Can Nintendo Reset for 2014

Nintendo's recent profit warning underscores the company's need to innovate its product line.

Jan 21, 2014 at 6:16PM

While Nintendo (NASDAQOTH:NTDOY) has been struggling for a while, the company's recent profit warning probably came as a surprise to even the most pessimistic of analysts. With the launch of new consoles by Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT), as well as dwindling demand for its hardware and software products, the lowered outlook does not bode well for the iconic Japanese videogame company. At this stage, it seems as if Nintendo will have to come up with something very good to survive.

Crushed expectations
Nintendo updated its guidance last week, and the outlook is grim. The company revised its April 2013 to March 2014 Wii U sales projection to 2.8 million units, from a previous estimate of 9 million, for a massive 69% drop. The forecasted drop in 3DS sales, while less dramatic, is still quite significant. Sales expectations of that device are being revised down from 18 million to 13.5 million units.

According to management, the lackluster demand for hardware led to lower-than-expected revenue from the company's higher-margin software titles. As a result, the company now expects an operating loss for the year ending March 2014, whereas it previously expected an operating profit. A recovery is clearly no longer expected for this year.

For some, the news isn't entirely unexpected, as Nintendo has been battling slowing sales for some time now. However, few could have predicted the severity of the downturn, an anticipated profit of around $530 million bending into a $240 million loss. Unsurprisingly, CEO Satoru Iwara has stated that the company is planning to implement some fairly large structural changes.

One way the company intends to turn things around is by shifting into mobile, a move which some say is long overdue. According to Nintendo's management, the move isn't as simple as it seems, but with the company now having recorded its third annual operating loss, analysts believe Nintendo's problem is structural. In Iwata's words: "we cannot continue a business without winning. We must take a skeptical approach..." In essence, Nintendo may have to diverge from its traditional model of sticking to its own hardware platforms in order to sustain software sales.

Outgunned by Sony and Microsoft
For a while now, Nintendo has seemed unable to keep up with the new kings of console gaming, Sony and Microsoft. Presumably, the release of the PS4 and Xbox One have done little to increase the Wii U's popularity. Initial sales figures for the new devices have been solid, Microsoft selling around 3 million units and Sony selling some 4.2 million consoles. Curiously enough though, the Nintendo 3DS seems to have been the best-selling device of 2013 as well as the last month of the year, according to an NPD report.

By now, the high-profile rivalry between the new offerings from Microsoft and Sony is in full swing. However, it is too early to call a winner. Breaking down the numbers, a Gamespot report argues that Microsoft may have made more money off its new console so far, as the company makes around $28 for each Xbox sold versus $18 earned by Sony for each Playstation. In any case, going into 2014, it seems unlikely that the Wii U will be able to give either of these new consoles any meaningful competition.

The bottom line
Nintendo's profit warning underscores the company's problems with the Wii U, with sales projections coming in way below what was expected.  As such, the company may now be forced to open up new avenues for growth, as its traditional products continue to lose ground. Management is considering a move into mobile gaming, which may help. In any case, Nintendo has plenty of work to do.

Nintendo isn't the only company that needs to innovate to survive
There's a fierce battle raging now for your living room entertainment dollars. in fact some of the companies mentioned above find themselves partly in the crosshairs of those shifting the industry. There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.

Daniel James has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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