Question: Analyze and record problems and their Core elements from the case below.

Market Dynamics

Competitive Trends in the Early 2000s

By the early part of the 2000s, video games were firmly entrenched in youth culture. A report published by the Pew Internet and American Life Project noted that in 2002, 60% of U.S. residents aged six and older played video games and more than 221 million games were sold.28 Clearly, games were a big business. Nintendo had fared well, outliving all of its early console competitors (Segas last console was the Dreamcast, released in 199929). But, Sony and Microsoft, two relative newcomers, threatened Nintendos future in console gaming.

By this time, Sony dominated with its PlayStation 2 (which could play DVDs as well as game titles). Launched in 2000, it was designed to be backwards-compatible with all games from the original PlayStation console. This meant it launched with a massive base of players, which expanded to 24 million within three years as new titles were built for the PlayStation 2s superior graphics. Sony was also battling Nintendo in mobile gaming. In 2004 the two companies released new handheld gaming systems. The Sony PSP was a portable device that had the most advanced graphics available for a portable gaming device. However, the Nintendo DS took a different approach to gaming, featuring two screens with more cartoon-like effects and simple game scenarios. While the PSP attracted attention from hardcore gamers, the DS was a hit with children, thanks to its easy-to-learn game-play and popular titles such as New Super Mario Bros.

Meanwhile, Microsoft was attempting its own aggressive push into gaming. In the 1980s and 1990s, Microsofts gaming efforts centered on support for PC game publishers and its own Flight Simulator franchise. That changed with the launch of the original Xbox in 2001. The Xbox went head-to-head with Sonys PlayStation 2. Both consoles competed for hard-core gamers on hardware performance and graphics popular titles like Madden and Half-Life 2 tried to immerse players in realistic 3D environments, and depended on heavy-duty processing power and a constant stream of new titles to keep players hooked. In-game scenarios were getting longer and more sophisticated and, like their PC counterparts, they let players perform a wide range of functions using various combinations of input buttons on the controller. The games were clearly aimed at a hard-core audience of regular players.

Although Microsoft had never disclosed how much it spent developing the Xbox, analysts estimated it lost $2 billion to establish the console in the market.32 In terms of the two consoles installed bases, Sony had a market share of 66% while Microsoft had just 22%.33 Squeezed in-between these two aggressive competitors, Nintendo had to think through how to fight back.

In 2001, Nintendo released the GameCube console (Exhibit 4). It was housed in a plastic cube about the size of a lunchbox. Inside, it featured an IBM-designed Gekko processor and ATI Flipper GPU, and had an optical disc drive.34 While adequate for basic 3D games and Mario Bros., the hardware failed to measure up to the PlayStation 2 or the Xbox. Nintendo dismissed the criticism, saying that the simple design and emphasis on fun-to-play software like Metroid Prime and Legend of Zelda was an asset, and would help attract new gamers who were turned off by long, complex console games. Indeed, the GameCubes software, toy-like feel, low-powered hardware, and cheap price ($200 at launch) appealed to families with younger children. However, many serious gamers derided it for its poor hardware specs and lack of compelling software. It sold nearly 22 million units worldwide before being discontinued. By comparison, the PlayStation 2 sold an estimated 130 million units.

Two-Sided Networks

The video game industry was a classic example of a business based on network externalities. The more consoles that were sold, the more independent gaming studios were incented to develop new titles. This in turn increased console sales. Console makers could also sell their own titles, a tactic that had worked very well for Nintendo and its Mario Bros. and Pokmon franchises.

As the video game market was growing, hardware was typically sold at a loss right after launch in order to build a customer base. Once the customer base was established, software could be sold at a higher price and/or volume to make a profit. Average console costs dropped over time, as manufacturing scaled up, component costs declined, and the learning curve kicked in. Sony lost an estimated $100-$160 per PlayStation 2 when it was first launched, but reportedly made up for the loss with profits generated by selling game titles and accessories. Microsoft also sold consoles at a loss, in order to establish a presence in the new industry.

But the positive feedback loops required to make a successful console were hard to maintain.40 First, a constant stream of new game titles was required to preserve the value of the console hardware, and convince gamers not to switch. If a platform failed to preserve a steady stream of new titles, negative feedback loops would kick in as gamers and developers abandoned the platform. Second, game development had become far more complicated in terms of game-play scenarios and technology requirements. In 1996, a typical PlayStation game cost $1 million to develop and sold for $49. By 2003, PlayStation 2 and Xbox games still cost $49, but development costs had risen to between $5 million and $7 million per game. The high costs meant console companies, major game publishers and independent studios had to rely on a high degree of collaboration. These requirements dissuaded smaller studios from producing lots of titles, which created an additional drag on the network externalities that powered successful platforms. Third, independent game studios did not want the console market dominated by only Sony and Microsoft, as it reduced their bargaining power in profitsharing negotiations. This dynamic was actually a boon to Nintendo many third-party publishers wanted to help Nintendo with its next console effort, which served as an additional positive network effect for Nintendo.

Periodic Market Cycle

The video game industry had a five-year hardware cycle. Once a new game console was released, new game titles would be launched on their own cycles over the five-year period. Many were one-off titles that were nominally successful or, in some cases, lost money. Others were popular and generated sequels every two or three years. Some, such as popular sports titles, had new releases or expansion packs every year.

Since there were a limited number of developers or game publishers, early mover advantage existed for console manufacturers. And once software developers devoted resources to building game titles for one hardware platform, it was difficult for them to switch to another platform owing to different staffing or technical requirements. Furthermore, once gamers invested in one console, they were less likely to switch consoles owing to the additional cost. These factors made it difficult for new hardware manufacturers to enter the market.

By the end of 2004, the competition was starting to approach the end of their respective five-year cycles. Sony and Microsoft would be launching replacements for the PlayStation 2 and Xbox in time for the 2005 holiday shopping season.42 Following this same five-year hardware cycle, Nintendo would have a new console hitting the market in 2006.

A History of Nintendo Management

The Playing Card Era

Nintendo was established in 1889 by Fusajiro Yamauchi to produce handmade playing cards decorated with drawings of flowers, famous people, and other objects (Exhibit 5). The name of the company, when rendered in the Chinese script used in Japan, meant luck-heaven-hall. The company began selling Hanafuda cards in two shops, one located in Osaka and the other in Kyoto, where Nintendo company headquarters are still located. The cards were a success, and the company rapidly expanded. It was run by Yamauchis extended family for more than 100 years.

At first, the company concentrated on the card business. But in 1959, with a young CEO named Hiroshi Yamauchi at the helm, Nintendo cut a licensing deal with Disney to have Disney characters printed on Nintendos playing cards, thus giving them a brand new look. In 1963, Yamauchi shortened the Nintendo Playing Card Companys name to Nintendo Company Limited, signaling that the company would not limit itself to playing cards, and that it would soon enter other business domains. And so it did.

Surviving as a Toy Company

In the early 1970s, Nintendo ventured into other businesses, including food and toys. One unexpected success in the late 1970s was Nintendos Ultra Hand, an extendable robotic arm designed by Gunpei Yokoi, an assembly line maintenance engineer working at Nintendo. Yamauchi saw that Yokoi had great ideas and engineering talent, and transferred him to product development where he came up with innovative products like a baseball throwing machine and a puzzle game. Eventually, Yokoi oversaw Nintendos early video game efforts, including the arcade version of Donkey Kong and the Game Boy.

Nintendo Management Under Hiroshi Yamauchi

Nintendos modern organizational structure was strongly influenced by the management style of the former president and CEO, Hiroshi Yamauchi, who led the company from 1950 to 2002. He was a member of the founding family.46

A charismatic leader with a strong vision of what the company could become, Yamauchi drove other family members from Nintendos board soon after he became president and CEO. Nintendo was originally a family-owned and -managed company but Yamauchi thought it was necessary to change its culture.

Yamauchi was a hands-on leader, apt to make quick decisions according to his vision for the company. He was always thinking of ways in which the company could please its customers, and welcomed the introduction of new ideas, experimentation, novel processes and products including food, toys, and, eventually, video games. This attitude extended to other companies in the Nintendo ecosystem, as one engineer later described: Nintendo is always trying to do something new and different. This message has been spread not only within Nintendo, but to other companies as well. As a result, our development partners have naturally tended to present us with new technologies and ideas.

Yamauchi established a flat organizational structure at Nintendo. He wanted employees to focus on customer value, and he believed an organization free from bureaucratic rigidity was best suited to providing it. Decisions were to be made quickly. Notably, Nintendo under Yamauchi promoted a risktaking culture, which was unusual for a large Japanese company. Therefore, when Iwata became president of Nintendo in 2002, the company was prepared to compete in a fast-moving, uncertain, and competitive environment.