I bet you think Nintendo made a ton of money from the Wii and DS?  Their turnover since 2006 has been exceptional, but you’d be surprised at the relatively small amount of profit they made, considering the boatloads of cash spent by folk on the little black and white boxes of motion controlled joy.  In fact, based on last years performance, and this years interim results, Nintendo could be in for a rocky few years ahead.  So why are they in trouble now?

Back in 2003/4*, Nintendo wasn’t looking great.  Their flagship products were either stillborn, the Gamecube, or were on their last legs, the Gameboy.  In a prescient opening to the 2004 Nintendo financial report, Saturo Iwata said the following:

It was easy to dispute this viewpoint at the time, Nintendo were flagging behind Sony and Microsoft in the sixth console generation, and hadn’t grown as a company for about six years.

A product called the Nintendo DS was released in November ’04 in the US, and it wasn’t clear that it was going to be the monster smash it became, largely because it looked like it had been designed in the soviet bloc.  The DS only sold 5 million units in 2004/5, the Gameboy Advance sold 15 million in the same year, and the Gamecube sold less than the DS.  Sales were flat and profits were falling.  Dire predictions about the future of Nintendo, comparing them to Sega and suggesting they’d be better off as a software only publishing house, were abound.  2005/6 was little better, while DS sales picked up slightly, GBA sales halved, it was as if there was a limit to the number of handheld sales of around 20 million a year.

It was then that Nintendo revealed the Wii.  It was largely rejected by the mainstream gaming press as a pile of old rubbish (much grist was generated by looking at its internal hardware and comparing it to the much more powerful Xbox 360 and Playstation 3 consoles which it was supposed to be competing against).  But, if the gaming press had been paying attention, Nintendo were trying to do something else, they were trying to halt the stagnation of the gaming market.  The Wii had two significant advantages over its main rivals, it was cheap, as it used relatively inexpensive hardware and eschewed HD fidelity, and it was great for playing in groups.  Its no surprise that the Wii sells out at Christmas, what other system was so heavily geared towards party and family games?

To say that the Wii was a success is an understatement.  It is now one of the most successful consoles of all time, selling over 85 million units since launch.  After a redesign, the Nintendo DS has sold nearly 150 million units which makes it the most successful handheld console ever.  So why do I think that Nintendo are in trouble?

While Nintendo have sold a lot of consoles, they have also had to spend a tremendous amount of money designing and buying hardware, building or renting facilities to manufacture and assemble units, on warehousing, distribution and marketing and on the salaries of all the new staff they’ve had to employ to keep up with demand.  The success of Nintendo at this time is unprecedented in their history, and they’ve gone from manufacturing around 20 million handheld and home consoles a year to nearly 60 million in 2008/9.  The tales of shortages at Christmas might be exaggerated, but I wouldn’t say they are entirely unjustifiable.

So revenue is up, but costs are also up.  Take a look at the following graph and you’ll see what I mean:

The spike in revenue is striking, but the bottom line, the net profit, the profit after the cost of all of Nintendo operations is deducted, doesn’t have quite the same dramatic shape.  In 2008/9 Nintendo’s revenue was up 260% but it’s profits were only up by 180%.  In an ideal world you’d want those figures to be pretty much the same, but because of the reasons above, they’re never going to be.  It’s not even a major problem, until the sales start dropping off.

Ah.  Now we’ve got a problem.  Nintendo’s revenue has been dropping off a cliff for the past few years and net income is back to pre-Wii and DS levels.  So even though Nintendo are turning over more than twice as much money as they were in 2004/5 (1,014 Billion JPY vs 508 Billion JPY), their profit levels are actually worse than 2004/5 (77.6 Billion JPY vs 98.4 Billion JPY).  You would normally expect to see profit increase relative to revenue, all other things being equal, as products are made more cheaply or more effectively and companies engineer out expense by replacing expensive hardware with less costly alternatives, but because the Wii was already a streamlined product at launch, it must have proved difficult to take out more cost.  It could be that it is actually becoming more expensive to make the Wii, as older chips are no longer mass-produced for other non-Nintendo products, reducing the significant economies of scale in chip production.

The other explanation for the reduced profits is the increased budget required to launch a new console.  We can see in 2003/4 Nintendo’s net profit takes a nose dive, before the release of the DS, so perhaps the costs of the Wii U and 3DS are having a significant impact.  What if this is just a blip and Nintendo are going to bounce back to their Wii/DS revenue of 2008/9 in the next few years?

The stars aligned when the DS and Wii both turned out to be massively successful.  There hasn’t been a better time to be at Nintendo than the past few years, as the cycles of their handheld and home console popularity converged like a perfect storm.  But, while this amounted to a massive boom, the waning popularity of both products at the same time means that both of their next projects had better be at least successful on their own terms. 

Looking at the 3DS, its not had the greatest of starts.  It sold 3.6 million units in its first six months, which is below the 4 million Nintendo forecast, but still higher than the DS sold in its first six months.  The problem is that Nintendo sold 7 million less hand held consoles than they did the year before.  The issues the 3DS has with player nausea, the difficulty of advertising a 3D product in 2D media, and lack of killer titles, mean that it isn’t assured of the same level of success as the DS.  That’s not a problem as long as the Wii U works out.  But I don’t think the Wii U is going to be a success, and it goes back to Saturo Iwata and the 2003/4 financial report. 

For all of the fuss about hardcore and casual gamers, there is one thing that is undeniable, Nintendo did grow the market for video games, for everyone.  That’s the reason for Sony’s Playstation Move and Microsoft’s Kinect, they saw massive amounts of cash to be had and ‘innovated’ in that direction.  Nintendo have effectively levelled the market, but Sony and Microsoft have now joined them in the casual market.  It may be cheaper to buy a Wii U than an XBox360 + Kinetic or a Playstation 3 + Move, but the essential Wii U package isn’t different enough to make people want to buy an additional console or upgrade from the Wii.

This is because the Wii U will not expand the market the way the Wii did, and its the same reason the 3DS won’t expand the market like the DS did.  The Wii U is not innovating in the right direction.  The unique selling point of the Wii was that you could play the Wii with your family on a standard definition telly.  The unique selling point of the Wii U, compared to everything else available, is that you can play on the controller when the telly is being used by someone else.  It is essentially changing the experience from a group activity to a single player activity.  It is a regressive move, not innovative.

I would love to be surprised by the success of the 3DS and the Wii U, as Nintendo is an innovative company, but I remain pessimistic.

* Dates are all based on Nintendo’s Financial year which run April to March.