And why the ‘Dreamcast analogy’ is misplaced

Earlier this week several market analysis outlets released their sales estimates of the US console market for April. Webbush, EEDAR and NPD all expect Nintendo’s six year old console, the Wii, to outsell the firm’s ‘next gen’ console. WiiU’s lacklustre April sales (60k units according to EEDAR) are projected to decline 19% month-over-month, and will only be a fraction of what competitors Sony (190k) and Microsoft (230k) are selling with their current gen consoles, PS3 and Xbox360 respectively. Furthermore, EA announced this week that it has withdrew support for Nintendo’s WiiU console as it currently has no projects under development for the WiiU. Contrary to the immensely popular Wii shortly after its launch, the WiiU is struggling to gain traction. In this light it may come as no surprise that several sources have speculated Nintendo’s retreat from the hardware market to the point that analogies have been made with Sega who withdrew from the console market shortly after launching the Dreamcast in 2001. While I agree with the notion that Nintendo needs to act in order to turn its fortunes around, I don’t buy into the argument that the toy manufacturer will abandon the hardware market altogether. Here are three reasons why:

Nintendo’s hardware – software integration. Nintendo has an unfair advantage over other console manufacturers and even ‘unconsole’ gaming platforms (e.g. Ouya, Apple or Facebook). Ever since the launch of the NES back in 1985, Nintendo has interwoven the development of hardware and software resulting in coherent and unique consumer value propositions. Creative Director and legendary games designer Shigeru Miyamoto has been instrumental in ensuring that Nintendo produces hardware that allow for unique gameplay experiences on one hand, and software that capitalize on the platforms’ unique features on the other (e.g. Wii – Wii Fit). While Sony and Microsoft own game development studios, some of which at very close proximity to the hardware development departments, the degree of integration is lower as ultimately they remain separate divisions. It was not until Saturo Iwata’s appointment as CEO in 2002 that the firm fully recognized this capability as one of its core strengths. Recognizing this advantage, Iwata has made attempts to further integrate software and hardware departments. While Mario (or any other Nintendo IP for that matter) would without doubt perform well on competing consoles or even non-gaming platforms, it is exactly because of Nintendo’s integrated hardware and software development that Mario is so much fun (and sells millions of units as a result). To retract from the hardware market would not only mean disposal of a generally vital business unit, it would imply serious degeneration of Nintendo’s games division.

The ‘next generation’ Console war has yet to commence. With each successive generation of video game consoles, market shares amongst competitors are reset. Since Sony’s ‘next gen’ console (PS4) is not expected until this Holiday season at the soonest and Microsoft has yet to announce its new console (which it will do so this week), Nintendo is enjoying a staggered start in the eight generation game consoles. As with the Wii at the start of current generation, critics are failing to recognize the WiiU as a proper next generation console. This perception has percolated with the market as illustrated by the console’s meagre performance. Yet, this perception could well change when Sony and Microsoft do enter the market with their next generation consoles. With every new generation, Console wars generate a lot of buzz with both expert and mainstream media and lead to consumer interest and eventually traction in the market. While it would be ignorant to ignore a general decline in the console video game market in addition to Nintendo’s inaptness to convincingly communicate the WiiU’s value proposition in absence of a killer-app, the market for video game consoles is expected to grow again once Sony and Microsoft will finally enter the eight generation. Not only will the WiiU benefit from increased interest in video game consoles by media and consumers alike, when positioned appropriately vis-à-vis Sony and Microsoft who will once again engage in head-on collision, Nintendo might eventually arise as the laughing third party.

Nintendo is well endowed with financial resources. After EA announced to have no further titles under development for the WiiU, critics argued that this was Nintendo’s ‘Dreamcast moment.’ Sega saw itself forced to abandon the hardware market in 2001 when major publishers flocked away from Sega’s Dreamcast to support new entrants Sony and Microsoft. When we compare Nintendo’s 2012 to Sega’s 2002 financial statements we see that the ‘Dreamcast’ analogy does not hold. At the time of Sega’s withdrawal from the hardware market, the firm whose operations comprised for 50% of arcade activities had an operating loss of US$ 592M (inflation corrected). At the time, the firm’s net assets were worth just over US$ 1B of which US$ 402M were cash reserves. At a similar pace, the firm would not last another year before running out of cash. Nintendo on the contrary had an operating loss of US$ 458M in 2012 against total net assets worth of US$ 12B of which US$ 4.6B were cash reserves. With over 31M 3DS handheld units sold since March 2011, the portable console market proves to be still lucrative to Nintendo. Similar to the less than glorious N64 and Nintendo GameCube days, portable consoles and games royalties give Nintendo a viable buffer for poor performance in the home console segment. If worse comes to worst, and Nintendo would indeed be forced to retract the WiiU from the console market, the firm would be well positioned to play bench for one generation. However, rather than retracting the from the hardware market altogether, it is more likely that Nintendo will use its cash reserves to upgrade the WiiU value proposition through offering a stronger library of high quality titles, and repositioning the console through savvy marketing.

Having said this, chances are that WiiU sales will ‘catch up’ with what would be considered satisfactory market performance. Nintendo has a staggered market position as it will take at least until this year’s Holiday season before Sony and Microsoft enter the market with their ‘next gen’ consoles. Important publishing partners have pledged support for the WiiU: Sega announced to bring their next three Sonic games exclusively to Nintendo platforms, and Ubisoft is confident that Nintendo will do what it takes to turn WiiU’s fortunes around and plans a strong line-up of titles (e.g. Rayman Legends, Watch Dogs, Assassin’s Creed IV: Black Flag and Splinter Cell: Blacklist) for the platform accordingly. Nintendo is currently making concerted efforts to get mobile and tablet developers to bring their apps to the second screen platform in addition to a strong line-up of first party titles planned (e.g. Pikmin 3, Wii Fit U, and Game & Wario). With the 3DS portable console Nintendo has already proven to be capable of turning a device’s fate around. Indeed, Nintendo will do everything to live up to their name when it comes to the WiiU: ‘Leave luck to heaven.’