Sunday, May 27, 2012

Nintendoom - Part 2 - Should Nintendo Go Third Party?

Last time, we discussed the general ‘doomed’ meme as an outgrowth of the belief that Nintendo's hardware markets are in decline.  A close corollary to that meme is  the pivot from asserting Nintendo is doomed to giving them some free advice  –  that the company should become a software only publisher.

#2) Should Nintendo, in light of its imminent decline, cut their losses and put software on someone else’s platform.

The advice of going third-party is not new.   During the GameCube era,  analysts and gamers alike looked to Sega as a precedent and advised a third party approach to Nintendo’s business strategy.

The thinking goes something like this.

  1. Nintendo’s decline is not a probability but a reality
  2. In the wake of weakening and objectively weak hardware sales, Nintendo must seek new revenue sources from its core competency (software)
  3. This revenue source  must therefore logically be placing their software on the widest audience possible  (at the time this was the PlayStation 2).

More recently, the discussion has hinged on the imepending ‘attack’ on Nintendo’s golden goose, the portable market, by tablet and smartphone devices and how the superior form factor and technology of these subsidized devices as well as the very low pricing of the ‘apps’ available post a mortal threat to Nintendo.

There is no shortage of insightful and sometimes flippant remark on why Nintendo shouldn’t go third party.  The same topic was covered at length by many people across multiple discussions on-line.  The financial argument is well covered, as is evidenced by a recent opinion piece that summed up the dynamics of opinion and the realities quite succinctly.

“Last year Angry Birds developer Rovio estimated that they brought in around $100 million in revenue for 2011. That’s all their products, including all the Angry Birds games combined. Zynga, with all their social and mobile titles, swung to a loss a little smaller than Nintendo’s, with around $1 billion in revenue. Furthermore, the entire Apple App Store in its whole lifespan has brought in around $4 billion in revenue. That’s all apps combined since 2008. (Apple doesn’t have individual profit data on all those app makers.) Nintendo brought in around $12 billion in revenue in 2011 alone 
The reason social and mobile gaming are getting so much press is because of how fast they are growing compared to conventional console gaming. Rovio’s $100 million 2011 revenue estimate is a tenfold increase from 2010. “

Thus the underlying issue is laid bare.  It is ‘growth’.   Investors like growth. Therefore we must ask the question: Why can’t Nintendo make 12 billion dollars selling  0.99cent and advertiser funded ‘free’ apps?

The problem with a Nintendo pivot to a high growth third party strategy is simply an issue of ‘scope’. Nintendo has often been lambasted for their hardware as being ‘inferior’ , from the cartridges and mini-DVDs of the N64 and GameCube to the unfavourable matchup between the DS and the PSP and to the genuinely surprising decision not to upgrade the processing technology behind the Wii over the GameCube, outside of overclocking the processors in the GameCube and adding a tertiary ARM CPU for wireless.

The criticisms however have tended to miss the point of Nintendo's hardware strategy. The company has often succeeded in marrying its hardware with its software.  The analysis that software is their only strength ignores the fact that they were often able to innovate on software by first laying the groundwork on hardware.  The Wii motion control technology, and touch screen of the DS allowed an entire class of Nintendo software to flourish where they could not find a home elsewhere at the time of their release.

Nintendo benefits from economies of scope in the sense that not only is it able to deploy their internal resources  (software engineers, hardware engineers, their capital reserves, R&D  etc) across a broad range of software, but those resources can be deployed in a way that enhance hardware development such that they support software.  This is an immeasurable competitive advantage for Nintendo that has allowed it to dominate the platforms it produces and yield higher than normal returns as a software developer on those platforms.

This philosophy is underlined by Nintendo’s assignment of software designers Katsuya Eguchi credited with the design of games as varied as Super Mario Bros. 3,  Star Fox, Wii Sports, and the Animal Crossing franchise with the position of overseeing the Wii U hardware.  Similarly, Hideki Konno of Nintendogs and Mario Kart fame was assigned to oversee development of the 3DS.   These are software people assigned to manage hardware design such that the resulting software will take full benefit of the hardware.

While the 3DS has had its share of perceived problems – high introductory price, excessive concern over 3D from Nintendo turning off some customers, lack of games during launch – It is hard to argue against Konno’s assignment.  The most interesting innovations of the 3DS in its StreetPass mode is undeniable. Streetpass has morphed into a community, an active social network of sorts that connect local players into a gaming community.

Until such time that their hardware sales are so untenably low or software prices on appstores rise high enough, there is little reason for Nintendo to pursue a wholesale third party strategy.

Final Analysis:
There is a wrinkle to this story.  What if, some argue, Nintendo were to continue with business as usual but  approach the smartphone/tablet mobile market incrementally, by first putting their legacy software on the platform.

Assuming Nintendo is to become a third party publisher, this approach is what I believe is the most likely ‘third party’ scenario for Nintendo.  It does not deny that Nintendo earns above average profits from its own hardware from the economies of scope enjoyed, but it also allows an avenue for the company to tap into a high growth market by selling older games, likely at a premium compared to similar games on the market, on the appstore environment.

The argument goes further by nothing that Nintendo can effectively price discriminate across various consumer groups, by selling older titles (such as their Virtual Console library) digitally as app-store prices to consumers who will gladly pay $4.99 for an old Nintendo game, while keeping their premium titles on their own hardware at premium prices.

There are however some problems as well. A problem with this approach is that it risks fragmentation of Nintendo’s own markets.  The Virtual Console (VC)  titles, specifically Nintendo VC  games, are also one of their aces in terms of drawing consumer attention to Nintendo hardware. The effect of making these games non-exclusive to Nintendo could weaken the proposition of Nintendo branded hardware.

Further, until the time Nintendo can articulate a more coherent Virtual Console strategy – treating VC as a platform and making it something more in-line with Apple’s itunes where bought games are tied to user accounts and is transferable between hardware and does not require repurchasing a game on a new platform –  the dream of a Nintendo titles on appstores seem to be strategically risky at best.

Part I  - Has Nintendo has Failed?
Part 3 - All we want is Mario in every box

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