Video Game Consoles: Nintendo's Seventh Generation Bounce Back

23 April, 2012

Abstract

Technological supremacy has long thought to be a key success factor in the video game consoles market. This was challenged by the Nintendo Wii, as they managed to achieve success with a technically inferior system to main rivals Sony and Microsoft. However, segmentation analysis suggests that Nintendo did not overturn technological capability as a success factor in the existing market; they created a new market where technology demands were less. Nintendo's real genius in bouncing back in the video games industry was establishing the covert needs of, at the time, a non-existent market, and satisfying those needs through the vision of a product - moreover, an innovative product.

1 Introduction

The video games industry can be divided into three broad sectors: hardware, software and infrastructure. The hardware is supplied by the console manufacturers ‒ technology plays a key role here. The software comprises of the games themselves and these are typically developed in-house (by the console manufacturers), or by third-party contractors or independents. Lastly, infrastructure consists of the supporting activities (e.g. publishing and distribution) needed for the products to reach the market successfully (1). The network of these activities forms a value chain which can be divided into five vertical stages as shown in Figure 1.

Customers (the market)

Video games had long operated as a "winner-take-all" industry. For console manufacturers, the winner was typically the firm that established market leadership by: (i) exhibiting a software advantage namely through game blockbuster titles, exclusivity deals and/or an extensive library; (ii) being technologically superior to the competitors in terms of graphics, processing power and multi-functionality1; and (iii) orchestrating all elements of the product launch well, particularly manufacturing, global distribution and marketing (2). At the end of the sixth generation in the consoles market, Nintendo were trailing in third to rivals Sony and Microsoft.

1 In the mid 2000s, technological advances in the existing market had become subject to diminishing returns, but they were still a favourable factor in gaining competitive advantage (3).

In preparing for the seventh generation, Nintendo found themselves at a cross-road: Would they be able to execute these market success factors better than rivals Sony and Microsoft in order to bounce back in this market? Short answer, probably not. Nintendo had less technical capabilities compared to the rivals (2), and as mentioned above, this was a key driving force for success in the existing market. Furthermore, Sony had a huge install base (3), and although this is not critical for success, it is a huge advantage. These key factors meant that Nintendo pursuing the existing market would not be an advisable competitive strategy. The key alternative strategies available to Nintendo were: (i) retreat into the handheld console market as they were dominate here (3); (ii) diversify into related industries which played to their strengths, they have done so in the past (4); or (iii) create a new market in the industry - socalled blue ocean strategy2. Nintendo chose to create a new market. In doing this, from the offset, Nintendo had to their advantage brand reputation and tacit knowledge about the industry. However, the journey ahead of them was long, and key decisions as to which competitive strategies to take had to be made along the way

The remainder of the report shall be structured as follows. First, the competitive strategies that were available to Nintendo as they pursued this new market will be discussed. Second, key strategies Nintendo could use to sustain its competitive advantage will be proposed. Finally, the report concludes with a summary of the key findings.

2 Gaining Competitive Advantage

When identifying new markets, a firm should decide whether to entertain a broad or narrow audience; both have significant implications on profitability (6). Nintendo decided to target a broad market as shown in Figure 2. Further to this, a very good competitive strategy is to look for a market that maximises core competences, yet minimise core weaknesses (7). Nintendo managed to do this with their chosen market. "We want to appeal to mothers who don't want consoles in their living rooms, and to the elderly and to young women", said Saturo Iwata, Nintendo President (5). Here, Nintendo found that these targeted non-gamers4 would respond well to a gaming machine that was low-cost, social inclusive and easily learnt ‒ these reasons have been key to the Wii's success in the new market (3). Moreover, none of these factors heavily depended on technological power therefore Nintendo could supply a technically inferior system and still be successful in serving the new market. This is what they did. Arguably this is the second biggest competitive strategy Nintendo made in order to bounce back in the consoles market (the first being the initial decision to create a new market). Many of the competitive advantages available to Nintendo henceforth pivoted around their ability of being able to supply a technically inferior system without compromising success.

2 Blue ocean strategy looks to create new markets and industries where there is little or no competition in order to escape from intense rivalry over the same market space (20).

3 This segmentation is rudimentary, but nonetheless, illustrates the key differences between the markets.

4 Interestingly, rivals Sony and Microsoft were also pursuing non-gamers, but for non-gaming purposes as they both attempted to enter the home entertainment industry (3).

In satisfying this new market, Nintendo had to decide on the nature of the product - incremental innovation, radical innovation or something in between? Nintendo opted for radical which owed to the code-name "revolution" during the Research and Development stage (8) Code-naming the Wii in such a way created industry discourse, and a favourable tension for Nintendo. This is similar in strategy to Sony's periodic leakage about the PS2 in 1999, in order to undermine Sega's Dreamcast in the 128-bit generation (2). Furthermore, historically it has been observed that companies which successfully enter new markets do so using radical innovative (9). In addition to this, innovation is a core competence for Nintendo (10) therefore the advantages of choosing this strategy were at least two-fold5. In creating the product, Nintendo decided to work with others (open innovation) and not just by themselves (11). This saw Nintendo leverage another core capability, culture and creativity. However in making the product, Nintendo outsourced most of the components (12). Traditionally firms have kept this role in-house due to the technological intensity (3), but as Nintendo's technology was relatively in-advanced, most of the components were common and readily available which allowed for outsourcing to be beneficial. In particular, the processor used was from a previous generation hence the games were backwards compatible (13). On release, this meant that there were many software titles available (3) ‒ a strong success factor. Furthermore, the cost of producing a unit console were low. Low enough for Nintendo to be able to price the same as their competitors or less, and still make a profit on hardware alone (12). This is different from the razor and blades business model currently being followed by their rivals (3). Nintendo decided to price substantially lower than their rivals6 (13). This effectively meant they were pursuing both product differentiation and cost leadership. This disagrees Porter's generic strategies for success which state that "cost leadership and differentiation are mutually exclusive strategies", and that companies which pursue both are "almost guaranteed low profitability" (6 p. 223) ― Nintendo's success must be an exception to the rule. Furthermore,to help facilitate the low-cost positioning and accessibility of the console, Nintendo selected the appropriate distribution channels (e.g. supermarkets and mass merchandisers)(10). And finally to launch the product, Nintendo organised its biggest ever marketing campaign (3). Their launch included a free game (Wii Sports). This is a rarity in the industry (10). Arguably the effect of this strategy was equivalent to a blockbuster release as it generated plenty of interest. This is evident from the sheer volume of literature available on the topic.

5 It is suggested maximising competences is one of the biggest advantages a company can make therefore for Nintendo to do this, is perhaps more than a two-fold (9).

6 In the US, launch prices were: $299 and $399 for Xbox 360; $499 and $599 for PS3; $250 for Nintendo.

So, in correctly identifying new market needs, forming the right partnerships, as well as orchestrating the product launch well; Nintendo bounced back in the video games industry. In terms of unit sales, they were the outright winner in the seventh generation, selling approximately double as many units as rivals Sony and Microsoft (3). Now the question follows: How can Nintendo sustain this competitiveness?

3 Sustaining Competitive Advantage

For the next round of competition, the main strategies available to Nintendo are similar to those found at the end of the sixth generation (detailed in the Introduction). However, the key difference is that Nintendo continuing to compete in the current market is now an advisable competitive strategy. Before, this was not the case as the "current" market only consisted of the existing market. Now, the current market consists of both the existing and new market. Furthermore, given Nintendo's phenomenal success in the new market, the overriding competitive strategy for the next round of competition is perhaps clear ― Nintendo should look to continue serving and growing the new market. Further to this, they should continue excluding the audience of the existing market. This is because current evidence suggests that the video games industry is deviating away from the winner-take-all characteristics (3). This behaviour appears to be becoming more market specific (14). This implies that would be difficult for any firm to serve two market successfully. In addition to this, the new market plays well into an array of macro-environmental issues such as the growing pressure to curb violence in video games found in the existing market (15). However, since the launch of the Wii in 2006, the external industrial forces depicted by Porter, shown Figure 4, have manifested into direct competition for Nintendo. In 2010, Microsoft and Sony released products Kinect and Move; both with similar functionality to the Wii (16) (17). Now with competition present, in order to retain market leadership, the two key competitive strategies Nintendo should look to pursue to maintain their dominance are: (i) continue to understand the customer and use this to build customer loyalty, and (ii) continue to provide cost-effective product innovation.

The main benefit in establishing customer loyalty is that it will reduce switching behaviour to substitute products. However, to do this, Nintendo must look to understand the changing needs of the customer. In particular, they should pay attention to what customers perceive as cool, and incorporate that into the innovative products. If done correctly, Nintendo could see similar successes to Apple. For example, in the smartphone consumer market, Apple perception of cool has lead to a sustained market dominance. Pioneers Blackberry have failed to offset this dominance, and have since announced their intentions to retire (18). However, as Nintendo seek to pursue innovation, they must not fall victim to path dependency. In addition to this, products they release must not go backwards on any hardware features - different from the previous strategy. The reason can be realised using Prospect theory illustrated in Figure 5. The reference point for the success of the next console will be set by console features from the previous round. If the console released is less capable, this will result in disutility therefore a loss in market share. The reason why the Wii was successful in the new market even though it went backwards on a key feature (processor) is because the new market were not existing customers. As such, they did not have a strong reference point. Moreover, their reference point was low enough for the Wii to be framed as a gain. Currently, Nintendo's planned successor to the Wii (the Wii U) appears to be positioned above the current reference point - which is good. However, it is rumoured that the new technological features are expensive, so it is likely the console will be pricey (19) - if this is true, this is bad. Low cost was key to their initial success in the new market and it still is.

4 Conclusion

The combination of low cost, plus product differentiation through innovation lead Nintendo to obtain a competitive advantage in the video games industry in the seventh generation. For Nintendo to sustain this competitive advantage, it is proposed that they should continue to focus on the newly created market. Further to this, to maintain dominance in this market, Nintendo must continue to; (i) successfully implement cost-effective product innovation, and (ii) understand the customers' changing needs and behaviour.

5 References

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