Nintendo

[Originally done in Jan 09. Interesting company, and Sean Malstorm's articles on disruptive business models are facinating reading for anyone who ever played computer games. But for Nintendo itself, I think their portable DS faces too much challenge from the iPhone to make the shares a buy.]

Sells games and the devices to play them on. Deals in two segments: mobile gaming (DS) and living room console (Wii). For a breakdown:

• The DS (released end 2004) is further along its product life-cycle than the Wii (released end 06).
• Currently (half-year ending Sept 08), 10m units wii vs 13.7m units DS. Software sales in units were about equal between the two, 81m (wii) vs 85m (DS). So assume the profit from mobile and console segments are currently about equal - Nintendo does not give a breakdown.
• I expect Wii product life-cycle to last at least few more years. Unsure about DS. See Q4 here. and Q14 here.
  

Business Model (I)
The game console business by Sony and Microsoft has typically been the razor blade model. Both of them lose money on the colsoles sold, and recoup their profits on the games brought for the consoles. Nintendo in contrast, sells a lower end console which it makes a small to medium profit on. Nintendo makes a large profit selling its in-house software (about 60%) and a smaller profit (estimate 10%) from third party software.

For the big picture, Sean Malstrom writes about Nintendo's disruptive strategy. In essence, this is to profitably sell an innovative but cheap, 'stripped down', 'easy to use', low end product, aimed at new customers (in this case girls, parents or 'casual users', not existing gamers). After conquering the low end of the market, the new entrant will have the market share and resources to conquer the 'high end' (for example, male teenagers who play conterstrike 17 hours a day). Unrelated examples of disruptive products are Air Asia and the iPod.

Cyclical Aspects
Video games (console) has their own cycle, tied to their console lifecycle. I expect wii product lifecycle to last at least few more years. Unsure about DS.

Games and unaffected by the economic cycle and generally hold up well in recession as a cheap form of entertainment.

Competitive advantage:
Nintendo has some competitive advantages in the current product cycle.

Most importantly, market share. All sales figures are estimates, but it is clear Wii and the DS are kicking ass. For the Wii:

• Installed base of Wii overtook the Xbox360 and PS3 consoles in Sept 07.
• Currently estimated at 24m Wii vs 21m XBox (http://nexgenwars.com/).
• In Nov 08, Wii sold almost double the amount of Xbox360 and PS3 combined - graph for US market here.
  

For the DS:

• DS started outselling the PSP around 2 to 1 in 06. Currently estimated 40m units sold life-to-date vs PSP's 25m. Recent US graph here.

From Sean Malstrom's excellent atricles Nintendo's Shield and Sword, some of the compeditive advantages that Nintendo has in the current generation are:

• Image. The Wii is changing the image of video gaming from that of a solitary, nerdy activity spent staring intently at a screen, to a fun-filled, social or family one. Hard to put into words - see the Shield article for pictures. "I believe as a principle that it is also the strategy to heighten the social status of video games in general." - Q5 of Nintendo Investor Relations Q&A here. This is similar to the way that Apple, with U2, positioned the iPod, as a for listening to music, beating other contenders, like Creative, that made (technically) superior and cheaper products that beat the iPod on every measurable metric.

• Games are far cheaper to develop for the Wii. May change the business model of game development from the risky, high-cost, 'blockbuster model' (movies) to the lower cost 'television model'.

• Being an integrated gardware and software developer allows them to evolve or innovate products which are more entertaining and usable. See A4 here.
  

Having said that, Nintendo does NOT have a sustainable competitive advantage. Dominance in the console industry has switched places 3 times in the past decade.

Business Model (II)
Nintendo is not a Buffet-like company which can sit back and milk its profits for years or decades, such as Coca-Cola or the Washington Post. At first glance, it's sale of games and hardware makes it seem like a hamburger company which sells consumable products on a continuous basis. This is wrong. It is better to imagine Nintendo as a company that undergoes a series of projects (in the short term each 'project' is a new game, in the long term a new platform), where the payoff from each project is unknown. They key is that they must keep releasing new 'projects' to entertain and surprise their customers in new ways. Their income is project based, not revenue based. Worse still, the payoff for each project is unknown at the start.

In their own words:

• "I basically do not think that an entertainment product can become a necessity... the future is not necessary stable...Because every business built on a single product which was once a necessity has been broken down by an innovative, disruptive technology....every company whose life expectancy was long or used to be called an excellent or a visionary company will collapse 5 or 10 years later.": A17 here.
  
• "[I] believe that once we think it is stable, then that is a sign of great danger.": A19: here
• "what we are most afraid is a situation where people stop playing with their DS. Before DS launched, people lived without DS without experiencing any inconvenience back then....we need to provide them with interesting proposals one after another in order to keep their interests." : A9 here.
• "our business can be finished as soon as our customers become indifferent to our products. Accordingly, we are always reminding ourselves that we need to offer something new before our customers get bored of our current proposals." Q4 here.
• "what matters to us is whether or not we can continue to constantly create and offer new surprises one after another" A24 here.
  

Compeditors

The biggest threat I see is the encroach of mobile phone gaming into the DS space. Mobile phones have traditionally been very hard to develop games fore, due to the fragmented market (meaning thatm, wven when using an OS independent language, you have to rewrite the games for different platforms due to the different input and output on different phones). And it has been hard to design a mobile phone gaming device - remember the adds for Nokia's Ngage.

The threat here is Apple's iPhone and iTouch (some sort of PDA), one of the few remaining integrated hardware and software companies:

• Apple challenges Sony and Nintendo
  
• Apples iPhone faces off with Game Champs
  
• Can the iPhone rule gaming?
  
• Review of Spore for iPhone.
• Videos of iPhone games: Rebel onslaught (using motion control) and Android/lode-runner (using on-screen joystick).
• Businessweek article: apple projected to sell 40m iPhones a year, which is the same number of DS units sold in 18 months.
  
• Iwata answers this briefly in Q8 here.

Although the iPhone is not as good as the DS for games (lacking buttons), it may be 'good enough' for most people. Especially since everyone is going to buy a phone anyway. The games usually sell for between 99c and $9.99. After looking at the Rebel Onslaught demo, I think iPhone will kill the DS. It is a matter of convenience and price.

Since I estimate that DS makes up to half their revenue/profit, stop the analysis here.