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Entertainment giant Nintendo announced record profits as millions turned to its games in quarantine. The pandemic ending, according to one analyst, would be a "horror story" for the company.   © Illustration by Hiroko Aida/Source photo by Ken Kobayashi
The Big Story

Exclusive: Nintendo chief plots post-Animal Crossing future

Pandemic gaming boom lifts profits, but console wars are set to intensify

JADA NAGUMO, Nikkei staff writer | Japan

TOKYO/KYOTO -- It was mid-March, just as the world was beginning to witness the rapid spread of the deadly coronavirus. The World Health Organization had just declared a pandemic. In an apartment near Indiana State University, 23-year-old Emma Barnard had decided to self-isolate, struggling with allergy symptoms and chest pains.

She found herself straining to breathe, preventing her from doing any physical activity. "I was in bed all day with nothing to do," the student said. Housebound, her thoughts churned: Did she have the disease? Would the pandemic soon run its course?

Luckily, she quickly found an outlet for her anxieties -- one that did not involve moving far from her room for several weeks. It was Animal Crossing: New Horizons, a game whose central narrative was oddly symmetrical to her life: Players are marooned on a desert island, and must find ways to amuse themselves.

Barnard spent her days methodically harvesting insects and trading vegetables, interacting mainly with cute, anthropomorphic animals. The distraction it offered was a "blessing," she said.

Some days, Barnard would immerse herself in the game for eight to nine hours, building a parallel home in a virtual world. For her, as for millions of others worldwide, Nintendo's Animal Crossing became an antidote to the tedium of confinement.

Animal Crossing quickly became the fastest-selling game for the Nintendo Switch. (Photo by Ken Kobayashi)

"I spent a lot of time fishing and bug-hunting," Barnard said, referring to the activities available on the virtual island. The bugs and fish are important currencies -- called "bells" in the game -- which help players decorate their island with their own unique flair.

Animal Crossing was "the perfect game" during Barnard's monthlong self-quarantine, she said. "It gave me the chance to get away from the real world and zone out."

Of course, the real world last spring could not have been further from Animal Crossing's digital idyll. Nintendo's release of the game coincided with the early weeks of the COVID-19 outbreak -- and it rapidly came to symbolize the cultural zeitgeist of the pandemic. As the epic "Gone with the Wind" channeled the upheaval and loss of the Great Depression for viewers in the 1930s, Animal Crossing became the escapism of choice for the self-quarantining and homebound. Barnard described the game's universe as "stress-free," and "a place where things are OK."

Before this year, no gaming company could ever have hoped in their wildest dreams that the world's population would be confined to their living rooms for the better part of a year. And this awkward source of good fortune is something Nintendo executives still tiptoe around when addressing the success of the game.

"I hoped for a hit, but the speed at which the game spread to people was faster than I imagined," Nintendo President Shuntaro Furukawa told Nikkei Asia in an interview in September.

Nintendo President Shuntaro Furukawa poses with Nintendo Switch at the company's Kyoto headquarters in September. (Photo by Tomoki Mera)

When Animal Crossing arrived on people's screens, travel was being restricted, cities were coming under lockdown, stock markets were crashing and governments were declaring emergencies. As the virus upended everyday lives and cut off millions from social interaction, the game's uplifting narrative captured the hearts of lonely souls and allowed their imaginations to roam the game's world -- picking fruit from trees, taking a stroll, or digging holes to search for fossils.

The game almost instantly became a global phenomenon, selling more than 26 million copies in just six months since its release. It now holds the record for the fastest-selling title for Nintendo's Switch gaming console -- which also ran into supply droughts, thanks to pandemic-fueled demand.

Today, the 131-year-old gaming company is arguably more successful than ever. Its share price has jumped over 20% this year, touching a 12-year high in September. Investors have poured money into the stock, convinced that Animal Crossing will boost earnings and the Switch's success will continue. Their hope has so far been borne out: On Nov. 5, the company posted its highest-ever net profit for the first half of the financial year, a leap of 243%.

Along with that, though, Furukawa is conscious of the dilemma that his company's success rests on the back of a pandemic. He was eager to steer the conversation away from Nintendo's COVID-19 windfall, stressing that the company is focused on the future.

"We will continue to create new ideas and develop new games," he said.

Inside the Kyoto headquarters, the 48-year-old president sat in a leather couch in the company's expensive-looking drawing room. Clad conservatively in a suit -- unlike many young gaming CEOs, who prefer more casual attire like polo shirts -- and a face mask, Furukawa spoke, quiet and collected, across a transparent acrylic panel.

Furukawa confessed to enjoying playing games on his days off, including Animal Crossing, as well as Clubhouse Games: 51 Worldwide Classics, which is a collection of card, board and other games from around the world. Furukawa's favorite at the moment is mahjong.

While Nintendo has done exceptionally well in producing innovative games that offer brand-new experiences, it is now facing a rapidly changing market, with new risks around every corner. These include the emergence of subscription-based services, newer, cheaper technologies, and cloud gaming. Not to mention the almost guaranteed outcome that, when and if the pandemic is brought under control, people will desert their living rooms.

"Once the pandemic is over, more consumers will be willing to engage in physical outdoor activities. That would be a horror story for Nintendo"

Kenji Fukuyama, analyst at UBS Securities in Tokyo

"Once the pandemic is over, more consumers will be willing to engage in physical outdoor activities as leisure," said Kenji Fukuyama, analyst at UBS Securities in Tokyo.

"That would be a horror story for Nintendo."

Carefully wording himself, President Furukawa acknowledged: "I don't expect this situation to last long. In the entertainment business, people are destined to grow bored if we don't continue creating new ideas."

The play's the thing

Gaming has been in Nintendo's DNA for more than a hundred years.

Founded in 1889 by Japanese entrepreneur Fusajiro Yamauchi, the Kyoto-based company began by specializing in the manufacture of an intricate Japanese card game called hanafuda -- "flower cards" in English -- which Nintendo continues to sell to this day.

The company, tightly run by the Yamauchi family, later expanded into manufacturing toys and board games, venturing into computer games and other electronic devices in the 1970s.

Nintendo expanded at a fast clip during Japan's 1980s bubble heyday. After exporting arcade machines, the gaming giant went global, establishing Nintendo of America in 1980 and a European subsidiary in 1990. In 1983, the company both listed on the Tokyo Stock Exchange and came out with the Family Computer, a console that would be modified and relaunched in the U.S. two years later as the hugely successful Nintendo Entertainment System. Several of the company's defining games, including Super Mario Bros. and Donkey Kong, were developed for the cartridge-based console.

Left, children play Nintendo's groundbreaking Famicom in 1987. Right, a man tests the new Nintendo 64 console a decade later. (Source photos by Reuters and Kyodo)

Change came in 2002, when game creator Satoru Iwata became the first nonfamily member to lead Nintendo. A charismatic company president, he contributed to the company's success with groundbreaking products like the Wii console, which made gameplay easier by replacing the traditional two-handed controller with a simple one-handed remote. It went on to sell over 100 million units and remains the company's bestselling home console.

But his real legacy was to be the Switch, developed under the code name NX and released in 2017. The device has a unique hybrid form where it can be used both at home as a console, or taken outside as a self-contained, portable device. It catered to both Japanese gamers, who favor handheld devices, as well as overseas fans who are used to consoles.

When Furukawa took the helm at Nintendo, the Switch had already been in stores for over a year. Japan sales for the Switch, at 16 million units, have already exceeded that of the Wii.

Part of that appeal is games, like Animal Crossing, that were designed to be best played on the device. Furukawa pointed out that developers from both the hardware and software side work closely together in the same building at its headquarters. "We've been doing this for over 35 years," he said.

Furukawa, who grew up playing games on the Famicom, joined Nintendo in 1994. As the company explored new games and consoles, like the famous Nintendo 64 which spurred the Mario franchise, Furukawa spent most of his time absorbed in accounting, including a 10-year stint at Nintendo's Germany offices.

He was appointed president in 2018 after his predecessor, Tatsumi Kimishima, believed Furukawa's overseas work experience and younger perspective would benefit Nintendo's future management. Furukawa was 22 years younger than Kimishima, who, at the time, endorsed Furukawa as a person "with extremely strong inner fortitude."

"He has clear and articulated opinions, he understands the Nintendo point of view, and he can express that to everyone in his own words," he said.

"[Furukawa] is the type of person who views Nintendo objectively and is very composed," said Masahiro Ono, an analyst at Morgan Stanley MUFG Securities in Tokyo. He points out similarities to Sony President Kenichiro Yoshida, who was also drawn from the company's finance side and is often described as a reserved man. "He is elusive and talks about the company in a bland tone, but understands he needs to make Nintendo's business less volatile and more stable," Ono added.

Volatility is the plague of the gaming industry. The Switch's immense success follows the dramatic failure of its previous console released in 2012, the Wii U, selling only 13 million units globally as the company's operating profits plunged into red. Advertising emphasized the responsiveness of the tablet-like console and its touch screen controller. But gamers quickly found that it only worked a few meters away from the home base hardware, as well as being disappointed by the lackluster lineup of software.

Nintendo's Animal Crossing games are displayed at a store in Tokyo. (Photo by Tokuyuki Matsubuchi)

The Switch, however, was a runaway success from the very first, its intuitive controller backed by a strong offering of new games. In April, the company was forced to temporarily suspend shipments of the console in Japan as it struggled to keep up with relentless demand while its supply chains were disrupted by COVID-19. The price of secondhand Switch consoles skyrocketed on online auction sites, with some selling 50% higher than retail price.

Yet nobody views Nintendo's success, outstanding as it is, as an endpoint.

"It's really from this point onward that Furukawa's skills as a leader will be tested," said Hideki Yasuda, an analyst at Ace Research Institute. Yasuda sees potential, though, adding that, "Rather than governing the company alone, he listens to opinions of others, even those outside of the company."

When asked directly, Furukawa himself is self-deprecating. "I don't have knowledge in game development," he said, "So I try not to get in the way of the people who are connoisseurs of our products."

"Gaming is a tough business that requires constant creation and risk-taking," he added, saying that while the company focuses on offering appealing content, "we are also very careful about our games' functions, like the controllers, to make sure even people who touch it for the first time can easily operate it."

Furukawa gives credit to the company's long-held philosophy. "It's our mission to make everybody around the world smile and have fun. We continue to challenge ourselves to make change -- the basis of our company," he said.

Dressed as Mario, former Japanese Prime Minister Shinzo Abe announces the country's ill-fated hosting of the 2020 Olympics. (Photo by Takaki Kashiwabara)

Many analysts also expect strong sales to continue, despite the back-to-back releases of next-generation gaming consoles by rivals Sony and Microsoft in November.

"They don't compete directly," MUFG's Ono says. "When looking at the specifications, Sony's controllers are clearly more advanced. But that's not what people want from Nintendo. People choose Nintendo's console because they want to play the software that goes with it."

One pond

David Gibson, who specializes in the games industry as the chief investment adviser at Astris Advisory Japan, points out that the fact that Nintendo "only really plays in one pond -- consoles -- represents a challenge."

Although the coronavirus has breathed life into the console market, it still pales in comparison to the mobile games market, which has seen unprecedented growth in the last few years. Mobile has become the clear center of gravity for gaming, according to Dutch research firm Newzoo. The company predicts that mobile will account for nearly half the $159 billion gaming market in 2020 -- well ahead of consoles, which will generate $45 billion.

Nintendo is stubbornly at the wrong end of this curve. The company has struggled to produce significant results in mobile: It released its first mobile game in 2016, and sales for mobile games still accounted for less than 4% of Nintendo's overall revenue for the year ended March 2020.

Meanwhile, the console market is up against major shifts with new players like Google, Amazon and game publishers such as Valve Corp., developer of online distribution site Steam -- the dominant marketplace for PC games -- accelerating their efforts in cloud-based gaming. That could eliminate the need for specific consoles and challenge what has been the standard business model.

Amazon aims to launch its cloud gaming service Luna next year, which gives subscribers over 100 titles to play across PCs, smartphones, televisions and tablets, for a monthly fee. It joins other similar services like Google's Stadia and Sony's PlayStation Now. China's Tencent Games has also been pushing their efforts in cloud gaming.

Furukawa said the company would "take action ... as the technology evolves," but noted that "the most important thing is still how appealing the content is."

And while the Japanese company is adamant about hewing to its strengths in content, paired with its software and hardware integration strategy, it has been slowly taking new steps to shore up longer-term growth.

Extending the life cycle of the Switch has been a key theme. In 2019, it also launched Switch Lite, a handheld version cheaper than the original Switch. The device, with its compact style and affordable price, has acted as an entry point for new gamers to dive into Nintendo's other products and overall gaming ecosystem.

Console-ation

Many experts say that Nintendo is sitting on a potential untapped gold mine, however, in the form of well-known and universally loved cartoon characters like Super Mario and Pokemon. In 2015, the gaming giant made the decision to push its intellectual property and broaden the use of its characters beyond games, including in merchandise, theme parks and movies.

Ace Research's Yasuda equates the power and level of familiarity of Nintendo's collection of characters to that of Disney's Mickey and Minnie Mouse. "Nintendo's characters appeal not just to specific age groups or genders, but to all kinds of people, all the way from 5-year-olds to 95-year-olds," he said. "That's something even Marvel hasn't been able to do."

It has experimented by announcing a partnership with Universal Pictures subsidiary Illumination in 2018 to develop an animated movie based on Super Mario, aiming to release it in theaters by 2022. It also struck a deal to build a Mario theme park, Super Nintendo World, within Osaka's Universal Studios Japan. The area was supposed to open this summer, but -- in a pandemic-related hit for Nintendo -- has been pushed back to next spring because the park suspended operations. In October, Universal Studios opened the world's first Mario-themed cafe and merchandise store to whet appetites for the park itself.

Untapped gold mine: Nintendo Tokyo, Nintendo's official store in Japan. (Photo by Ken Kobayashi)

Last year, it also opened its first flagship store in Japan, selling consumers exclusive merchandise as well as the chance to trial the company's latest releases on the Switch.

"By brand-building and rousing consumer interest, we want more people to become interested in playing our software and hardware," said Furukawa.

But investors want to see more, and their priorities are set to clash with Nintendo's conservative management. One Japanese institutional investor who is a Nintendo shareholder expressed frustration over the company's lack of concrete strategic goals.

"The company needs to act with more speed," he said. "Much of Nintendo's earnings are still from console and software. They have not been able to deliver results from other businesses."

Furukawa takes the stand that a wholesale strategy shift would amount to overexposure. "We haven't set a sales target because we don't want to increase the exposure of our characters just for the purpose of earning profits," he said. "That would damage the value of the intellectual property."

Hong Kong-based activist fund Oasis Management has been a Nintendo shareholder since 2011. Founder and chief investment officer Seth Fischer holds the view that the company has "the potential to monetize its great collection of characters,'' but points out that Nintendo is still "conservative."

"The company could be more aggressive by experimenting with different platforms," Fischer said. "When we began engaging with Nintendo's management years ago, my young kids didn't know who Mario was. They've come a long way since then, but I'm sure Nintendo can do more."

But as Nintendo's hardware dominance faces disruptions from cloud gaming and rival tech platforms with major ecosystems, it will be vital for the company to wean itself from console-related income.

"Nintendo's big challenge will be whether it can transition from a major console maker to a major content publisher, and really turn into an IP holder like Disney," MUFG's Ono said.

UBS's Fukuyama predicts that the sales for the Switch will likely peak out this fiscal year. With earnings outside of its hardware and software business still small, "it is important for Nintendo to build other businesses that will support it when sales for the console decline," he said.

The games industry has been flooded with rumors of Nintendo planning to release an updated version of the Switch, called Switch Pro, along with a new lineup of games.

Furukawa avoided talking about any new projects, saying, "There is nothing we can say in detail," with the assurance that "we will continue to develop new products that our customers desire, so please wait."

"It is important to have a workplace where you can resolutely take on new challenges," said Furukawa. "Nintendo has had that environment ever since I joined the company, but it will be vital to continue."

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