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

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In summary, Nintendo quickly built a large installed base for its game console and tactically explored the benefits of network externality from both game developers and consumers. In addition, Nintendo strategically lowered the added values created by game developers, chip suppliers, and retailers to raise its own added value. As a result, Nintendo created and sustained its competitive advantages.

4. In 1987, a new 16-bit technology was introduced to the market. It was faster and could produce substantially better graphics than the 8-bit NES. NEC and Sega were the first companies to introduce 16-bit systems. Discuss how Nintendo should respond to this threat. Should they introduce a 16-bit system at the earliest opportunity? Should they delay? Are there any specific strategies you would recommend?

Nintendo should delay the launch of 16-bit system. First, Nintendo had leading position in the 8-bit market and continued to create value, thus an immediate introduction of a 16-bit system would cannibalize its 8-bit product profitability. Moreover, as Nintendo continuously offered complementary products such as new games, game magazines and hot-line service to maintain its 8-bit system customers, these royal customers would face high switching cost when switching to a different brand gaming system, even though the new 16-bit system offered better gaming experience. Finally, if Nintendo directly competed with NEC and Sega in the new 16-bit system, a price war was inevitable, compromising the profitability of all the market players. In contrast, without Nintendo’s deference, NEC and Sega would be able to price the new 16-bit system at higher level and capture all the 16-bit system market, cushioning the effect of technology transition for Nintendo as well. Such a win-win strategy would not result in fierce retaliation among different market players and the video game industry could be more sustainable.

However, it does not mean Nintendo shall completely ignore rivals’ new 16-bit product. Instead, Nintendo shall continuously evaluate the trade-off between giving up 16-bit products and extending the life of 8-bit products and find the best opportunity to introduce the 16-bit products. Meanwhile, Nintendo shall focus on the drawbacks of rivals’ product so that it can close the gap when launching the new system. Moreover, Nintendo shall consistently maintain its installed bases by offering more strong complementary products. For example, it could develop games that less dependent on the graphic quality so that the remaining value could be extracted from the old 8-bit system. Nintendo could also signal the market, particularly the existing customers, with an implication that it would worth waiting for Nintendo’s next generation products. In addition, Nintendo could get around the 16-bit system and develop an even better gaming product. Last but not least, Nintendo could strategically leverage its large installed base by offering existing customers certain discounts and promotion programs when launch the new gaming system so that its market share would not significantly lose to competitors.