While MS have dramatically misread the market, I'd be very surprised if, internally, they didn't have a few scenarios worked out depending on the initial success of the Xbone. So I don't think that Scenario One is particularly realistic. A company the size of MS, and with the catastrophic product failures that they've had under their belt, I think would if nothing else have planned for their product to not sell 1 billion units.
On the other hand, it's clear from the fact that they have already gone into panic mode, less than six months after launch, that their figures must at least be at the low end of acceptable. So while I think that Scenario B is more plausible, I don't think it's reasonable to infer that MS are happy with the Xbone's sales figures or that they are meeting or exceeding targets. So I think it's a kind of Scenario B.5.
The thing is, I don't know of any product situation with MS where they released a product to lacklustre feedback, which was handily beaten by a far superior product, but which they nevertheless stuck with, improved the value of, and eventually turned around. Bing is on life support, and charitably Windows Phone can only be called a 'work in progress'. It will be very interesting to see what, if anything, MS do to try and save the Xbox brand. My feeling is that if we think MS's actions so far have been of dubious moral worth, then going forward we are going to see some outright horrible ways of trying to extract money from their userbase. When you mismanage a product so spectacularly that you spend $100 million just on making the controller worse, you have to recoup that investment somehow.