Doom and Gloom: What Will it Take for the Wii U to Find Success?

There’s been quite a hubbub in recent days about various industry analysts predicting the Wii U to be a complete and utter failure. In particular, managing director of Wedbush Securities Michael Pachter has placed himself squarely between the sights of an increasingly frustrated Nintendo fanbase. Yesterday, sites were reporting bits and pieces of his forecast proclaiming Nintendo’s Wii U to be a “mistake” that is “something they probably can’t recover from.”

Today, Pachter has taken to the NeoGAF forums to defend his position and provide a little background for his analysis. But first, let’s briefly recap yesterday’s comments from Pachter, as well as a few other industry analysts. Even though Nintendo has yet to officially list sales figures for January, the number of units moved is estimated to be somewhere in the ballpark of 55,000. This abysmal number of sales, as compared to that of the original Wii which became nearly impossible to find for months after the initial launch, combined with an increasing lack of third-party support, indicates to analysts this is a sign of bad things to come. So far so true, as developers of upcoming titles such as BioShock Infinite, Grand Theft Auto V and Tomb Raider have already stated the Wii U will not be receiving a slice of the multiplatform pie.

In the face of poor unit sales and a lack of third party support, what would the Wii U have to do to turn a profit? The obvious solution, according to other analysts, is first-party games and third-party exclusives. “Great games, unique to the platform, would be a very good start,” said Colin Sebastian, and analyst for Baird. IDC research manager Lewis Ward agrees. ““Games, games, and more games,” he said. “The relationship between key releases — primarily first-party titles — and hardware sales is especially clear in Nintendo’s case. The sooner they get titles like Pikmin 3 and Wii Fit U on the console side and Pokémon games and titles like Animal Crossing: New Leaf on the 3DS side on store shelves, the better.”

Pachter remained unconvinced, stating that, “I think they have made a costly mistake. And their handheld business can’t save them in the face of cannibalization from smartphones and tablets.”

Now, getting back to Pachters remarks made on the NeoGAF forums, he further explains why he seems so cynical toward the Wii U. As an analyst, his explanation involves a lot of statistics and sales figures. “Nintendo has historically made money, and a lot of money, on each hardware unit sold. The DS at $99 US is more profitable for them than the 3DS at $169 (see many quotes from Nintendo in Kyoto about losing money, or being barely profitable),” Pachter explained. To add to his point, he mentions that, “The DS sold 23.5 million units in [Fiscal Year]:07 (ended March 31), 30.3 million in FY:08, 31.1 million in FY:09, and 27.1 million in FY:10. Nintendo made money, and a lot of money, in each of those years.”

To prove his point about the 3DS being less profitable than most gamers imagine, even though it’s generated higher sales than the original DS by this point in the handheld’s lifecycle, he made the following remarks. “Many of you point out that the 3DS is selling better than the DS at a similar point. That’s true, but the DS was always profitable, and the 3DS is not. Also, the DS saw sales go from 8.8 million units in its first four quarters to 18.0 million its next four, to 20.2 million in its third full year; I’m pretty confident that the 3DS will not get to 20 million units, but even if it did, it would generate little profit from hardware. Keep in mind that the DS redesign to a lite version boosted sales, and there was little competition for 12 year-old and older from smart phones and tablets. Now, parents who can afford it are opting for Kindles, iPads, and smart phones for their teenagers, and the more casual of those are perfectly happy playing Angry Birds and putting their DS or 3DS into a drawer.”

To back up his point about Nintendo not profiting from 3DS hardware sale, Pachter relayed the following figures. “Nintendo made ¥90 billion in FY:06, ¥226 billion in FY:07, ¥487 billion in FY:08, ¥555 billion in FY:09, and ¥356 billion in FY:10. In FY:11, DS sales dropped to 17.5 million units, and operating income fell to ¥171 billion; in FY:12, combined DS and 3DS sales were 18.6 million units, but operating income disappeared, and Nintendo generated a LOSS of ¥37 billion.” So what does all that mean? Pachter explains that, “obviously, the loss was impacted by lower Wii sales and lower software sales, but the point here is that the 3DS doesn’t generate much of a profit per unit, if any, and the DS did.”

Look at Satoru Iwata, in his cute Luigi hat. Look him in the eye and tell him his company isn’t doing well.

To quell the naysayers who accuse Pachter of predicting Nintendo’s complete collapse, he offered this reassurance. “My comment about the Wii U being a ‘mistake’ from which the company ‘may not recover’ was intended to say that if Wii U sales don’t materially improve, Nintendo is unlikely to be profitable. They have around ¥1 trillion (around $11 billion) in cash, so they aren’t in danger of going out of business for decades. However, if they aren’t profitable, they aren’t doing a good job for shareholders.”

“To elaborate, if the Wii U is not generating profits, and if the 3DS is not generating profits, the only thing that will generate profits is software. Nintendo is ensured high sales of its proprietary software, but it makes the most money on its royalty business, collecting fees from third parties for the privilege of letting them put out games on Nintendo platforms. Publishing (software) revenues peaked at ¥675 billion in FY:09, and are on track to come in around ¥235 billion this year; my call is that if hardware sales don’t materially improve above current combined levels, software sales are unlikely to materially grow. If software sales don’t materially improve, losses or break even will become the norm. Nintendo will not “recover” to its formal highly profitable glory.”

For those who like skipping down to the end for the summary of details, here’s the bottom line: According to Pachter, “the important point is that if 3DS sales level off at 15 million and Wii U sales level off at 8 – 10 million, software sales will be much lower than they were in the past. If Nintendo doesn’t make a profit on hardware, they can’t afford to cut prices further. If they do cut price, it will likely occur as their manufacturing costs come down, but I don’t expect big hardware profits in the foreseeable future. They are stuck with software profits, and at current sales levels, they are unlikely to make an overall profit from software.”

This all seems like a fair bit of speculation based on current trajectory, but anyone who’s taken a hard look at Nintendo knows you can never count “the house that Mario built” out of the game. Nintendo has a history of releasing consoles that don’t come close to outselling their current generation competitors, take the Gamecube or the Nintendo 64 for example. The deciding factor, as is almost always the case, will come down to the software available on the Wii U. Somehow, Nintendo must find a way to convince third-party developers that, even though the console isn’t selling great, devs should not only port their popular titles to the Wii U with console-specific functionality, but also create unique IPs exclusive to the console. A tall order for sure, but I find it hard to believe Nintendo isn’t already cooking up something special for their loyal fans in preparation for this year’s E3; which could make-or-break Wii U console sales.

What do you, the gamers, think about Nintendo’s current situation? Is it far too early for speculation? Or do these analysts have a point, considering Nintendo’s history and current lack of high-profile software releases on the Wii U? Share your thoughts, and “mild” dissatisfaction with Pachter’s assessment of Nintendo, in the comments below.