Fragile Finances

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.