2. NINTENDO: FIGHTING THE VIDEO GAME CONSOLE WARS1 2.1. Introduction The 2011 Electronic Entertainment Exposition (E3) in Las Vegas was a moment of truth for Nintendo, video games’ most iconic company. Despite the recent success of its flagship product, the Wii video game console, Nintendo was facing decreasing sales and lower revenues. The company’s hardware sales were down by 10 million units compared to 2009, and software sales were down by 30 million units compared to 2009. Income was in decline, and shares seemed to be in permanent retreat. Nintendo’s stock had retreated to levels not seen since the company’s mediocre performance before the launch of the Wii. --- INSERT FIGURE 2.1 HERE --- Nintendo’s problems were taking place at a time when the industry’s standard business model was being transformed by online social, and mobile gaming – market segments that Nintendo had been reluctant to enter. For many observers Nintendo’s problems could be traced back to Nintendo’s conservative management style and incremental innovation policy. Nintendo was still very much a family-owned and managed business. Long time CEO Hiroshi Yamauchi, great-grandson of Nintendo founder Fusajiro Yamauchi, continued the top-down management style that traditionally prevailed in the company since its incorporation in 1889. He moved away from day-to-day control of operations when in 2002, Satoru Iwata, until then Head of Corporate Planning, took over as the first ever non-family President in the history of the company. 1 This chapter was written under the supervision of Professor Joseph Lampel at Cass Business School. The manuscript was submitted and accepted for publication in February 2013 as an invited teaching case in The Strategy Process (ed. Lampel, J. and Mintzberg, H.). The chapter’s preferred reference is: Rietveld, J. and Lampel, J. (2014). Nintendo: Fighting the Video Game Console Wars, The Strategy Process (in ed. Mintzberg, H. et al.), Fifth Edition, FT Press. This dissertation chapter was revised from the teaching case with cosmetic edits to improve readability. Iwata went on to successfully turn around Nintendo’s fortunes with the Wii console launched 2006. He was now determined to do it again with the WiiU, Nintendo’s next generation video game console. To create maximum buzz, Iwata chose the June 2011 E3 conference in Las Vegas to make the announcement. The game plan was clear: Nintendo was out to remind industry analysts, and through them shareholders, that the WiiU could count on the 87 million owners of Wii consoles to rebuild its market position. 2.2. Swimming Up River The company behind some of entertainment’s most famous fictional characters such as Mario and Donkey Kong began life as a playing cards company in Japan in 1889. When Hiroshi Yamauchi took over presidency from his great-grandfather Fusajiro Yamauchi in 1949, Nintendo moved from playing cards to electronic toys to handheld gaming devices (Game & Watch) and arcade games (Donkey Kong) before entering the video game console market in the early eighties. American companies such as Coleceo and Atari dominated the video game console industry in the late seventies and early eighties, producing the first, and then second, generation of video game hardware. By 1983 however, the industry was in crisis. An influx of new video game consoles with poor quality, questionable publishing practices, and the commercial failure of movie tie-in games such as E.T. the Extra-Terrestrial, marketed by Atari, led to a loss of consumer trust and the collapse of sales. It was against this background that Nintendo released its 8bit cartridge-based Nintendo Entertainment System (NES) video game console in 1983, first in Japan, and two years later in the U.S. Almost immediately, sales of the NES took off in Japan, but success in the U.S. was much harder to achieve. The 1983 industry crash was still vivid in the memory of U.S. based distributors, retailers, and most importantly, consumers. As the first company to launch new hardware after the crash, Nintendo faced an uphill struggle. Nintendo had to rebrand the NES twice, sell the console to retailers on a consignment basis, and spend $5 million dollars on marketing during launch in the New York area alone. To reassure retailers that unlike many other console makers that went out of business, Nintendo was here to stay, the company also offered buy-back guarantees for its products. Gradually retailers started stocking and eventually selling the new video game console. The efforts paid off, not only for Nintendo, but also for the infant industry that had been struggling under adverse publicity and consumer skepticism. Nintendo’s NES differentiated itself from the home computer industry by innovative controller design and processing chip utilization that delivered exceptionally sharp graphics. These advantages, however, were soon challenged by the 1986 introduction of the Sega Master System in the U.S. Sega’s console imitated NES’s controller design, but used a processing chip that was twice as powerful. The company was no stranger to the video games industry, having been active both in the Japanese coin-op arcades and the video game console markets. Sega’s Master System challenged Nintendo in the hardware market. Contrary to other hardware manufacturers, however, Nintendo considered hardware as less important than software. The company put software development atop its agenda, whereas, to quote the company’s president Hiroshi Yamauchi, hardware was a “necessary evil” – necessary for delivering superior software performance, but not Nintendo’s main business. Putting software first meant drawing on Japan’s longstanding tradition in animation to create visually appealing games. Employees with a background in art and animation, rather than engineering, as was common in the U.S., allowed Nintendo to differentiate itself by focusing on character and plotline development. This led to iconic video game franchises such as The Legend of Zelda (1987), Metroid (1986), and Mike Tyson’s Punch Out (1987), games that sold in excess of a million cartridges and with highly profitable sequel spin-offs. Nintendo further consolidated its strong software library by forging exclusive partnerships with Japanese software developers such as Bandai, Capcom, Hudson, Konami, and Taito. The company set a maximum amount of five games published per year for each publisher, in addition to imposing a two-year exclusivity clause that prevented the release of games on other platforms. Nintendo also set minimum quantity production orders for cartridges. With these restrictions the company was signaling to game publishers that they were expected to meet consumer quality expectations if they wished to do business with Nintendo. While the new policies delivered higher quality games, they also led to discontent among game publishers who chafed under Nintendo’s restrictive licensing practices. The period between 1986 and 1991 marked an era in which Nintendo further refined its business practices. To protect its video game consoles against unlicensed publishing practices Nintendo prohibited production of cartridges by companies other than itself. Starting in 1991 Nintendo also discontinued working with its distributor, Mattel, deciding instead to bring in- house all marketing and distribution activities. External software development support for Nintendo’s system increased as game publishers were attracted to the console’s growing customer base. To retain consumer interest Nintendo launched Nintendo Power, a magazine aimed at young consumers, with at its peak had over 4 million subscribers. This customer loyalty program paid off handsomely for the company as it used the publication as a vehicle for product announcements and advertisements. Total console sales for the NES reached 61.91 million units worldwide. By 1989 Nintendo was generating ¥34,271 million ($446 million) in profits. In the third generation video game consoles, Nintendo attained an 83% worldwide market share, largely due to its exceptional in-house game design capabilities, and strong alliances with external game development companies. --- INSERT FIGURE 2.2 HERE --- 2.3. Jockeying for Position As confidence grew, so did the threat from outside competition as the thriving game industry attracted new entrants such as SNK, NEC, and Philips who became active manufacturers during the fourth generation video game consoles. Nintendo was also facing additional competition from established rivals such as Sega who was planning to release a new video game console, and Sony who was making concerted efforts to expand its position in the video game industry. Notwithstanding the changing competitive landscape, Nintendo steadfastly held fast on the strategy it set during the second half of the eighties. In 1989 Sega released the Genesis, a next generation 16-bit video game console that was more than four times as powerful as Nintendo’s 8-bit NES console. Sega also made its Genesis console backward compatible, meaning that its users could switch to the new console without rendering their existing games collection obsolete. Additionally, Sega successfully imitated Nintendo’s game development strategy by establishing alliances with external developers, and developing iconic games in-house such as Sonic The Hedgehog. Sonic The Hedgehog for the Genesis sold over 15 million copies and the franchise still is Sega’s best- selling franchise to date. Nintendo was slow to respond to Sega’s challenge. Riding on the success of the NES, Nintendo delayed releasing a successor to the NES until 1991 out of fear of cannibalizing its own market. When Nintendo released the SNES, the new video game console lacked the backward compatibility that made older games playable on the new system. Nintendo watched its market leadership slipping away as Sega’s Genesis sales kept rising, fuelled by a strong line-up of games. What turned the tide for the company was the release of the bestseller video game Donkey Kong Country in 1994.