The Unfortunate Truth of Nintendo’s Wii U Losses

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Nintendo’s announcement that Wii U will be sold at a loss at launch came as a pretty huge surprise. Multiple key Nintendo figures, including Nintendo of America COO Reggie Fils-Aime, had seemed to assert that Nintendo wouldn’t be pricing Wii U at a loss. Reggie in particular said that “we believe in making money on our hardware, even if it’s small amounts of money at the start.” To see Wii U selling at a price that will actually lose the company money seems… kind of crazy.

There’s no question that this will prove problematic for Nintendo as they attempt to return to full profitability… but just how problematic?

3DS Software Sales are Not Recouping Losses

Mr. Iwata addressed the most necessary step to finding success while facing hardware losses himself: “It’s important for us to develop a healthy business next fiscal year by combining sales of hardware and software.” It’s not a new strategy for Nintendo – they were counting on worldwide 3DS software sales to make up for the losses they had to shoulder on 3DS hardware. Given that Wii U’s initial install base is going to be limited to their rough 5.5 million shipment estimates, they’re going to need to count on 3DS sales again alongside Wii U software sales.

Unfortunately, while 3DS software and hardware are doing well in Japan, they’re not soaring yet in the rest of the world. Let’s take a look at what Nintendo had to say about their second-quarter losses and revised forecasts in yesterday’s financial report:

Sales of the “Nintendo 3DS” hardware and software were weaker in overseas markets than expected. In addition, the yen appreciation was beyond the expectation level and the exchange losses totaled 23.2 billion yen.

What’s causing the disparity? I think there are a few factors.

Factor number one has to do with regional trends. Japan has gained a reputation as the land of the handhelds, while the West is more about home consoles – and that’s pretty nicely expressed in the latest sales trends, as you can see from the chart below:

Factor number two has to do with the quantity and type of software released. 3DS has had a fairly flooded year in Japan – over a dozen more games have released there than in the United States, including Fire Emblem: Awakening, Brain Age: Concentration, and most recently Bravely Default: Flying Fairy. The West is still waiting on these games, and the titles we’ve received in their place consist largely of licensed games and flops like Heroes of Ruin. It doesn’t take much to figure out why 3DS software is doing better in Japan!

Factor number three was directly addressed by Mr. Iwata: Nintendo DS is undoubtedly the more enticing option to budget consumers due to its $99 price point and already well-established software lineup. As a result, New Super Mario Bros. was not far behind New Super Mario Bros. 2 in terms of sales, despite being over six years older and the latter being a brand-new release.

Without correcting these issues – without making handheld platforms more attractive to Western consumers by offering a more robust software lineup – I don’t foresee Nintendo 3DS making any huge waves in the West anytime soon… possibly even including this holiday season. I mean even the newest New Super Mario Bros. for crying out loud is struggling to pick up the mass market in the way that its DS predecessor did.

And with Wii U’s initial software sales limited to the system’s initial install base and thus limited in terms of the extent to which those games can make up for Nintendo’s hardware losses, not having an outstandingly strong handheld leg to stand on could potentially keep Nintendo in the trouble zone for longer than they anticipate.

On the bright side: Wii has had a relatively dry last few years, and as such Nintendo hasn’t been able to take advantage of much in the way of home console software to make up for 3DS’s performance in the West. The introduction of a large, diverse, brand-new round of software with the release of Wii U will at the very least turn this situation around. I also have no doubt that Wii U software sales will do better than 3DS software sales in the West… but, again, those sales will be limited at first by the install base and can’t replace the strength Nintendo needs from 3DS.

Wii U Still Hasn’t Proven Itself in the Mass Market

The news that Wii U is selling out pretty much everywhere is a good sign – but does it bode well for mass market acceptance, or just for the dedication diehard Nintendo fans who’ll buy any big new system the company puts out? I’m sure Nintendo won’t have any problem finding the 5.5 million Nintendo fans they expect to sell Wii U to before the end of the fiscal year… but what about after that?

I’ve already predicted that Wii U is priced too high to reach the kind of mass market consumer that went after Wii six years ago. While I don’t often say this, I think I can agree with Michael Pachter’s latest prediction that Wii U pricing will prove too prohibitive to drive hardware sales beyond those initial adopters and may set even those diehards too far back to meet Nintendo’s software sales predictions. Wii was able to achieve an average attach rate of four games per system, but when you tack on the cost of two extra games to Wii U (Deluxe Set), the idea that history might repeat itself really does seem unreasonable.

I’m happy to see that Nintendo’s at least mindful enough of its customers to offer Wii U at an at least fairly reasonable price despite the fact that they’ll lose money on it at first. Had Wii U been closer to $400, I actually might not have been able to make room for it this year. Even though the Wii U price is “reasonable,” that doesn’t mean it’s going to meet the needs of the market.

Could the factors that contributed to Wii U’s high cost of production – and therefore to its higher price – actually wind up overshooting the expanded audience that flocked to Wii? The idea of overshooting comes into play when a product winds up missing its target audience by piling costs and features on top that actually wind up driving away consumers instead of reining them in.

To use an example, we saw a massive drop-off in sales between the 2D side-scrolling Mario games and the 3D-perspective ones. While the 3D games were “better” and more “modern,” the increased complexity of both the gameplay and controls wound up drawing fewer people in than previous Mario games did. The “new features” made the games less attractive to the masses.

For Wii U, overshooting the market could be stuffing a bunch of technology into the Wii U GamePad that most people really won’t care about. Does the average person really care about NFC? How about the GamePad camera? How about the idea of a second screen for the home console in general?

There’s no doubt that the Wii U GamePad makes up a large part of the costs of the system – standalone GamePads are over half the cost of Wii U itself in Japan. If people in general just don’t really care, that’d be an example of Nintendo overshooting the market. They’d have dumped a bunch of money into something that increases Wii U’s cost without actually boosting profits.

Mr. Iwata said that Wii U’s initial high pre-orders were thanks to people outside of the mass market – likely those who have been following Wii U from the beginning. As such, its potential outside of that small group is still untested. Will Wii U sink or soar? We don’t know yet, but whether or not it can sustain its momentum following the launch window will give us a pretty good idea.

On the bright side: Games are inevitably what sell hardware, and Wii U’s got stuff like New Super Mario Bros. U and Wii Fit U in the pipeline. These games have been tremendous hits, particularly in Western markets, and they could be just the ticket to both keeping Wii U going in its first year and giving the West the software sales boost it needs to put Nintendo squarely on the road to profitability.

The Unfortunate Truth: Nintendo May Not be Able to Make Up Hardware Losses with Software

I started off by explaining how – and why – 3DS game sales in the West haven’t made up the difference for the negative margin of the system, and expressed concerns that they won’t do so for Wii U either. But my second set of comments about how the Wii U is still unproven in terms of the mass market – the same mass market that rejected the 3DS prior to its price cut and prior to the injection of mass market games (i.e. 3DS’s Mario trifecta) – were aimed at establishing something else: Wii U might be overshooting the market. It might even be overshooting the dedicated Nintendo fanbase, who might not be able to afford as many games as expected alongside a $300-350 system. If that’s the case, Wii U software sales won’t make up the difference, either – at least, not at first.

It’s going to take a robust and constant stream of quality, must-have titles to ensure Nintendo’s success not just with 3DS and not just with Wii U, but with their overall business. 3DS may be selling at a profit now, but without games to drive real sales, that profitability cannot be realized. And with Wii U starting off at a loss, Nintendo’s going to need to compensate with strong profitability across the board to appease its investors going into the next fiscal year and the years beyond.

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