Briefly, What Are the Network Effects in the Video Game Industry?

2. Briefly, what are the network effects in the video game industry?

Video game industry is a two-sided market. Console producer is the intermediary. Video game developers and consumers are the two sets of agents. Game developers are more willing to produce games for a console that has a large number of users. In turn, consumers are more likely to own one particular console that provides greater access to different games.

3. Describe and evaluate Nintendo’s strategy in each of the following areas. Why did Nintendo take the actions it did? How did these affect the value created by the industry? How did they affect the portion of that value Nintendo was able to capture? a. Pricing of consoles and games; b. Strategy toward game developers; c. Strategy toward chip suppliers; d. Strategy toward retailers

First, Nintendo priced game consoles low at or even below cost, but priced game cartridge high with a huge mark-up. It also practiced bundling of the software and hardware. Low console price and bundling practice enabled Nintendo to build a large installed base for its gaming platform. A large installed base allowed Nintendo to drive down manufacturing cost. More importantly, it encouraged game developers to create the best games. Great games encouraged more consumers to purchase the game console, leading to an even larger base, lower cost, and more games. Such a positive feedback loop established Nintendo unique and valuable position in the video game industry. It was very difficult for competitors to challenge this installed base by imitating Nintendo’s practice.    

In terms of game development, Nintendo initially kept strong in-house new game development capability and successfully launched several big hit games. This success lured many outsiders to develop games for Nintendo. But, the benefits and the corresponding added values created by these outsiders were limited due to Nintendo’s strong R&D presence, which enabled it to be less dependent on those outside developers. Later, Nintendo started licensing game development rights to a restricted number of outsiders. Each licensee was allowed to develop only a limited number of games every year, and was required to absorb the manufacturing cost and place a significant amount of minimum orders payable in advance. In addition, the security chip embedded in the game cartridge left little room for game developers to get around Nintendo’s authority. These initiatives further increased the outsiders’ opportunity cost, made them more dependent on Nintendo’s authorities, and consequently lowered their added values.

Next, when dealing with chip suppliers, Nintendo chose the out-of-date 8-bit microprocessor and essentially treated it as a commodity. In that way, Nintendo was able to establish cost leadership and price its game console low to undercut competitors. Moreover, commoditized chips allowed Nintendo to not tie up with any relationship specific assets. Its switching cost was low due to the presence of numerous chip manufacturers in the market. In turn, Nintendo’s large quantity of chip orders made those chip suppliers more rely on Nintendo’s business. As a result, chip suppliers’ power was reduced while Nintendo’s buy power was enhanced.    

Finally, in the arena of retailing, Nintendo initially offered retailers very generous provisions to encourage them to feature Nintendo’s products, particularly when entering the US market. After gaining substantial market demand, Nintendo required retailers to place orders, take delivery, and pay in quick succession, enabling itself to capture the value fast while compromising retailers’ opportunity cost. In addition, Nintendo tactically under supplied the retailers to intrigue an even higher demand and increase consumers’ willingness to pay for its products. Nintendo even threatened to cut off retailers if they carried competitor’s products or discounted Nintendo’s products, impeding potential competition and maintaining its nearly monopolistic market power. As a result, retailers who relied on Nintendo’s products for considerable profits were cornered to a weak position and lost their buyers’ power.