Nintendo: Time To “Switch” It Up
By: Sooruj Ghangass & Alif Karmali
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Nintendo Lagging
Nintendo is a historic and renowned video game company, which has come to define the video gaming industry. With iconic and timeless characters including Mario and Zelda, the company’s franchises have been cemented as inimitable mainstays. However, Nintendo’s recent endeavors have struggled to meet the market’s needs, with competitors outselling Nintendo in the console product category. As a result, the high-quality games Nintendo produces are being limited by its weak console penetration.
Device Convergence
The recent emergence of new device formats has disrupted the video game industry. Smartphones, tablets, and personal computers serve secondary gaming purposes while also being widely available and functionally diverse. Video game consoles have had to adapt to this trend, increasing functionality by offering computer-like processing power, internet browsing, and multimedia applications. This has resulted in the creation of hybrid devices such as the Steam Machine and Alienware Alpha, eroding the distinctions between handheld, console, and PC platforms. Consequently, consumers have begun comparing consoles on technical specifications such as internal memory and graphics processing capability. These technical decisions are carefully considered by consumers because of the significant upfront investment and the subsequent limitation on game selection. As hardware platforms become more homogenized, innovation in the video game industry is being primarily driven by game development. Although gaming console sales have tapered off by 19 per cent year over year in the most recent generation, game sales have continued to remain strong. As a result, the historically long R&D cycles for console development are becoming increasingly risky for Nintendo as dedicated gaming machines are giving way to general purpose hardware. Instead of conforming to this trend, Nintendo insists on an unorthodox innovative console design process, prioritizing hit-or-miss features such as dual-screen formats and motion control over technical specifications.
Console creator revenues are driven by console sales, as well as licensing fees, for games developed on their platform. In addition to their console creation unit, Nintendo also acts as a game developer, generating revenue on the sales of games that they create, including Mario Kart and The Legend of Zelda. Currently, Nintendo’s console sales account for just over 40 per cent of total revenues, but only a fraction of their net profit due to the characteristically low margins on consoles. Historically, Nintendo’s revenues have understandably peaked in years of console releases as consumers pay large upfront costs to acquire the hardware. However, Nintendo’s profits have paradoxically been largest near the end of a console’s life when game production for their platform has peaked. This can be explained by examining the industry from the game developer’s perspective. Developers assess the success of a console before committing development resources to it to ensure that the platform has a large enough user base to market their game towards. As a result, new consoles often have an initial lack of games available on the platform, which increases as the success of the console becomes more apparent through strong unit sales reports and developer confidence grows.
Nintendo Problems
Within the already shrinking gaming console market, Nintendo has found itself losing market leadership from 36.2 per cent in 2011 to 16.3 per cent of the market in 2014. Nintendo’s core strengths are in creativity and innovation, rather than the technological focus that hardware in the gaming industry has migrated towards. Consequently, Nintendo’s consoles have been outsold by competitors for three of the past four console generations, with the Wii as the sole exception. Recently, the lone success story of Nintendo has been its handheld gaming devices that have dominated their Sony counterparts. With increasing competition from casual mobile and tablet gaming, continued success in the handheld segment is uncertain.
The same innovation that has guaranteed Nintendo success in its game development has been one of the primary reasons for the failure of their console offerings. With their focus on innovative console features and controls, Nintendo’s hardware is significantly more difficult for developers to create games for in comparison to Microsoft and Sony consoles. The Wii U characterizes Nintendo’s tendency to complicate hardware offerings. It boldly attempted to blend features including tablet controllers and motion sensing technology to create an environment in which developers could design unique and interesting games.
Game studios who do choose to develop for Nintendo consoles face an undesirable tradeoff. With the high cost of blockbuster game development, publishers strive to offer their game on a wide variety of platforms to recuperate their large investment. Therefore, developers attempt to design games in a way that they can be easily ported between consoles. This either results in Nintendo’s unique features being ignored by developers or forces developers to incur additional costs to make use of these features, with no discernable benefit to doing so.
These added complications of developing for Nintendo hardware, coupled with inferior hardware, have resulted in a Wii U game selection one-quarter of the PS4 selection. As third-party support (developers that are not also the console creator) for the system declines, fewer consumers purchase the console due to the lack of title selection. This leads to further decreases in third-party development as the console’s user base declines, creating a vicious cycle.
With game sales generating considerably higher margins than hardware, Nintendo’s profits have tended to fluctuate with both first and third-party game production. Consequently, the recent decline in Nintendo’s profitability can be seen as a result of their over-complicated consoles. They discourage third-party development and restrict the reach of their first-party games, due to their hardware exclusivity.
Exiting Hardware - Why Now?
Assessing the recent movements in the industry alongside Nintendo’s particular situation, it is recommended that Nintendo should end its hardware development. The core competencies of Nintendo are better aligned with the game creation aspect of the industry, as their technological deficiencies are insurmountable in a device-converging environment. Now that gaming devices are ubiquitous and technologically advanced, Nintendo should develop for other platforms in order to best leverage their creative resources. For example, with new gaming formats such as virtual reality increasingly becoming the future of the industry, Nintendo’s hardware exit is more important than ever before. As previously mentioned, Nintendo is not a high-tech company and cannot hope to compete by innovating in a space in which it has no expertise.
By acquiring additional resources to increase game development, Nintendo can prepare to develop successful content for these platforms instead of developing subpar hardware that stifles the success of their game franchises. Limiting Mario and Zelda to a single console diminishes their exposure to receptive audiences by restricting the hardware on which they are available. This approach also means that Nintendo must be well-received simultaneously, in both its console and game design, which is increasingly difficult in the current competitive environment.
Calls for Nintendo to exit hardware have been commonplace since the Wii U was condemned as a failure in 2014. The question is then: why have they continued to develop hardware? As a creative company, akin to Disney or Marvel, Nintendo’s culture is wedded to controlling the entire creative process to ensure product integrity. Developing consoles in-house enables Nintendo to publish content that is tailored to the platform. Long-time president, Hiroshi Yamauchi once said, “at Sony, hardware led and software followed. For us, it was the opposite.” This indicates that perfecting game content has always been the primary focus of Nintendo. Their purpose in developing consoles has been to facilitate the success of their games, however, their consoles are now limiting this vision. Leveraging their in-house talent effectively would involve divesting hardware development teams, while doubling down on the high-quality game development that Nintendo is enshrined for in gaming history.
Games such as Pokémon Go demonstrate the potential audience Nintendo could serve if their games were available on a variety of platforms including mobile, PC, and competing home consoles. For example, the recent Super Mario Run release garnered 40 million mobile downloads within four days.
Nintendo Switch
Despite the above concerns, Nintendo is making a final stand with the Nintendo Switch, a unique format that blends handheld and console devices. Development for this system will once again be complicated by an unconventional control scheme and inferior technical specifications. Already, the Switch launch has been characterized by mixed reviews and console defects. However, the simultaneous release of The Legend of Zelda: Breath of the Wild has received outstanding reviews, and is only limited by its exclusivity to Nintendo consoles. Therefore, with the industry moving in an unfavourable direction, Nintendo should cease console development regardless of the performance of the Switch.
Nevertheless, Nintendo should continue to develop games for the Switch and see out its lifecycle. Switch games should be released as timed exclusives, being released to other platforms within an 8 to 12 month timeframe. This will maintain the incentive to purchase a Switch, but will allow Nintendo to develop expertise outside of the Switch and commit to a console exit.
By exiting hardware development, Nintendo is estimated to lose $539-million in lost hardware licensing fees, which is equivalent to selling 20 million additional units of full-priced console games. Compare this to Call of Duty: Black Ops that sold 30.24 million units, or the console game market which is estimated to be 150 million in annual unit sales. With the console market comprising 7.3 per cent of the total video game market, Nintendo will need to achieve a 3.3 per cent market share of video game sales across all platforms to break-even with this strategy. Although this break-even is slightly understated due to additional porting costs that Nintendo will incur, with Activision Blizzard holding 5.1 per cent market share, there is an established precedence for game developers to achieve this. Nintendo will be able to reach this target since its transition to platform-agnostic game development will access a much larger market. Moreover, Nintendo’s historical fan-base will be re-engaged and jump at the opportunity to purchase Nintendo franchises across different devices.
As a close competitor of Nintendo’s throughout the late-1980s and 1990s in both consoles and games, SEGA offers a case study of the result of delaying a hardware exit until it is too late. As Nintendo gained a lead in hardware with their NES systems, they pushed SEGA out of the console space. However, SEGA failed to cease console development and stubbornly pushed on with their exclusive content. Today, SEGA is an afterthought in the gaming landscape, a mistake Nintendo should avoid by imminently protecting their franchises through expanded game development.
How They Should Do It
Nintendo’s software strategy should revolve around leveraging their franchises and focusing resources into game development. Nintendo’s franchises can be categorized into three tiers representing their gaming adoration and prior success: the first tier comprises the most well-known franchises that are universally recognized, such as Mario or Pokémon, while the second includes franchises that are recognized by gamers and beloved by many, but are less prevalent or recent. Franchises such as Metroid and Kirby would fall into this category. Finally, the third tier consists of cult classics or one-off games that never received extensive attention. Pikmin or Earthbound are games that sold well in the past, and could be revived in Nintendo’s post-console strategy. With game development as the new focus, Nintendo should deploy resources according to this tier structure. The first should be exploited regularly, following an annual development schedule. The second-tier franchises should be developed at least once per console generation. The final tier may not see development, depending on demand, and should be targeted towards niche segments, which are currently underserved. Cheaper mobile game development can be used to test demand and innovative ideas before committing to console development. High-quality, enjoyable game development will permeate each of these games as Nintendo must compete on quality to establish a strong market leadership position.
Also, Nintendo should leverage their franchises through cross-franchise mechanisms to incite loyalty in audiences. Games such as Mario Kart or Super Smash Bros encourage gamers to become familiar with multiple Nintendo franchises at once. In-game features or additional content could be unlocked through owning multiple Nintendo games, enhancing the gaming experience while also promoting additional game sales. Similarly, merchandise with in-game functionality could also foster loyalty and additional revenue streams that would reward repeat Nintendo purchasers across multiple platforms. Amiibo characters — figurines using NFC technology to enhance the in-game experience — are an existing example of this, serving both gaming and collectible functions.
A cultural concern from Nintendo regarding open marketplaces, such as Steam or Google Play, is having to compete with inferior games that may dilute their brand reputation. However, Nintendo will be competing with comparable big-budget games on consoles and PC markets, and should focus their biggest productions for dedicated gaming platforms. This is in line with management’s preferences to employ creativity and immersion in their game design. Additionally, creating Nintendo applications or games within the mobile space can tie together various franchises and games while catering to a wider audience, which might not be accessible otherwise.
One major risk of this strategy is the lost revenue and potential downsizing a hardware exit would entail. Although, this cannot be mitigated entirely, doubling down on game development could offset short-term revenue losses, as evidenced above. Similarly, there is a significant investment required to divest hardware and commit to game development. However, Nintendo’s large cash position of $5.6-billion is suited for this purpose, allowing the organization to pivot at a time of industry inflection.
Imagine jumping across a skyline as Mario in virtual reality or roaming the fields of Hyrule on horseback on your tablet. By reinvigorating the creative successes of past Nintendo projects, Nintendo will pave its future in the gaming industry. Creativity, strong franchises, and innovative game development are what Nintendo should be known for, instead of tying their transcendent brands to a failing console line.
