Poke’Mon Go is a new sensation. Just launched on July 6, the app is already the #1 app in the world – and it isn’t even available in most countries. In less than 2 weeks, from a standing start, Nintendo’s new app is more popular than both Facebook and Snapchat. Based on this success, Nintendo’s equity valuation has jumped 90% in this same short time period.
Some think this is just a fad, after all it is just 2 weeks old. Candy Crush came along and it seemed really popular. But after initial growth its user base stalled and the valuation fell by about 50% as growth in users, time on app and income all fell short of expectations. And, isn’t the world of gaming dominated by the likes of Sony and Microsoft?
A bit of history
Nintendo launched the Wii in 2006 and it was a sensation. Gamers could do things not previously possible. Unit sales exceeded 20m units/year for 2006 through 2009. But Sony (PS4) and Microsoft (Xbox) both powered up their game consoles and started taking share from Nintendo. By 2011 Nintendo sale were down to 11.6m units, and in 2012 sales were off another 50%. The Wii console was losing relevance as competitors thrived.
Sony and Microsoft both invested heavily in their competition. Even though both were unprofitable at the business, neither was ready to concede the market. In fall, 2014 Microsoft raised the competitive ante, spending $2.5B to buy the maker of popular game Minecraft. Nintendo was becoming a market afterthought.
Meanwhile, back in 2009 Nintendo had 70% of the handheld gaming market with its 3DS product. But people started carrying the more versatile smartphones that could talk, text, email, execute endless apps and even had a lot of games – like Tetrus. The market for handheld games pretty much disappeared, dealing Nintendo another blow.
Competitor strategic errors
Fortunately, the bitter “fight to the death” war between Sony and Microsoft kept both focused on their historical game console business. Both kept investing in making the consoles more powerful, with more features, supporting more intense, lifelike games. Microsoft went so far as to implement in Windows 10 the capability for games to be played on Xbox and PCs, even though the PC gaming market had not grown in years. These massive investments were intended to defend their installed base of users, and extend the platform to attract new growth to the traditional, nearly 4 decade old market of game consoles that extends all the way back to Atari.
Both companies did little to address the growing market for mobile gaming. The limited power of mobile devices, and the small screens and poor sound systems made mobile seem like a poor platform for “serious gaming.” While game apps did come out, these were seen as extremely limited and poor quality, not at all competitive to the Sony or Microsoft products. Yes, theoretically Windows 10 would make gaming possible on a Microsoft phone. But the company was not putting investment there. Mobile gaming was simply not serious, and not of interest to the two Goliaths slugging it out for market share.
Building on trends makes all the difference
Back in 2014 I recognized that the console gladiator war was not good for either big company, and recommended Microsoft exit the market. Possibly seeing if Nintendo would take the business in order to remove the cash drain and distraction from Microsoft. Fortunately for Nintendo, that did not happen.
Nintendo observed the ongoing growth in mobile gaming. While Candy Crush may have been a game ignored by serious gamers, it nonetheless developed a big market of users who loved the product. Clearly this demonstrated there was an under-served market for mobile gaming. The mobile trend was real, and it’s gaming needs were unmet.
Simultaneously Nintendo recognized the trend to social. People wanted to play games with other people. And, if possible, the game could bring people together. Even people who don’t know each other. Rather than playing with unseen people located anywhere on the globe, in a pre-organized competition, as console games provided, why not combine the social media elements of connecting with those around you to play a game? Make it both mobile, and social. And the basics of Poke’Mon Go were born.
Then, build out the financial model. Don’t charge to play the game. But once people are in the game charge for in-game elements to help them be more successful. Just as Facebook did in its wildly successful social media game Farmville. The more people enjoyed meeting other people through the game, and the more they played, the more they would buy in-app, or in-game, elements. The social media aspect would keep them wanting to stay connected, and the game is the tool for remaining connected. So you use mobile to connect with vastly more people and draw them together, then social to keep them playing – and spending money.
The underserved market is vastly larger than the over-served market
Nintendo recognized that the under-served mobile gaming market is vastly larger than the overserved console market. Those console gamers have ever more powerful machines, but they are in some ways over-served by all that power. Games do so much that many people simply don’t want to take the time to learn the games, or invest in playing them sitting in a home or office. For many people who never became serious gaming hobbyists, the learning and intensity of serious gaming simply left them with little interest.
But almost everyone has a mobile phone. And almost everyone does some form of social media. And almost everyone enjoys a good game. Give them the right game, built on trends, to catch their attention and the number of potential customers is – literally – in the billions. And all they have to do is download the app. No expensive up-front cost, not much learning, and lots of fun. And thus in two weeks you have millions of new users. Some are traditional gamers. But many are people who would never be a serious gamer – they don’t want a new console or new complicated game. People of all ages and backgrounds could become immediate customers.
David can beat Goliath if you use trends
In the Biblical story, smallish David beat the giant Goliath by using a sling. His new technology allowed him to compete from far enough away that Goliath couldn’t reach David. And David’s tool allowed for delivering a fatal blow without ever touching the giant. The trend toward using tools for hunting and fighting allowed the younger, smaller competitor to beat the incumbent giant.
In business trends are just as important. Any competitor can study trends, see what people want, and then expand their thinking to discover a new way to compete. Nintendo lost the console war, and there was little value in spending vast sums to compete with Sony and Microsoft toe-to-toe. Nintendo saw the mobile game market disintegrate as smartphones emerged. It could have become a footnote in history.
But, instead Nintendo’s leaders built on trends to deliver a product that filled an unmet need – a game that was mobile and social. By meeting that need Nintendo has avoided direct competition, and found a way to dramatically grow its revenues. This is a story about how any competitor can succeed, if they learn how to leverage trends to bring out new products for under-served customers, and avoid costly gladiator competition trying to defend and extend past products.
Whether Sony will make money on PS4 in 2014 is far from proven. Especially since it sells for $100/unit (20%) less than xBox One – which compresses margins. What investors (and customers) can expect is an ongoing price war between Nintendo, Sony and Microsoft to attract sales. A competition which historically has left all competitors with losses – even when they win the market share war.
And on top of all of this is the threat that console market growth may stagnate as gamers migrate toward games on mobile devices. How this will affect sales is unknown. But given what happened to PC sales it’s not hard to imagine the market for consoles to become smaller each year, dominated by dedicated game players, while the majority of casual game players move to their convenient always-on device.
Due to its limited product range, Nintendo is in a “fight to the death” to win in gaming. Sony is now selling its PC business, and lacks strong offerings in most consumer products markets (like TVs) while facing extremely tough competition from Samsung and LG. Sony, likewise, cannot afford to abandon the Playstation business, and will be forced to engage in this profit killing battle to attract developers and end-use customers.
When businesses fall into profit-killing price wars the big winner is the one who figures out how to exit first. Back in the 1970s when IBM created domination in mainframes the CEO of GE realized it was a profit bloodbath to fight for sales against IBM, Sperry Rand and RCA. Thinking fast he made a deal to sell the GE mainframe business to RCA so the latter could strengthen its campaign as an IBM alternative, and in one step he stopped investing in a money-loser while strenghtening the balance sheet in alternative markets like locomotives and jet engines – which went on to high profits.
With calls to focus, Microsoft is now abandoning XP. It is working to force customers to upgrade to either Windows 7 or Windows 8. As PC sales continue declining, Microsoft faces an epic battle to shore up its position in cloud services and maintain its enterprise customers against competitors like Amazon.
After a decade in gaming, where it has never made money, now is the time for Microsoft to recognize it does not know how to profit from its technology – regardless how good. Microsoft could cleve off Kinect for use in its cloud services, and give its installed xBox base (and developer community) to Nintendo where the company could focus on lower cost machines and maintain its fight with Sony.
Analysts that love focus would cheer. They would cheer the benefit to Nintendo, and the additional “focus” to Microsoft. Microsoft would stop investing in the unprofitable game console market, and use resources in markets more likely to generate high returns. And, with some sharp investment bankers, Microsoft could also probably keep a piece of the business (in Nintendo stock) that it could sell at a future date if the “suicide” console business ever turns into something profitable.
Sometimes smart leadership is knowing when to “cut and run.”
Microsoft CEO Steve Ballmer appears to be planning a major reorganization. The apparent objective is to help the company move toward becoming a "devices and services company" as presented in the company's annual shareholder letter last October.
But, the question for investors is whether this is a crafty move that will help Microsoft launch renewed profitable growth, or is it leadership further confusing customers and analysts while leaving Microsoft languishing in stalled markets? After all, the shares are up some 31% the last 6 months and it is a good time to decide if an investor should buy, hold or sell.
There are a lot of things not going well for Microsoft right now.
Everyone knows PC sales have started dropping. IDC recently lowered its forecast for 2013 from a decline of 1.3% to negative 7.8%. The mobile market is already larger than PC sales, and IDC now expects tablet sales (excluding smartphones) will surpass PCs in 2015. Because the PC is Microsoft's "core" market – producing almost all the company's profitability – declining sales are not a good thing.
Microsoft hoped Windows 8 would reverse the trend. That has not happened. Unfortunately, ever since being launched Windows 8 has underperformed the horrific sales of Vista. Eight months into the new product it is selling at about half the rate Vista did back in 2007 – which was the worst launch in company history. Win8 still has fewer users than Vista, and at 4% share 1/10th the share of market leaders Windows 7 and XP.
Microsoft is launching an update to Windows 8, called Windows 8.1 or "blue." But rather than offering a slew of new features to please an admiring audience the release looks more like an early "fix" of things users simply don't like, such as bringing back the old "start" button. Reviewers aren't talking about how exciting the update is, but rather wondering if these admissions of poor initial design will slow conversion to tablets.
And tablets are still the market where Microsoft isn't – even if it did pioneer the product years before the iPad. Bloomberg reported that Microsoft has been forced to cut the price of RT. So far historical partners such as HP and HTC have shunned Windows tablets, leaving Acer the lone company putting out Windows a mini-tab, and Dell (itself struggling with its efforts to go private) the only company declaring a commitment to future products.
And whether it's too late for mobile Windows is very much a real question. At the last shareholder meeting Nokia's investors cried loud and hard for management to abandon its commitment to Microsoft in favor of returning to old operating systems or moving forward with Android. This many years into the game, and with the Google and Apple ecosystems so far in the lead, Microsoft needed a game changer if it was to grab substantial share. But Win 8 has not proven to be a game changer.
In an effort to develop its own e-reader market Microsoft dumped some $300million into Barnes & Noble's Nook last year. But the e-reader market is fast disappearing as it is overtaken by more general-purpose tablets such as the Kindle Fire. Yet, Microsoft appears to be pushing good money after bad by upping its investment by another $1B to buy the rest of Nook, apparently hoping to obtain enough content to keep the market alive when Barnes & Noble goes the way of Borders. But chasing content this late, behind Amazon, Apple and Google, is going to be much more costly than $1B – and an even lower probability than winning in hardware or software.
Then there's the new Microsoft Office. In late May Microsoft leadership hoped investors would be charmed to hear that 1M $99 subscriptions had been sold in 3.5 months. However, that was to an installed base of hundreds of millions of PCs – a less than thrilling adoption rate for such a widely used product. Companies that reached 1M subscribers from a standing (no installed base) start include Instagram in 2.5 months, Spotify in 5 months, Dropbox in 7 months and Facebook (which pioneered an entire new marketplace in Social) in only 10 months. One could have easily expected a much better launch for a product already so widely used, and offered at about a third the price of previous licenses.
A new xBox was launched on May 21st. Unfortunately, like all digital markets gaming is moving increasingly mobile, and consoles show all the signs of going the way of desktop computers. Microsoft hopes xBox can become the hub of the family room, but we're now in a market where a quarter of homes lead by people under 50 don't really use "the family room" any longer.
xBox might have had a future as an enterprise networking hub, but so far Kinnect has not even been marketed as a tool for business, and it has not yet incorporated the full network functionality (such as Skype) necessary to succeed at creating this new market against competitors like Cisco.
Thankfully, after more than a decade losing money, xBox reached break-even recently. However, margins are only 15%, compared to historical Microsoft margins of 60% in "core" products. It would take a major growth in gaming, plus a big market share gain, for Microsoft to hope to replace lost PC profits with xBox sales. Microsoft has alluded to xBox being the next iTunes, but lacking mobility, or any other game changer, it is very hard to see how that claim holds water.
The Microsoft re-org has highlighted 3 new divisions focused on servers and tools, Skype/Lync and xBox. What is to happen with the business which has driven three decades of Microsoft growth – operating systems and office software – is, well, unclear. How upping the focus on these three businesses, so late in the market cycle, and with such low profitability will re-invigorate Microsoft's value is, well, unclear.
In fact, given how Microsoft has historically made money it is wholly unclear what being a "devices and services" company means. And this re-organization does nothing to make it clear.
My past columns on Microsoft have led some commenters to call me a "Microsoft hater." That is not true. More apt would be to say I am a Microsoft bear. Its historical core market is shrinking, and Microsoft's leadership invested far too much developing new products for that market in hopes the decline would be delayed – which did not work. By trying to defend and extend the PC world Microsoft's leaders chose to ignore the growing mobile market (smartphones and tablets) until far too late – and with products which were not game changers.
Although Microsoft's leaders invested heavily in acquisitions and other markets (Skype, Nook, xBox recently) those very large investments came far too late, and did little to change markets in Microsoft's favor. None of these have created much excitement, and recently Rick Sherland at Nomura securities came out with a prediction that Microsoft might well sell the xBox division (a call I made in this column back in January.)
As consumers, suppliers and investors we like the idea of a near-monopoly. It gives us comfort to believe we can trust in a market leader to bring out new products upon which we can rely – and which will continue to make long-term profits. But, good as this feels, it has rarely been successful. Markets shift, and historical leaders fall as new competitors emerge; largely because the old leadership continues investing in what they know rather than shifting investments early into new markets.
This Microsoft reorganization appears to be rearranging the chairs on the Titanic. The mobile iceberg has slashed a huge gash in Microsoft's PC hull. Leadership keeps playing familiar songs, but the boat cannot float without those historical PC profits. Investors would be smart to flee in the lifeboat of recent share price gains.
The leadership of Microsoft's entertainment division are leaving, as reported at TechFlash.com "Bach, Allard leaving Microsoft in Big Shift for Consumer Businesses." Whether by their own choice or by request, the issue is simply that Microsoft has not driven the XBox to a dominant position versus the Sony Playstation or the Ninendo Wii. It is competitive, but not a big winner. The entertainment division has only recently moved beyond break-even, after years of losing billions of dollars. In the high-growth gaming business, Microsoft has simply not performed, despite its vast resources. And mobile devices developed in this division have lost over half their market share in under 2 years to Apple and Google.
Some of the weakness may have been that the leaders were long-term Microsoft veterans, comfortable to Mr. Ballmer and other leaders, rather than executives committed to their markets. Messrs. Bach and Allard were not they type of leaders to challenge the Microsoft Success Formula, instead willing to accept mediocre results rather than violate Microsoft Lock-ins that would have jeopardized their careers. Microsoft was willing to lose money, and not be a big winner, as long as the division leadership didn't challenge Lock-ins or the company focus on desktop computing products.
I'm not optimistic now that the division is reporting directly to CEO Steve Ballmer. He had an enormous role in the company decision to commit vast resources to Defending the old Success Formula by massing hundreds of billions of dollars behind development and rollout of Office 2007, now office 2010, Vista and now System 7. Yet, these projects have done nothing to grow Microsoft; instead only helping the company hold onto old customers. Worse, Mr. Ballmer himself recently informed the world in his CEO Summit (as reported in Computerworld "Microsoft's Ballmer admits 'Window's Vista was just not executed well") that he's not a good leader of product development – costing the company thousands of man-years in wasted development when admittedly mismanaging Vista!
Now, largely due to the ongoing Defend & Extend management practices of Mr. Ballmer, Microsoft and Apple's valuations are in a dead heat. Growth at Microsoft is poor, while Apple with its multiple new products is growing much faster – causing Apple's value to catch up to what has historically been the world's largest software company.
As I commented on the recent interview for bnet.com (available as a podcast) Microsoft's Defend & Extend management practices are deeply rooted in the industrial economy. But they are insufficient for success in today's rapidly shifting marketplace. I discussed this in more depth for my keynote address at the Western Michigan Innovation & Energy Summit last week, and a second article was published in the local newspaper on Saturday "Customer is Always Right? Columnist says not for Innovative Businesses." Specifically, Microsoft's total commitment to maintaining old operating system and Office customers has created an inability to re-focus resources on high growth markets like gaming and mobile devices.
Although Microsoft has solutions – including tablet technology – it's management is Locked-in to Defending what it always did and not committing to new growth markets. Anyone who thinks Microsoft will be the major player in cloud computing, just because it has demonstrated some new products, must look closely at how poorly the company has developed these other growth markets. Technology and products are not enough when management is Locked in to protecting past markets. Microsoft is far behind Google, and has practically no catch of being a major player with so much resource dedicated to Office 2010 and System 7.
Thus investors as well as customers and employees are not doing so well at Microsoft. In the rapidly shifting technology and gaming markets, this inability to commit to new markets is deadly. For Microsoft, replacing the heads of the entertainment division is most likely analogous to rearranging the deck chairs on ocean liner Titanic. The pending outcome is rapidly becoming inevitable. Time to look for lifeboats!
"Strategic Plans Lose Favor" is a recent Wall Street Journal headline. Seems like some big companies, and big consulting firms like Accenture, McKinsey and the Boston Consulting Group are rapidly learning what this blog has been pushing for a few years. That flexibility trumps traditional approaches to strategic planning.
When Office Depot's strategic plan was leading to revenue struggles, the company set up a situation room to track key indicators and adjust to market shifts much quicker.
"Strategy as we know it is dead" according to Walt Shill, head of strategic planning at Accenture. "increased flexibility and accelerated decision making are much more
important than simply predicting the future." (Do you think he's been reading this blog and my book?)
"business leaders will start to rely less on static five-year strategic
plans and more on rough "adaptive" strategies that consider multiple
scenarios" according to Martin Reeves, Senior Partner at BCG. (Where'd he read that – on this site?)
""The rate of change and width of volatility is much wider and faster
than what we would have assumed coming into this," Jeff Fettig, CEO at Whirlpool
McKkinsey has opened a "Center for Managing Uncertainty." Really.
As this recession has come on, and lingered, businesses are clearly starting to realize that market shifts happen fast, and businesses cannot be slow to change. Adaptability is one of the most important capabilities to compete in the post-2000 business world.
And the real market leaders are incorporating this kind of thinking into their organizations. While the earlier quotes show how, caught on the defensive, organizations are finding new ways to react, the best performing organizations are taking market leadership by being Disruptive. Like Apple. In a Harvard Business Review blog Roberto Verganti, professor at Politecnico di Milano tells us "Apple's Secret: It tells us what we should love."
The good professor of design and management points out that Apple does not ask customers what they want. Instead the company designs products which take customers to new levels of performance beyond what they imagined. Instead of being reactive, Apple uses scenario planning to understand future market needs and create shifts with its products. This approach leads to breakthrough performance, such as the success of Nintendo and its Wii product line.
To be successful businesses can no longer try to Defend & Extend their old strategies. They have to be market focused, and flexible to manage through market shifts. And to earn superior rates of return they have to be market leaders that use scenario planning and White Space to launch new solutions meeting emerging needs which attract customers and grow sales.
Some think this is just a fad, after all it is just 2 weeks old. Candy Crush came along and it seemed really popular. But after initial growth its user base stalled and the valuation fell by about 50% as growth in users, time on app and income all fell short of expectations. And, isn’t the world of gaming dominated by the likes of Sony and Microsoft?