Nintendo is planning to ship 2 million Switch by March 30, 2016. Here is a reporter from the Wall Street Journal.
His thinking isn’t out of the box. But you, good reader, do think outside the box. It’s why you are here.
First, the answer is obvious that Nintendo doesn’t take a huge risk by overproducing Nintendo Switch and no one buys them. This is a new brand for Nintendo, and it could be unsuccessful. We won’t know till its out. Nintendo isn’t going to make tens of millions of these thing only to have the system flops leaving too many systems in the pipeline. Obsolete inventory is one of the worst problems you can have as a business, which is why companies try to minimize it and lenders keep an eye on it. Sega had the same problem with the Dreamcast, so it’s not an outlandish proposition. Better safe than sorry.
Second, a shortage makes the system seem successful. Let’s say Nintendo shipped 5 million and only 4.8 million sold. That’s good, but there are systems left over. To the public, it will seem like it did OK. Now, let’s say there are only 2 million and ALL of them sell out with customers hungry to get their hands on it. Now the system seems like a huge success. See, people don’t read financial and sales reports. They only know if something is successful by whether it’s on the shelve or not. If Nintendo Switch is sitting on the shelve and collecting dust, it’s a flop. But if they fly off the shelves, it’s a success. They get to say to customers “We are so sorry. Please understand, we didn’t think this will be as big of a success. We’ll make more. We promise.” That’s much better than going to investors and saying “Please forgive us. We made too many Nintendo Switch and we can’t sell them.”
Nintendo may also be using this initial system to create the first generation consumers. They will be the more dedicated Nintendo fans who will buy into the system, love it, and create buzz about the system. Word of mouth is still the most powerful form of advertising. Nintendo may be using them and their enthusiasm to gauge future production.
In the video game industry, you have to think long term. Nintendo is not looking at this Q4 2016. They are looking at the 24 quarters thereafter. Their earnings will be based on the next 6 years. Nintendo’s bad earnings today are due to the mistakes made with the Wii U and the 3DS. If the Switch is successful, they will ride the success for another 5 to 6 years, and that’s what they want.
To illustrate this, here is Nintendo’s Net Income ratio (Operating ratio divided by Sales). Here is this Generation (you can find the data here)
Now here is the Wii Generation
See the difference. Note that the Great Recession happened in 2008. While the ratio declined, it was still far higher than anytime in the last 5 years. Nintendo knows that if this thing flops, they are stuck with poor earnings for another 5 years. This is what Nintendo is trying to avoid. This is why Nintendo isn’t aggressive with Nintendo Switch productions.
Nintendo isn’t going to flood the pipeline. They are being conservative, which is good. It’s how they’ve stayed in business for so long. Moreover, if the system creates a lot of buzz early on (through a shortage or the first generation buyers), then the system can improve demand and have a profitable next 5 or 6 years. Nintendo is finally getting out of the Generation 8 slump. Nintendo’s earnings today are a result of that. 2016 will have bad results, and there isn’t much the company can do about it. They are right to prepare for a great 2017 and make sure the next years are profitable.
This is why Nintendo is the business and the analyst are, well, the analyst.
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