Can Nintendo Keep Winning?

November 5, 1990, 3:00 PM UTC
Courtesy of Nintendo

Nintendo is the shogun of the home videogame, a phenomenon that has captivated millions of children and adults in America and Japan. The Kyoto company’s sales have multiplied nearly tenfold in as many years, to some $2.5 billion in the year that ended in March. Estimated profits: an electric $350 million.

Toy industry analysts are saying that this Christmas could be Nintendo’s biggest ever in the U.S., which accounts for two-thirds of videogame demand. Even in the face of a slowing economy, U.S. sales are expected to exceed last year’s by 30% or more.

Small wonder that Nintendo shares have been as hot on the Tokyo stock exchange as its games in toy stores. While the market has plunged 40% so far this year, Nintendo is up 63%. Helped by the dollar’s fall, the company’s ADRs, which trade over the counter in the U.S., have risen 80%. To judge by its recent market capitalization of $19 billion, investors figure the company is worth more than Sony (SNE) or Nissan Motor. (Fortune has used estimates for annual sales and profits because Nintendo recently changed its fiscal year from August to March without restating historical results. For the seven-month period ended in March, it reported $208 million of profit on $1.5 billion in sales.) Nintendo owes its success to its powerful products and its viselike grip on the market. The company, which supplies all the hardware and software necessary to transform the family TV into an interactive electronic playground, accounts for more than 80% of worldwide sales of videogames. As one out of every four families in the U.S. knows, it’s easy to get hooked. You connect the Nintendo Entertainment System, a phone-book-size gray plastic console that retails for $99, by a wire to the back of the TV. (If you can’t master this detail, your child surely can.) Next, snap in a game program, which takes the form of a reusable plastic cartridge stuffed with chips. Finally, switch on your TV, take up one of the system’s push-button controllers, and play.

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Nintendo offers more than 200 titles, on themes ranging from baseball to medieval warfare. The games, which retail for $50 and up, are more whimsical than the early shoot-’em-up offerings of video arcades. Super Mario Brothers, the all-time best-selling series of games (39 million copies), involves quests through fantasy realms by an Italian plumber who can transform himself into a raccoon. So powerful is Mario’s charm that he has become an international cultural icon. In a recent poll of U.S. schoolchildren, he proved more popular than Mickey Mouse. Game industry experts—some of them Nintendo addicts—believe the company could be the next Disney (DIS).

Just as Mickey Mouse helped pioneer the animated picture in the 1930s, so might Mario help establish a new medium called interactive entertainment. Says Jim Willcox, a columnist for Toy and Hobby World magazine: “We are seeing the rapid evolution of play, from board games to videogames to electronic games in polygraphic forms.” Already Nintendo’s competitors are experimenting with powerful combinations of computers, laser disks, and high-definition TV screens, as well as games that use human actors rather than cartoon characters. Possible in this decade: videogames in which the viewer manipulates his own image, in effect becoming simultaneously director and star.

To reach that bright future, however, Nintendo must face a business challenge that would daunt even Mario. Its games are in so many homes that demand is nearly saturated; now the company must unlock new markets in order to thrive. Tokyo security analysts are bullish about its prospects—for example Mark Yim, a Japan-based analyst for Baring Securities, projects 28% annual growth for the next four years. But in the U.S., Nintendo is haunted by the ghost of Atari Inc. That pioneer of videogame hardware and software (remember Pong?) ballooned into a $2-billion-a-year giant, then collapsed when children became bored with its wares. Cautions toy industry analyst Sean McGowan: “We don’t know yet what’s different between Nintendo and Atari.”

Few analysts predict that Nintendo will crash, but several think that this could be its last year of big growth. For example, Thomas Kully of the Chicago brokerage William Blair projects that Nintendo’s U.S. sales will go into recession, drooping 10% in 1991 and 7% in 1992. Among the doomsayers is James Chanos, a New York money manager who has sold the stock short and stands to gain if it goes down. He calls Nintendo a fad that has run its course.

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You’d never suspect the tumult of the American market from the austere calm of the company’s Kyoto headquarters. The interiors are stark white, the floors bare tile, and in the spartan lobby the sole decoration is a pale three-million-year-old fossilized shell. President Hiroshi Yamauchi, 62, seems conservative, frugal, and reserved. Nintendo is his ancestral business; founded in 1889, it manufactured traditional hanafuda playing cards until he took it into the high-tech age. With 11.4% of the stock, worth $2.3 billion, he is one of Japan’s richest men, yet he owns neither car nor house. “I don’t really like videogames,” he says in a Kyoto drawl; he prefers the ancient chesslike game Go. Even the name Nintendo, which means “leave it to heaven,” speaks of a company that views business from a lofty remove.

Don’t be fooled. Nintendo is working every angle to stay on top, muscling suppliers, unleashing powerful new products, and expanding methodically into other parts of the world. The Japan Economic Journal, the country’s leading economic daily, lists Nintendo as one of Japan’s best businesses, in a class with such heavyweights as Toyota Motor (TM) and robot maker Fanuc.

Behind those bare walls, Yamauchi has fostered a management style that is a remarkable marriage of wacky originality and rigid discipline. In the R&D center, for example, scruffy young designers hunch in front of video screens amid mounds of stuffed animals, toy trucks, and teetering stacks of comic books. “There’s a lot of overtime,” says creative director Shigeru Miyamoto, Mario’s inventor, who is 38 but looks 24. He wears a button-down shirt and subdued tan and maroon tie in a pattern consisting of scores of tiny Mickey Mouse images. To spur creativity, he often organizes his 200 designers into rival teams.

[fortune-pullquote]Papert of MIT wants to create educational tools that “look more like Nintendo than like books.”[/fortune-pullquote]

The group turns out only about 10% of Nintendo’s games; the rest come from contractors, on whom Yamauchi spins off the risk of developing and marketing new titles. Nintendo’s success has spawned a brat pack of self-made millionaires like Koichi Nakamura, 26. Four years ago he hit it big with Dragonquest, which has sold more than ten million copies. (When a new version appeared in 1988, Japanese police asked stores to release it on a Sunday to reduce school absenteeism.) Nakamura runs his Tokyo design company with the flamboyance of a Silicon Valley entrepreneur. Recently, feeling flush, he treated his 20-person staff to a surfing vacation in Hawaii.

There is nothing liberal, however, in the terms Nintendo sets for such contractors. To earn a license, a software supplier must develop a game on spec, win Nintendo’s approval, pay Nintendo to manufacture the cartridges, bear the cost of marketing and advertising—and agree not to supply the game for other makes of machine.

Yamauchi claims such rules protect the consumer from a confusing flood of boring software, which he thinks led to Atari’s downfall. Retailers like Michael Goldstein, vice chairman of Toys “R” Us, agree. Says Goldstein: “When videogames were hot ten years ago, the quality was not there. That’s not true this time around.” But some U.S. game producers charge that Yamauchi is a monopolist.

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Because of its licensing rules, Nintendo found itself embroiled last year in the politics of U.S.-Japan trade. A congressional subcommittee on antitrust held hearings on Nintendo’s practices and wrote a letter of complaint to the Department of Justice on December 7, Pearl Harbor Day. The department passed the matter to the Federal Trade Commission; an investigation is under way. Meanwhile the company faces two private antitrust suits, including one by the largest U.S. developer of Nintendo software, Atari Games. (A remnant of the original Atari, Atari Games belongs to Time Warner, which also owns the publisher of Fortune.) The suits, which Nintendo contends have no merit, could eventually force it to ease its rules and loosen its grip on the U.S. market.

Long before Nintendo has to make such concessions, if Yamauchi has his way, the company will have established an entertainment franchise far broader and more powerful than it has today. Among the moves he is making to boost the voltage of the business:

• Games For Grownups

An astonishing 34% of Nintendo users are adults. Yamauchi wants to expand that market with Game Boy, an $89.95 hand-held machine that incorporates its own liquid crystal screen and uses $20 game cartridges. By Christmas, Nintendo aims to sell at least four million Game Boys in the U.S. with the help of TV ads. The company is also courting grownups with software offerings such as Jeopardy and Tetris, a highly addictive puzzlelike game that is the first international software hit written by a Soviet. The object is to prevent falling shapes from filling the screen in a disorderly pile; to score points the player must maneuver them into neat rows that vanish once complete. A category Nintendo plans to avoid: pornographic games, like strip-mahjongg, that are available on the Japanese black market.

• Super Nintendo

This month in Japan Nintendo will introduce its next-generation game console. The new unit, which will retail for about $190, incorporates a 16-bit graphics chip that produces much more lavish video images than the eight-bit chip in Nintendo’s current machines. NEC, the $25-billion-a-year electronics giant, tried to leapfrog Nintendo by launching a similar unit two years ago (see photo). It barely managed to dent Nintendo’s market share. The first game Nintendo will offer is Super Mario World. It makes full use of the souped-up chip, sending Mario bopping and beeping in a video world that has been totally transformed. In place of the schematic scenery of earlier games are brilliantly colored Dr. Seussish landscapes in which objects look solid, many kinds of motion occur at once, and actions are accompanied by stereo sound. Nintendo says a U.S. version may go on sale next year; it is hoping that the improvement is great enough to get millions of users to trade up. A possible turn-off: Games from the original Nintendo don’t work on the new machine.

• Branching into Europe

For videogames, the Old World is the next frontier: Few European households have them. To remedy that, Nintendo established a subsidiary in Frankfurt this year. It plans to wean European consumers on the same eight-bit systems that are now becoming obsolete in Japan and the U.S. Eventually, as Europeans graduate to more advanced games, Nintendo may market the older designs to Eastern European and Soviet kids.

• Nintendo Network

The company envisions nationwide tournaments in which customers compete from their living rooms using Nintendos and TVs hooked to telephone lines. (To connect, customers will need a $100 package that includes a communications cartridge and a junction box that fits underneath the Nintendo console.) Scheduled to start next year, the network at first will be just for games, but later Nintendo may use it to convince consumers that its products are more than mere toys. The company already operates a banking and investment network in Japan, where 100,000 users can play the stock market from their machines, and has allied itself with Fidelity Investment Services, the giant mutual fund house, to let U.S. consumers do the same.

• Education

To wangle its way into academia, last May Nintendo gave $3 million to MIT for studies on how children learn. Seymour Papert, director of learning research at the university’s media lab, says he wants to create educational tools that “look more like Nintendo than like books.” Among the effects he would like to harness: “flow,” the rapt state a child enters when playing an exciting game.

If such gambits work, Nintendo could grow mightily throughout the decade. But if demand wanes and Nintendo must shrink, it could do so more gracefully than most businesses. It has zero long-term debt, fixed costs are low, and it can easily cut back on suppliers. The company has built its success on Yamauchi’s tough practices, but ingrained in its culture is the recognition that market forces are ultimately beyond anyone’s control. As Nintendo ends its 11th year of surging growth, that awareness could be its greatest strength.

Reporter Associate: Jessica Skelly von Brachel

A version of this article appears in the November 5, 1990 issue of Fortune.

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