The Launch of the New Wii U Gaming Console

In November, Nintendo will launch its new Wii U gaming console.  The company hopes to revive lackluster gaming revenues that have resulted from the maturation of the original Wii product line, as well  as the shift to mobile gaming that has hurt the console business overall.  Kyle Orland writes in this article about Nintendo's pricing strategy.  The firm will be pricing at below cost at launch.   In some ways, we should not find that fact surprising; after all, most gaming companies price below cost at launch. However, Orland notes that Nintendo did not have to do that when it launched the original Wii.  It actually turned a profit at the start.  That proved rather unusual though, running contrary to most product launches in the gaming industry's history.

Source: Nintendo

Why do most gaming consoles sell below cost at launch?  Three major reasons exist. First, companies hope to capitalize on network effects.  They want to build the installed base quickly.  As they do so, the value to each customer grows, and the attractiveness of the console to software developers increases as well. Second, the companies hope to use a "razor and blades" model to make money.   A higher installed base of consoles brings with it higher software sales, which can be very profitable.   Third, the cost of producing a console decreases significantly over time.  Those cost decreases occur for two reasons:  economies of scale and learning curve effects.  

For these reasons, Nintendo rightfully can expect to improve console profitability over time.   Still, they will need strong launch sales to kick off this virtuous cycle.  With the explosing of mobile gaming, the question remains:  Can consoles bounce back?  Have their struggles in recent years simply been due to the usual cyclical downturn in the later years of a technological generation, or are they experiencing a permanent disruption to their business due to the emergence of attractive substitutes?

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Struggles at Zynga

As many of this blog's readers know, Zynga - the social gaming company - has suffered recently.  According to this Fortune magazine article, "Shares are down nearly 74% since its stock market debut. User engagement has dropped 53% in less than three years according to social game analytics firm dystillr."  What has happened to the firm?

Several factors explain Zynga's struggles.  First, the company's games lack the depth of some traditional console-based video games.  Therefore, the games appear to have a limited life span.  Many users seem to tire of the games fairly quickly. Here we see a catch-22.  Zynga's games don't require the kind of upfront investment to develop that console-based games need.  However, the payoff down the road may be more limited - less risk, less return.  Second, the company depends upon Facebook a great deal.  As Facebook users have shifted toward accessing the social networking site via mobile technology, Zynga user engagement has declined.  Zynga appears to make less profit on its mobile games, as opposed to games that users accessed via Facebook on their laptop or desktop.  

Beyond that, I think Zynga's difficulties point to a bigger trend in the video game industry.   The shift toward mobile and social gaming clearly has disrupted the console-based gaming business.  Most of these mobile and social games require much less money to develop.  However, they also appear to have a limited lifespan in many cases.  Therefore, we have moved to a situation where gaming companies may need to innovate much more quickly.   Users appear to require new versions and new experiences much more often now.  They enjoy mobile games, but they "consume" them very quickly.   The new winners in the video game business will be those firms that can churn out streams of hits.  

The question remains:  Will those winners be able to develop franchises (a big hit followed by a stream of sequels and spinoffs), or will they have to develop unique new games much more often than in the past?   In the movie business, sequels generally make less money than original films.  Video games defied that logic for many years.  In console-based gaming, sequels proved to be an engine of profitability.   Can that happen long term in mobile gaming, or will consumers demand variety and newness to a much higher degree?

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Social Makeover at Electronic Arts

Fortune reporter Alex Conrad wrote a good article this week on the challenges facing Electronic Arts.  EA once stood at the pinnacle of the video game business.  Eight years ago, I wrote a case study about the firm.  At the time, EA had a stable of high-performing video game franchises, with healthy profits each year.   Today, EA faces many challenges.  It lost in excess of $1 billion in 2009, and it lost more than $300 million in the second quarter of this year.  Social gaming firms such as Zynga have burst onto the scene and disrupted the console-based video game industry. 

Interestingly, the signs of trouble stretch back to a time well before Zynga arrived on the scene.  EA became increasingly reliant over the years on building franchises, with a series of sequels building off of a popular game.  Moreover, those franchises often relied on others' intellectual property (whether it was a movie character or John Madden and the NFL players/teams).  Acquisitions played a key role too.   Fewer and fewer blockbuster hits emerged organically within EA's studios based solely on its own intellectual property.  As EA became more reliant on others, and less successful at creating home-grown hits, the threats to its competitive advantage increased.  Then, just as EA became vulnerable due to these trends, social gaming came along to disrupt the business substantially.

Now, EA must decide how to counter the social gaming threat.  The article suggests that one way it will do so is by adapting some of its popular titles for the social world.  However, one wonders if that is the optimal strategy.  Perhaps they will leverage those strong brands to make popular social games.  On the other hand, one must acknowledge the significant differences between console-based games and social games such as Farmville.  Will a firm trying to adapt titles from the console business end up creating a suboptimal social gaming experience?  Will the mindset of creating high quality, graphics intensive console games (which require substantial R&D expenditures) get in the way of producing successful social games (which have simple graphics, much less technological sophistication, and which require much less development investment)?   Companies focusing completely on social games, without the history of console game development, may actually have an advantage here.   EA itself seems aware of these challenges.  That may be why they have acquired several social gaming companies.  How they manage those acquisitions will prove critical to their future success.

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