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Financial pain is inevitable as Nintendo faces its toughest challenge

Financial pain is inevitable as Nintendo faces its toughest challenge

Fri 26 Oct 2012 7:00am GMT / 3:00am EDT / 12:00am PDT
BusinessPublishing

Selling the Wii U at below cost is a difficult decision - but don't try to shoehorn it into another tired "death of Nintendo" narrative

It isn't unprecedented, exactly, but the announcement made by Nintendo president Satoru Iwata earlier this week concerning the Wii U's pricing was momentous nonetheless. "Rather than determining a price based on its manufacturing cost, we selected one that consumers could consider to be reasonable," he stated during the firm's latest financial briefing - or, in short, Nintendo is set to launch its new console at a price lower than its cost of manufacturing.

"Today's market, flooded with smartphones, tablets and other perfectly game-capable devices, simply won't support a profit-making, high cost console"

This is a compelling sign of just how difficult market conditions have become for Nintendo. For years, the company has been pulling off a pretty remarkable trick - competing with bigger rivals like Microsoft and Sony, and even beating them, all while refusing to be drawn into the business model of selling hardware below cost. Other hardware manufacturers routinely launch their hardware at loss-making price points, recouping investment through software sales and betting that manufacturing costs will fall faster than price cuts (not a bet that always pays off, at least not at first). Nintendo does no such thing. It makes a profit when you buy a console, and makes more profit every time you buy a game.

Or at least, that's how things used to be. The first big crack to appear in Nintendo's dam came with the price cut to the 3DS in early 2011, which brought the system's price tag below its cost of manufacture only a matter of a few months after launch. By all accounts, Nintendo's high unit sales and talent for dropping manufacturing costs has now reined this situation in, with the 3DS back at or below break-even, but a precedent had been set. Now the Wii U will break with Nintendo's traditional business model entirely, launching from the outset at a loss-making price point.

I have no doubt that such a move was debated hotly in Nintendo's Kyoto boardrooms, but in the end, it's reality that has won out. Today's market, flooded with smartphones, tablets and other perfectly game-capable devices, simply won't support a profit-making, high cost console - and some of Nintendo's critics would do well to recall that Sony and Microsoft will also be announcing deeply loss-making next generation hardware in due course. This is how consoles are sold; the wonder, in some ways, is that Nintendo has held on to its ability to sell at above cost for such a long time.

"People have been buying up the Yen in bulk, driving up value relative to other currencies, and making life very hard for export-driven companies like Nintendo and Sony"

It's worth thinking about the factors which have driven Nintendo's decision - which have, in effect, backed the company into such a corner. The wider market picture is definitely a part of it; this Christmas, Nintendo will not just be competing with rival game systems, but also with iOS, Android and Windows Phone / Windows 8 devices aplenty. Christmas lists (and birthday lists, and shopping lists of all kinds throughout the whole year) only have space for so many devices. Nintendo has always had a wide view of its competition; many years ago, it already understood that it wasn't necessarily competing with Sony so much as it was competing with "watching TV" or "playing board games" or "going out". Now it understands that it must jostle for mindshare with devices like the iPad, the Nexus 7 or the Galaxy Note. They don't do the same things as a Wii U, of course, but Nintendo of all companies can see that they're still powerful competition. Moreover, since Nintendo's software prices remain very high compared to the low-cost or free-to-play business models which dominate on phones and tablets, device pricing is a vital weapon in this battle.

That's the factor we're all going to talk about, inevitably, because Nintendo's newly aggressive stance on pricing matches up with an ongoing industry narrative - the squeezing of dedicated consoles by powerful multifunction devices. However, we should be careful not to overstate that side of the argument, because the fact is that while Nintendo is undoubtedly feeling heat from the changing market, it's only a mild glow of warmth compared to the sweltering, searing heat wave that is the perilous state of the Japanese export economy.

Oh god, you think, this sounds dull. It is - far more dull than an exciting narrative about a former reliable pillar of the industry being felled by advancing technology and market change. It has the benefit, however, of being quantifiable. Nintendo reckons it lost ¥23.2 billion due to Yen exchange rate problems over the past six months - that's about $290 million. That figure only hints, however, at the sheer lack of options which Nintendo has on pricing due to the strong Yen. On its balance sheet, the value of every Euro or Pound the company earns is only about 60 per cent of what it was a few short years ago; the value of every dollar has pretty much halved. Local consumers can't see the broader picture (our spending power has remained stagnant or even fallen during this period), but looked at globally - as Nintendo must - a console priced at $300 back in 2007 now effectively earns the company only $150.

The reasons for this are really dull, unless international finance interests you to an unnatural degree (guilty as charged - I'm just as good at parties as you might expect), but in a nutshell: the world is in recession, the USA and Europe look like pretty risky places to keep your investments, but Japan, due in part to an unusual arrangement where the country's (massive) debts are mostly owed to its own people rather than to other nations or international banks, looks like a nice safe option. As a result, people have been buying up the Yen in bulk, driving up its value relative to other currencies, and making life very, very hard for export-driven companies like Nintendo and Sony.

I'm going to go out on a limb here, because it's a big "what-if" scenario - but I think that if the Yen hadn't soared in value over the past four years or so, Nintendo would probably be breaking even on the Wii U price point, and we wouldn't even be having this discussion. If anything, we'd be having a very different discussion - marvelling at Nintendo's extraordinary ability to cling on to solid profit margins and audience share even in spite of such a challenging market. Take the Yen value out of the equation, in other words, and the assessment of Nintendo's current situation would be completely reversed - from "everything is going wrong!" to "my, aren't they resilient!".

"Nintendo's crisis response is its competitors' default setting"

None of this is to say that Nintendo doesn't face an enormous challenge in terms of staying relevant in a market where things like iOS and Android exist. However, consider the company's track record - specifically, the extraordinary power of its IP. Nintendo is arguably the world's second most valuable repository of universally recognisable "family" IP, after Disney, and that IP has allowed it to maintain enviable profit margins over the years even despite strong competition from much larger companies like Sony. Now, in the face of the toughest economic test Japan has ever faced (history, I suspect, will record this period as being more economically damaging than even the Asian Financial Crisis and the bursting of the property bubble in the early 1990s) and a powerful challenge to the very concept of the dedicated games console, Nintendo has been forced to.... do exactly what Sony, Microsoft et al have been doing all along. Its crisis response is its competitors' default setting. Even now, even in the face of such challenges, I'm not sure any wise industry insider or analyst would want to bet against Nintendo.

13 Comments

Bruce Everiss Marketing Consultant

1,692 594 0.4
The strong yen doesn't help.
Also they are competing for people's gaming time with devices that are effectively free (they come with the phone contract) and with games that are free. Free is a very popular price, as the legions of download IP pirates will tell you. Against this the established console manufacturers have a huge problem getting people to spend real money. Microsoft have the best approach. They are now selling a cross media device that can access all sorts of IP on a phone like contract. That it can play games is a bonus. The real product is Xbox Live and the Xbox itself is merely a way to access this.
I think that the Wii U will succeed, because it is the only way to access the latest iteration of some of the very greatest properties in the video game industry. However it will never get anywhere near the success of the original Wii. The world has moved on and there are better gaming platforms for most people's lifestyle in the real world.

Posted:2 years ago

#1

Daniel Hughes Studying PhD Literary Modernism, Bangor University

436 497 1.1
Popular Comment
Great article Rob. What are your thoughts on Nintendo's digital push? Reading Iwata's financial analysis, it's interesting to see that off roughly 20 million 3DS systems, Nintendo's digital business is tracking to be more profitable than it was off its former peak of 56 million Wii and 10 million DSi systems. It's absolutely clear now, that more digital content is being sold per user on Nintendo systems. Given Nintendo's new digital strategy is in its infancy, the real turning point for Nintendo's profit margins could come from eShop across Wii U and 3DS. Why they haven't confirmed universal, cross-system accounts and a cross-system Virtual Console service I don't know, because I feel that would really help Nintendo's digital business. They're moving very quickly to offer a serious digital alternative to their rivals, with their own unique twists as per usual, but they aren't moving quickly enough to ensure universal accounts on their systems. Nintendo Network should become exactly that, a unified network, rather than system specific services, and that unified network makes most sense when it comes to Virtual Console purchases.

"The strong yen doesn't help."

Bruce, only you could read this article and reach that conclusion. The whole point of this article, is that the biggest current threat to Nintendo's business, to its revenue, to its profit margins, is the strong yen. It not just a case of it 'not helping', but a case of it severely impeding Nintendo's ability to post large profit margins and move more competitively on price. With more favourable currency markets, Nintendo could sell Wii U and 3DS at a lower price, or at a more profitable price, and benefit regardless. As it is, the strong yen forces Nintendo to sell at a loss, and is arguably a bigger threat to Nintendo's ability to remain competitive than any other factor in the industry. The 3DS's success (though still below Nintendo's high expectations) is a clear testament that with the right software and services, Nintendo can compete against the multitude of options available to people today. The fact 3DS is after 19 months and only one Christmas season (versus two Christmas seasons for DS), slightly outpacing its enormously successful predecessor globally, is also a clear sign that Nintendo are moving in the right direction and remaining highly relevant in the gaming industry.

"However it will never get anywhere near the success of the original Wii. The world has moved on and there are better gaming platforms for most people's lifestyle in the real world."

That's a more interesting point. I'll ignore the latter sentence, because it will rely on anecdotal evidence about how many 'casual' users have moved away from Wii, about how consoles can't hope to compete with social networks, tablets, smartphones etc, because I've heard all that before, and I'm still not convinced they pose an existential threat to consoles, or even a threat to the ability of the console business to continue to grow. The point about whether or not Wii U can outdo the Wii, of course, is an interesting one.

Nintendo's initial Wii U shipments are below the comparative Wii shipments by a small margin, due to manufacturing constraints (in Iwata's financial briefing). It may also be a conservative estimate on Nintendo's behalf, given the constant revisions to their forecast 3DS and currency exchanges have demanded, at times making their business seem unhealthier that it is. It is unthinkable that Nintendo can post a five fold increase in raw unit sales, or a similar percentage growth, as they did with GameCube to Wii. Even if the console industry were to boom massively, short of moving into India, Brazil and China and actually being successful in those markets, overcoming all local competition, Nintendo could not hope to shift 500 million Wii U systems. Could Wii U post comparable revenues and profit margins to Wii? Rob's analysis gives us the answer: without a shift in currency markets, absolutely not.

But can Wii U sell in similar numbers to Wii? I believe it can. I believe Nintendo's biggest challenge is to ensure that Wii U's software ecosystem and growth curve are far healthier and more stable than Wii, because Wii was too front-loaded, leading to Nintendo's inability to support such a huge install base. Third parties were constantly caught on the hop with Wii. They have a chance with Wii U (with Ubisoft at least seizing it with both hands) to be far more involved. Nintendo's collaborations with Platinum are also a good sign. The point, dismissing Wii U's ability to sell up to 100 million systems in 6 years is premature. It's a given it won't represent the kind of growth Wii did, but everything else is up in the air. If Nintendo can match their strong first party support with a more consistent, appealing and profitable digital service, and strong third party support (even if that support isn't as complete as their rivals), they will be in a very strong position to sell a lot of Wii U systems. The real challenge isn't even responding to their rivals, or bringing the price of the machine down, it's making sure that the right content is there, and that the content comes on a consistent basis. As Iwata said at GDC, as he was bizarrely condemned for saying, in this age of ever more platforms and ever more ways of playing games, content is still king.

Edited 2 times. Last edit by Daniel Hughes on 26th October 2012 3:53pm

Posted:2 years ago

#2

Gwyn Howell Developer

7 8 1.1
Why doesn't Nintendo create another company in the USA, and license its IP. That way, profits from the west would not need to be transferred into yen. I have absolutely no idea about finance so this is probably an absurd idea. Just a thought ...

Posted:2 years ago

#3

Tony Johns

520 12 0.0
Lets hope that software sales for games will turn Nintendo's loss into a proffit soon.

To see them fall from the hardware race like SEGA did last decade would be so sad for the videogame industry, and if I were to buy a console after I finish university in around 3 or 4 years time, I would love to keep buying Nintendo.

After this gen of buying multiplatform and knowing how expensive it is, I will only buy Nintendo consoles next gen and gen after gen as long as they continue to make hardware and amazing software of games.

After I finish university and get a good job, my life experience knows that I just can't buy multiplatform again, and for the WiiU I may as well wait until the 5th year before I get one and then just get a few of the best games I want for the system.

That is if EB Games and other gaming stores like JB HiFi that also does gaming retailing like EB does and what GAME used to be like, if those other gaming stores are still around with used games and pre owned games being cheaper, I would not mind being a late adaptor because of my change in lifestyle.

Posted:2 years ago

#4

Thomas Dolby Project Manager / Lead Programmer, Ai Solve

342 293 0.9
@ Gwyn
I'm no financial expert either, but even if they have another company (they do actually have Nintendo of America), all the money has to go home to Japan at some point, and there's just no escaping the fact that dollars can't go back home without being half the value they once did.

To avoid these problems they would have to completely uproot the company (I imagine their development studios too), which I guess isn't even considered an option with the culture divide.

Posted:2 years ago

#5

Jim Webb Executive Editor/Community Director, E-mpire Ltd. Co.

2,287 2,507 1.1
Excellent article, Rob.

Excellent article, Daniel.

Daniel, they have announced a universal account system (Nintendo Network) but haven't gone into major details on it yet. Your account will be accessible from the Wii U, 3DS and eventually PC's and mobile phones and other devices.

Posted:2 years ago

#6

Daniel Hughes Studying PhD Literary Modernism, Bangor University

436 497 1.1
Thanks Jim. A little digging tells me Miiverse will also come to 3DS, which is an important step. I just find it frustrating and disappointing that Nintendo aren't ensuring this unified account/Miiverse system comes out at the launch of Wii U. They've improved from the lack of eShop at the 3DS launch, but to not have this ready to go from day one with Wii U, or even before Wii U launches to allow people to trade in their Wii without fear of losing their digital purchases, is a mistake and a sign to me that for all the progress Nintendo have made with eShop and now DLC, they really need to step it up with unified accounts. It's good that they're coming, but the launch of their new home console is the best possible time to roll this out and there are no signs Nintendo are going to do that.

Posted:2 years ago

#7

Jim Webb Executive Editor/Community Director, E-mpire Ltd. Co.

2,287 2,507 1.1
The Nintendo Network itself is already here. Several 3DS games are already using it for the online infrastructure.

The eShop will also be there from day 1 on Wii U.

As for transfers, that's a different issue because the Wii itself will not have access to the Nintendo Network. So the only way to transfer over games and stuff is the same way it was done with a DS to 3DS (or 3DS to 3DS) transfer. Requires both consoles, a downloaded app and an Internet connection. That's just the nature of the Wii, not the new network.

What they have failed to do is communicate these aspects early on. Waiting this close to launch is a bad idea. I do expect more Nintendo Direct videos to cover this but again, it would have served them better had they made the information more open already.

Posted:2 years ago

#8

Lawrence Sonntag Journalist

2 1 0.5
I'm very glad you discussed the strong yen, Rob, excellent analysis. It's frustrating to hear people attribute Nintendo's financial state to superfluous factors.

Posted:2 years ago

#9

James Berg Games User Researcher, EA Canada

190 250 1.3
@Rob, excellent insight, thank you! The yen was a factor I hadn't even considered for the upcoming Wii U launch.

@Daniel, thanks as well for adding valuable insight to the conversation. I'm not convinced that the Wii U can match the success of the Wii, but I was one of those who dismissed the original Wii, so I'm hesitant to make the same mistake twice. The Wii had the advantage of being novel, and letting people have completely new experiences. It's a family console as well, with kid-friendly games, and it's the ultimate casual living room console for when non--hardcore-gamer friends come over.

Unfortunately, I just don't see that with the Wii U. The tablet is certainly novel, but it's not a living-room-wide engagement. I'd argue it's actually the opposite - you're focusing on a small screen, while your friends are focused on the TV. There's several humanitarian UN resolutions preventing me from having children, but those friends of mine that have more than 1 spawn are deathly afraid of the Wii U, and the inevitable brawls that would result from there just being -one- special controller.

Posted:2 years ago

#10
Years ago when MS entered the games race people predicted that the industry could not support three players. It turned out not to be true... at least in the short term. But I think that time has now come. Microsoft is the most secure and Sony the least. The best thing for Nintendo would be to survive until one of the other players effectively gives up. At least they still have their 10 billion or so in cash.

Posted:2 years ago

#11

Daniel Hughes Studying PhD Literary Modernism, Bangor University

436 497 1.1
@James

That's a great point. Because of my age and the age of my friends, I don't really have any kind of parental perspective on this. I do think, however, one thing people are over-looking, is the way Nintendo have sculpted the form factor of their recent controllers to represent devices people are familiar with. One (often overlooked) aspect in Wii's success was the form factor of its controller: it was deliberately designed like a TV remote, a device anyone who bought the machine or were attracted to the machine was already familiar with, and it was one more element that ensure Wii was able to take off.

When we look at the Gamepad, we see the traditional controls that hobbyist gamers want (dual sticks etc), and we see this in a tablet like case. Now obviously, tablets aren't as widespread as TV remotes, but as another recent article on GI points out, the 7 inch tablet market is about to explode. The Wii U Gamepad is a 6 inch screened device, resembling a tablet. I don't think this is any coincidence, and I think it shows that Nintendo are more forward looking with the Gamepad than many people would give them credit for. There will be very little initial benefit to tablet users seeing a familiar device in the Gamepad, but in the years to come, this could be an element that plays into the long-term success of Wii U, by attracting consumers from the tablet market who are becoming familiar with videogames. If 7 inch tablets do take off into the hundreds of millions or even multiple billion devices, Nintendo only needs to achieve a small overlap to attract millions, or even tens of millions, of new consumers. To do so though, they'll still need the right content to attract those users, because form factor on its own obviously isn't enough.

Posted:2 years ago

#12

Andy Samson QA Supervisor, Digital Media Exchange

238 185 0.8
Nintendo in some ways might be a step behind but they make up for it by being two steps ahead with innovation . A lot of people also probably do not realize is that with the Wii U, Nintendo is turning any SD or HD TV into an SMART TV. Whatever LG has on their Magic remote Nintendo has already done it with the Wii. LG has recently integrated Voice recognition into the Magic Remote and the GamePad can work like this too for Nintendo TVii. With the GamePad there's a whole lot more functionalities built in that can make the experience even so much better.

Posted:2 years ago

#13

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