For the past two decades, the history of the video game industry has been as predictable as most of its products: More advanced technology creates more powerful consoles, which run more realistic games. It was all about leveling up. That is, until Nintendo decided to stop spending its quarters playing a game it couldn't win. Faced with competition from technically spectacular machines made by Sony and Microsoft, the company had to reimagine what a game console could be. It came up with the Wii, which skimps on graphics and processing power but includes an intuitive, motion-sensitive controller that is revolutionizing the game business.
"Nintendo took a step back from the technology arms race and chose to focus on the fun of playing rather than cold tech specs," says Reggie Fils-Aimé, president and COO of Nintendo of America. "We took a more intuitive approach and developed something that could be fun for every member of the family."
For Nintendo, necessity was the mother of invention—the company's previous-generation GameCube was in a losing battle with Sony's PlayStation 2 and Microsoft's Xbox. Then But when Nintendo introduced the Wii in fall 2006, hardcore gamers loved it so much that it outsold Sony's PlayStation 3 as well as Microsoft's Xbox 360 every month except September 2007, when Halo 3 was released. By winter, Nintendo faced a shortage—unheard of for a console released the previous year. (This is a mixed blessing, to be sure: Analysts estimate the shortage could cost the company over a billion dollars in sales.)
Nintendo's performance is all the more remarkable since, from a financial perspective, the company is in a different business than Sony and Microsoft. In simple terms, those companies lose money selling consoles and make it back by charging third-party publishers a license fee to make games. In fact, they live on license fees, since their own games account for about one quarter and one fifth, respectively, of total software sales for the PlayStation 3 and Xbox 360. Nintendo makes money selling consoles, makes more money selling games, then takes in still more in license fees. It has sold just under half of all Wii software itself, which means it makes much higher margins, especially since games for the less powerful system don't cost as much to develop.
"Not to sound too obvious," Fils-Aimé says, "but it makes good business sense to make a profit on the products you sell."
Nintendo also makes plenty of profit from its handheld game business. According to video game industry analyst NDP, Nintendo DS has sold 17.9 million units in the U.S., compared to 10.7 million Sony PSPs sold. And Nintendo has sold about half the games for its machine as well. In 2007, the company's stock shot up from $32 to$74 by yearend—giving it a higher market cap than Sony, which is not bad for a former playing card maker with an Italian plumber for a mascot.
The key to Nintendo's success in software, as in hardware, is its willingness to reinvent what games can mean. Though the Wii lacks the processing horsepower of its competitors, it can scan weather, news, and some Web sites through a wireless Internet connection, and customers can download classic Nintendo games from an iTunes-style store. The company has released a plastic rifle contraption that will let the Wii play shooting-gallery games and it has introduced a second-player mode to its "Super Mario Galaxy" game that lets young children play along with adults. Many of company's most impressive innovations—like the tiny in-controller speakers that make the sound of an arrow being shot, while the television plays the thwack of it hitting its target—involve inexpensive, off-the-shelf parts deployed in clever ways.
Now the rest of the business has to keep up with Nintendo. "The fundamental interface in games has always been a controller, and Nintendo is bringing opportunities to developers to think about how interactions use motion. That has opened doors of creativity throughout the video game business," says Simon Jeffery, president and COO of Sega of America. "Nintendo's success is about creative leadership and the willingness to do things differently."