How the Wii is creaming the competition

Business 2.0 Magazine tells the inside story of how Nintendo outfoxed Sony and Microsoft and got itself back in the game.

By John Gaudiosi, Business 2.0 Magazine

(Business 2.0 Magazine) -- A year ago it looked like game over for Nintendo's storied console business. The Kyoto-based gamemaker--whose Nintendo Entertainment System ushered in the modern age of videogames--was bleeding market share to newer, more powerful systems from Sony and Microsoft.

Even as the videogame business grew into a $30 billion global industry, Nintendo saw its U.S. hardware sales shrink to almost half of what they had been nearly 20 years earlier.

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The Wii is reversing 20 years of declining Nintendo console sales.
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The DS broadened Nintendo's market. The Wii goes even further; grade-schoolers and grandmas are getting into the swing.
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CNN's Nicole Lapin talks with Scott Steinberg of Embassy Multimedia about the latest in gaming systems.
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Today, as anybody within shouting distance of a teenager knows, Nintendo is the comeback kid of the gaming world. Instead of joining Sony (Charts) and Microsoft (Charts, Fortune 500) in the arms race to pack their consoles with ever-higher-performance graphics chips (to better attract sophisticated gamers), Nintendo built the Wii--a cuddly, low-priced, motion-controlled machine that broke the market wide open by appealing to everyone from grade-schoolers to grandmas.

Unorthodox? Maybe. Effective? You bet.

The Wii is a pop culture smash of such dimensions that Nintendo still can't make consoles fast enough. Even so, it's outselling Sony's PlayStation 3 and Microsoft's Xbox 360--at least since January. (The Xbox had blowout pre-Christmas sales.) And while its competitors lose money on every console they build, expecting to make it back selling high-margin games, the Wii was designed to sell for a profit from the get-go.

Nintendo's turnaround began five years ago, when the company's top strategists, including CEO Satoru Iwata and legendary game designer Shigeru Miyamoto, zeroed in on two troubling trends: As young consumers started careers and families, they gradually cut back on game time. And as consoles became more powerful, making games for them got more expensive.

Studios thus became more conservative, putting out more editions of Madden NFL and fewer new, inventive games that might actually grow the market.

Iwata and Miyamoto eventually concluded that to gain ground, Nintendo would have to do something about the game controllers, whose basic design had hardly changed since the first NES paddles. Changing how the controllers interacted with the consoles would mean changing how engineers designed a system's electronics and casing and eventually the games themselves.

The first product to test the new strategy was not the Wii but the DS handheld game system, released in 2004. To appeal to a broader audience, Nintendo abandoned the kid-friendly Game Boy name it had given its other popular handhelds, while building in Wi-Fi networking, voice recognition, and two screens (See correction below).

The idea was not to load the DS with technology but to help draw in new gamers by offering options other than the old button-based controls. Some DS games would work through the tap of a pen and simple voice commands.

The $150 gadget got off to a tepid start. Until gamers tried it, they tended to be wary. "People thought it was weird," says Perrin Kaplan, vice president for marketing at Nintendo of America. "It took about two years for people to warm up to it."

But warm up they did, largely thanks to Miyamoto. The creator of Nintendo's blockbuster franchises--Donkey Kong, Super Mario Bros., Legend of Zelda-- offered up Nintendogs, a Tamagotchi-like simulation in which players use every feature of the DS to nurture virtual puppies. The game struck a chord with female gamers in particular, says John Taylor, an analyst at Arcadia Research.

During the first holiday season after Nintendogs hit the market, Nintendo sold 5.6 million DS units--a standout performance that was nearly twice its total for the rest of the year.

Soon after Nintendogs, the company released Brain Age, a game designed for more mature players in which they solve a series of puzzles by filling in answers or speaking phrases aloud. "That further bolstered the market by attracting older boomers and even senior citizens," Taylor says. The DS surge encouraged Nintendo executives, who saw their strategy to grow the market taking shape.

They wouldn't have to wait long to put it to a bigger test. Work had already begun on the console, code-named Revolution, that would become the Wii.

Nintendo's top strategists knew early on that they wanted to build a machine with a wireless, motion-sensitive controller. But equally important was the chip that would be the brains of the Wii console itself. The more powerful processors that Sony and Microsoft were using would make the screen action look better but would also guzzle more electricity.

What if Nintendo used a cheaper, lower-power chip instead? After all, the DS, with its efficient mobile processor, had already proven that you could create new gaming experiences without the fastest chips. A low-power chip also meant that the machine could be left on overnight to download new content.

It was settled: The design team made the risky decision to build the Wii around a chip similar to the one that powered the GameCube, an earlier Nintendo entry that posted disappointing sales. If the Wii succeeded, it wouldn't be on the strength of breathtaking graphics.

Next, engineers settled on a new approach for the Wii's looks. Just as the DS shunned the Game Boy name to appeal to a broader audience, the Wii would adopt a sleek white exterior instead of the toylike loud colors used on the GameCube. Even CEO Iwata got involved in the design process; at one point he handed engineers a stack of DVD jewel cases and told them the console should not be much bigger.

Why so small? To work with the motion-sensitive wireless controller Nintendo planned, Iwata reasoned, the console would have to sit directly beside the TV. Make it any larger and customers would hesitate to leave it there.

While the console team worked on the shell, Miyamoto and another team perfected the controller. He was determined that its design be as simple as possible--he insisted on several revisions that enlarged the "A" button to make its importance obvious.

When design work was done, players could arc the Wii remote to throw a football in Madden NFL 07, tilt it to steer off-road vehicles in Excite Truck, and swing it to play sports like Wii tennis and baseball. Market tests suggested that the product was everything its designers hoped: engaging enough that nongamers might give it a go, and simple enough that newbies could quickly get up to speed.

Finally it came time for Nintendo to market the Wii to the world. In addition to its standard TV campaigns targeting schoolkids, the company pumped 70 percent of its U.S. TV budget into programs aimed at 25-to 49-year-olds, says George Harrison, senior vice president for marketing at Nintendo of America.

He even put Wii ads into gray-haired publications like AARP and Reader's Digest. For Nintendo's core users, he took a novel, Web-based approach: "To reach the under-25 audience," he says, "we pushed our message through online and social-networking channels" including MySpace.

But Nintendo's most effective marketing trick was to give away its killer app, Wii Sports, with every $250 console. It was a calculated attempt to speed up the process that brought success to the DS. And because Nintendo makes about $50 in profit on every Wii sold, it can afford to give away a game.

To be sure, not everything has gone according to plan. Although Nintendo shipped more than 3 million Wiis in 2006, supply-and-demand problems have plagued the machine since its launch. Demand continues to outpace supply and may continue to do so until summer.

It's a problem many businesses wouldn't mind having, but it means that Nintendo might be leaving money on the table--something no company can afford to do for long, not even the newly revived Nintendo.

John Gaudiosi is a freelance journalist in Raleigh, N.C.

Correction: An earlier version of this story incorrectly stated that the DS handheld game system has two touchscreens.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.