I feel like I got a warm-up physically before acquired episodes these days, like a marathon. My back does start to hurt by the end from just standing still the whole time. Oh, me too, me too. I've actually stopped working out mornings before we record because I don't want to be too tired. Like, I need my stamina. Yeah. We should figure out, like, recording on the peloton or something. That'd be a breathy. Welcome to season 12 episode 4 of acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. The last left are Nintendo heroes in 1990, when they single-handedly revived the video game industry and captured 95% of the market share globally. We did our seven powers analysis and determined the company had a better competitive position than basically any company in history and the game was theirs to lose. But somehow they did just that indeed they did and then they won and then they lost and then they lost and then they won again exactly today's story will be about the fall and how Nintendo managed to blow a 10 run lead in the bottom of the ninth, but like all great heroes when faced with foes like Sega, Sony, Microsoft and eventually even Apple, Nintendo's creativity and cleverness has kept them a major player and certainly the most unique player in the video game landscape today. So David, as you mentioned, this is a weird story for us, usually the narrative on acquired goes something like revenues kept climbing every year and now they're making more money than they ever had before. But with Nintendo, it's been a very cyclical road and they actually lost money in long periods of time like 2011 to 2018 and their greatest strengths are their greatest weaknesses all the way through. So on the eve of the release of the Chris Pratt movie Super Mario Brothers, we tell Nintendo's part 2 story today from the console wars of the 90s forward. Well, before we get into it, we want to let you know about the latest over at ACQ2, which you can search in any podcast player. It's got some great episodes. The next one to drop will be with the CEO of Retool, David Shoe. He's a super contrarian founder and really interesting to just hear his take on startup wisdom generally. We've also gotten lots of emails from folks saying you really love the Statsig episode with Vijay Rajee so that is a great one to check out too. There's also the Slack. The Slack community has become a critical research tool for David and I since so many of you have insights and real work experience in the areas that we are covering. If you are not in the Slack yet, that is definitely where the best discussion is happening on top of what we were able to learn before we recorded an episode kind of about it all afterwards. So that is acquired.fm/slack. And David, without further ado, please take us in and listeners, as always, this is not investment advice. David and I may have investments in the companies we discuss and this show is for informational and entertainment purposes only. It'll be very fun at the end of the episode to talk about whether we think Nintendo is a good stocked owner at this point in time or not here in 2023. But before we talk about all that, we first need to talk about one more giant success from Nintendo in the 1980s, a very small giant success that we intentionally left off in the last episode because it's going to be very, very important here in part two. And that is, of course, the Game Boy. Yes. So we talked last time all about Gunpei Yukoi, Nintendo's effectively chief engineer and his genius behind building everything from the ultra-hand to the light gun shooting range to mentoring Shigeru Miyamoto and everything he did for Nintendo. One of his first early successes that we kind of glossed over last time was the game and watch business. Now these were portable, dedicated, handheld video game systems, meaning by dedicated, each piece of hardware only played one game. There was a Donkey Kong game and watch, there was a Mario game and watch, there was a Zelda game and watch, even, of course, a Mickey Mouse game and watch, but each piece of hardware only played that one game. It was also actually on the game and watch where Gunpei invented the D-pad that is on every single controller. How I realize that. Yeah. That is where the D-pad was invented with the game and watch. Huh. Pretty, pretty freaking awesome. And the game and watch actually sold a ton of units, I think 43 million units got sold before it ended life. Yes. And this is the thing. It's is don't know that much about it because it was never that popular in the West. It was huge in Asia, though. Like you said, 43 million units, over a billion dollars in lifetime revenue from this product line, which back then in the 80s and kind of pre NES, that was super, super significant for Nintendo. Now if you're thinking about this, given everything we talked about last time about technological and video game, innovation and marvels that Donkey Kong and Mario were and the NES and how advanced it was, how the hell did Gunpei and Nintendo get Donkey Kong running on a portable piece of hardware in 1982? Three NES. How did this come about? It would be through Gunpei's philosophy, which really becomes sort of the second core piece of Nintendo philosophy beyond the name of the game is the game. And Gunpei's technology philosophy is lateral thinking with a withered technology because the NES still was cutting edge hardware in many ways. Absolutely. It was years ahead of the competition. It had the first GPU architecture and a consumer focused device. It was not withered technology. It was the opposite of that. So sitting next to all of this silicon and PC and computing and graphics innovation that happening in the 1980s that the NES took part in was another adjacent market and silicon ecosystem, which was calculators. So we've talked a little bit about the calculator industry on the show in the past on like our TSMC episode, specifically the history of Morse Chang and Texas instruments. We got a cover TI at some point in the future. I think that was on our voting for LPs for next potential episode. But by the early 80s, the calculator industry was kind of like the PC industry is today other than the Mac and Apple Silicon. It was total commodity, very mature, cheap, completely understood technology. And you could make it for very, very low cost. It was also specifically dominated by Japanese semiconductor companies, very convenient for Nintendo. So Gunpei just expanded his mind a little bit in what could be silicon technology powering video games. And he reached over and grabbed a bunch of mature technology from the calculator industry. And voila, portable doggy Kong. And you know what the LCD screen is basically the same type of screen. It's no more advanced of a processor doing simple math to decide whether the character moves left or right and summing points and things like that. It's a calculator. He would mistake this for an arcade quality port of Donkey Kong, but it doesn't matter. People now can play Donkey Kong on the go. This is amazing. People love it. Huge deal. Legend has it that the way Gunpei came up with the idea for doing the game and watch in the first place was he was on the train in Tokyo. And he observed a businessman who was also on the train who was just killing time by pressing buttons on his calculator and doing random things on his like business calculator. And I think that tells you a ton about the potential demand for on the go video entertainment in the 1980s. Man, I'd say that was apocryphal, but that has literally happened to me where I pull out my phone and I'm up to date in my email. I'm up to date on Twitter. I pull down. No new tweets are coming in. So I'm like scrolling around on the home screen, doing nothing, opening and closing the same apps over again, just because it's entrancing. And now imagine no smartphone, no Twitter, no Instagram. Seriously. What else are you going to do? Like how did people even live back then? Barbaric. Newspapers, man. Newspapers, right. So time marches forward, everything that we talked about in episode one on Nintendo comes to pass. The NES launches, achieves 95% global market share, Nintendo's on top of the world, etc, etc. All this is all happening. Gunpei, who remember was not involved with the development of the NES, Gunpei goes over to Yamuchi and says, hey, I think we can basically combine the NES and this old Game and Watch technology and make a similarly awesome portable cartridge-based console. And Yamuchi and the rest of Nintendo are like, well, yes, of course, if you could do that, that would be amazing, who wouldn't want to buy one of those things. But part of what made the NES so great was it was years ahead of all the competition and technology. Like how are we going to do that in the portable era? So Gunpei is like, don't worry, Mr. Yamuchi, I've got it. I can make it all work. This device that I have in mind, it'll play awesome games, it'll have great battery life. We can get it to market super fast and get this. I'm pretty sure we can sell this thing even cheaper than the NES.
Everybody's like, this is too good to be true. How are we gonna do this? It's quite the promise. He's like, here's the big reveal. It's gonna be black and white. And not even black and white, but black and green. Yeah. So God bless Yama Uji. That man was a visionary and he completely got it and for a non-technologist he understood technology better than anybody because he gives good pay to go ahead on this. Everybody else at Nintendo is like, this is not gonna work. You know, I know we're still in the 1980s here, but the 1980s are more advanced than you might think. Like black and white is like the 1960s. Nobody wants black and white, especially in the video game market, which is supposed to be this advanced technology, graphical market. And to play games that they're accustomed to seeing in color, you're gonna go downgrade Mario, like that's a terrible experience. Right. Terrible terrible idea. So internally this project gets the nickname. I'm not exactly sure how to pronounce this, but it's either dominant game or Dame game D-A-M-E-G-A-M-E, which basically means hopeless game. But nevertheless they push ahead. And in April 1989, they were released this device in Japan, followed shortly in the US for $89 and 95 cents. And this device, of course, is named the Game Boy. We talk about this all the time on acquired things that are in technology and our industry in the past that just seems so natural. We don't even think about them. Why did they call it the Game Boy? They called it the Game Boy to dig it Sony, who if they've made it would have called it the Game Man. Why? Because they had the Walkman. Oh, no way. That's really why isn't this hilarious. It's so obvious when you think about it, but the Game Boy, it's like a Kleenex. It's like, oh, portable handheld gaming system. It's a Game Boy. This is Nintendo on the rise, looking over at their kind of like big brother in Japanese technology corporations at Sony, and feel like we are beating you to the punch here on technology. Oh, I love it. I had no idea. So freaking awesome. It obviously becomes a huge success. So the first Japanese production run of the Game Boy sells 300,000 units, almost immediately. And the first US shipment of 1.1 million units also sells out immediately. And the killer app, especially in the US, driving sales is not a kids game, but Tetris. And we won't tell the whole story. It's pretty amazing of how Tetris, the game, comes out of the communist Soviet Union and makes it on to the Game Boy in the US and becomes the most popular game of all time. But go watch the movie. I've heard that it's great. It is. Yeah, I watched it this week. It's obviously a little over dramatized, but it is pretty crazy that, you know, talk about the name of the game is the game. A Soviet programmer invented this game that was then so obvious to everybody who looked at it, that this thing was the perfect game. That there was this massive geopolitical mini war over who could get the rights to this thing and all these different countries on all these different consoles and Nintendo. We think of them as this very sort of nice and shiny company, making stuff for kids, but executing the steps they needed to take to obtain the license for Tetris is a wild story. The movie is awesome. The important thing that the movie does a good job of underscoring is Minoru Arakawa deeply understood once he saw a demo of Tetris for Game Boy, that this could expand the market beyond just games for little boys and teenage boys. This is not a kids game. This is an adult game. Yes, and now we could sell Game Boy's to every one of all ages, everywhere, and not just as a toy. Totally. It's funny. I was laughing as you were saying all that bad about you know image of Nintendo is this friendly, you know, cuddly company. I think we debunked that in part one pretty well. Right. There's plenty of corporate espionage behind the Mario smile. Oh, yeah, plenty, plenty, plenty. But yes, a the Tetris story is amazing on its own, but be like for our purposes here. And it really was Arakawa in the US who saw this at Nintendo America, the opportunity, just like Goon Paisal with the businessman playing with his calculator on the train back in Tokyo, everybody loves games. It's not just kids. And if they can get this device that is easily adoptable and at a low enough price point by a broader market, Nintendo is just going to crush it. So Nintendo America, in their tradition, as we talked about in part one, they just have the most amazing advertising campaigns around the launch of the Game Boy at father's day. I don't know if it was 1990 or 1989. And last time in 1990, they come out with a campaign called punish your father and the whole thing is like your dad has been stealing like the kids Game Boy. And so for father's day this year, punish him by buying his own and stopping him from stealing the kids Game Boy. This is so brilliant. They start buying ads in airplane magazines. And the ads say like if you're reading this, you are obviously bored and you need a Game Boy and you need Tetris. Oh, that's awesome. They're literally marketing it at business travelers, which makes sense. Seriously, you walk in an airplane today and who's playing candy crush a lot of business travelers. Exactly. So in the US, 46% of Game Boy players are adults. This is so different from the NES market. It becomes this businessman status symbol. And like I remember this in my own life, like everything in these Nintendo ads actually happened in my family. Like my dad used to steal my Game Boy all the time. We had to go get him his own. Did you have one of the original fat ones? Oh, totally. I was five years old when it came out. So I was exactly in the target kid demographic. And I think my dad, I was talking with him about this this weekend. He still plays the original Tetris cartridge on like an old Game Boy advance at this point to this day. What this is how universal the appeal of this game in this system is it's unbelievable. So Nintendo ends up selling 32 million Game Boys in the first three years, which is way more than the NES. That's roughly $3 billion in hardware sales alone. The Game Boy and then it's sort of quasi successor, but really the same platform, the Game Boy color. They would go on to sell a hundred and 18 million units worldwide, which is over double the NES and the fourth highest selling console of all time period. Wow. Just amazing. And this was Nintendo's first taste and really the whole industry's first taste of massively expanding what already was a huge gaming market. Yeah, it also was at a completely different price point. I wasn't allowed to get a console, but my first video game system was a Game Boy color because I think it was a little over a hundred bucks or something for the color one versus around the 200 or more price point for the at home consoles. It takes both the kids gaming market and the casual adults gaming market that it creates and marries those into one device and leaves the core gaming market to the home console. Yeah. You would have been like exactly in the target demo for Pokemon when it came out. Absolutely. You bet. I bought the translucent purple Game Boy color so that I can get Pokemon blue. Oh my God. Probably like 70% of people listening right now. Regardless of their age or the bucket. I mean, I bought Pokemon when it came out, even though I was a teenager at the time. Yep. All right, listeners. Now is a great time to tell you about a long time friend of the show, Vanta, AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year, an audit or a static PDF, then everyone would not and you're done. But in an AI first world, that doesn't hold up anymore. Yep. Your risk surface changes every week now. A vendor turns on an AI feature or someone writes in a new model without telling IT and your posture is different than it was last week, let alone at your last audit. Vanta's own research found that around 70% of companies have this quote unquote shadow AI running with no security review at all. Right. And that's where Vanta comes in. They're the leading agentic trust platform, meaning they've built the thing. That closes the gap and the way that they close that gap is Vanta agent think of it as a GRC engineer that's governance risk and compliance except that it's software and it doesn't sleep. It finds the issues drafts the fixes and cuts the time that you'd spend on vendor assessments in half in half, which is exactly why more than 16,000 companies today run on Vanta companies like ramp cursor and snowflake all stay audit ready and catch the risks that crop up between audits. Across every vendor, every AI tool, the whole environment, and that's the real value. Trust has to be continuous now, which is why Vanta automates your security, your compliance and the work to earn and prove trust were huge fans of Vanta over here and literally hundreds of acquired listeners have become Vanta customers at their companies over the years. So you can get a thousand dollars off Vanta at Vanta dot com slash acquired that's V a NTA dot com slash acquired for a thousand dollars off and just tell them that Ben and David sent you. Okay, so we're in this era Gameboys flying off the shelves, but the NES is getting a little long in the tooth and so how does the whole
- Super Nintendo thing work. - Yeah, here's where we're gonna change gears. So Game Boy, another incredible smash success for Nintendo. But back on the home console side of things, we're entering some shopping waters here. So where we ended last episode, one third of US households have an NES, Nintendo has roughly 90% global market share. They've got this amazing combination scale economy, network economy, distribution power. By the midpoint of the eight-bit generation in the NES, it looks like Nintendo's mode is impenetrable. And the reality was, for the eight-bit generation, it was, there were other competitors on the market. The hardware side of the former Atari, remember Atari got split into two companies, when Warner Brothers sold it off. The hardware side of Atari releases a new console, the 7800. It sells about a million units, like, okay, you know, also ran. - And the NES lifetime sold 62 million, just to put that in context. - Sega, in response to the NES in Japan, they release a home video game console called the SG-1000. It does okay, but also only sells about a million units. They take the third revision of that console called the Mark III, and they export it to the rest of the world as a system called the Master System. It flops in the US, where they sell off the distribution rights to it, to Tonka, like the Tonka truck toy company. - No way. - Tonka has no idea what to do with this thing. - And also, this underscores how much people thought of this as kids' toys. The pure set is Mattel and Tyco and Tonka. - Hasbro, exactly, this is the toy aisle. Nobody understands this stuff in the US. But importantly, this quote unquote master system console from Sega does fairly well in Europe and in Brazil. And so it ends up selling between 10 and 15 million units worldwide. Again, no NES, but this is enough of a success from Sega to give them some hope that like, well, maybe we should continue investing in the home console business. And as we mentioned in part one, Sega at this point was primarily an arcade company. Did you know this? Sega was actually founded by Americans. - Yes. - Even though it's a Japanese company, it was originally an American company. - Involved in like World War II military service in Hawaii, is that right? - Exactly. So Sega is a portmanteau of service games. And the company was started to make kind of like Nintendo like gambling games or thinly disguised gambling games and that morphs into arcade games for US military service bases around the world. - Crazy. I love how these companies evolve to sort of morph and survive over time. - They know that they're not gonna dethrone the NES in the eight-bit generation. But they think maybe we can try and do what Nintendo did to get this huge advantage with the NES, which remember was, just like Steve Jobs in the iPhone, we wanna produce something that is years ahead of the competition. We might actually be able to leapfrog Nintendo here and do the same thing to them. And Sega actually has two advantages at this point in time that Nintendo does not have. One, Moore's Law has continued to progress since 1983 when the Famicom came out in Japan. And Moore advanced and cheaper processors are now available to everybody. Specifically, 16-bit processors are now cheap enough that you can put these in a living room, quasi-kids toy home console. Nintendo obviously also had access to this technology. But sort of in an innovator's dilemma type situation, they don't really have the motivation to pursue it. 'Cause the NES is the gift that keeps on giving for them. Like they wanna keep that console generation going as long as possible. Right, it's like they do have to come out with something eventually, but if they can delay that eventually another year and no one forces their hand, that is very good news. Exactly. And Sega, again, because they were so successful in the arcade business and the arcade business moves so much faster than the console business. New technologies, new games, new game concepts are coming out all the time. They already have a pretty robust 16-bit arcade board that they've been using on some of their arcade hits at the time like Shinobi or Golden Axe. Those were 16-bit games running on advanced arcade boards that Sega was producing. And so what does it mean when you say the eight-bit generation, the 16-bit generation? Eventually we'll get to 32, 64. 64 becomes part of the marketing, in fact, for Nintendo. Yes, it basically means that the CPU for the machine can process eight bits at a time. And so that affects everything downstream. Sound, graphics, processing power. It's basically the effectively bandwidth that the CPU has in order to process information concurrently. Right, and specifically, I remember at this time in the jump from eight-bit to 16-bit processors, like the color palettes that the games could use, like with eight-bit processors, it couldn't even fit so many colors in there, but 16-bit processors, you could fit hundreds more different colors that could be used in the game, you know, stuff like that. Yep, and of course, this stuff is exponential. So eight bits, what does that mean? Well, two to the eighth different combinations that are possible, so 256 different values in each chunk of data that it's processing. You could see how going from eight-bit to 16-bit, which takes you from 256 different possible values to 65,536 different values. It is sort of enormously forward. Right at this moment in time, it's this whole soup of factors that come together to really give Sega an opportunity to break into the market. Even though the NES is so dominant, older consumers, especially teenagers and adults, they value graphical performance and they're willing to pay for it, as long as they're good games to actually back it up. And so Sega's like, well, we've got a bunch of really good 16-bit games that we've made for the arcade, we can probably do this. Yeah, it is interesting how much graphical capability mattered in those days. And it still matters today, but it kind of matters less. When you go from like almost photo realistic to even more almost photo realistic, it makes them more impressive and it makes it more interesting to look at on a 4K TV, but does it literally make it more fun than playing something on my Switch? Probably not, but back in those days, that's a huge leap forward. Totally. I mean, even like on the Switch and on the virtual consoles, I love going back and playing Super Nintendo games and Sega Genesis games, which you can do on the virtual console of the Switch, which is so fun. But going back to the NES era, it's tough. I grew up with those games. I remember playing them and loving them, but like I can go back to 16-bit games. 8-bit is pretty tough. Yeah, and I'll say like I still play my N64 Super Smash Brothers. That game is more fun than Super Smash on my Switch. So you do hit some point, I think around 64-bit graphics, where like more bits no longer equals more fun. So back to Sega here in 16-bit. In 1988, they launched a new console called the Mega Drive in Japan. That was in late '88 and then they turned around in early '1989 and launched it in the US. And they decided, of course, that the Mega Drive is probably not a good brand name for the US. And so they name it the Sega Genesis. New beginning for Sega in America. Yes, surprisingly, it doesn't sell well in Japan, either at launch or really ever. It's really weird, I couldn't figure out why. Yeah, maybe just like Nintendo had such a lock on distribution and game developers and market share in Japan, that even like the quality arcade games that Sega was making wasn't enough for the Japanese market. And when it launched in Japan, it didn't have Sonic yet. Exactly, well, we will get to that. So it doesn't have Sonic in the US either. So even if you think you know the history of the console wars and the Genesis in America or you lived it as I did, I didn't remember this exactly as it happened. So initially the Genesis is also a flop in America. It sells about 500,000 units in the first year, which again is okay, but this isn't that much better than the old master system here. And Nintendo isn't necessarily viewing it as the competitive threat that says, "Okay, we need to release our next generation system ASAP." They're like, "Okay, cool, this one also isn't beating us, so I guess let's keep riding the sales of the NES." Right, why would we change things? So the next year in 1990, Sega decides like, "Hey, we need to make a change here." And specifically we need to make a change in Sega of America. So they install a new CEO, a guy named Tom Kalinsky. Now, if you're looking for an executive to come in and turn around your ailing video game console business to do things differently, you probably wouldn't go higher, Tom. Tom at this point is a toy executive. He's in his late 40s. He knows nothing about video games and his most recent job is he was the CEO of Mattel before being ousted by the board for underperformance. - And his big success.
was Barbie. Right. Yeah. This doesn't exactly scream like video games. Now video games are part of the toy market, but Sega is trying to change this. They're trying to appeal to teenagers and older adults. Well, it turns out that actually Tom had a second act in him and ends up being the very best hire that Sega ever could have made because he shows up and he's like, guys, if our strategy is to literally do what the marketing slogan was at the time when he showed up, which is Genesis does what Nintendo don't, which is kind of great. Yeah. The problem, though, is they were doing like a piss poor job of executing on it. So even with this great tagline, the actual commercials that Sega was showing on TV were this really cheesy 80s jingle. I'm not even going to try. Like, don't look at that. They're just like weeny. So when Tom shows up and surprisingly coming from the toy industry, he's like, if we're going to do this, we got to go all out. We can't still like keep one foot in the toy industry here. We need to go full on punk rock, MTV, directly appealing to teenagers. None of this like 80s jingles in our commercials anymore. No, it needs to be the, what everyone knows, Sega and that scene. And we need to pivot the whole company. Sega needs to be the aggressive video game company full stop. Yes. So he presents to the Sega board back in Japan. He flies over to Tokyo and presents a four point plan of how exactly Sega of America is going to dethrone Nintendo. And it's great. The way he gets recruited for this, David and I both read this book, console wars, which is really fun if you want the whole blow by blow on this. Tom actually gets recruited by the chairman of Sega while he's on a family vacation in Hawaii on the beach. The chairman of Sega walks up to him and says Tom Kalinsky. And for as compelling as the Nintendo story is, it's compelling because they won long term for this brief moment of time, the Genesis era, I think Sega probably has an even more impressive narrative and sort of heroes journey with Tom Kalinsky. Oh, totally. We're going to get into what they do this four point plan. But it is freaking brilliant. I think this is the best example we've ever seen on the show of how to compete against an entrenched incumbent. Yeah. They literally walk up to Nintendo and just punch them in the mouth. It's so great. So here's the plan. Point one, we need to preemptively start a price war. So we know that Nintendo is working on a new 16-bit system. They're just dragging their feet because they feel no sense of urgency here. We also know, given Nintendo's history, everything we talked about in part one, that they like to make money on their hardware. They want high hardware margins. So here's what we're going to do. We think they're probably going to price the Super Nintendo when it comes out at the equivalent of $250. We're selling the Genesis for 200 right now. We're going to preemptively cut that to $150. And this is perfect counter positioning. Nintendo's incumbent strategy is to make money on hardware. What are we going to do? We're not going to make money on hardware. Exactly. So we're going to preemptively put pressure on them to cut costs on the Super Nintendo. I don't think Tom and Sega even realized how important this would become. Put a pin in this. We're going to come back to this in one sec. This is a critical move, especially the preemptive. It's not just we're going to make it so they can't make money. It's that before they launch, we have to make them cost conscious. Number two, we need to change the pack-in game, like the bundled game that the Genesis comes with in America. I had forgotten about this. The original pack-in game was a arcade port called Altered Beast, which I think it was an okay arcade game. It wasn't that good. It wasn't as good as Golden Axe and whatnot, but it maybe had the worst American localized title ever. Who's going to buy a game called Altered Beast? Yeah. Altered doesn't really make you feel one way or another. It's sort of an uninspiring word. Yeah. Altered Beast. I don't even know what that means. Tom's like, look, I know when you were recruiting me in my early time here, you say good in Japan over there, you're working on a top secret "Mario Killer" game. I know that your plan is to sell that separately from the system because you want to maximize revenue from this game that you know is going to be a pretty good seller. We need to bundle it in to the system here in America. I know we're going to lose money on this, but we got to up our install base and we need a Mario Killer that is going to be with every single Genesis. So that's point two. Point three, speaking of games, and this is also just a brilliant insight. He's like, we need to make American games for American audiences. And that means two things. One, we need to have our own Sega development studios here in America, which Nintendo doesn't have. And never went on to have, right? I don't think there's an Nintendo game development studio in America still. Nope. The closest that they had was their second-party studio rare, which they stupidly let get acquired by Microsoft when Microsoft is launching the Xbox, but rare made Donkey Kong country and GoldenEye 64 and lots of great games for the Super Nintendo and the N64. That was in the UK. They never had development studios in America. So Tom says, Nintendo is missing a huge opportunity. And so are we. We need to have our own studios here. And we need to really embrace American third-party game developers, which Nintendo, they aren't embracing any third-party game developers. Nintendo. Nintendo. Exactly. And specifically what this means, Sega at this point is locked in a heated negotiation, shall we say, with our buddy Trip Hawkins and Electronic Arts. As we talked about on our episode with Trip, back a few years ago, Trip is just awesome. He literally recounted this story for us. Totally. So more on that in a second. But Tom's like, we need to settle all of that contentiousness. It hadn't progressed to litigation yet, but we need to settle all of that. We need to bring electronic arts into the Genesis fold and bring them into the home console market. And then the fourth point, as we alluded to, no more of this 80s jingles in our marketing. We're going to go directly straight on after Nintendo with our commercials and our advertising. So naturally, given this brilliant plan of how to compete as an underdog, what do you think the Sega parent company board says to all of this, they reject it. As corporate boards want to do. But fortunately, Ben, like you said, the chairman at the time, Hayo Nakayama, he sides with Tom and he pushes through this plan and says, okay, I hire you to make your own decisions in America. I trust you in understanding the American market. You can go ahead and do this. We're not going to do this in Japan, but you can do this in America. And this is kind of a career bet for Tom, because this is probably his last act one way or another. If he fails, he goes out in spectacular glory. But if he succeeds, then this is probably his job for a while. And clearly, this market is enormous. Being CEO of Sega of America is a pretty great job if they succeed. Yep. So what happens? Let's go through it to these points. Point one, the preemptive price war. Oh boy, was this important. So Nintendo was, as everybody knew, working on the super Famicom slash super NES. It would come out in Japan in late 1990 and in the US in late 1991, two years after the Genesis. When they launch it, they launch at 25,000 yen in Japan and 199 in the US, which even that was $50 more than Sega had cut the price of the Genesis to more importantly, though, then Sega being cheaper than Nintendo from day one, is that Nintendo was planning originally to include backward compatibility in the super Nintendo so that it could also play any S games. When I read about this in the research, I was just like, oh my god, they blew it. Which that is of course the right strategic move to leverage the fact that you already have tens of millions of people that are Nintendo customers. You want to come out with something that makes sure they remain Nintendo customers, but your competitor dropped the price. So you decided to cut something and the thing you cut is the thing that makes it so you no longer take advantage of the fact that you have this huge install base that would have given you a stair step into the new generation totally. So Nintendo estimated that including backwards compatibility in the super NES would add about 75 dollars to the bill materials. And that's huge. Yeah. And so rather than come out with the super Nintendo priced at $250 or $275 or $300, because the Genesis had already been preemptively cut to $150, they're like, oh, we really can't do that. Let's cut out this $75 cost and come out at $200. Hard to say if this was a mistake on Nintendo's part or not, they kind of had to do this. Certainly the mistake was not pushing their advantage and coming out with the super Nintendo earlier. They absolutely could have. They let the Genesis beat them to market and then this preemptive price war.
forces them to take what really would have been their best built-in advantage for the new generation of porting the existing install base over to the Super NES and just kind of hit reset on the whole industry, which is crazy. It's funny, strength leads to strength. If Nintendo had just been aggressive and obsoleteed themselves, they would have probably been in a great position, but instead they sat back, they sort of tried to play defense, they tried to give enough running room to their NES to keep making good money as long as possible. Then it left this opening for Sega to come in and pull this move, and then suddenly Nintendo no longer has an advantage to leverage. It's like the classic football Prevent Defense thing. Well, Prevent Defense prevents you from winning. You've got to keep being aggressive and playing offense. It reminds me of I think my favorite company values sheet of all time, which is the legendary Nike corporate values. So good. I think it's number two is we're on offense all the time. Yes. Yeah, you don't win by playing the Prevent Defense. Nope, absolutely not. And I think we could maybe give some leeway to Nintendo here, in that this was all happening for the first time. People didn't totally understand console business dynamics yet. I mean, if you fast forward to today, Sony and Microsoft, not only always have backwards compatibility in each new console they release, they also do forwards compatibility. So like new games for a couple of years that are coming out for the PS5 or the Xbox Series S and Series X. Those games will also be playable on the previous generation hardware. Now you couldn't do that back in the day. But this is so important to feathering in each new console generation that literally billions of dollars of engineering across not only hardware, but software titles are invested in this today. Nintendo didn't know that, but this becomes a huge, huge mistake. Yep. Okay, so that's one point two, the pack-in game. Obviously, this is Sonic the Hedgehog. Sonic is just the most perfect example ever of counter-positioning in brand. Yes, totally. So if you think about what Nintendo's real strength is in games, that we talked about so much on the last episode, it's these amazing stories and not narrative, but story driven fantasy worlds that you can get lost and explore in. You know, that's what Mario is. That's what Zelda is even more. That's what Metroid is. But you know what? That style of game is, besides being amazing, it's also really slow. And that is the opposite of Sega's DNA, which is all in the arcades. That is fast. And nothing is faster. Like, I want to know what kind of drugs the people were on that came up with Sonic the Hedgehog. I think it was an internal competition within Sega of Japan. It was. It was a employee pitch. Yeah. What would lead you to come up with a trash-talking supersonic blue hedgehog? That originally had fangs and an electric guitar. That's right. Also like a human girlfriend that was not wearing much clothing, I think originally. Yes, scantily-clad human girlfriend. Yes. And the best and the worst of the 1990s. But mostly, especially what the final version of Sonic, just freaking awesome. It doesn't get any better than that. So Mario is family-friendly and kind of slow and open to exploration. And Sonic is not only fast, but aggressive. The whole brand of Sega kind of adopted the brand of Sonic on its means of competing against Nintendo. Totally. So remember how we talked about in the, I think it was maybe the 1990 Q survey that Mario was more recognizable than Mickey Mouse? Well, by the 1993 Q survey, Mario is still more recognizable than Mickey Mouse. But Sonic is even more recognizable than Mario by American consumers, which is like- Wow. Just ridiculous. A couple years later, like that is how successful Sonic was. And this was part of Kalinsky's genius. It was bundled in with every Genesis console. So Sega is giving up on the incremental $50-$60 pop revenue that they could get from Sonic the Hedgehog. But this really drives Genesis console sales. Okay, point three. We need American games for American audiences. So Nintendo at this point in time is basically making two types of games. They're making the timeless works of art like we were just talking about the Mario's and the Zelda's and the Metroid's. And they're also making super quirky Japanese stuff. What they are not making is super quirky American stuff. And specifically, they're not making American sports games. Now, they are making sports games. They make punch out, they make excite bike, they make a bunch of baseball games, third parties, make games. The developer Tecmo famously makes Tecmo bowls, you know, on American football games, so like they're out there. But these games don't capture the actual American experience of these sports. They're sort of cartoon approximations of something based on a sport. But it's not like you're playing Madden. Exactly. And we talked about this a lot with Trip Hawkins on our episode with him. But that's what was so game changing about EA's John Madden football. It was 11 on 11 real football with real playbooks. Like if you ever played football or if you were a student of the game or if you watch the NFL every Sunday, you know, it was still a rudimentary video game by today's standards. But this was actually like simulating the game of football in a way that nothing coming out of Japan really ever could. Now that first version of Madden came out in 1988 for the Apple II. Because electronic arts at this point in time was a PC game publisher. They weren't in the console business at all. They didn't want to play ball with Nintendo and the ridiculous licensing terms that Nintendo had. And they're right in the middle of these negotiations with Sega. Because Trip and EA had famously gone out and reverse engineered the Genesis in a clean room. And he had these grand plans of he was going to make his own Genesis cartridges, not pay any royalties to Sega. And then he was going to take his program to other third parties and like completely end around Sega altogether. Which he had to sort of negotiate from that point, but they were ready to do like they actually did the unbelievable engineering feat of in a clean room environment reverse engineering the way to make games work on this system. Totally. So you can imagine why Sega the parent company would be and were really, really pissed at electronic arts and not want to play ball with them. But Kalinsky's like, no, no, we got to settle this. We got to embrace them. If we can get Madden on the Genesis and not on Super Nintendo, this is going to be huge for us. So they do and Sega basically completely bends over backwards to EA to accommodate them, which is the right move, by the way. Absolutely. The pie massively grows by this game, seeing the light of day on Sega exclusively versus if they enter litigation, it's like, okay, let's divide up a small pie. No, absolutely not. The answer in this moment where this is rapidly expanding market and a fight to the death between second and Nintendo is no side quibbles, figure it out, move forward, launch the product, everybody makes money. Totally. So Sega's original program and their program for other third parties was $10 licensing fee per game unit. For EA, they give them a $2 licensing fee per game unit capped at a million units. So EA will never pay Sega more than $2 million on any game. Very, very different. But like you said, Ben, this is just an enormous win. So that first year, that first version of Madden that comes out on the Genesis, EA and Sega's prediction is that it'll sell 75,000 copies. It ends up selling 400,000 copies. Oh my God. It is just a huge hit for them. And this is the exact kind of thing that is not on Nintendo and soon to be the Super Nintendo. EA eventually does bring Madden to the Super Nintendo, but they have a separate studio working on it. They've got the ATM working on the Genesis version and they've got the BT working on the Super Nintendo version. So the Genesis versions were always better. And I remember this as a kid, this is a big reason I was lucky I had the Super Nintendo and the Genesis. Like I wanted Sonic, but even more, I wanted really good Madden games. Oh, wow. I didn't realize because these days, you know, the Xbox and the PlayStation versions are like, I think equivalent. If there's any hardcore Madden fans out there, they're probably gonna come at me with, no, it's way better in this that or the other way. FIFA kind of the same thing, but I didn't realize there was such a difference then. Yeah, back in the day, they were actually made by different studios. And there were some things about the Super Nintendo architecture that limited the frame rate that it could run at. So like, basically, it was always better on the Genesis. And it's worth saying point one in eliminating the backwards compatibility. It made Nintendo have to fight Sega on an even playing field. It didn't mean Sega was gonna win. It meant even playing.
that negated their advantage of large previous install base. 2 and 3 are the games, you know, you've got, with.2, Sonic being faster, brighter, more exciting than Mario, when you see them head-to-head, which Sega was making sure that you saw them head-to-head. Sonic seems like a much more interesting game that you kind of want to buy, regardless of the fact that you have loved Mario the last few years. - On the surface, it is much more compelling. - Yes, and of course with Matt and now they have even more advantage. So the scales are really starting to tip towards Sega. - So point four, punching Nintendo in the mouth. Kalinsky goes out and brings on a guy named Steve Race, who had mastermind did a re-box resurgence against Nike in the 80s, with the pump sneakers. Remember that? - Oh, yeah, that was Steve Race's brainchild. And Kalinsky tells him to just go wild on the marketing. Steve would go on to leave Sega and become the first president of Sony Computer Entertainment America for the launch of the PlayStation. But before that, he would pretty much single-handedly yank Sega and really the whole video game industry. I mean, this really sets the stage for the PlayStation out of the toy world and into full-on media technology, the MTV generation, this is Sega and his work. So they go out, they hire the Goodby Silverstein ad agency, and they come up with the welcome to the next level campaign, which was just so great and had the trademark way that all of the ad spots ended with the Sega scream. - Yep. There's also some pretty amazing Jujitsu here around the idea that you've graduated from Nintendo. That's cool that you used to do that, and that was for babies and now you're a real grown-up, and it's time to graduate to a real grown-up system. - It worked on every level. It was so great. So they premier the campaign during the 1992 MTV Video Music Awards. What a perfect marriage of everything here. Literally, the same VMAs where many years later Kanye would take the mic from T-Swift. This is like not the toy aisle here. This is pop culture as it's pinnacle. They also invent the term blast processing. If folks remember this, the Genesis has blast processing, and that's what makes Sonic fast. It's a completely made-up marketing term. There was something in the development manual like somewhere for the Genesis about something that maybe could be translated as blast processing, but like it didn't actually do anything. - Apple's been hot on this recently. What is the A12 Bionic, the neural engine, and marketing terms for something highly technical, such that it doesn't actually describe the technical thing that it's doing. Or another Apple example is the Retina display. Once they start marketing the Retina display, it doesn't matter if their competitors have something that's just as many pixels per inch. It's not a Retina display, but that's completely meaningless. - It all goes back to the Genesis. It's got huge font on the actual console in I think it's gold letters in Japan and silver letters in America that say 16 bits on the console itself, it's amazing. - I love it. I mean, that is their competitive edge. - Totally. One of my big takeaways from this whole series is just how much Apple took from the video game industry in their marketing. Stephen Tom and the team at Sega also do super innovative stuff that really just brings the industry forward into the modern era. Before this era of Sega, there weren't actually release dates for video games when new Nintendo games would come out. They'd just start showing up at retailers and not even on the same day, just like some regions of the country would get them before others. There was no organization. Tom and Steve in the marketing department at Sega of America, they're like, nope, this is the movies. We are doing worldwide release days for our games and they're gonna be just like movie premieres and we're gonna have celebrities. We're gonna have big marketing events. The date is gonna be plastered all over everything. - Totally. I mean, there's millions of people that know May 12th, 2023 is going to be Zelda Tears of the Kingdom. This has become the way that you market video games. - And that all started with Sega of America. Specifically, it started with Sonic 2 where they had Sonic Tuesday. It's the launch day. Oh, so hokey, but this is hugely innovative. The other thing that Sega of America does in their marketing and Ben you will love this is they literally do the Pepsi challenge. So they take trucks like 18 wheelers and they outfit them with super Nintendo's and Sega Genesis is in the back and they drive them around to malls across America. And they invite kids in to play head to head Sonic versus Super Mario World. And then they ask them which game they prefer after like five minutes of playing. So the first five minutes of Sonic are really good. The next couple hours not as good. - Right. And this is an amazing trick. It's the same thing that all the TV manufacturers do. They gamma up and contrast up and brightness up all the TVs when they're in the store and you get mesmerized by the one that's got the most insane Christmas light colors on it. And then you take it home and you're like, ugh, this is kind of terrible for watching the dark night rises or whatever. And it turns out that when you're comparing things side by side, there are things that appeal to you that are actually not the best long term option. - Totally. So they keep track of all this and low and behold, seven out of 10 kids in America prefer Sonic to Mario. And of course, Sega trumpets that in like the Wall Street Journal and all of the investor press and like everything, it's amazing. - Yeah. So at the same time, it's Sega's genius and the fact that they like showed up to play but also Nintendo keeps dropping the ball. I mean, the games that they're shipping for the Super Nintendo are like, again, very conservative. Very like we're gonna try to maintain our lead. You play the Mario game for it. You're like, okay, yep, it's Mario again. And like it's nice. I like Mario, but this isn't new. I don't really understand necessarily why this even needed to be 16-bit. - Right, Super Mario world is an amazing game, but is it that much different from Super Mario Brothers 3 on the NES? No, like it's got Yoshi. Yoshi is no Sonic. So all of these four points by themselves, would any one of them have dethroned Nintendo? Certainly not, but all four of them working in concert and Sega's just amazing execution. By God, they do it. So it's tough to tell exactly because both companies in Nintendo and Sega were highly incentivized at this time to be creative in what they were reporting as their console sales data, shall we say? - Right, this is when you have to really tease out the cell into the channel numbers versus the cell through the channel numbers. - Yes, but as best as I can tell, I think it is basically fair to say that every year that they're competing head-to-head on the market, the Genesis and the Super Nintendo, the Genesis outsells the Super Nintendo in America. You can certainly quibble with that. The data is not perfect, but take a step back, even if it's 50/50. We went from Nintendo having like, for all intents and purposes, 100% of the market neck and neck with the Genesis. Nintendo basically fights to a draw. It's not like the Super Nintendo was a failure. It was a success, but corporate-wise for Nintendo, this is a huge failure. They basically have given up half market share to this new entrant in one generation. - All right, listeners. Now is a great time to thank our long-time friend of the show, ServiceNow. If you are running a large enterprise, AI agents are likely spread across every team and deploying them is no longer the hard part. - Yeah. The hard part is knowing what permissions they have, what employees are using them for, or what decisions AI is making. AI security for an enterprise at scale is not a small concern, like the risks are real. - Exactly, and the challenge with AI is governing it, securing it, measuring it, and making sure that it actually delivers value. That is why ServiceNow built the AI Control Tower. - Yep, AI Control Tower gives enterprises a single place to see, manage, govern, and optimize AI across the entire business. And it works with any AI, not just theirs. Every device on your network, every permission across every system, every AI agent visible and secure in one place. - And ServiceNow can do this because they've spent more than 20 years building the operational backbone of the enterprise, the workflows, governance, approval, security controls, and institutional knowledge that power, how work actually gets done across IT, HR, customer service, finance, and security. - ServiceNow already runs more than 100 billion workflows annually and trillions of transactions for more than 85% of the Fortune 500. So when companies need a place to govern AI at enterprise scale, they're building on a platform at the center of how their business already operates. - And in a future that isn't going to be one AI, it's going to be thousands of AI agents working across every function of the company. But the question is, who's managing them all? - So if you're trying to turn a. AI ambition into real business outcomes and make it work safely, securely at scale. Go check out servicenow.com/quired and tell them that Ben and David sent you. - So what exactly made it so that the Sega Genesis advantage wasn't a durable thing that they sort of kept winning with? - Yeah, it's a long and sad story, but basically Kalinsky and Sega of America and the parent company and the board back in Japan massively disagree on how and when to launch the Sega Saturn, the next 32-bit console generation. That conflict and that mismanagement becomes a total disaster and it starts a downward spiral for Sega with the failure of the Saturn and then they follow it up really quickly with the Dreamcast. That also never really gets traction. Dreamcast was actually an awesome console and very innovative on a lot of fronts, but they just start bleeding cash. They end up exiting the hardware business and the company basically goes bankrupt and has to get acquired by a Pachinko manufacturer called Sammy, it's really sad. - Brutal, they now make games for Nintendo platforms. - Well, and the great outcome of that is that you can play Genesis games on the virtual console on the Switch, so good for consumers. - The story feels abrupt, but I remember it feeling abrupt when it happens too. - Yep, a story for another day, but for our purposes here in the Nintendo story, the point is that Nintendo has now fallen and they've fallen pretty hard. There were a couple other self-inflicted Nintendo wounds around this time too, starting in 1988. They actually get embroiled in two separate antitrust lawsuits with each of the successor Atari entities, both the hardware side and the game side. They win both of these, but this really hurts Nintendo's brand image. It kind of comes out to the American public through this that what we know from doing part one Nintendo corporate wise is not really this family-friendly gentle kind company. There's a great quote from Howard Lincoln in game over about this lawsuit. He says, "I thought to myself, "you have no idea what you've taken on Atari. "Where a tiger who will skid in you piece by piece." Obviously he doesn't say that publicly, but this isn't really good for Nintendo's image. Fun side note on this, the Atari Games case is actually the start of the video games career for the then baby lawyer Mitch Lasky of Benchmark and GameCraft podcast fame. Oh, no way. Yeah, super fun. Mitch talks about that on GameCraft. They're just so arrogant at this point in time. They're arrogant and they're getting beat up. And then they do even more dumb stuff. So Nintendo's sues blockbuster during this time for renting their games, which is just really dumb. Like what's a really good marketing for games is renting them and letting people try them. And what are American consumers really gonna hate you suing them to stop that? They also sue the maker of the Game Genie, which is one of my favorite video game artifacts from this period. And the Game Genie was the thing that let you like enter weird cheat codes and modify the games and stuff. This shows another example of Nintendo's belief that they know better than anyone else. What makes a game fun? And you are not to modify their game rules at all because Miyamoto will come down from the mountain and tell you what is fun or not. (laughs) So true, so true. It's also, we would be remiss, I think, if we didn't point out too, that all this was happening during the like incredibly ugly and sad era of Japan bashing in the US that we talked about a little bit on the Sony episode. You and I were kids, so thankfully, didn't really experience this. But I remember people in my parents' generation just sang like really awful things about Japan and Japanese companies at this time. And there was this real worry in the US, especially in the business community that as Japan's economy was ascending so rapidly, that Japanese companies would come take over all of American media and movie studios and stuff like that. - Yep, we talked about this a lot on the Sony episode. And this culminates for Nintendo in another well-intentioned but really self-inflicted wound debacle where they buy the Seattle Mariners, which really was well-intentioned. The owner at the time was gonna move them to Florida and Nintendo kind of has a good will gesture for how good the people of Seattle and Washington state had been to Nintendo of America, steps in as like a white knight savior to buy the Mariners and keep them in Seattle. Major League Baseball tries to blackball them from buying the team because they're like a weird foreign company. - It's also a company buying a team. I mean, that's not really sports team ownership in the US is owned by individuals. - So kind of again, well-intentioned but probably ill-advised move on Nintendo's part at this point in time. And don't win a World Series despite having kangaroo feet junior, Alex Rodriguez, Randy Johnson. But they do make a super Nintendo game out of it that's pretty damn good. There you go. So anyway, by the end of the 16-bit generation, Nintendo's fall is pretty precipitous here. And the magnitude of it is actually kind of hidden initially because of Sega's subsequent total implosion and even bigger fall with the Saturn and then the Dreamcast. But Nintendo is really irreversibly weakened from this era. So we talked about the numbers, how in a single generation they go from 90% global market share to basically 50. But more importantly strategically, like the net result of this is that a lot of the things that made the NES so powerful in the market are completely negated by the end of this. So first and most importantly, the whole years ahead of the competition hardware advantage, that's gone. They're now behind the competition. To they lost control of the third party developers, they had this incredible lock on the third party ecosystem with the NES. Now developers like Electronic Arts and others are saying, well, look at Sega and look at these other new folks like Sony who are going to enter the ecosystem. I can make more money with less drama on their platforms. Screw you, Nintendo. And less drama and often better economics. They're willing to cut special deals with me that you're not. Exactly. And in many cases, they have more advanced capability. So it's an easier platform to program for. And then maybe worst of all, Nintendo's brand value just takes a huge hit in this generation. And we've talked about this as we've gone along here. But to put a fine point on it, older kids and teenagers no longer play Mario. Or at least they don't want to admit that they do. Sonic doesn't become the long-term replacement, but Tomb Raider does, Halo does, Grand Theft Auto does, Call of Duty does. Nintendo, ironically, gets kind of trapped in the toy aisle ghetto for the next 20 years. All right, so we're through the Genesis era. We've unfortunately seen basically the end of Sega. But there's another sort of adult oriented gaming firm that's gearing up in the shadows right now to come aggressively at Nintendo and expand the gaming market even further. And that is Sony. So take us to the PlayStation. So the whole 16-bit generation story for Nintendo that we just told was really one of arrogance bordering on stupidity and self-inflicted wounds for Nintendo. But ultimately, they were competing against at best a roughly equal-footed competitor in Sega. And really an underdog. Sega did not have the financial firepower, the technological firepower that Nintendo did. It was like amazing that they came from out of where they did and battled Nintendo to a draw. That's not going to happen in this generation, because now the big boys are coming. And we talk about these often unacquired of self-inflicted wounds. This may be the worst self-inflicted wound of all time, what Nintendo does here. Because as we talked about on the Sony episode, the PlayStation was supposed to be the Nintendo PlayStation. Yes. And somehow this partnership that Nintendo had been working on with their fellow Japanese technology and consumer electronics giant Sony to enter the CD medium and the 32-bit era. Somehow that went from being a beautiful partnership to basically almost signing their own death warrant. So at the June 1991 consumer electronics show, there's big expectations Nintendo and Sony are all set to announce the CD ROM add-on for the Super Nintendo system to bring the CD format to Nintendo powered by Sony, the Sony and Nintendo PlayStation. They're all set to announce it, and in fact, Sony does announce it at their press conference. And then the very next day Nintendo turns around. And then their press conference doesn't mention it at all. And instead trumpets their major CD ROM technology partnership with Sony's Arch rival Phillips. They betray Sony, they stab them in the back. So much, hubris.
so much hubris like dumb decision to do this period even dumber decision to do it this way to let them whip in the wind publicly like that and they just light a fire under exactly the company that you do not want a light of fire under at this point to come and destroy you and to illustrate how much bigger Sony is I mean in 94 is when the Sony PlayStation would launch they were doing 38 billion in revenue and at that point in time Nintendo was a four billion dollar revenue company so Sony is the much bigger beast here yeah now look this partnership that they were working on with Sony it's unlikely that it ever actually would have worked out because there's just like too much money at stake the video game market is too attractive despite the fact that Sony didn't enter the portable market with the game man and Nintendo stuck it to them with the game boy like the bad blood goes way back here and the reason that Nintendo pulls out of the partnership is they couldn't come to terms on how they were going to split the royalties on software revenue which as we talked about in part one like that's where all the economics are in the business it's a razor and blades right which is actually quite rational there is not really a viable alternative history where the Nintendo PlayStation came out there is a viable alternative history where like Sony waited a little longer to enter the market and they didn't have as much burning hatred for Nintendo as Nintendo generated here so that happened at the 1991 CES Ken Kudoragi goes off and within Sony music builds the PlayStation franchise and Steve race comes over from Sega and gets involved on the American side the PlayStation finally comes to market at the end of 1994 in Japan in 1995 in America and it's an amazing console it's CD-based it's got incredible power it's much easier to develop for they've got all of Sony's both technological and financial firepower behind it and it's a 32-bit system on par with the Sega Saturn yes it's a 32-bit system so just blows away the super Nintendo on every dimension here much more storage availability for games and game developers by using the CD format much more powerful processor it's clear that this is going to be a big investment from Sony here and they're going to be a big player in the industry Nintendo again probably in hubris tries to compete directly with Sony here in response so they go off and they partner up with legendary Silicon Valley company silicon graphics SGI as we talked about on the injuries in series back in the acquired canon to build the N64 they're going to leapfrog the 32-bit generation and go right to 64 bits with the N64 but one it comes out too late so the 64 doesn't come out until 1996 after the PlayStation has already had a year plus to be on the market and establish both the install base lead and the third party developer network to the N64 famously uses cartridges again instead of CDs they have a very particular way they love doing things they do they do which I think was partially an anti piracy thing they cared so much about stopping piracy that they were willing to hamstring developers into needing to use a much more constrained format in the cartridge than CDs because they thought well CDs are just going to get pirated and we don't have as many mechanisms to prevent that yep and then the third part of this yes the N64 was a very powerful 64-bit system but it required very expensive silicon graphics hardware to develop for that the PlayStation did not so like really the whole thing is just a giant f you to third party developers who already hate Nintendo so at this point everybody pretty much abandoned Nintendo for the Sony platform the N64 would sell 33 million units in its lifetime that's about half of what the NES sold versus the ps1's 102 million units so Nintendo just gets the floor wiped with them by Sony here which was obviously predictable and the N64 ended up being a fantastic console to play Nintendo first party games on yes and they even more than ever before entrenched that that is what our company is all about I mean super Mario 64 Mario Kart 64 super smash brothers star Fox gold night I mean these are all first party titles the only one that wasn't his golden I and that was rare which was a very close relationship with Nintendo yep that was a second party title Nintendo owned at that point in time some like 25 30% of rare and rare developed exclusively for Nintendo platforms so that's the N64 PlayStation and then in the next generation the wheels just totally come off the bus Sony and the PlayStation 2 goes on to become the best selling console of all time still to this day the ps2 has sold more units than any other console including the game boy including the Nintendo switch everything they sell 155 million PlayStation 2's my god did I love my ps2 I mean never pimp my ride people are putting ps2's in cars that was the ultimate rapper status symbol this was the console that I got after my bar mitzvah when I was finally allowed to have like a real console not just a game boy and it is the last console I owned until I bought a switch a month ago and I've had an n64 that I bought as sort of like a novelty thing to play smash after I graduated college but like that not a real thing the ps2 is totally the workhorse system that I grew up on as a teenager I mean this is Sony at its absolute pinnacle in the like pre internet era it was their consumer electronics expertise it was bringing DVD players to the living room of homes around the world for the first time right it was a DVD player and a game system in one for the price of just a game system I mean for god's sakes there was all this fun I remember in the media at the time when it was launched in the American media about should we allow Japan to export these things because what if adversarial nations to the US get a hold of these and use them to build missile guidance systems I mean the ps2 was a literal super computer at the time and this is the other huge advantage that Sony had over Nintendo and anybody else except Microsoft that we'll talk about in a second which was they could afford to subsidize the crap out of this thing so the PlayStation 2 launched for 299 in the US I don't actually know what the bill of materials was but it cost way more than 299 for Sony to make every one of those but they had so much capital that they could take that loss and then make it up on the software library over time for the high end consoles this is how the business works to this day between Sony and Microsoft yep for Nintendo oh god it's such a sad story their answer is the frickin game cube the game cube the poor game cube I actually have like a really fond memories of the game cube but this was just the epitome of Nintendo was like a kid that was really cool in middle school and then got awkward impurity and in high school gets stuffed in a locker they had no idea who it was for they made it and it was more competitive on a specs perspective than the ps1 and they did try to market it like it was for everyone like it was a game system for kids for adults yeah except it looked like a lunch box totally and it also was competing against the supercomputer ps2 yeah literally people are worried about this thing guiding nuclear missiles like what do you think the American teenager is going to want to buy the thing that their parents are freaking out of out nuclear war or a thing that looks like their little brothers lunch box and the ps2 you know it's black and it's sleek and it's the same playbook that the Sega Genesis ran in terms of we're like the grown up gaming machine on top of all of this Microsoft enters the market yes another company so suddenly you have a two horse race both of which have infinite treasuries and are subsidizing this market they really want to get into and neither of the two horses is Nintendo yeah so Microsoft with the Xbox Microsoft takes at least a five billion dollar loss on the first generation of the Xbox and they are thrilled about that because this is their entry into the long term strategy of getting into the video game market and owning the living room they was there how do we get Microsoft in the living room even though they took that loss on the whole generation like I think that's hardware and software included I don't think Xbox as a franchise was profitable at all for Microsoft on that first generation they're willing to take that enormous capital loss which is basically all of Nintendo's treasury to compete against them and they've got Sony Nintendo just
This gets rocked. And on top of all of this, there was a bill coming due that Nintendo had to pay eventually. And this is where they had to pay it. They finally leave cartridges. So they have zero backwards compatibility with the GameCube because they were too stubborn to adopt discs sooner. And on top of the fact that they're moving away from the cartridges, they go with mini CDs. Mini DVDs. What on earth? So like, did you learn nothing? It's not backwards compatible with any of the stuff that they've had before. Which the N64 wasn't either another dumb move, but that had to happen because of the Silicon graphics technology, which was dumb in the first place. Yeah. It is truly hard to believe that Nintendo would come roaring back from this moment. So this is Nintendo at their ultimate low. Yeah. So put some numbers on that. The GameCube sells barely over 20 million units for the generation versus the 155 million that the PlayStation 2 sells. Even the Xbox beats the GameCube. The Xbox sells 24 million units with that $5 billion plus loss of Microsoft's taking. So any other company like this is Sega's failure with the Saturn and the Dreamcast that basically bankrupts the company, this is that time's 10, like this is a smoking, smoking crater for Nintendo. Except unlike Sega, all the way back to the beginning of this episode, they had one very small but very big thing that kept them alive through all of this. The gift that kept on giving the Game Boy. Yep. Before doing the research for this part too, like I didn't realize the Game Boy and its successors saved Nintendo's skin for like 20 years. So that's Game Boy, which includes the Game Boy Pocket, its Game Boy Color, its Game Boy Advance, and then of course they would launch the DS, which we'll chat about in a minute here. But it is amazing that Nintendo basically had a monopoly on portable gaming. This entire time there's the home console wars they're playing out and there's this whole side thing that's happening where Nintendo is selling millions of units as the only credible player in handheld literally everybody's rigging all their hands about the home console business and that's all that anybody who serious pays attention to. But over in the handheld market, Nintendo is just continuing to crush it like it's like 1989 here. So remember how we said all the way back in the beginning of the episode that the Game Boy is the fourth best selling console of all time. And then we just said that PlayStation 2 is the first best selling console of all time. There's two in three are the DS and the switch, and then the Game Boy Advance isn't far behind. So everything, and we're going to talk about the switch at the end of the episode obviously. But everything that Nintendo gets wrong in the home console market, they get right in the handheld market. We could have retitled this episode as Nintendo, the handheld gaming company, and that wouldn't have been far from the truth. That is 100% the truth. So let's go down the checklist, global monopoly. Yes. Sony does launch the PlayStation portable. I had one. Oh, you have one. Oh, that's awesome. I never had one. Got stolen out of my locker in high school. Oh, no. Brutal. Brutal, which is a great device, but it was for a different market segment than the Game Boy. It never competed head to head with Game Boy. It had a really fancy screen, so it was like pretty good for watching movies. It was more like a small computer is kind of like an iPad as probably the precursor to an iPad type device. Totally. Very Sony device. Yes. All the way to the proprietary memory sticks. Very Sony. Yes. So global monopoly. Check. Most innovative technology, ironically, also check, thanks to Gumpa Eukoi's maximum of lateral thinking with withered technology. A huge and dominant third party developer platform. Check locked in consumer software libraries with perfect backwards compatibility. Check. Literally everything that they got wrong in the home business, they get right in the handheld business. So the Game Boy and Game Boy color sell 118 million units over a 12 year run. That is the more impressive headline number. But the Game Boy Advance, which comes out in 2001, only ends up having about a three to four year lifespan before the DS comes out in 2004. During that time, the Game Boy Advance sells 81 million units, making it the 10th best selling console of all time despite having this incredibly short primary lifespan. So average selling price for the Game Boy Advance is about $100 a pop. That is $8 billion just in hardware revenue. And remember Nintendo is making margin on this hardware revenue during those years. It also does 375 million units in software sales, which is almost double what the Game Cube did. So like literally you're right, like this episode should be titled Nintendo, the handheld gaming company. It's crazy. I mean, it just gives them so much margin of safety to screw up generation after generation over in the home console market. And then the DS, I was perfectly within the generational window where I missed the DS. So I didn't realize what a monster this was. And what I mean in the window, I was too old to buy it as a kid and too young to buy it as a old, funny daddy will get into that in a minute. The DS was a monster. Before we just said the PS2 sold 155 million units and the DS is the second best selling console of all time, it sold 154 million units. So basically neck and neck with the PS2, let's be conservative and say that the average selling price for the DS was $100. It was actually more, but we'll be conservative. We'll say it's $100. That is $15 billion in hardware revenue for Nintendo. And that's just the hardware, the DS sells almost a billion game units at an average selling price of like $30. So that's $30 billion in high margin software revenue. And at this point, Nintendo is still dramatically a first party publisher for their own platforms. And so that billion units sold also most of that or at least half of that is them. Isn't it, Nintendo? Yeah, it's incredible. And the DS franchise generated almost $50 billion in revenue for Nintendo. Wow, that's wild. How is it possible that this same company is failing so spectacularly on the home console side while simultaneously succeeding so spectacularly on the hardware side? And I'll say the portable side is the side that's paving the future for what Nintendo would become for better or for worse. They are the ones who are having this very strong opinion of, let's innovate on a gaming device and what a gaming device is. And to this point, that hasn't really been Nintendo's MO. I mean, you look at the NES, the controllers, kind of what you would expect. The SNES, okay, cool. They came out with the shoulder buttons on top, the L&R, okay, that's a small step forward. You know, at the end of '64, I think, does deserve credit, particularly Mario 64. That was the first game and game system that showed how to do 3D games, like it was incredibly innovative. Totally agree. And then the GameCube is a very me too console, you know, everything about it is like we wish we had done some of this on the N64, but it's too little too late now. But what you're seeing in the handheld, especially in the DS, is, okay, this is super innovative to have two screens. One of them is a touch screen with a 3DS that would come later. One of them is a 3D screen, Nintendo is starting to at least a handheld group figure out. The way forward for us is we design innovative hardware that can inspire new types of games to be played and new types of games to be designed, especially by our first party team and house. And that does all kinds of amazing things for them. Think about the Wii, think about the Switch switching, literally, and the Joy-Cons and how popular that is. It also does terrible things for them, which we'll talk about for the Wii U. But this is when they really discover they are unapologetically innovating on the hardware to play games. And that is what defines them. This is so much the future direction for Nintendo that in 2002 when Hiroshi Yamahuchi is leaving the company and transitioning to the next CEO, Sataru Uwata, and leaving it in his hands, his final request is, quote, "that Nintendo give birth to wholly new ideas and create hardware which reflects that ideal and makes software that adheres to that same standard." Yes, and it's not just new types of games to be made on new types of hardware, it's serving the end goal of enabling new types of people to play games. So what's going on here and why the handheld business becomes such a juggernaut for Nintendo is, I think, as we alluded to earlier, it starts serving two completely different markets than the PlayStation and the Xbox, and both of those other markets are a completely ignored by Sony and Microsoft and be very, very large.
So the first is the kids market. This is the bread and butter all the way back to the NES and the toy aisle. As Sony and Microsoft moved into the Grand Theft Auto era and the Call of Duty era and the Halo era, core gamers and more mature content, the Game Boy became the new home for kids. It's cheaper, so like if you're a parent of a four or a five year old, you're not going to worry about buying a hundred dollar piece of plastic for them. It's less immersive, which is actually a feature for kids because it's easier to play. And then back to the Nintendo kind of guarantee seal of quality brand, you can be pretty sure that little Susie and little Jimmy isn't going to be playing really violent or adult content games on your Game Boy Advance or DS or what have you. So it's really compelling for little kids and their parents. And as we talked about a few minutes ago, nothing embodies this more than Pokemon. We talked about Pokemon on the NFL episode where Pokemon is, I think in my opinion, wrongly listed as the highest grossing media franchise of all time because the NFL really should be a single media franchise and is bigger, but it doesn't matter. Pokemon is number two or number one, no matter how you want to say it. Lifetime Pokemon franchise revenues are just under a hundred billion dollars. And the primary medium for it is the freaking Game Boy. Yeah, so let's take a little detour and tell the Pokemon story here because it is incredible. I think this is not a super deep story, but so cool, so many little aspects of this are like one in a million chances. So you mentioned a hundred billion dollar lifetime franchise since 1996 when it came out. Sixty billion dollars of that is merch. Like video games is only 35-ish billion of the hundred billion, so people became such big fans of this that they tripled quadrupled to the actual video game sales in merch revenue. And that's sixty billion dollars if you compare it to say, I don't know, the Marvel Cinematic Universe, which people think of as a big media property. The MCU is thirty billion dollars lifetime, which is half of Pokemon's merch revenue. Yes, now Pokemon is a masterfully managed business franchise IP. I don't know for sure the breakouts, but I believe a large portion, if not maybe even the majority of that merch segment, is the trading card game. All the way back to Hana Frutacards in Nintendo, almost fifty billion cards have been sold. That's five zero billion Pokemon cards exist in the world wild. All right, so Pokemon 1990 Game Boy comes out and Satoshi Tajiri had started this thing called Game Freak like a decade before with some of his friends as a fan magazine for video games. They eventually get into making their own video games. None of them really necessarily take off certainly not to the extent of Pokemon. So at Game Freak's Satoshi Tajiri is sort of pitching internally, hey, we should make something for the Game Boy. I saw the functionality with the link connector and I loved collecting bugs as a kid and it sort of made me think about bugs going back and forth on the link cable between these two Game Boy's. I wonder if there's something we can do around kids and bug collections and trading them or battling them or something and so he comes up with this concept and he pitches it internally. Now internally, what is it? It's four programmers that started life as a video game magazine. Yes, riled up about this concept and he goes and pitches it to Nintendo. Nintendo is not excited about it, but there's one person who sees promise and says, "I think we should green like this and I will mentor Satoshi Tajiri. That person is Miyamoto." And so suddenly you have the very best game designer in the world seeing promise in your hair-brained concept. Literally bug collecting, which if you know anything about Miyamoto personally, like obviously that would resonate with him. Yes, Game Freak raises money from Creators Inc, who I think the right way to kind of think about it as Creators Inc is the publisher and Game Freak is the developer. Yeah, I think Creators also manages the trading card game. Okay, make sense. So they then spend six years developing the game. Four people over six years with a whole bunch of setbacks, living off of basically Satoshi's dad's money because they're living in his basement and trying to survive off of him having a real job. And in 1996, it's finally ready and they launch it. Yeah, I believe it was read in green in Japan initially and then it was read in blue in the US. Oh, you're right. And the whole thing is so unbelievably frail that when they go to translate it and make an American version, they actually need to recode the whole thing from scratch because it's like spaghetti code everywhere. So it does well, but unlike every other Game Boy game that peeked and started trailing off, this thing just accelerates. And it just goes and goes and goes and everyone in Nintendo is shocked. Everyone at Game Freak is shocked. Everyone at Creators is shocked. No one expected this thing to be this successful, especially after taking six years to bring it to market with basically four crazy people. Yeah, it's just wild and you know, obviously fast forward today and Pokemon is enormous on just about every dimension, but it goes from that to selling just on court video game consoles Nintendo consoles over half a billion lifetime units of console software sales. It's incredible. Do you know the trivia with the names of the Pokemon characters? Oh, no, I don't. So Ash Ketchum in the Japanese version is named Satoshi after Satoshi to Jerry. So Satoshi's nemesis, you know, Gary Oak, the sort of rival of Ash Ketchum in the Japanese version is named Shigeru after Shigeru Miyamoto. That's awesome. Yeah. But this would evolve eventually into and we'll come back when we talked about Pokemon go later, but it would evolve into the Pokemon company, which is sort of the licensing body that is 32% owned by Nintendo and the other thirds are owned by Game Freak and Creators. And I think the way they basically operate is as if they're a studio of Nintendo at this point. It's also successful second party business of all time. Wow. I don't know that for a fact, but I assume it is a fact I can't think of anything else that is a second party business that would be as big as Pokemon. Yeah. So obviously the kids market is cute. I mean, I remember this is all I did all day at recess and any time I could bust out my Game Boy at school like this is what we were doing. And it spans generations like I think it's all kids are doing today all day at recess. And we're old now like I have kids not yet at Pokemon age sadly. Okay, so that's the kids market obviously huge the other market that the Game Boy slash DS franchise serves for Nintendo and this is perhaps not surprising given if you think back to the original history with Gunpei observing the businessman on the train playing with the calculator. But it's what eventually becomes the casual gaming market. Now people aren't thinking about it quite as that at this point in time. Nintendo totally discovers slash and vents casual gaming. They 100% do I mean this is my dad and millions of dads around the world playing Tetris in the 80s and 90s. It really like Nintendo codifies this and embraces it best with the DS. This is brain age brain age with these like mind training games that were targeted at older people and like grandparents. It's Nintendo's which is Miyamoto's dog raising simulator. That's like really popular with women and older women as opposed to most video games. And it turns out that this category which nobody knew existed until Nintendo accidentally found it and then they didn't even like truly embrace it until the mid 2000s. This is actually the biggest gaming category of them all by far and it's incredible because the modern instantiation of casual gaming certainly the largest is mobile free to play casual gaming and Nintendo sort of invented it before mobile and before free to play. Totally so brain age one and two combined sell 34 million copies on the DS Nintendo's sells almost 25 million copies Tetris all the way back on the game boy sold 35 million copies now most of those are bundled in the US. These are billion dollar franchises within Nintendo that nobody thought about for decades it's kind of crazy. So we asked the question how is Nintendo screwing up so royally on the home console side while they're succeeding so spectacularly on the handheld side. I think it's one that the kids and the casual segments were viewed as these kind of ghettos for a long time that no serious company and certainly nobody like Sony or Microsoft would go after and go compete with wrongly so by the way. And the people who would have competed with them were Atari and Sega and both were basically defunct by this.
point. So Nintendo had this lane wide open because everyone else who's trying to come into the industry is coming after the core gaming segment or the serious gaming segment or the high arpeo, the high average revenue per user, people that are buying $60 DVD discs to play. And so, you know, then to the other side of how are they allowed to screw up so badly in the home side? I don't want to say it doesn't matter, but it kind of doesn't matter. So Nintendo's revenue and operating profits more or less stay flat from the NES era all the way through to the mid 2000s, even though the home console business basically just gets like doused in gasoline and lit on fire, but the handheld side completely replaces it. Nintendo's kind of always doing a solid four to five billion in revenue a year, call it and maybe half a billion to a billion dollars in operating income. Like there's no gun to their head. Yeah. So handheld, very good business for Nintendo. And when you couple that with a generation of home console that is also a good business for Nintendo, when they absolutely knock it out of the park and define a brand new form factor and a brand new way to play games that has mass mass audience, then they do the most revenue in the company's history. And that's going to be the Wii. And we're going to get to that. Now is a great time to talk about one of our favorite companies, LaGora, the agentic operating system for legal work. Yes, most of you have dropped a contract into a chatbot by now. But as a lawyer, how far can that really take you? It's never seen your firm's precedence. It doesn't respect confidentiality. And you can't check where its answer came from. So LaGora's founders approached this the way that great founders do. Early on, the team moved into the office of a big law firm in Stockholm and learned four months how the work actually gets done. A couple of thousands of enterprise customers and a 100,000 users later, they still work that way. They employ a hundred legal engineers on staff. These are lawyers sitting inside of firms and legal departments to deploy LaGora onto live situations like the deal closing this week or the policy review due Friday. The product has gotten very powerful in a short period of time. A year ago, the goal was a good answer from a chatbot. With the LaGora agent, you hand it the work and it comes back with a plan, tasks like running diligence on a data room or reviewing a new vendor contract, get completed inside the tool you use every day like Microsoft Word and against your own precedence and playbooks. Every finding is sourced, the lawyer directs the work and signs off before the system executes any steps. Every legal team can get access to the same AI models, so the models themselves do not give you an edge. What you can do with your own data, people, playbooks, that's the whole game. Today, over a hundred thousand legal professionals at more than 1800 law firms and in-house legal teams in over 50 markets use LaGora and when LaGora goes head-to-head with its top competitor and a pilot, it wins 70% of the time. A demo is one thing, but what matters most is an associate who reaches for it at two in the morning during a closing or whether a general counsel trusts what it says before the board meeting. So if your legal team wants to check it out whether you're at a firm or in-house, go to LaGora.com/acquired and be sure to tell them that Ben and David sent you. All right, so the Wii. There's a little bit of a lead up to the Wii, which is some leadership changes. Satoru Uwata comes in and succeeds Hiroshi Yamauchi as president of Nintendo LTD, the parent Japanese company, and right around this same time, in 2003-ish Reggie Fisa May works his way up the ranks and comes in as the president of Nintendo of America. And so you've got this pretty awesome tag team of leadership that is ready to do something very different. And the GameCube comes out. They sort of know right away. This is a miss. They're still doing everything that you sort of think they would do to try to occupy the time until they have something really great, but they're already foreshadowing very early that yep, yep, yep, we hear you developers and gamers like we need to be doing something different. And they're learning from the DS, which they just launched and became this enormous success. They're like, oh, maybe these people want to play games at home too. Totally. So there's this great keynote in 2004 where Reggie comes out on stage. He's introducing himself and he says, I'm Reggie. I'm about kickin' ass, taking names, and we're about playing games. And then they have this whole keynote of kind of the most hardcore Nintendo I've ever seen. It's almost like a dark in your face. They don't know who they are as a company. It kind of reminds me of Luke Skywalker at the beginning of Return of the Jedi. Like you're really not sure which way it's going to go. Could be dark. Could be light. But what you do see is them starting to really embrace something. So they start talking about the DS and they're showing off the backwards compatibility. It looks kind of funny, but you can put in a Game Boy game and it kind of sticks out in a way that is clearly awkward, but they know that this is an important thing because they have this massive install base of people that had all these Game Boy's and Game Boy advance and everything over the years. So okay, we're embracing that check. You also see them talk about everything they sort of can in the GameCube, but then Reggie invites Satoru Wada out on stage in from Japan to talk about this revolution that is coming for home gaming. That's right. The code name for the Wii was Project Revolution. Yes. And they really start sort of just foreshadowing how they really want to change everything again and how it's an exciting time to be working with Nintendo as developers because everything is just about to be so different and truly a revolution. They laid this groundwork a whole year before they even announced the name Wii. Yeah, and I think almost two years before the Wii actually comes out. I think that's right. Yeah. The Wii is such an enormous success on basically every level, but it really is the triumph now fully across all of Nintendo as a company and all their product lines of the Goompay Yukoi lateral thinking with whether technology maximum infrared motion sensing, which is what the Wii Moe uses is an incredibly novel technology to bring to video games, but it's a well understood quote-unquote withered technology like TV remotes have been using this for decades. It's a World War II technology. Yeah, but it works just unbelievably well. The Wii goes on to be incredibly counter-position to the PS3 and Xbox 360. Again, we talked on the Sony episode about all their problems with the PS3. There was this like cell-based supercomputer that was a total beast of program for. And here's the Wii that's underpowered and using this old technology, but opening up brand new markets, it sells over 100 million consoles. Coming back from barely 20 that the GameCube sold. What a turnaround. It beats the PS3. It beats the Xbox 360. It becomes the seventh best selling console of all time and the fourth best selling home console and the games they make for it. They make Wii Sports and they bundle it in with the Wii. They make Wii Fit. They make Wii Play. This completely revolutionizes the market. My favorite sidebar story on this is remember how Travis Kalanick was like a world champion. We tennis player. Right. Second best in the world or something. Which later got debunked because turns out there were no global leader boards. I think he was just really obsessed with Wii tennis or something like that. He was probably really good at it and just told people he was second best in the world. Totally, but this is part of the market that the Wii enables which is like Travis Kalanick doesn't have time to go spend you know thousands of hours playing Call of Duty. But he will go play Wii tennis and he'll get like really into it. Totally. And they intentionally make the controller look like a TV remote because they just want people to call it the remote. They don't want people to be intimidated by it. It's like, look, if you can use a TV, you can use a Wii. Totally. The Wii mode. They also made it smaller. I think the mandate was that it's the size of three DVD boxes so that it's not this big intimidating. I guess the console itself. Yes, exactly. And this is where we should talk a little bit about the different segments of games because it's starting to become important. And I think this will help us understand Nintendo today. The Wii really starts to lay the groundwork for understanding where they're positioned today. We have three people to thank for conversations that we had leading up to this. Nick Fight from Rec Room, Long Time Friend of the show, and some games industry veterans, the creators of Xbox Live Arcade, John David and Greg Kinesa, for kind of going down memory lane with us and helping us to understand the way that this landscape looks. So there are many segments of games, but it's worth breaking it down to three. There's casual, there's mid-core in the middle, and then there's a core gaming audience. And so casual games are what we've been talking about that have sort of broad appeal that you can kind of pick it up and play. It's a quick in and out. It takes you minutes to understand, but hours to master. It's Tetris, it's Braini, it's Witanis. Exactly. And in the modern casual world, the most common type of monetization model is free to play. And this is the thing that's really taken off on mobile, you know, you see Candy Crush, that's sort of almost brainless thing that you could listen to a podcast while you're playing this type of game.
and the revenue per user per day, if you're really good in this sort of thing, is like 20 to 40 cents. That's the way to sort of think about the monetization potential. If you're not good at it, it can be like one to five cents. Then there's mid core games, which it's like games where you pick up where you left off. That's sort of how I think about it. Like not core games like World of Warcraft, but a version of that where they're taking these core game mechanics and you're making them more approachable. And so they take some time to learn, but once you learn them, you really love the game. Zelda Breath of the Wild is a really good example of this. And when we are talking about ARP Dow, the average revenue per daily active user that metric we mentioned before, it's more like a dollar in terms of monetization potential. Smaller market than casual gaming, but a dollar per person, like that's definitely a market worth going after, a dollar per person per day. Once you get into the core gaming segment, I mentioned the World of Warcraft, but this is really anything where you're like training yourself even to play it at all. And your grandma can't pick it up and start playing. - League of Legends. - Right. The revenue per user on that is through the roof, but it's a much smaller audience. And so I wanted to sort of paint this picture to try to help us understand where Nintendo decides to start playing from here. They've typically been kind of a mid core company with their titles. You think of the Zelda's, the Super Mario Odyssey. And with some casual games, you think about Super Smash Brothers or Mario Kart, you know, you're kind of button mashers. Those games lean more casual. What they did with the Wii, which in some ways was shooting themselves in the foot. And David, you can push back on this if you disagree, is that they started walking away from their mid core characters that really defined who Nintendo is and launched a casual gaming home console. The thing that was a hit for the Wii was Wii Sports. It's these sort of lifestyle games. And the things that I don't even ever remember playing on the Wii are Mario and Zelda. That's not what that platform was for. - Yes, I would agree with exactly how you characterize that. And I also agree that by doing this Nintendo shot themselves in the foot, but I don't know that you can blame them necessarily. I think it actually was completely brilliant at the time. And it completely revitalizes the company. So with the Wii and its success, Nintendo's revenue almost quadruples from the $5 billion exchange to just under $20 billion in 2009. - All-time high. Even to date, even including all the switch success, that was still the all-time high. And operating income goes through the roof to over $5 billion. They're killing it. This is like an unbelievable revolution as they would have said. Unfortunately, though, you know, and this is where you can debate whether it was possible to see this coming or not, right after the Wii launches and brings this revolution. So that's 2006, 2007 time frame. The app stores launch on mobile late 2008 into 2009. And that just sucks all of this away. And this is the problem about shooting themselves in the foot. They were so vulnerable to this in a way that Microsoft and Sony weren't because the core gaming market and the hardware and the platforms that Microsoft and Sony were putting out, they weren't threatened by mobile. Mobile didn't take share from them, but it took like all of Nintendo's share. - Right, 'cause the Wii was not the Mario console. The Wii was the casual gaming console and the greatest casual gaming experience in the world launched and fell right into everybody's pocket a few years later that swept out their entire current market away from them. And then it took them a decade to basically go back to their roots with the switch and figure out how to like revitalize all the mid-core Nintendo IP onto a platform that was dedicated and best in class for that use. - And this is like the really sad part of the story if they just get rugged here. - And you could see it at the stock price. It is nuts when you look at when Iwada came in and took over in 2002. And we talked about the Wii was released in 2005. In the four years from October of 2003 to October of 2007, Nintendo's market cap nearly eight X'd from nine billion to 70 billion. They were a 70 billion market cap company, but very briefly, I think their market cap was even bigger than Sony's for that year. But by 2012, it was all the way back down below where it even started to eight billion dollars. - Yeah, the impact of mobile gets felt pretty much immediately in 2009, which is just the third full year that the Wii is on the market. And when it should be hitting like the fat part of its life cycle at its prime, that's when the app store is really hit. And Wii sales declined 20% that year when they should be accelerating. And then they fall roughly another 30% each of the next two years and software sales, which are more important to climb even more. That's on the home console side and the Wii, which is like maybe a little more insulated from mobile. Meanwhile, the DS, which was this juggernaut is just getting rocked. - Yeah, it's weird. In some ways Nintendo called it because they realized that casual gaming was gonna be a huge market and they realized that portable gaming was gonna be a huge market. But they did not have any strategy around mobile. - Yes, it was the perfect marriage. So Nintendo launches the 3DS to try and differentiate in versus smartphones and having the 3D screen. They launched that in 2011. But sales stall out pretty much immediately. I'd forgotten this about the 3DS. And they have to do a major price cut on it within six months of launch. So they dropped the price 30% less than six months after the console launches, like that is bad. So that does stem the tide for a bit. And 3DS sales do grow for the next couple of years. But then the smartphone juggernaut is just too big. 2013, 14, 15, 3DS sales just fall off a cliff. - This saving grace that they had their entire life or from 1990 onward of no matter how much we screw up our handheld gaming's system will sort of protect us. Shields are gone. - Totally. And so now Nintendo is in a Sega post Saturn and Dreamcast type situation. There is an existential crisis happening. So in Nintendo's fiscal year 2012, they report their first ever annual loss. So this was a company that even during the crappy years was making half a billion to a billion dollars in operating income is just coming off the Wii year bananzas where they're making $5 billion in operating income. All of a sudden they're bleeding cash and it gets doubly bad because the only way out of this for them, if they're gonna keep their hardware strategy, is to rush out a new console, which means they have to invest capital in R&D and in marketing for launching a new console to try and stem the losses both on handheld and mobile. It's rough. So they rush out the 3DS. They rush out the Wii U as the successor to the Wii. Oh, the Wii U is a piece of garbage. The thing sucked. - And there's so many insights with the Wii U that are correct. - Directionally correct, let's put it that way. People want touch screens. Okay, you're right, phones and iPads are really starting to take the market by storm. So having a controller for you're a home console that has a little touch screen on it. Okay, I can see that, but God is this convoluted. You basically handed people what looks like a portable console this controller with a screen on it. - But it's gotta be in range of the console. - Right, they can't actually use it as that. They have to use it as a controller for the console. And there's all sorts of innovative things they can do that this is sort of where the maximum of Nintendo really comes into play where they're obsessed with designing hardware that enables new game experiences and then designing games to work with that hardware. They still, at this point in time, have never shipped a game on any hardware where they did not design the controller. And so they're starting to make all these very clever use case games for this very strange piece of hardware where like there's accelerometers in the controllers you can tilt it back and forth where you can put it down on the table and you can write on it or you can be playing chess and you can flip it side. It's weird watching the commercials for this 'cause you're like, wow, this could do everything. This is like a very innovative console, but a bunch of things were wrong with it, including the fact that it was rushed to market, wildly misnamed, it sounds like it's an accessory for the Wii, which it wasn't. It was a full new generation. - Yeah, it was bad. So the Wii U just really compounds the gravity of the situation for Nintendo. It only sells 13 million units in its entire lifetime. Remember, the GameCube was bad selling over 20. It's Nintendo's worst selling console ever. Save for the virtual boy, which was worse. - And these losses continue year after year after year. I think most of the years from 2011 to 2017, '18 were in the red. - Yeah, and so as that happens, shareholders and shareholder activists start demanding that. Nintendo go the way of Sega and get out of the hardware business. There's this really, really obvious value maximizing at least in the short term move that Nintendo could do, which is take their IP and publish it on smartphones. - And this argument makes a lot of sense. What does this company have anymore? They do have IP that is super valuable that you should put everywhere, but nobody likes their last console. They can't prove that they've been able to do two consoles in a row. They can't prove that they've been able to leverage their user base into buying the next console literally ever. They can't prove that there's any purpose to everything they learn from the Wii because all that great casual stuff that they learned from the Wii is now happening on smartphones, which they have no play in. So it would be very reasonable to be like, you really need to stop making hardware and you have this unbelievable asset, which is some of the world's most valuable IP. - Yes, so there's a legendary story which may be apocryphal and after some more research, I think actually is apocryphal, but the spirit of it is absolutely on point. Mitch and Blake tell this over on the GameCraft podcast where at the 2013 shareholder meeting, Kowada's up on stage, he's taking questions from the audience. He gets in an argument with a shareholder, not even an institutional shareholder, just like an individual shareholder who's there who says like, hey, my daughter loves playing games on her smartphone and she loves playing Nintendo games. Why are there no Nintendo games on smartphones? And that Awada's like mortal honor is offended and he jumps off stage and punches the shareholder in the videos. - What? Really? - So I don't think this really actually happened. I think it's an urban legend, but it very well could have because Nintendo and Awada were just so stubborn through all of this. They're like, no, the Wii U, it's the future. Like please buy our console. - And they're philosophically opposed to a mobile than a number of ways. One, they like controlling the whole experience. They did not design the smartphone controller. Therefore, they don't feel that they can make great games for it, which is pretty stupid, but it's how they feel. They also philosophically hate the business model that's doing well on mobile, which is free to play. They think it's like the devil. They think it is an immoral thing to do. - So ironic given Nintendo's history. - Right, you talk to video game veterans and they do say like, we are very grateful that Nintendo exists in the industry because otherwise it would literally just become this detritus of capitalism. - I totally sympathize with this point of view. And Awada says, this is an actual quote from him around the time. He says, "Making smartphone games is absolutely not under consideration. If we did this, Nintendo would cease to be Nintendo. Having a hardware development team in-house is a major strength. It's the duty of management to make use of those strengths. It probably would be the correct decision in the sense that the moment we started to release games on smartphones, we'd make profits." - Remember, they're not making profits at this point in time. However, I believe my responsibility is not to short-term profits, but to Nintendo's mid and long-term competitive strength. Now, he's absolutely right. And history proves him right here. But from a shareholder perspective at the time, people are like, you gotta go, we've had enough. - Well, the funny thing about this survivorship bias is if history didn't prove him right in the long term, we also wouldn't be doing this episode. Somebody could have had that same opinion and then gone the way of Sega. And today we would be talking to you about the Xbox or some other episode. - Totally. Nintendo's stock price from the highs after the Wii declines over 80%. So like, oh, it's brutal. And I think there's probably a decent chance that Awada would have been forced out. Unfortunately and completely tragically, he dies way, way, way too young and unexpectedly of cancer in 2015. - Age 55. - Age 55, it's just terrible. It's also really sad because he and Miyamoto and other Nintendo executives finally do realize that they have to change things. And they come up just like Tom and Sega had the four-point plan. They come up secretly and internally around this time in 2013, with an internal three-point plan for Nintendo. And it is everything that they need to do. And it starts with point one, we need to stop fighting this smartphone battle and embrace it. But we're gonna embrace it in a Nintendo way and this is super smart. We're gonna build a new standalone business unit and we're gonna do it in partnership with the Japanese mobile company DNA to co-develop smartphone games using Nintendo IP. But we're not gonna fully transition the business to smartphone games like the investors want us to. We're gonna use this as a way to unlock RIP and spread it out more broadly to the rest of the world. Kind of like we've seen Pokemon has done. The Pokemon IP is applicable so far beyond the Game Boy games. And all of the revenue and activity from that, it drives sales back to the Game Boy games and to the Game Boy platform. We can and should be doing that same thing with all of our IP with Mario with Zelda, et cetera. Speaking of, if we wanna do that right, just like we see Pokemon doing it, it's not just that we wanna do mobile games, we also wanna do theme parks, we wanna do movies, we wanna capitalize on nostalgic. 'Cause now, just like you and me Ben, the core Nintendo customers from the old days have gotten old enough that we have nostalgia for the NES, the SNES, the N64. They start releasing NES, SNES, classic edition and it's like re-releasing the home consoles with HDMI ports. This is genius, they make tons of money from this. So they sign a partnership with Universal Studios to start building Super Nintendo worlds first in Japan and then in Hollywood, it's just open, it's coming to Florida, it's coming to Singapore. And then really these points one and two, embracing smartphones, embracing the IP strategy is really to buy time so that they can rethink the hardware strategy and reimagine what the future of Nintendo is gonna be. Because I think Nevada is totally right. For better or worse, Nintendo is not Nintendo if they exit the hardware business. Xeiga is a shell of its former self and Nintendo probably would ultimately have gone the same way if they had exit the hardware business at this point in time. - All right, so in 2013, they start laying the groundwork for the switch for leveraging the IP to the movie coming out right now and theme parks and of course mobile. - So that takes us to the summer of 2016 and a big surprise announcement, the very first smartphone game with quasi Nintendo IP, it's not through their partnership with DNA, it's not Mario, it's not Zelda, it's Pokemon and Pokemon Go. And this is like the perfect everything, mobile game, wafer Nintendo to dip its foot in the water. Oh, it's just amazing. Pokemon Go is one of those things that you just cannot make up what happens here. The craziest thing is I had been playing Ingress for the previous 18 months. And so when Pokemon Go came out. - You and all the nerds out there. - I was like, wait, this is just Ingress with Pokemon in it, this is very strange. - Do you know how the Nintendo Pokemon Google relationship starts? - No. - So, Niantic, which developed Pokemon Go in collaboration with the Pokemon company and Nintendo is one of the main shareholders of the Pokemon company was a spin out from Google. And Niantic was the team that within Google had made the mobile location based game Ingress that Ben was just talking about, which was super geeky and like really fun, but it was basically Pokemon Go without the Pokemon. - Yeah, it was like a test of the infrastructure and to develop the right game mechanics. And the IP that it was using was sort of an old sci-fi novel, but it wasn't like exactly one to one. That's right, but the spark of this relationship actually goes back to 2014 and the 2014 April Fool's joke, Google loves April Fool's jokes. And I had forgotten about this until I read about it and the research and then I was like, oh yeah. Which was the Google Maps Pokemon Challenge. So on April Fool's Day 2014, Google released a video saying they were recruiting for a new position within Google that was like the, I think they called it like Pokemon master or something like that, like the Google Pokemon master. And that it was a competition to get this job and the way you could compete was by capturing Pokemon on Google Maps and they had like a video for it and all this stuff and it was hilarious. Now what I don't know and wasn't able to find was were they already starting to think about Pokemon Go and building a game together because very clearly the work that went into putting Pokemon showing up on random spots on Google Maps was exactly the work that needed to go into building Pokemon Go. But this was a total like underapp surprise. Nobody outside of Google and Pokemon Company and Nintendo knew that this was coming. Then one day in the summer of 2016, it hits and it's just a cultural touchstone. - I mean, I'm sure.
- Totally. - Almost everybody listening to this episode remembers this. - I was convinced AR had arrived. I was like, oh, we found the AR use case. The world will never be the same. - Every venture capitalist was running around trying to find AR and VR companies. Niantic spins out and then does raise a boatload of venture capital from all the big VCs. Pokemon Go itself gets over 500 million downloads just in 2016, which is mind-boggling. - Now, a lot of those folks churn, but it becomes a real viable ongoing smartphone game. - But the ones who don't churn spend. - They love it. So it has well over 100 million ongoing monthly active users. It now earns about a billion dollars every year. It's one of the top mobile games out there, period. Investors in Nintendo get so excited about this. And in particular, what this means is a harbinger or other Nintendo IP, coming to mobile, that within two weeks of Pokemon Go's release, the Nintendo stock price doubles (laughs) from call it a 15 billion dollar is to a 30 billion dollar market cap. And everybody's just going, wow, like this is Nintendo is finally gonna embrace smartphones. The reality is maybe perhaps in part because of Pokemon Go's success and the breathing room that abys them, they don't. The funny thing is that this game is not released by the Pokemon company that Nintendo has 32% ownership in. This game is released by Niantic who has secured a license to the IP from the Pokemon company. And to your point around the stock spiking, Nintendo has to issue a press release, telling investors mid-quarter, hey, y'all are real excited. We do not expect this to impact our revenue meaningfully for the quarter. This was a license. - What's interesting is, I think the stock does drop back a little bit when they issue that press release, but not that much. People are still really excited. They're like, this is the great unlocking of value. It's happening. (laughs) - But to like really underscore this, I mean, there's a few interesting nuances here. One, to this day, only 3% of Nintendo's revenue is the entire basket of mobile and licensing and theme parks and movies. They clump mobile in with all that. They don't look at games like Pokemon Go or what we'll talk about in a minute, Super Mario Run as a Nintendo game. They look at this as, oh, we've licensed RIP for someone else to do something with. And the fact that it's a game, even though that sounds like what we do as a company in our core business, oh no, no, no, no, no, this is different. This is a license. - It's actually part of the IP strategy and it's actually marketing. - Right. It is only 3% of their revenue. So all of this Pokemon Go stuff that happened is like, okay, a lot of people got reminded what Pokemon is again. But Niantic makes a bunch of money from that. Nintendo doesn't make a bunch of money from that. - Yeah. Now, I suspect the Pokemon company made and continues to make a bunch of money from Pokemon Go, not quite as much as Niantic. - But a bunch is relative. Like it's not impactful to Nintendo's business. - It's not transformative. Certainly not to Nintendo. Also, it's worth pointing out, if the Pokemon company were the developer of this game, there's no way it would have the attractive business model that it has. It is a whale driven micro transaction game that Nintendo is philosophically opposed to. And so in the same way that Apple gets to claim, you know, were the privacy company, but then get paid tens of billions of dollars by Google. Nintendo gets to claim like, oh, you don't touch these dirty micro transactions. And yet, we're selling a license to a company that is making billions of dollars from doing that. - So Pokemon Go is the first quasi-Nintendo IP to hit smartphones. Later that year in the fall of 2016, they do come out with the first game in the DNA partnership Super Mario Run. And a whole bunch of people download it. It doesn't end up becoming a big ongoing game like Pokemon Go. - So Miyamoto gets up on stage in an Apple Keynote, which was really cool to see, 'cause you know, these companies are like, sort of spiritually aligned, although one sort of ate the other's lunch. You know, Nintendo's throwing stones at Apple saying that their business model is moral evil. So you got Miyamoto announcing on stage that they're gonna bring Mario to the iPhone, which to me watching it, I remember thinking like, okay, so they have no strategy. This is like him waving their arms around and being like, oh my God, the Wii U is so bad, we don't know what to do. - Don't look over here, look over there. - And I think even in the Keynote, they say, we don't know what the price is gonna be yet, but it's not gonna be in that purchases. You're gonna buy it once up front because that's how we believe game should be bought. Which of course is him saying, we're not gonna make any money on this, 'cause you're not gonna sell a $60, $70, $80 or skew on the iPhone, you're gonna sell a $5 skew on the iPhone. And so the game itself is effectively the original Super Mario, but since Nintendo doesn't own the controller, it's sort of a little bit of a weird mechanic. You're like tapping on the screen to make him jump and you're holding it to make him jump higher. - Yeah, it's like a really weird baby between the original Super Mario and a runner game, which runner games are somewhat popular niche genre on mobile. - Right, 'cause you're not controlling the speed at what you're running, you're just going. The funniest thing about it is it's so Nintendo in all these different ways. They're super, super anti-piracy. So even though they're making basically no money on this thing, they won't let you play it without an internet connection because they're so afraid of people jail-breaking the iPhone that you can't play it on a plane or in the subway. It's so-- - That's so Nintendo. - Sometimes they like cut off their entire body to spite their face. - I had forgotten that, that's ridiculous. - Matthew Ball puts it the very best. He has a great piece written in 2020. It will link to it in the show notes, which is basically, here's why Nintendo looks a lot like Apple and Disney, but isn't actually as attractive of a business as Apple and Disney. It's kind of the crux of the piece. And there's this paragraph that says, 2016 Super Mario Run is one of the 10 most downloaded mobile games of all time with over 700 million installs. However, it has achieved only 75 million in gross revenue after four years according to sensor tower. These downloads are a testament to the power of Nintendo's IP, but 11 cents per user, and less than 100 million in total top line, likely makes Super Mario run the worst performing game with nine-figure installs by far. Which, you know, on the one hand, point taken. On the other hand, this is explicitly not Nintendo's strategy, which brings us to the announcement at the end of 2016 and then the launch in March of 2017 of the Switch. Now, the Switch is so interesting. It obviously goes on to become this enormous success. I love mine, I've played the hell out of it. 123 million sold in the first six years. - Yep, it's the first console you've bought since the PS2, is that right? - Yeah. - Well, I guess I had a PSP, but I didn't consider that a console. - Exactly. - It is this amazing success, but when it's announced, so many people, certainly the investor community, and I raised my hand and count myself among this, I thought it was a terrible idea. It was not obvious, at least to Wall Street, that this was the savior that it ended up being. When they announced it, Nintendo's stock drops 7%, and then it keeps falling until launch. Remember, everybody's all excited about like, "Oh, Nintendo's finally coming to mobile." There's a great, bull case narrative for Nintendo out there, and then they drop the Switch and people are like, "What the hell is this?" - We're making a thing that's like a phone, but bigger, and you need to also carry it with you, so now you need a second device. It's an underpowered home console, combined with a big portable console that doesn't fit in your pocket. - Even though you do have a console that does fit in your pocket. - Right, you have better versions of like, both of those out there on the market. Now, this will be really fun for us to talk about, 'cause I think there's two things going on here, and I think Nintendo saw both of them. The one that they certainly saw, Ben is what you're talking about earlier of the mid-core market being underserved at that point in time, and in particular, the mid-core market for Nintendo IP. There wasn't a really good platform to play Nintendo or otherwise mid-core type games out there, and the Switch was the perfect platform to do it. That certainly was one thing that the market didn't appreciate that Nintendo saw. I think there was also another dynamic here, at least this is my experience with the Switch, while the dynamics in the mobile gaming industry on the one hand were very different than the Atari 1983 video game crash in that obviously that industry still makes tons of money. It's by far the biggest segment of the gaming industry. I think it's $120 billion annual revenue industry in and of itself now mobile gaming. On the other hand, some of the same problems are definitely there. It's filled with shovelware crap. Even the games that make the most money are crap. This is why Nintendo is philosophically opposed to it and so many people appreciate their point of view. And so when the Switch launches, it's actually kind of a throwback to the NES seal of quality. A lot of people certainly, myself included, I would play more casual, like I said,
certainly mid-core, but also more casual mobile games. If I had a seal of quality knowing that this wasn't crap, this wasn't going to try and drain my credit card of hundreds if not thousands of dollars and treat me like a whale. And that's what the switch becomes. Even despite all the success of mobile, there was this room for like quality. Your right that quality is the way to describe it. It's not first party, it's not third party, it's quality. And Nintendo is going to basically have a pretty low volume throughput of third party games. And the way that they designed the device kind of forces you to custom make games for it, because it's not great for porting other games. So it sort of flies in the face of everything else happening in the industry, which is we want our game available on the most end points, because it's going to be some kind of open world services oriented events-based game. And you want to be able to play that with all your friends no matter what devices they're on. And what Nintendo is saying is we're going to make a device so weird that it's basically a smartphone, but without Bluetooth. It does have Bluetooth. It's just neutered and you can't use headphones. Yeah, right. What the heck? I can't use my Bluetooth headphones with it. It's weird. And also it is going to have like a 2013-14 era tegrad chip. The Nvidia tegrad finally finds its use case. It's so strange. And so what it means is it's a great first-party device, because Nintendo is not making their games for any other platforms. So they're happy to custom write for this weird thing. And indie developers at first probably won't write games for it, because there is an audience. But over time, if it gets an install base, it's great as an indie developer to develop a really high-quality game purpose-driven for it. But if you're developing Call of Duty, it's pretty unclear that this is a great device for you. Yeah, I think we need to separate out two different parts of the market, because on the one hand, when you're talking about Call of Duty, when you're talking about fittingly Madden, like Madden football is not on the switch still to this day, stuff like that, the very, very high-end, the core gaming market, what you're saying is absolutely correct. There is no Call of Duty for Switch, right? Pretty sure. It actually is going to be part of the divestiture. Oh, I love it. I love it. Microsoft has announced that Activision will do it if they're acquired. Right. But only as like a concession to the DOJ. And no consumers actually want. So I think that's 100% right on core games. But indie games, the Switch becomes this very vibrant, flourishing platform. And like, yes, you have to do some work to import it over. But it's actually not quite as hard as you're making it out to be, especially if you originally developed the game in Unreal or in Unity or for the PC or for Steam, because the Switch runs on the Tegra on Nvidia system on a chip, like you got to do some stuff with the controls to make it work. But you can port these games over. And so games like Hades is a great example, or Undertale, or Celeste, like these indie games that I've played and I loved on my Switch, like the Switch is by far the best platform for games like this, because they kind of harken back to the old 16-bit Nintendo era for the first time in generations. Nintendo has actually become a really viable third party platform for the right type of developer, and it tends to skew more indie. We talked to folks in preparation for this episode who have games that even tend to be kind of more mobile smartphone-based games that are actively working trying to get them onto the Switch because of this quality dynamic and that players on the Switch are much more likely to monetize even though it's a smaller audience base. I mean, people on the Switch will buy like 20 plus $60 games over the life of owning their Switch. This is not a casual, arped-out type audience. This is a high monetizing, high-intent audience. Yep. And then finally, I think there is another element that we really got to give Nintendo credit for with the Switch that I and very few other people saw the potential and when they announced it, which is that the use case that they marketed, the primary use case of seamless playing between on-the-go and at home, is actually pretty compelling. Totally legendary game director and designer Hideo Kojima of the Metal Gear Solid franchise. He was one of the few people pre-launched that like publicly really recognized this. He has a quote he says, "The fact that you can play something at home and take it outside, this is the gamer's dream. The Switch is an evolution of that." And before the Switch, you really couldn't do this. Your same save state, your same progress, your same everything. Yep, exactly right. The other thing they got right with the Switch, which has been huge for them, both as a business and as an unlock for player dynamics, is they finally, finally got online. Yes. This is a thing where people have been saying, "Oh, Nintendo is always five years behind." I think Nintendo was like 10 years behind in online play. This was literally their third attempt. They now finally have this thing called Nintendo Switch Online, and there's two versions of it. There's a $20 and a $60. But they finally have some semblance of like an Xbox Live type service that works. And before, I think they had the Nintendo Wi-Fi connection and the DS and Wii era, and that had some really weird sub things inside of it. The Wii shop channel and DSi shop, and they had this whole friend code thing, and then they deprecated all of that, and they launched the Nintendo network. And inside of that, they had the Nintendo eShop, and the eShop eventually got folded into Nintendo Switch Online when that launched. But it has taken a long time, and some pretty like half-to-in-the-water technology bets to get here. Famously, they launched Switch Online, and they said it's great because it's peer-to-peer. And everyone was like, "That's terrible for us. That's good for you because you don't have to build data centers, but it's slow and buggy. What do you mean it's peer-to-peer? Xbox Live is existed for like eight years." Xbox Live is existed for like 18 years. Yeah, it is wild. So they finally kind of have their act together with that. I have never bought a physical game for my Switch. I've only bought them digitally. The difference between the $20 and the $60 is there's a bunch of differences, but one of them is like you can get access to the N64 emulator if you do the $60 online instead of the $20 a year online. And I think you get the Mario Kart DLC courses if you buy the $60 version. Yes, you do. The functionality is good, and now there's compelling reasons to subscribe to Nintendo, which is a pretty big unlock in their business. And if you had told me in 2016, before they launched the Switch, that at some point I'd be paying an auto-recurring subscription to Nintendo, for services I may or may not be using at any given time, to play on a dedicated Nintendo device at that point in history. I would have told you you were completely insane. The Switch really is just an incredible comeback for Nintendo. And while the Wii was also an incredible comeback, it was kind of one that they had clear line of sight into from their experience in the handheld business, and they sort of knew, of course, creativity was involved in making it, but if we can build this, we're pretty sure they will come. The Switch, I don't know if it was luck or genius or just what, but this was the first time they were the true underdogs, and they had all the deck stacked against them, and they proved everybody wrong. Right. And the big question is, do they have to keep doing this, and betting the farm on inventing a brand new form factor half the time they fail on, or have they now discovered something that is a durable platform for the future that they can keep building on top of, leverage the existing base? I mean, how frickin attractive is it now that they have 123 million people who have bought these things for developers? Developers finally want to be in business with Nintendo again. Especially Indies, but the major third parties too. Okay. We are going to have a very robust analysis discussion of this, because Nintendo is literally right at the crossroads again of what to do about the next generation. The Harvard Business School should be like surrounding Nintendo and doing a say-on to like, it is like the most incredible business strategy microcosm to learn how they are going to handle this unique position that they're in right now. Oh, forget Harvard Business School. This is why we're here. Acquired is on the scene. All right. So let's finish out the story and then we'll go to analysis. So once they launch the switch, it is an immediate hit. Nintendo plans in the initial two million unit worldwide production run. Remember, you was such a flop. They only sold 13 million units in the whole lifetime. So like two million units, it sells out immediately. They have to airship more units from their production lines to retailers across the world at a cost of $45 per unit just to get more in the hands of demand out there, which was a brilliant move that the old Nintendo never would have done. It's worth eating that cost to serve demand and build out the install base. What a difference. Yeah. Although I wonder if they still have some of that in them. I mean, it's the sixth year of the switch. And I was like backed up to like a month to get one online and I drove to a target and got the last one in person.
And like, I think there's still some games going on over there for limiting supply. Yeah. Now, and they can probably use the excuse of, "Oh, chip shortage." But like, there's no chip shortage on the Tegra from 2014, look. Anyway, it's a huge success to your point about the mid-core market. It launches with Zelda Breath of the Wild, which originally was supposed to be a Wii U game. It launches also on the Wii U. It's forward and backward compatible to the Switch. And Switch copies of Breath of the Wild sell at literally a one-to-one rate as the console itself for a hundred percent attach rate. This is never before happened in history of a non-bundled game. You can't separate out Breath of the Wild from the Switch's initial success in that first year or two. It was a generational game that deserves its own episode on a different podcast, and I'm sure has many out there. And this is one where, like, when you talk to game industry insiders, a hundred percent of people are like, "This game is just so beautifully designed." The quote that I got from someone I was chatting with is, "When Breath of the Wild 2 comes out next month, the whole industry will stop, will not go to work, and will just play Tears of the Kingdom." Similarly, though, to the Switch, I think there's some questions of, like, what could Tears of the Kingdom do to top Breath of the Wild? But we'll see. The Switch sells over 15 million units in the first year, so, like, more than the Wii U, just in the first year, goes on, as you say, to sell 123 million units so far it's still on the market. We'll see. I think it's unlikely it will pass the DS and the PS2, but it depends how long Nintendo waits to launch the successor and what form the successor takes. My money's on Switch 2 in the next six months. I think that is where the betting line is, but we will discuss. On the back of all this Nintendo revenue just explodes from less than 5 billion at the end of the Wii U era, immediately in the next year to 10 billion after the Switch launches, then 12 up to 16 billion during 2021 and the pandemic, the stock goes up another 50 percent. As Switch sales now have started to slow that were in the sixth year of the console lifecycle, the stock has fallen again a little bit, but they're still doing five to six billion dollars in annual operating income. It's still a 50 billion dollar market cap. Nintendo today is so far removed from Nintendo of the Wii U era. And then there's the IP. We are literally recording this the day before the Super Mario Brothers movie comes out, which is supposed to actually be pretty good. I suppose we pretty good. I want to go see it. I mean, they've got Chris Pratt. They've got huge stars. This is a departure for Nintendo. Now they did do a Super Mario Brothers movie for me once Nintendo. Yeah. We won't talk about that one. That was a disaster back in the day. Matthew Ball points out that the 1993, I think that's when it was, movie was so bad that it set the whole industry back by a decade for licensing video game IP for movies. I totally believe that because obviously, as we see here now in the mid 2020s, video game IP is fantastic for movies and TV shows, but yeah, it was because of that movie. I think in large part, the people shied away from it. The first Super Nintendo world opened at Universal Studios Japan in 2021. And the first American one opened at Universal Studios Hollywood just a couple of months ago. By all accounts, they're both pretty awesome. Two more are opening in 2025 in Singapore and Orlando, Pokemon Go continues to crush it on the IP strategy. You're talking about a lot of things right now that don't seem to make much money from Nintendo. I just want to point out it is getting their characters out there. That's all well and good. Maybe they'll start making a bunch of money in the future, but like so far, non-material to the top line. I think that's the point. Well, all right, let's transition to analysis and talk about this first. Yeah, so what is the end game? Is the end game to get people to fall and love with the characters all over again on a continuous basis so that then they go buy more Switch games and Switch 2 stuff? I think yes, with the additional nuance that I'm no brand IP strategist here, but I think the additional goal is generational management that frankly, the Pokemon company has done so well. Every year is a new cohort of children in the world who can and should be brought into the Nintendo fold and Pokemon has done this so well. You and I played it growing up and kids today play it growing up equally if not more passionately. And I think once you start moving into like across generations like that, you really do need a broad multimedia IP strategy to make sure that you're engaging and bringing the new generations into the fold. The better comp is probably the NFL than Disney originally, I was like, oh, they're running the Disney playbook. But Disney takes on all of the in house work of operating their own theme parks and having all their own employees and needing to like have that core competency. Also Disney has hundreds of stores. Nintendo has like I think two stores, but they don't have like physical touch points with consumers as much as in part one, we talked about world of Nintendo in the stores to sell the games. It's so different than the actual boots on the ground stuff that Disney has that sort of makes up the Disney flywheel. And so you know, in our old Disney plus episode, we talked about how a dollar on a Disney movie in revenue equals two dollars in parks and merch. The way that Nintendo is sort of structured where they've decided they want to make great hardware to play games and they want to make games and they don't want to not do anything else because that's all not very Nintendo. That's a different strategy where all of this other stuff is brand building and it might make some money. I mean NFL films was like break even. So it's probably one click away from NFL films, but it's certainly not the Disney flywheel. I think the NFL and NFL films is the exact analogy. I think the mobile games strategy within Nintendo is don't lose money, but extend the IP. We're not trying to build it into a revenue driver. In other words, they're willing to give away margin dollars to not have to be in those businesses, but accomplish the same touch points with customers. Yep. Okay. So that's the IP. Let's talk about the big question. What is switched to? Yes. Okay. So here's an interesting way to tee it up. Let's work backwards from Nintendo Switch online. So that launched in December 2018. So the Switch didn't have it at first, which I think is interesting. It grew very quickly. Three months after launch, it had eight million subscribers by January of 2020. It had 26 million September of 2021, 32 today, a reasonable estimate based on everything they've sort of disclosed is somewhere between 35 and 40 million subscribers. There's about 100 million active Switch players per month when you sort of think about the churn and people buying multiple devices and devices breaking and stuff like that. Do you have an attach rate of like 35 to 40% on a recurring revenue software business? That's pretty good. It's pretty good. It's not something you would want to just throw away like did with the NES install base. And with the NES install base, it was theoretical, right? It was like, well, these people who we have relationships with should stay our customers, but our customers, the hour is doing a lot of heavy lifting in that sentence because they were your customers when they bought a game last time. You hope they will be your customers when they buy a game in the future. Flash forward to today with the Nintendo Switch online, there are 40 million people who are your current customers who are paying you money. Their credit cards are automatically being charged every month. Yes. And when you do some quick math, there's two price points. There's the $20 in the $50. Some of the average revenue per customers, I don't know, 30 bucks, maybe 35 bucks, depending on the mix between those two skews, that's a billion dollar, maybe a billion and a half dollar recurring revenue, super high margin software business. And that is before you even factor in the digital games. It's probably a $3 billion business when you think about the one off digital purchases people are making. So there's a company called Nintendo that does all the stuff they used to do, but also makes a billion dollars of recurring revenue and another two billion on top of that of super high margin software revenue. This is so funny, unacquired, we always talk about how software is the best business model of all time and media is the second best business model of all time. And video games are truly the best because they are software that is media. And Nintendo with help from studying Atari figured that out before anybody with the NES and built this incredible juggernaut. But then they like forgot it for a very long time. Everything you just described is not new innovative business models. Well, SaaS is new, right, but Microsoft figured this out 20 years ago. And this was the whole point of the Xbox and why they were willing to lose $5 billion up front on it because they knew that if they can get those Xbox live subscribers and now the game past subscribers, that's a really, really, really good business model. And Nintendo has only just figured it out. So funny. So they basically make 10 billion dollars a year selling physical things on a
non-recurring basis, and they make $3 billion a year selling digital things that have super high margin revenue, and a billion of that is recurring. So I think that's the framing that you sort of have to go into when you think about what their next move should be. Now they're Nintendo. So they're going to do whatever their next move, whatever they want it to be. But if it's what should it be, the answer is figure out how to launch a next generation piece of hardware that makes people upgrade very similar to the way that people do what their iPhones that has backward compatibility to every other thing that they've purchased in your ecosystem before. So preserve, you know, make it so that you're growing your monthly active customer base. If they're thinking like this, we might see them do the thing that Apple shifted to, which is instead of reporting total devices sold, reporting their monthly active participants in their ecosystem, and make it so that the Switch 2 has all these cool capabilities that make people want to upgrade, but the same great games work everywhere. This is the forward compatibility piece that Microsoft and Sony and Apple, too, have figured out of like make sure the software for a certain period of time keeps working with the old Switch consoles. And they've already done this for a half generation, like you have the Switch Lite, and when you were at my house and you were playing with the Switch OLED that I went and bought a couple months ago, I could see a glimmer in your eye. I could see you saying, boy, if they don't release a Switch too soon, I might be buying this OLED thing because boys is nice. If I didn't know that we were going to have this robust discussion about the Switch 2, I would have already bought a Switch OLED. It's so funny, because I went out and bought and I was like, I can't believe I'm buying a thing that's a six year old piece of hardware, like how is this thing not outdated? And then as I started to do the research, it seems like what happened was they were planning a Switch Pro that was going to release some time during COVID, but then when demand popped right around the time of Animal Crossing in 2020 hit and they sold a whole bunch of them, they were supply constrained. I think the plan for Switch Pro went out the window and they were like, let's just extend the life of the Switch and some of the features they were planning for the Pro, like the OLED screen went into this mini step of the Switch OLED before they do the Switch 2. Which kind of presages, I think it's unlikely Nintendo will do this because they're Nintendo, but if you really want to take the logical conclusion of this business model to the extreme, you turn the Switch hardware line into the iPhone hardware line, where it's not Switch 1, 2, 3, blah, blah, I'm going to guess iPhone is 13, 14, 15, but like you might upgrade every now and then and there's plus models and like incremental S models, but you enter the ecosystem at whatever point feels right to you and your part of the ecosystem. And we shouldn't take credit for this. This is the exact thesis popularized by Crossroads Capital who's a Nintendo long and writes awesome letters that we'll link to on the sort of bull case for Nintendo, but if you are a buy on Nintendo right now, this is the sort of thing that you believe they should do. And there's sort of this question of like, okay, but what will Nintendo do? What do the close insiders at Nintendo who don't care about the stock price, who don't really care about their revenue, who don't really care. I mean, they care enough about shareholders. I think they care about the spirit of Nintendo as we just discussed for several hours. Make really fun games on hardware that pushes the envelope on what types of experiences are possible for people. So I think if they get a bee in their bonnet about a new hardware idea that they think is groundbreaking and will enable a whole bunch of new game experiences, they're going to do that, and then they will figure out the business model implications later. I think the thing that is a little scary and we'll see how much this is imprinted on Nintendo. The Wii U debacle and when smartphones came out really existentially challenged Nintendo for the first time ever. Like they could afford to have that philosophy during the 90s and the 2000s when they had the handheld business to save them every time. They could kind of do whatever the hell they wanted and it was fine. There was no existential risk. We've seen now, even with all the incredible success from the switch and the $5 billion of annual operating income that they're generating right now, they're in a much more precarious position. Like if they don't get things right, consumers will just leave and go back to mobile. They can't do another Wii U. Now we're full on and bull and bear, so let's just pull that forward and do it now. This is one of Matthew Ball's point on the bear case, which is everyone's all hot on the switch as the best selling console Nintendo has ever done blah, blah, blah. But really it's not one console, it's two because it cannibalized their other business line. So you kind of have to look at not how is it doing against the Wii, how is it doing against the Wii plus the DS or the NES plus the Game Boy. And that really kind of puts it in a different perspective where they have no backup plan. They can't move forward and one while keeping the other one stable. They now have one platform for better or for worse and they really can't screw it up. Which is a great thing. As a consumer, that's awesome. It's just like, please don't screw it up. So here's all the other bangles on the bear case, Nintendo missed mobile and they'll never have a business on mobile and all the future growth is in mobile gaming and they just are not there. Disagree. I hate mobile gaming and I love my switch. Okay, but let's talk about the business. So Nintendo is cute doing 13 billion of revenue a year, 5 billion of operating income. But let's look over at mobile. Let's see how Apple and Google are doing. Who by the way, make no games, just operate stores and sell devices. They're getting away with murder on mobile games. 61% of app store purchases are games. Turns out that the killer app is mobile games casual, free to play mobile games turns out to be the killer app for the iPhone 90 billion dollars in total revenue per year, which means almost 30 billion dollars for Apple and Google. That is nearly three X Nintendo's very impressive revenue from the switch this year. That is the pot of gold in gaming. Yes, totally true. I think one of the things that this episode has really crystallized for me though is that it's kind of wrong to think about gaming as one market because it's not. I think that's right, especially as we're entering the sort of era of people hanging out in video games. I mean, the meta versus here, it's just in people spending time in a digital environment that isn't necessarily VR is necessarily immersive. It's like, you know, hanging out on Discord while you're playing games together or whatever. To the extent that video games are where you hang out with your friends, that's like a super different use case than me playing Mario Kart to pass the time in my living room. It's also a super different use case than someone who wants to basically play a slot machine on their phone while they're on a flight. These are all such different human experiences and like jobs to be done that it is totally crazy to call them all gaming. And to your point, I bet if you talk to an Nintendo executive, you know, they look over at mobile and they're like, okay, sure, Apple is making 27 billion dollars a year Apple and Google on people playing what you're calling mobile games. But if I look at that, I think only two billion of those are games. And the rest of that is something that's not games. It's some kind of like statistical extraction of people's money through digital marketing. Yes. And I think the reality is even more fine-grained than that. For example, I love the new Halo Infinite. It's had a lot of problems as a live service, but it's finally getting ironed out. And having spent a large portion of my teenage years on Halo, I just love playing it. If you were an alien or let's say, if you were a 60 year old person, observing me playing Halo Infinite versus observing somebody else playing Fortnite on the surface, it looks pretty similar. You're in a live service environment with other people and you are shooting at them. But the job to be done of those two experiences is completely different. Yeah. And those are very different markets. Yeah. You said live service, which is another Nintendo bear case. Nintendo is not a good live services company. So even if you're writing off the whole mobile market, Fortnite on Xbox and Fortnite on PlayStation, people play those games as forever games because they're live services. You need to have fresh content to introduce. You need to be able to sort of have events. The way you monetize those games is with this live orientation, which Nintendo has none of in their DNA. So that's sort of like a second market that is not particularly addressable to Nintendo or at least they don't seem to want to address. Well, I think they're building into it. Mario Kart 8 Deluxe has certainly become that, especially with the new waves that they're building into, which is their version of seasons. Like a Mario Kart 8 wave is the same as a League of Legends season. Well, it's the same concept, whether Nintendo is as good at seasons as riot is, they're absolutely not. But they're building towards it clearly. As you sort of look around it, I'm not sure it's a bear case, but it is interesting to just note where everyone else has sort of ended up in this market where Microsoft is trying to do the Netflix of gaming. They're really pushing into this predictable revenue subscription. You pay us, we give you all you can eat, we don't even care if you play on Xboxes. We want this to be available anywhere and you should use our app that you pay a subscription forward to play games on all devices. That's a very different strategy than what Sony has done.
And at least for the last five years, they might be changing right now, but we're sort of in the middle of a potential pivot for them. They're basically playing the same old console game and they're playing it with the highest monetizing audience of people who want to pay a whole bunch of money for a game and get the unbelievable graphics experience out of it and play it on that device. It's interesting how all three of these companies, Nintendo, Sony, and Microsoft, after competing for a while, have now all chosen completely different lanes to occupy in terms of what they're marketing to consumers and what the business model around that is. And I think the big question for Nintendo is do they care about the strategic position and picking a lane and deciding to be Microsofty in this way with the subscription, or is it really just like, do they pay attention to their shareholders? I don't know. It is a legitimate question, we don't know. But thank God that someone is an Nintendo in the world and gets to innovate and drive things forward because everybody else is just kind of copying each other and figuring out is there a cash grab to be had or are we gonna miss out on some big thing? We need to hurry up and go chase it. Nintendo is really not doing that. - Yeah, I think that is what is clearly different about Nintendo now than the past 20 years, which is they're no longer stupid. (laughing) They may not be as commercial as shareholders would like them to be, but they're no longer stupid. And I think you probably gotta have some faith that they're gonna figure it out. On the other hand, relative to a Sony or a Microsoft, where you can be pretty sure that they're not gonna screw up the next generation, there is still that wild card risk with Nintendo. - Totally, which is the bear cases. Games are hit driven, consoles are even more hit driven, and they take six to eight years to recover from a mistake, and now they have all their eggs in one basket. Just to close out the bear case, even with the Switch's success, revenue still hasn't matched the 2008 peak. Sure, they're doing more with like this licensing, movie, theme parks, other mobile apps, but it's not clear how they will make a material amount of revenue from all of that relative to their core business. We've talked a lot about the bear case. The bull case, I mean, if they actually transitioned to this durable platform business, they have a billion plus dollar subscription business on their hands. They have a $3 billion digital high margin direct to consumer business on their hands. They also, on top of all of this, to your video games are the best business model of all time, they also have durable IP, perhaps the most valuable IP in all of video games, on top of the subscription business, creating the additional stickiness, and as we get into the Crossroads capital viewpoint here, there's a valuation bull case, because you have this company that if they're actually set up in this way, and they do actually execute the platform playbook, their price to sales is at a measly three and a half X, where they're trading right now. You compare that to Apple, that's half of Apple. If they're actually gonna go execute Apple strategy, and they actually have the ability to have the margin structure and the growth rate and the durability that Apple has with the iPhone business, with the app store on top of it, you can make a case that you should value those companies the same based on their multiple of revenue, but then let's get to profits. Their price to earning is only 13 X. For comparison, Frick and Sony is at 16 X, Apple's at 28 X, Disney's at 54 X earnings. So Nintendo's got a $3 billion digital business. If you value that comparable to other SaaS businesses, that's like a $21 billion business. You add in their cash. So that gets you to $34 billion. If you look at Nintendo's actual market cap where they're trading today, it's $47 billion. So that means the difference between those two is $13 billion. Would you value their entire hardware business, hardware switches, and hardware cartridges, games for the Switch, and all the future licensing revenue at just $13 billion, that's a freaking steal. That's like the whole AWS narrative around you by AWS and you get the retail business for free. If everything goes right, and if you believe the whole platform thesis, that's the valuation bull case that Crossroads is sort of astutely pointed out. What's really interesting is that Crossroads and others have been talking about this narrative for a long time. (laughing) At the same time, it's funny. A video game's executive told me last week, we've all thought Nintendo was gonna go out of business for the last 20 years. - Right, right, right, right. - I suspect there are a lot of people listening right now at the end of our two par call it seven eight hour series on Nintendo that have learned a lot and are surprised about a lot of things. However, I think people that actively follow the stock and either are long or short in it are not surprised. This is not new information per se. There's just so much uncertainty. And I do think we're in a very fun period here 'cause we will get to learn what their strategy is. I think in the next six months around the next generation console. - Yes, and that will be amazing. I guess though there is sort of a third option, which you never know with Nintendo, which is that we don't and they just do nothing. I don't think they will do this, but they could, right? - Is there a really compelling reason right now to release another hardware generation? Is the switch under attack from any angle? - Right, why release another? The switch OLED's a great device. - Right, it's awesome. I was playing it at your house, I'm tempted to buy one. The only reason I'm not is 'cause I think there might be a switch to coming soon. - And I'm actually not sure what the switch to would have. Maybe it would solve a developer problem where there are certain developers that are frustrated right now by the processor and there's a bunch of games that can't get created that consumers might want. - Certainly that is a big thing. The processor is woefully, woefully underpowered at this point. - But processes are so good in particularly in the gaming world that can a mobile processor from 2014 that Nvidia made run the latest games? Sure can. Will it run them with ray tracing? No, do most consumers care? No. - That's a good question. There's also some weird way left field thing that they can do is they could actually decide we want to be the next Disney and they could do theme parks in house and movies in house and merch in house and design all the toys themselves and sell them in stores that they own. - Which is what Marvel did. Marvel initially didn't make their own movies and then they kind of stair stepped into it and then when they started their own studio, that's when that really took off. - Right. The tea leaves are reading against it since they're constructing for whatever new theme parks in partnership with NBC Universal. So I imagine they've got a pretty long data license on that to break ground. - Yep. - Yeah, that's the bear in the bull. - All right listeners, now is a great time to talk about one of our favorite companies, Statsig. - Yes. There is a reason why the best product teams rely on Statsig whether they are iterating on their core product features or shipping AI-powered experiences at scale. - Yep. In the crazy speed of today's AI world, shipping fast is just table stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you shipped next. - This is where Statsig comes in. It brings experimentation, feature flags and product analytics into one unified system so teams can ship safely, test rigorously and directly link what they changed to how users actually behaved. - So if you want to make learning your competitive advantage whether you're building new AI experiences or just evolving your existing core product, go to Statsig.com/acquired to get started. - We're out of order here, but I would like to do power and playbook if you're game for-- - Oh, yeah, for sure. - All right, so what of the seven powers and for listeners who are new to acquired, go listen to our previous episode with Hamilton to learn what power is. Do you think that Nintendo has in the time period from 1992 today? - Well, let's start with what we talked about last episode and what we talked about with Hamilton and Chengy about this amazing magical, alchemical blend of scale economies, network economies and switching costs that the NES was in the 1990s. I think they basically do not have that anymore. That has disappeared in all the ups and downs over the last 20, 30 years. I think you could maybe argue that none of the console players have this anymore, at least not in the same way that the NES did. They do have these elements, but so do their competitors, so it's not differentiated anymore. Hmm, good point. So I think that's actually no longer the case for Nintendo. I think they absolutely have a cornered resource in their IP, for sure. That's the strongest one now. That may be the strongest one and potentially also process power. There's nobody else that can make Breath of the Wild. There are other studios that can make other amazing games, but the cordon Nintendo games, serving that mid-core audience, nobody does it better and I don't think anybody can really compete with them. I have a hard time with this. I'm sure there's any developers.
Eh, okay, fair enough, too much nostalgia, maybe. I mean, I haven't played Breath of the Wild yet. I don't know what I'm waiting for, but I don't know. I'm not sure that they uniquely can create that type of game if you were to pluck out all the IP. Yeah, that's fair. You're right. It's cornered resource. It's the IP. I do think there's a new one that they've introduced with Nintendo Switch Online, which is no pun intended switching costs. I bought my games from Nintendo, like I don't own them. It's a different version of switching costs. Totally. And interestingly, if I let my subscription lapse, if I don't pick it up again for six months, there's like a six month grace period, then I lose all my saved data. So if I'm someone who got super invested in all the progress I made in Breath of the Wild, I have to keep paying Nintendo, assuming that I bought the game digitally instead of as a little-- - As a cartridge. - Yeah. Which is weird that they offer both, by the way. It's a very contrive. It's very Nintendo. I think that is actually a console games industry problem as a whole not just Nintendo. Xbox and Sony have the same issue. You look at the PS5 and the Xbox series X through one line. You're like, "Why the hell do you have CD slots?" On the other hand, core gamers feel very strongly about this for the reason you said. They really want to own their games and make sure that nobody can ever take them away from them. - And resale. I can't ever sell. I just paid Nintendo $120 for two games in the last week. That's money I'm never getting back. - They still have a weaker version of that scale economy, network economy, switching cost thing. It's just not solely theirs. Like Microsoft and Xbox have their version of it too. - Right. If I'm an indie developer, the 120 million switches is a very attractive group to distribute it to. And so are the playstations and so are the Xboxes. - I think the switch in Nintendo is counter-positioned against the smartphone gaming market right now, in particular because of this quality concept. I can be very sure that when I buy a game for my switch, it's gonna be quality. - Right. And Apple to adopt that stance would have to forego revenue. So it is counter-positioning. - All right. Playbook. - Playbook. - There's a great line that Shigeru Miyamoto has, which is a delayed game is eventually good. A bad game is bad forever. - So good. - I think about this all the time. Ever since I first read the quote when we were first starting researching three months ago, it is something I think about a lot for acquired episodes. It's like, we loosely have a schedule. You know, we do six episodes every six months, but you and I just keep canceling stuff when we're like, eh, quality's low. And I'm not sure it's the best way to run a business, but it is the best way to create art. - Yes. - What is it to our discussion about what is it that the people who work at and run Nintendo think they're doing there? - Yes. - It's somewhere in between. - Right. They really do value the art. And I think that's pretty rare. When you look around it like Activision, EA, the people making the big decisions do not care about the art. They are running spreadsheet businesses. And Nintendo is not. But there's a bunch of stuff to read into in this quote, which is great. A delayed game is eventually good. A bad game is forever. Also nestled in that quote is that Nintendo doesn't improve upon their games after releasing them. - Right. - That's so the opposite of Epic Games. - Such a good point. And even my favorite example, Halo Infinite. Halo Infinite was a bad game when it launched. It still has a lot of room for an improvement, but it is so much better than when it launched. - Fortnite didn't have Battle Royale when it launched. - Right. - It's crazy. So that's another interesting one. Matthew Ball points out a third thing about this quote where he looks at the word is. - Now we're into Bill Clinton territory. Define is. - And Matthew's point is, well, a delayed game could be eventually good. But I think there's this sort of artist polishing thing, which is like, if I just take enough time and I make it the way that I want, it will eventually be good. - Yes. - I think Nintendo falls victim to this. We haven't really talked about the games themselves side of Nintendo, 'cause that's way beyond the scope of acquired as a podcast. I think there's a big element of this, though, within Nintendo. I think they think that every Zelda game is amazing, and it's not. - Yes. Yeah, you can kind of feel that. - All right, I'll jump in with a couple here. One that really popped up to me in this episode in part two is the jobs to be done framework. And we talk about this sometimes on acquired, not a lot, certainly not as much as we talk about seven powers and other ideas. But the handheld market in particular really highlights this for me, and how everybody in the industry like basically ignored it forever. And I don't know if Nintendo thought about this consciously, but the Game Boy and the DS were hyper-serving two jobs to be done. One was games for kids, and one was games for casual adult players. And neither of those audiences were being served well at all by all the innovation and investment going into all the other gaming platforms, and Nintendo just got it right. And so on the surface, you look at the Game Boy, and you're like, "What is this thing?" But then like it's actually serving these wildly diverse audiences in very good ways. - Yeah. - That's such a good point. - Two more that I wanna talk about. One, I don't really know what the takeaway is for this on me, but I've really stuck on this episode of like how stark the difference is for me on Switch games versus smartphone games. I know that smartphone games are a much bigger market and are likely to continue to be, but the actual experience of playing them is so bad. And many people argue with me on this. - That we're being reductionists on how bad mobile games are, and we're not talking about any of the good ones. - Totally. And back to what I was just saying on the jobs to be done framework. I think a lot of people that are playing those games that game is accomplishing a job to be done for them. Absolutely. But what this really makes me think and makes me a little bit sad for is how badly Apple failed the consumer in gaming on iOS. There is an alternative history where iOS and iPadOS is a Nintendo like gaming platform and like game design and the art of gaming is flourishing there. And then it would be so compelling as a consumer that like my phone that I have with me all the time also has these beautiful game experiences. And that is just so not the case. - The ethos of what these devices were supposed to be and Steve Jobs' Apple is very Nintendo like. And when you think about the App Store and App Store review and we don't need fart apps, when you have an enormous pile of money on the scale, it's pretty hard to let your values outweigh it. And I think that happened to Apple. I think they all sort of looked at it and I'm not saying Steve Jobs would've been any different. Steve probably would've let the same thing happen and the whole thing was set in motion while he was there. But I don't think anyone had any idea how much money well driven casino mechanic type games, loot box games, Candy Crush type games, how much money those could make. And if you sort of could go back opriori and say Apple, you can have a much more closed down App Store that looks a lot more like Nintendo Switch Online or you can have what it is today. I think they wish, maybe they wish they could've gone the Nintendo route. But being the most valuable company in the world and the most profitable company the world's ever seen is also pretty attractive. - I think they want to think that they would've gone the Nintendo route but they for sure wouldn't know. And it's funny, I was just thinking as you say that on the one hand nobody could've predicted and nobody did predict how big the mobile gaming market would become, but I'm thinking all the way back to bring it full circle to the origins of Nintendo. Of course you could've. It's called gambling, it's human nature. It's been there forever. The more things change, the more they stay the same. - But it's not just gambling. It's gambling combined with social status and sometimes it's not gambling, sometimes it's literally. - Dude, what do you think casinos are? - That's true. - Gambling combined with social status. - That's true. - It's just all digital now. - Yep. - You can't tell a, what is Nintendo? 135, 140 year old company story, without it fundamentally boiling down to being like, human nature is human nature. And the Nintendo story just illustrates so much for me that the seeds of success are sewn in a fall and the seeds of a fall are sewn in success. The Nintendo story with the ups and downs, the falls came from their successes and the successes came from their falls. - Right, yeah, their greatest strengths are their greatest weaknesses. - Yes. - All right, so my last one is kind of a what would have happened otherwise. And that question is, how is this company not owned by Disney? (laughing) You have to imagine Bob Eiger was on a plane in Japan at some point discussing this. it's unimaginable that he wasn't they bought Pixar they bought
Lucasfilm. They bought Marvel. And in 2012, the year that Lucasfilm was purchased, Nintendo was only worth $12 billion. Oh man. So assuming that that happened, how did that meeting play out? And I think nothing has ever come out about this, but either Disney would have had to decide we don't want to be that in the video games business. I mean, they bought Playdom and they do have games. I think they make billions of dollars from mobile games. But maybe they decided that IP is not the type of IP that we were buying. And we think that movie IP is more repurposable into our flywheel than games IP. I don't think that's the case. No, because it would be perfect. It'd be so perfect. Mario Zelda, the whole cast Donkey Kong is first class IP, along with those three franchises they bought and the Disney Princess series. Totally. I'm not the first person to say this, but like I suspect this new Mario movie is going to do really well. You know what's going to just freaking crush it. Absolutely. When there is a Zelda movie television series, whatever, people are going to go absolutely nuts. We talked about it in part one, but like more people like Mario than like Zelda, but people who like Zelda get freaking tattoos of like, like they name their daughter Zelda. It's going to be like Lord of the Ring style. Yeah. So one thesis I have is that Japan as a nation would never let Nintendo be sold to a foreign buyer. It's like the reverse of what almost happened with the Mariners. Yeah. I just have a hard time imagining the Japanese government allowing a deal to go through. And I have to imagine there's sort of some discussion with the state before you even try to propose it. I mean, it's a national treasure. The Olympics opened with nods to Mario. I think when a camera or what year it was, but the Japanese Prime Minister came out of a tube, like one of the Mario green supertoops. A warp tube? Yes. So I think no matter how bad this company does the state would nationalize it before it would ever get sold to a foreign buyer. Yeah. So man, I would kill though to hear the conversations between Bob Eiger and there's got to be audio tapes out there. I know. I know. Somebody recorded that meeting on their smart phone. All right. If anyone has that recording or any knowledge of any conversations, we promise we won't tell anyone acquired
[email protected]. Yeah. Join this lack. You can DM in this lack too. Yeah. Exactly. Oh, that's such a good point. Yeah. There's no way that that conversation didn't happen. Right. No way. No way. All right. Carvouts. So I have two Carvouts podcast and podcast related. One is really, really good vanity fair article with Kara Swisher that just came out. Friend of the show, former acquired guest Kara Swisher pioneer of our industry and our category. So good. When we had her on the show way back when we told the story of the recode acquisition and she's had like six more chapters in her career since then, which is just so I hope we have six more chapters in our career at that age. Yeah. Good for her. You know, she has two children that are about my daughter's age too. Amazing. Wow. I could not imagine being 20 years older and parenting young kids like I am now like her energy is just incredible while also doing all these things. So that's Carvout number one. Carvout number two is a long, long, long time coming. But I have finally listeners will be like finally, finally, really gotten into hardcore history. Nice. It's always been an inspiration for us in theory. And I've never just actually spent the time to dive into it and dance so good. Like he's the OG. Everything we do is trying to be a shadow of him. So so good. If you haven't listened to it, go check it out. Yep. All I do is research for acquired. So I'll come up with some other ones. But the Tetris movie is great. I think it's like totally worth your time. It's a fun watch. Let's see. I should come up with one. Oh, I did just listen to a great podcast episode this week. Invest like the best with Patrick O'Shaughnessy. Always a great show. I mean, truly like he's just one of the best interviewers alive and friend of the show. We've done a home and home with him and we need to do something again. He interviewed Darryl Mori, the GM of the Philadelphia 76ers. I think he's the GM, right? Oh, wow. I'm not up on my MBA. Yeah. So he left the rockets. He was considering leaving basketball. He thought he was out and he is now, oh, the president of basketball operations at the 76ers. Wow. I am so behind on my MBA drama. So he took Kinky's job. Wow. It is a fantastic interview. It is really fun. It actually dovetails off this episode. Well, they spend a lot of time on the topic. What makes a good game? And they're basically for all the video game nerds out there who love thinking about balance and things that are p or overpowered or nerfing versus buffing and sort of trying to make a game the most competitive. This episode spends a lot of time on that. And obviously Darryl has thought a lot about this problem. And how do you continue to tweak the rules of sports to make it a the most competitive like the best true game and the pure sense of the word, but also the most interesting to watch, which in some situations, mean you actually want to make it less skill driven. You want to make it more about luck because you want the any given Sunday effect. And so there's a lot of very interesting points that he makes. And as usual, Patrick does does a spectacular job with the interview. So highly recommend it. We'll link in the show notes. I haven't listened to that one yet. I need to go add it to my queue. It's awesome. Related to that. I'm cautiously interested skeptically interested to see how the pitch clock goes in baseball this season. Oh, yeah. Well, I'm literally going to the Mariner's game tonight. The former property of Nintendo of America. And I'll have to keep you posted. It'll be fun. Yeah, you'll have to report back. Well, with that, you should join the slack. It is a great way to discuss this episode share childhood stories of playing Nintendo here from people who are involved in the industry, who are always dropping great nuggets in after we record. So awesome place for post episode discussion that is acquired.fm/slackacq2. Let's turn it out bangers. So go subscribe. If you're not subscribed, you should because the next one seriously with the CEO of retool was like one of my favorite conversations we've ever had on the show. David is so great. We've also got some really great ACQ to episodes coming up too. So stay tuned there. We're taking the deuce to the next level. We are speaking of the next level. David, that is a fancy shirt that I see wearing. How can people get sweet merch like that? In the acquired merch store acquired.fm/store. All right, listeners, with that, we'll see you next time. We'll see you next time.
PodcastTranscript AI