Nintendo (NASDAQOTH:NTDOY) is a company in crisis: Its latest living room video game console, the Wii U, hasn't sold nearly as well as Nintendo had anticipated, and sales of its handheld video game machine, the 3DS, have also come in far short of expectations.
Facing rising competition, Nintendo unveiled a plan to rejuvenate its business back in January. The company promised, among other things, to alter the way in which it prices its games.
Investors are now getting their first look at Nintendo's new policy: This month, buyers of Nintendo's 3DS will get a digital copy of Pokemon X or Pokemon Y, two of the company's best-selling games. While the move should help Nintendo sell more hardware, and thereby expand its platform, it could put pressure on retailers like GameStop (NYSE:GME).
Nintendo's 3DS comes up short
At this point, the Wii U is widely accepted as a disappointment as far as sales are concerned: In January, Nintendo reduced its estimates for the Wii U's sales by some 69% for the fiscal year, effectively ending the debate over the console's success.
But what remains far more interesting is the 3DS, and Nintendo's future in the handheld gaming space. While Nintendo's supporters will concede that the Wii U is a sales disappointment, most continue to cling to the notion that the 3DS is selling well. IGN's Keza MacDonald, for example, characterized the 3DS' recent sales as "solid," and described 3DS software sales as "amazing."
However, while Apple's mobile devices haven't destroyed the market for Nintendo's handhelds entirely, they're obviously having a noticeable impact: When Nintendo cut its sales estimates for the Wii U, it also reduced its estimates for the 3DS, both in terms of hardware and software. Historically, Nintendo's 3DS is -- at this point in its life -- selling much worse than its predecessor, despite the fact that the market for video games continues to grow at a rapid pace.
Bundling digital games is a growing trend
Nintendo's plan to bundle a free digital copy of Pokemon X or Y could be seen as a sign that the 3DS is falling further behind Nintendo's sales expectations.
Both games retail for $40, while the 2DS (the less expensive version of the 3DS) sells for just $130. To qualify for the deal, gamers have to purchase an additional game at full price in addition to the console, but Nintendo is still offering what amounts to a 20% discount for new buyers.
This isn't the first time Nintendo has bundled a digital game, and it likely won't be the last -- it included a digital copy of The Legend of Zelda with the Wii U last year. In January, Nintendo said it would be open to giving loyal customers discounted or free games going forward. It's difficult to imagine how Nintendo would work such a system without -- as it's doing with Pokemon -- giving away digital copies. And Nintendo isn't alone in pushing this strategy. Later this month, Microsoft will give away a free digital copy of Titanfall to new buyers of its Xbox One console.
While the inclusion of a select few digital games is unlikely to have much of an effect on GameStop's business model, it's just another sign that the industry is moving toward digital distribution.
By giving away a digital copy of Pokemon, Nintendo is effectively cutting GameStop out of the transaction -- twice. First by removing them from the initial sale and again by preventing them from making money off used games. At the same time, some gamers may be more comfortable with going to GameStop to pick up a physical copy of the latest Nintendo release. It's what they've done for years -- they're used to it. Offering up digital freebies could incline some to break their habit, turning to digital going forward.
As the vast majority of GameStop's revenue and profit comes from the sale of video game software (used and new), the industry's move toward digital distribution remains an existential threat.
Nintendo's future remains uncertain
Nintendo's willingness to give away one of its best games is definitely a win for consumers, and it could entice some holdouts to pick up a 3DS -- in the long run resulting in more software sales for Nintendo.
But Nintendo's problems don't stop with the Wii U. The 3DS, while still selling millions, is not doing as well as Nintendo anticipated. To make matters worse, the dominant mobile players, including Apple, Google, and Amazon, are increasingly shifting their focus to video gaming.
Ultimately, Nintendo's decision to give away one of its best games highlights the precarious situation the company faces.
Sam Mattera is short GameStop. The Motley Fool recommends and owns shares of Amazon.com, Apple, and Google. It also owns shares of GameStop and 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.