Wade Armstrong: The Nintendo Wii: Funny Name, Good Market Segmentation

The Nintendo Wii: Funny Name, Good Market Segmentation

Posted Monday December 4, 2006 in Business

Three new game systems — Microsoft’s Xbox 360, Sony’s PlayStation 3, and Nintendo’s Wii — are on the market for this holiday season, but it seems like the Wii’s getting all the press. Article after article lauds Nintendo, which fell from first place in the console wars to third with the previous generation of systems, for its savvy in accepting third place while pushing for profits (Nintendo’s previous-generation GameCube finished third in shipments to the PlayStation 2 and the Xbox; Nintendo made more profit than either competitor). But It’s not true that Nintendo accepts finishing third in the race. Nintendo has found a separate market segment, one in which it plans to trounce all comers.

Third Place isn’t a Good Thing

James Surowecki’s New Yorker article, which seems to have set off the pro-Nintendo trend, talks about how third place in a market might be a good thing, and suggests that former GE CEO Jack Welch’s well-known rule of thumb — be first or second in a market, or get out — may be wrong. Third is no picnic, though, just ask RC Cola or computer-maker Gateway. Most of the companies that seem to be in third are actually in first or second, just in a different market segment:

Surowecki uses the example of Honda as a third-place manufacturer; Honda would say it’s the #1 seller of high-power, high-fuel efficiency cars.
Brewer Sam Adams isn’t third behind Coors and Anheuser-Busch; Sam Adams occupies a higher-end segment in which it is in first or second.
Apple isn’t third, behind HP and Dell; it, again, serves unique segments, including the graphic design segment, from which it can draw near-monopoly rents.
Enterprise Rent-a-Car isn’t in third place behind Hertz and Avis; with urban and suburban locations and its “we’ll pick you up” tagline, Enterprise has found a different segment with unique rental-car needs, in which Hertz and Avis don’t compete.
Nordstrom was, for a long time, thought of as third, behind Federated and May’s; in fact, Nordstrom occupied an upscale segment, and even second place wasn’t enough for May’s — Federated bought it.

Like these other successful companies, Nintendo is taking advantage of a difference in how it sees the market and how Microsoft and Sony see the market.

How Sony and Microsoft See the Market

Sony and Microsoft both want to “own the living room.” Nobody knows exactly what that means yet, but it seems to be some function of being a one-stop shop for all of the media that people consume at home. Both the Playstation 3 and the Xbox 360 have online stores through which the user can buy media, and the PS3 has a Blu-Ray drive for high definition movies (the 360 offers an optional HD-DVD drive).

Both systems offer high-definition video out, and can display high-quality graphics that look very realistic on today’s big flat-screens. The benefit for the serious gamer is substantial, with lifelike first-person shooters, sports games that look like TV broadcasts, and real-world scenery in role-playing games.

The Wii’s Segmentation

Nintendo’s Market Opening

But only 20% of American households currently have high-definition TVs, according to the Consumer Electronics Association, and Gartner predicts that only 64% will have HDTV by 2010. For the other 80% of the country — and still more than a third in four years — HD output is an expensive feature that delivers no benefit on conventional TVs.

Who has HDTV? Technophiles. Who demands HD output? Technophiles and the hardcore gamers who want the best visuals possible on their games, regardless of cost. Other users are currently delaying their HDTV adoption, likely because of cost, and will be happy to pair a lower-cost system with their current-generation TVs.

The same is true of in-home media. iTunes may dominate the world, but less than 20% of the market owns an iPod and even fewer have ever bought anything, video or audio, from iTunes. Again, who demands in-home media? Technophiles.

What Wii Offers

The Wii is a cheaper offering — $259 vs. $299 for the Xbox 360 and $499 for the PS3. The Wii doesn’t have the HD output that the other consoles feature, but it does have the revolutionary Wiimote, a motion-sensing remote that lets you play sports games and wield weapons in games by moving as you naturally would in those sports or with those weapons. Graphics are better than in the previous-generation consoles but not up to the PS3 or 360. The Wii also has instant-on, so you can start playing without waiting through a boot-up sequence.

These are all great features for the non-technophile, casual gamer market:

The lower cost appeals to people who already are price-constrained out of the HD market.
Instant-on makes it easy to casually play a game for just a few minutes.
The Wiimote emphasizes exciting and absorbing gameplay.
Lower graphics quality forces developers to focus on gameplay (and consumers who don’t have HD are less likely to be focused on high graphics quality).

Can the Wii Grow With Its Segment?

The Wii has good growth potential, too. Nintendo seems to be on a five-year product cycle; in five years HD will be mandatory, but then there will be a new Nintendo. In the meantime, Nintendo will have avoided:

Taking sides in the Blu-Ray vs. HD-DVD war, in which both sides fight over the standard for next-generation DVDs (if Blu-Ray loses, Sony could be saddled with dead, expensive technology on its PS3)
Building in an expensive Blu-Ray or HD-DVD player, before those players’ parts become cheap, commodity products.
Investing in movie and music download services before the market figures out what it wants in those.
Using expensive, non-commodity parts that enable HD output.

All of these products will be procurable at commodity prices in five years. In the meantime, Nintendo can:

Update with more powerful CPUs, if necessary.
Add on more controllers or external players via the USB 2.0 ports.
Even come out with Wii version 2 in two years, because it’s making a profit on every unit shipped and will have positive cash flow to finance a response to any unexpected market changes.

Best of all, with the unique Wiimote and instant-on functionality, as well as its lower price point, the Wii will be a great second game machine in many homes. As a complement to, rather than a substitute for, the Xbox 360 and Playstation 3, the Wii has access to a larger market than either of the other two systems.

Can Microsoft and Sony Enter the Wii’s Segment?

Principally because of price, not anytime soon. Microsoft and Sony take big losses — hundreds of dollars — on every console shipped, so they’ll be unable to make price cuts to enter lower-income markets anytime soon. Nintendo, which makes profit on the Wii at current prices, can always cut the price to hurt the competition, which will force its competitors to focus on the high end for the next year or two.

The Wiimote also offers some protection from competition. While other vendors could offer similar products for the 360 and PS3, neither system will have the library of games that take advantage of the innovative gameplay options such a remote offers. For people who really enjoy the Wiimote — and online reviews suggest that’s most everybody — the deep library of games using its features will offer Nintendo a one- to two-year lead on any competitor who really wants to compete directly on that kind of gameplay.

Why Not Third?

It looks like Nintendo can avoid being in third — they’ve found a unique segment and can continue to serve the needs of that segment better than can Microsoft or Sony. Staying out of third isn’t just for big companies like Nintendo; small companies can do it too. In fact, staying out of third — or out of the bottom of the market — is important for most start-ups, because our costs aren’t as low as the big guys, and our names aren’t as famous, and they can step on us as soon as they please.

The trick for the start-up is to move into the un- or under-served segment, just like Nintendo with its Wii. By finding that segment, and catering to its needs, you can grow without being badly threatened by big competitors who would, themselves, need to start afresh to succeed in your segment. So the answer isn’t not third because Jack Welch says not third — it’s not third because the job of an entrepreneur is to have the vision to see a place in which your company is not in third. And that’s a fun job.

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