video games

The Nintendo Method: Nintendo’s unparalleled profitability

January 2007

“Innovative but highly risky” or perhaps “doomed to third place” – these seem to reflect the consensus amongst observers of Nintendo’s strategy in recent years and months. You might be surprised to find out that Nintendo is in fact one of the most uniquely stable and profitable performers in the industry. It is this aspect of Nintendo that I want to examine in this month’s column.

In October, Nintendo revealed a blistering set of results for the first half of its 2007 financial year). This exceptional performance was driven by better-than-expected sales of its DS handheld compared to its sales in the first half of its 2005 financial year.  Nintendo is subsequently on course to meet full-year revenue forecasts of 740 billion Yen (£3.3 billion) and profits 100 billion Yen (£446 million). Should these targets be reached (which, given that Nintendo’s share price is currently near its 6-year high and not too far from its all-time high, shareholders appear confident about), Nintendo will have recorded its best ever year. This is quite an achievement given that today’s market environment is arguably the most competitive in which the company has operated in its 30-year video games history.

However, what’s most remarkable about Nintendo is not its current performance but the consistency of its financial performance over the last decade or so, a period in which its consoles, from generation to generation, have sold in decreasing volumes and it has lost considerable market share to new market entrants. Despite this, Nintendo’s financial results have been surprisingly uniform with revenues around the 500 billion Yen mark (£2.2 billion) and operating profits (total profits before taxes and exceptional costs such as losses derived from adverse exchange rate movements) of around 100 billion Yen (£446 million). Net profits have varied a little more widely, largely because of Yen/US Dollar exchange rate movements, but for the most part have remained around the 90 billion Yen mark (£400 million).

Critics would point out, with some validity, that Nintendo has, until this year, shown little evidence of consistent growth over the last decade but I would wager that every games business would swap their profit history for that of Nintendo. Even EA, during its best-ever year (2004) “only” managed net profits of US$577 million (£305 million). A better comparison is with fellow console manufacturers Sony and Microsoft but here the contrast could not be starker. Whilst Microsoft is well known for having yet to record a full-year profit from its games division, Sony’s games division has been highly inconsistent since its inception, switching, in the space of just a couple of years, between driving the whole of Sony’s profitability to dragging it deep into loss.

Nintendo’s secret is pretty simple really: it makes a profit on everything it produces. Unlike its console manufacturer competitors Nintendo aims to produce its hardware using as much currently available technology as possible. This reduces both its R&D costs (which are up to a tenth of the amount spent by Sony and Microsoft for each new console) as well as its manufacturing costs. This allows the hardware to be sold at a competitive retail price as well as at a profit. Underpinning its hardware sales is a software development and publishing business that also compares favourably with most other publishers, not only making a full margin on its own substantial software sales but also making up to around USD$10 on every game manufactured for third party publishers. Nintendo is, in short, a money-making machine and its strategy does not look like changing any time soon (Nintendo recently claimed that their Wii console will be profitable for Day 1).

The uniformity and extent of Nintendo’s profits has led to it becoming the first major listed games company to pay a dividend (cash paid to shareholders in proportion to the number of shares they hold). It has also given it financial reserves that dwarf every other dedicated games company. In June 2006, Nintendo had 748 billion Yen (£3.3 billion) in cash reserves and short-term investments; the next largest, EA, had £1.3 billion.

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