Nintendo's financials are in trouble - but the company's losses don't mean it's Game Over
There are still a few months left to run of Financial Year 2011/12, but it now seems certain that this will be the year in which Nintendo marks an unwanted milestone - the first full-year operating loss ever to be announced by the company. Revised financial guidance from the firm points to a ¥65 billion ($843m) net loss for the full year - a harsh turn for a company which only a few years ago was one of Japan's most successful and valuable enterprises.
It's really tempting to try to fit those figures into the industry's general narrative of the moment. It's so neat and tidy to say, hey, Nintendo's made a huge loss - its first ever - just as the handheld and casual markets which have been its bread and butter are swallowed up by smartphones and tablets. The two must be connected, and the link only looks stronger when you consider that Apple's record-breaking sales and profits were announced only a few days before Nintendo's warning.
The Yen has risen so high that it has forced Japanese firms to choose between slashing their profit margins down to the bone, or raising prices and being uncompetitive
As ever, though, the situation is a bit more complex than that. We all know that 3DS struggled on the market at launch, of course, and you can assign various different reasons to that depending on your own biases. Consumers don't want a dedicated handheld when they already have smartphones. Nintendo didn't market and explain the console well enough. The launch software line-up was weak. The price was too high. In truth, the problems sprang from a combination of these factors, and no one factor can be pinpointed as the sole reason for the weak launch.
Therefore, Nintendo had a pretty horrible Q1 and Q2. It was lumbered with a system that didn't sell, forced to accelerate software development and intensify marketing (both of which cost a lot of money) in order to get it moving, and finally forced to accept a serious price drop which shaved its profit margins down to levels that the firm has probably never accepted on a hardware product before.
Those factors alone would have made life hard for Nintendo in 2011/12, but had a sucker-punch like the 3DS' launch flop come at any other time, the company could probably have absorbed it without too much damage to the bottom line. Instead, the 3DS' difficulties came at the worst possible time for the company.
Several factors made the past year a pretty fragile time for Nintendo. Some were internal - most notably, the fact that the Wii is rapidly winding down towards the end of its lifespan, causing a hefty drop in sales (not unreasonably, given that the console is within touching distance of 100 million units sold already) and the requirement to ramp up R&D and manufacturing on the Wii U.
Others, however, were external - most notably, the value of the Yen. Nintendo's financials have historically been extremely vulnerable to fluctuations in the Yen exchange rate, since the firm not only sells a large volume of products overseas, it also holds huge assets denominated in foreign currencies. As a consequence, many of Nintendo's weaker quarters in the past have actually had nothing to do with operational difficulties, and everything to do with vast movements in the value of US Dollar denominated assets which have to be translated into Yen for Nintendo's balance sheet.
This time out, though, the Yen presents a more direct problem for Nintendo - as it does for the entire Japanese export sector. The currency has risen so high, and stayed there so long, that it has forced Japanese firms to choose between slashing their profit margins down to the bone, or raising prices and being uncompetitive. Nintendo has had little choice but to follow the former option, and that's had a critical impact on the firm's profitability.
Want an illustration of how serious the Yen problems are for Nintendo? Right now, US$1 buys you about ¥77 - so a $169 Wii with Mario Kart bundle is worth about ¥13,000 (of course, Nintendo doesn't take that entire $169 back to Japan, but it's a reasonable illustration). At the start of 2010, just two years ago, the exchange rate was more like ¥93 to the dollar, so that $169 bundle would pull in ¥15,700. Back in mid-2008, before the financial crisis hit - but well into the lifespan of the Wii, so pricing and so on had already been planned for ages at this stage - the rate routinely hovered around ¥110, making that bundle worth ¥18590.
Look at a Wii console on Amazon Japan today, and you'll note that the basic Wii bundle (which doesn't include Mario Kart in Japan, but does come with an extra Wiimote and a copy of Wii Sports Resort) costs around ¥18500. Look familiar? That's how much Nintendo expected people to be paying for the Wii - not just in Japan, but everywhere. Currency fluctuations since then haven't just robbed Nintendo's coffers of a cent here, a Yen there; they mean that American consumers are, in effect, paying ¥5,500 less for their consoles than Japanese consumers are - around $71 lost on every single console sold.
With the 3DS off to a good start and the Wii U preparing to launch, it seems very likely to me that Nintendo will be back into profitability for the 2012/13 financial year
It's not just the Wii, of course - this applies to every single piece of hardware (including the already steeply discounted 3DS) and software which Nintendo sells outside Japan, with European prices being even more aggressively impacted by the currency changes than US prices, in some instances. This, more than almost any other factor, is what has made 2011/12 into a horrible year for Nintendo - not least because it denied the company any strategic flexibility. A price-cut for the Wii in light of tough sales was to be expected in calendar 2011, but to Nintendo's bean-counters, the Wii is already selling for $71 less in 2011 than it was in 2008, without any of the sales bump a real price cut would have generated. Ouch.
Of course, while the currency problems explain a lot about the financial figures, the situation with regard to missing hardware sales targets is a separate matter. The Wii was meant to sell 12 million units this fiscal year - it's now projected to manage only 10 million, although again, it's interesting to wonder what would have happened here if macro-economic conditions had allowed for a more flexible price strategy. The 3DS was expected to sell 16 million units, and will instead sell 14 million.
There are two ways of looking at those numbers. The first is that actually, the 3DS numbers are in pretty rude health for a console that was supposed to be on its deathbed only weeks after launch. The installed base right now is 15 million, and will tip well over 17 million by the end of the year. That's comfortably in the realms of being a viable platform, and even if it's not quite up to Nintendo's expectations, it's well on the way to reassuring developers that this is a good console on which to place their bets.
On the other hand, those Apple figures loom ominously over the whole affair. In the past three months, Apple sold the best part of 70 million iOS devices - with record-breaking sales of iPhones and iPads, as well as extremely solid sales of the iPod Touch. In other words, Apple's iOS sales for three months were four times greater than Nintendo's 3DS sales for the entire financial year. Even accepting that many of those iOS devices will never be used to play a game, that's a statistic that lends fuel to the arguments of those who expect dedicated handheld consoles to die out sooner rather than later.
It's not all doom and gloom for Nintendo. The company's partners will no doubt be reassured by the fact that even if the full year results aren't great, the crucial October to December quarter saw Nintendo making a profit - and on the strength of that performance, with the 3DS off to a good start and the Wii U preparing to launch, it seems very likely to me that Nintendo will be back into profitability for the 2012/13 financial year. Most importantly, the Yen doesn't really have any more shocks to deliver - any further rise in value will have to be counteracted aggressively by the Japanese government, if the country wants to retain any export economy at all.
It doesn't fit with the industry narrative, but it's important to see these figures for what they are - a reflection of a macro-economic difficulty that's impacting one of the industry's most successful companies. It's not proof that iOS is killing Nintendo faster than expected, or that the casual games sector has disappeared overnight. Both of those things might still come to pass - but anyone claiming that this week's figures prove the argument one way or another is guilty of twisting unrelated figures to prove their own biases, and nothing more.