Nintendo Is Missing Out By Not Bringing its Games to Apple's iOS

Despite the exploding popularity of mobile gaming, Nintendo (NTDOY 3.03%) has staunchly refused to participate. Rather than bring its wildly popular Mario, Zelda and Pokemon franchises to mobile platforms, including Apple's (AAPL -0.35%) iOS, Nintendo has stood by its long-standing business strategy: keeping its games confined to its proprietary hardware.

In the past, this made sense -- those that wanted to play Nintendo's games were forced to buy its devices, resulting in additional profits and giving it the ability to extract valuable licensing revenues from third party publishers.

But times have changed: Nintendo's handheld business is unraveling. As mobile gaming grows ever more popular, Nintendo's management may need to reconsider its strategy.

Demand for Nintendo's handhelds is crashing

When Nintendo reported earnings late last month, it revealed a staggering decline in the sales of its handheld console, the 3DS. Last quarter, Nintendo sold just 820,000 3DS consoles -- a more than 40% decline from the same three month period in 2013.

This does not appear to be an aberration, but rather, an acceleration of an ongoing trend. In its last fiscal year, Nintendo sold 12.24 million 3DS consoles -- a more than 12% decline from the prior year. The following chart shows Nintendo's total handheld console sales (the 3DS and its predecessor the DS) over the last five years.

Per Nintendo's annual reports, Y-Axis tens of thousands

Nintendo's current handheld, the 3DS, is trailing behind its predecessor, the DS, in unit sales. Originally released in the first quarter of 2011, the 3DS has been on the market for just over three full years. The following chart compares the annual sales of the 3DS and the DS during their three first full fiscal years on the market.

Per Nintendo's annual reports, Y-Axis tens of thousands

While Nintendo's DS saw robust growth in its second and third years (and also its fourth, though not pictured) Nintendo's 3DS has already begun to stagnate.

iTunes revenue continues to surge

Of course the DS had a huge advantage over its successor: It didn't have to compete with mobile devices. Apple's first-generation iPhone wasn't around until the DS's third year on the market, and it was another year before the app store made its debut. The DS never truly had to compete with tablets, as Apple's iPad was not unveiled until very late in the DS's life.

The 3DS, however, has had to compete with mobile devices from its very first day -- and they're clearly taking a toll. Since its debut, Nintendo has sold more than 44 million 3DS consoles, which isn't a terrible figure, but simply doesn't compare to the 150 million iPhones and 71 million iPads Apple sold in the last year alone (not to mention the hundreds of millions of Android-powered devices).

To be fair, it would be disingenuous to make a direct unit comparison -- Nintendo's 3DS specializes in gaming; mobile devices, including Apple's iPhones and iPads, are suitable for a wide variety of tasks. A better measure would be to look at app revenue.

Apple's iTunes has emerged as its fastest-growing business: From October to the end of June, Apple's iTunes, software, and services revenue grew 14% on an annual basis, generating more than $13 billion in revenue for Apple. Although that segment includes many other products (notably music) analyst Horace Dediu estimates third-party apps have become the largest grossing component.

During its last earnings call, Apple revealed that it has now paid app developers $20 billion. Much of that is going to game creators: Last year, research firm Distimo estimated that mobile games were responsible for nearly 80% of iTunes app revenue.

In Nintendo's own home country of Japan, mobile gaming has overtaken traditional consoles. Last year, according to CESA, Japan's mobile gaming market generated $5.1 billion in revenue -- more than traditional video game hardware and software combined. It's not surprising, then, that the 3DS saw its demand take the sharpest dive in Japan -- declining by nearly 60% last quarter on an annual basis.

Will there be a market for a 3DS successor?

Ultimately, Nintendo's 3DS is far from a failure. Unless sales fall off a cliff in the near term, Nintendo should sell at least 60 million 3DS units over its lifetime, and tens of millions of software titles.

But the trend is nothing short of frightening. The mobile gaming market is massive, and continues to grow at a rapid rate. As a competing platform, Apple's iOS appears to be weighing on the market for Nintendo's handhelds -- the 3DS's lifetime sales will not come close to the DS's more than 150 million.

When it comes time for Nintendo to release a follow up to the 3DS, perhaps in 2016, it will face a market saturated by Apple's mobile devices, and a mobile gaming ecosystem full of developers generating billions. Though Nintendo's management remains opposed to mobile game development, the demand for its handheld consoles is clearly waning.