving forward, but they'll implement some type of a tiered system informing consumers at what graphical fidelity your respective SKU can play a given game at. I'm not sure if this is technologically feasible in a manner that is purely accessible to everyone, regardless of their technological prowess, but if they're able to pull it off - it's pretty fucking genius. You'll basically be able to pursue mass market consumers with an affordable baseline, and attract power users who value high end graphics/performance as well as those who are willing to undergo refreshes every 1-2 years. They'll also have 100% backwards compatibility under this model, well - at least for retail releases.