Kudos to Microsoft (MSFT 0.04%) and Sony (SONY -0.52%) for their success on the video-gaming front. Their respective Xbox and PlayStation franchises repeatably raised the bar for what game consoles are capable of doing.

From a purely business perspective, though, both technology giants may want to take a lesson from the much smaller gaming brand name Nintendo (NTDOY -1.22%).

Four years since its debut, sales of Nintendo's Switch console are still stronger than unit sales of the newest iterations of the PlayStation and Xbox (see chart below), and sales are still accelerating despite the fact that the console debuted four years ago. Perhaps most bullish of all, Nintendo is extracting a massive amount of revenue from Switch owners well after they've purchased the game-playing platform.

Young man sitting on a couch, playing a video game.

Image source: Getty Images.

Switch's success spurs software sales

It's a somewhat nuanced and rarely discussed aspect of the video game business, but selling consoles like the Xbox, PlayStation, and the Switch aren't the point. They're a means to an end. The ultimate goal is selling games playable on consoles; the more, the better. Indeed, it's been repeatedly reported that the (relatively) new PlayStation 5 is being sold at a loss, while Microsoft recently conceded its Xbox console has never been profitable. This is in contrast with Nintendo's Switch, which even at wholesale prices drives more per-unit revenue than the consoles cost to produce.

That's amazing, but it's not the most amazing part of Nintendo's story. Far more amazing is how well Nintendo is (still) selling Switches, and then monetizing them.

The graphic below partially puts things in perspective, comparing total sales of the Switch to unit sales of the Xbox and PlayStation since the Switch's release in early 2017. The PlayStation franchise is still the best-selling of all time, but Nintendo has driven more sustained annual growth from the Switch over the course of the four years it's been available than any other console has in its first four years of sales.

Sales of Nintendo's Switch continue to grow four years after launch.

Data source: VGCharts. Chart by author.

Nintendo released a lower-cost Switch "Lite" in 2019, sparking fresh demand from more budget-minded gamers. Both Xbox and PlayStation are upgraded following their initial releases as well, although the Switch seems to get the most traction from its incremental improvements and new game launches that spur sales of consoles.

The impact of the growing base of Switch users is even more impressive. Digital sales of games and game-related content has soared from on the order of 11 billion yen per quarter in early 2018 to a quarterly pace regularly in excess of 80 billion yen now (roughly $720 million). As a portion of total game software sales, digital downloads have grown from less than 20% to roughly 50% now.

Digital downloads now account for nearly half of Nintendo's software sales, quadrupling in four years thanks to strong Switch sales.

Data source: Nintendo. Chart by author. All currency figures are in billions of yen.

It matters. Profit margin on downloaded games is considerably higher than cartridge-based or disc-based games. Not only do digital downloads not require packaging, they aren't sold to retailer middlemen at a wholesale price.

The takeaway

None of this is to suggest Sony and Microsoft are fumbling their respective video-gaming businesses. Both are doing well enough in terms of leveraging their consoles' reach to generate sales of content and games directly to consumers.

But there's clearly something special about Nintendo's Switch and the games it can play. Underscoring this specialness is that fact that it's a less powerful platform than recent iterations of the PlayStation and Xbox, facilitating its lower price. The Switch's game library offsets any shortcomings the console itself may seem to have among hardcore gamers. This combination of right-priced hardware and a digital ecosystem that's keeping paying customers engaged is one that clearly works, making Nintendo a compelling video-gaming investment prospect.

And before you think 2021 and 2022 are the years the Switch finally peaks -- and software sales with it -- know that Nintendo is reportedly working on a next-generation version of the console it's calling the Switch Pro. Little's been disclosed about the effort, including the most important performance specs and the likely release date. Given what we can tell about the project to-date, though, the Pro should prolong the marketable life of the Switch series by appealing to current Xbox and PlayStation fans looking for something fresh. They'll be plugged into a digital-monetization platform that's already proven a reliable winner.

All in all, this rare "pure play" from the video game arena at least deserves more credit if not a place in your portfolio.