Acquired - Nintendo's Origins

Episode Date: March 16, 2023

You may think you know the Nintendo story: a plumber named Mario, a princess named Zelda… and didn’t they buy the Seattle Mariners at some point? We thought we knew it too. And then we started researching and were blown away.The lovable Disney-like Nintendo that we know today is a 130 year-old a playing card company (i.e. gambling), forged in the shadowy world of the Yakuza and shaped by a four-generation cycle of bitter family betrayal. And its unlikely transformation into a global multi-billion dollar media monopoly was led by an iron-fisted patriarch who — amazingly — never played a video game in his life! Get ready for one of our favorite stories Acquired has ever told — we couldn’t make this one up if we tried!Links:Our Atari episode with Nolan BushnellVideo of id Software’s legendary PC “port” of Super Mario Brothers 3Episode sourcesCarve Outs:Everything Everywhere All At OnceMichael Lewis on Tim Ferriss and on CSPANSponsors:ServiceNow: https://bit.ly/acqsnaiagentsHuntress: https://bit.ly/acqhuntressVanta: https://bit.ly/acquiredvantaMore Acquired!:Get email updates with hints on next episode and follow-ups from recent episodesJoin the SlackSubscribe to ACQ2Merch Store!

Oh, have I ever done my Mario impression for you? No, I would not expect you to have a Mario impression. I don't know where this came from. Maybe all the Super Smash I was playing in college on N64, but here it goes. That is amazing. Wow. I had no idea you had that in you. I'm very impressed.

See, I've been storing that up for this episode. Wow. When Charles Martin moves on from this mortal coil, I think Nintendo knows who the replacement is going to be. That is so good. I'm never going to be able to look at you the same. Good, that was the goal. All right, let's do it.

Let's-a go. Who got the truth? never gonna be able to look at you the same good that was the goal all right let's do it let's go who got the truth is it you is it you is it you who got the truth now is it you is it you is it you sit me down say it straight another story on the way welcome to season 12 episode 3ired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Video games are an absolutely enormous industry with a market size of over $100 billion of consumer spend every year. That makes it bigger than Hollywood and the music industry combined today in 2023. And while we are all aware that games are a fixture of life today,

from your kids playing Minecraft on an Xbox to you popping open Candy Crush on your phone for a flight, this phenomenon of humans spending all this time playing video games is actually pretty new. Once upon a time, video games were a tiny niche market aimed at just teenage boys as a subset of the toys category that had fits and starts. It was not all up and to the right. And in the early 1980s, the video game industry in the US had some dire straits and nearly evaporated entirely until Nintendo made a huge bet and changed history forever. Oh man, I've been a gamer all my life. I love video game history. I was so looking forward to doing this episode and covering Nintendo. And I had no idea what an incredible story it is of how Nintendo single-handedly resuscitated this industry

and achieved 95% global market share and dominated this multi-billion dollar industry that was left for dead. That is the story we're going to tell today. Like, we're not going to get to the Switch. We're not going to get to the Wii. We're barely even going to get to the Super Nintendo. Yes. On this episode, we'll be covering Nintendo's early years, or at least the first

hundred years of the company, up until about 1990. And then I think we have a part two in the works, because the story of Nintendo after 1990 is like a completely different company and a completely different set of analyses to do. So consider this a part one and truly a story all to its own. Well, listeners, we have a big announcement. We are renaming the LP Show. The LP Show has been public for the last year and has effectively served as Acquired's ESPN2 channel. The deuce.

Yes. So we're going to make it official. The LP Show is now known as ACQ2. It still has the same great expert interviews with founders and investors like Vijay Raji, the former Facebook exec who founded Statsig, and Megan Reynolds, the head of capital formation at Altimeter. You can still find it in every single podcast player, whether you are an LP or not. So if you've never given it a shot, there is no better time. Just search ACQ2 in any podcast player, and we have some banger episodes coming up in the next couple months on the calendar.

For our LPs, just so you're not confused, we will keep updating your old feed with all these new episodes, just so you don't miss them. And speaking of the LP program, we are revamping it. It is not going away. We want to basically shift away from it being about these episodes and make it more about bringing you closer into the Acquired kitchen. So for our limited partners, we're bringing back private Zoom calls that will email you about the next one soon, and we'll be adding a new feature. You can help us pick future episodes. So LPs, look out for an email on that and more stuff to come. You can join at acquired.fm. Okay, listeners, now is a great time to tell you about longtime friend of the show, ServiceNow. Yes, as you know, ServiceNow is the

AI platform for business transformation, and they have some new news to share. ServiceNow is introducing AI agents. So only the ServiceNow platform puts AI agents to work across every corner of your business. Yep. And as you know from listening to us all year, ServiceNow is pretty remarkable about embracing the latest AI developments and building them into products for their customers.

AI agents are the next phase of this. So what are AI agents? AI agents can think, learn, solve problems, and make decisions autonomously. They work on behalf of your teams, elevating their productivity and potential. And while you get incredible productivity enhancements, you also get to stay in full control. Yep. With ServiceNow, AI agents proactively solve challenges from IT to HR, customer service, software development, you name it. These agents collaborate, they learn from each other, and they continuously improve, handling the busy work

across your business so that your teams can actually focus on what truly matters. Ultimately, ServiceNow and Agentic AI is the way to deploy AI across every corner of your enterprise. They boost productivity for employees, enrich customer experiences, and make work better for everyone. Yep. So learn how you can put AI agents to work for your people by clicking the link in the show notes or going to servicenow.com slash AI dash agents. After you finish this episode, come discuss it with the other 14,000 smart, thoughtful, kind, curious members of the Acquired community at acquired.fm slash slack. And without further ado, David, take us in. And listeners, this is not investment advice. David and I may have investments or make investments soon in the

companies that we discuss. And this show is for informational and entertainment purposes only. So there are quite a lot of books written about the history of Nintendo, some of which are very good. And we've read basically all of them at this point. In particular, I would highly recommend Game Over and Power Up. Yep. And I read Super Mario, also great. But the thing that we realized, and Ben and I were texting about this as we were doing the research, all these books either focus on the Nintendo Japan story or the Nintendo America story, or the video games in America story, or the video games in Japan story, and they keep them separate. And it's super weird to us. I think that kind of misses the point of the story here, which is that the rise of video games and the rise of Nintendo is this

incredible interwoven global tale. Nintendo of America wouldn't have happened without Nintendo of Japan and Nintendo of Japan would not at all be what it is without Nintendo of America. So what we're going to try to do here is unite these stories and tell them together as one canonical Nintendo story. I think maybe for the first time. I don't know, at least that we've found. So this is going to be fun. So speaking of this, we start our story appropriately enough, not in Japan in the late 1800s friend of the show and one of, if not maybe the original father of Silicon Valley, Nolan Bushnell of Atari. And certainly the father of the video games industry. We had a chance to interview Nolan back in 2019 on the show. You can find that episode in our

back catalog. He is such a character. You can't understand him without listening to him. And he is one of a kind. So Nolan grows up in Utah, of all places, in the 1950s. And he's just from birth this incredible hustler and entrepreneur. And one of the jobs that he gets growing up is working at carnivals. He's literally a carny and he keeps referring to himself as a carny in our interview with him, which is fun. Arcade games back then in the 50s and 60s were not what we think of arcade games today. They were what's called electromechanical games. So these are things like everything from you shoot the water gun to make the balloons pop to little lights and stuff going on.

You swing the hammer to hit the bell. They were games, and they might have involved some circuitry components, lights and sounds, but they were not video games. And lots of bars had games like this. They were something to do at bars. In fact, one of the leading companies that made these electromechanical games back in the day was a little company called Sega, which we'll come up later. So Nolan, in addition to having this incredible entrepreneurial streak and background

in arcades, he does something pretty unique. He goes to college at the University of Utah and majors in electrical engineering. And this was a pretty special place and department to be in at that time. Other folks who came out of the University of Utah Engineering School around this time, Alan Kay, Jim Clark of Silicon Graphics, and Netscape Ed Catmull of Pixar. All of which have been protagonists of Acquired episodes. I know, I know. It's just incredible Silicon Valley DNA that comes out of that time

and specifically focused on graphics and innovating there, which of course Nolan becomes part of this tradition. So while he's there, he programs on a DEC PDP-1. This is one of the original old school computers from the 50s and 60s. They, MIT and several others had one of these devices and folks at MIT had in their spare time created a game for it. The very first video game played on a programmable computer, which was called Space War. And it was a very, very early rudimentary, you know, kind of like Asteroids, not quite Space Invaders. Or Galaga.

Yeah. It's funny how many early video games were space games because of Space War. They were inspired by and derivatives of Space War. And of course, what's like a really easy graphical game that you could put on a black screen that you had green little lines that you can manipulate on? Well, space, there's a lot of black in space. Yep. So when Nolan sees this, he's like, whoa, holy crap, you know, nobody else who is playing Space War in the entire world or using a PDP-1 has also worked at Carnival Arcades. And Nolan's like, man, this would kill it if I could bring it back to the arcades. But of course, at the time, I think a deck PDP-1 cost over $100,000, which is

over a million dollars today. So the idea that you could domesticate this animal, not even bring it into homes, but get the price point down to a point where bars or arcades or carnivals could afford to buy these things. Like no way. Totally. I mean, it just literally never pays back when you're thinking about, I don't know if it was nickels or quarters, but whatever you're putting in the arcade machines, it's just never going to pencil. So when Nolan graduates, he comes out to Proto Silicon Valley and he gets a job as an engineer at one of the leading companies there at the time, a company called Ampex. Their main market was making tape recorders that were used for movies, television, music, recording industries. But all the time that Nolan's

working there, he can't really get both his entrepreneurial and carnival master DNA and this idea out of his head of like, if you could domesticate video games and bring them to the consumer market, they would do really well. So finally, after a couple of years, by 1969, he thinks, you know, thanks to Fairchild and National Semiconductor and now Intel at this point, silicon has gotten cheap enough that maybe you could do this and basically take space war and build a machine cheap enough that you could sell it into arcades and carnivals it's total moore's law story it's like exactly the way that we opened our nvidia episode with maybe not yet but i can see it in the next year that'll get cheap enough to make this new business viable yep so he packs up and

leaves ampex goes to start a company with fellow Ampex employee, Ted Dabney, and their business plan is they're going to do exactly this. They initially called the company Scissorgy, but it turns out that name is already taken by a candle maker in Mendocino, I think Nolan told us. I was going to say the problem with that name is that it's terrible, not that someone else also decided it was a good name. Thank God it was terrible. So Nolan racks his brain and comes up with an alternative idea. He's become a big Go player, and he takes the term Atari from the game of Go, which Atari basically means check,

the equivalent of check in chess, in Go. They build a game called Computer Space that's based on Space War. This is the first commercialized programmed video arcade game in history. They put it together. They contract with a arcade distribution firm called Nutting Associates to distribute it. And it's okay. It's not really a profitable enterprise yet. One, because the amount of silicon required to run the game, remember this is coming from cutting edge scientific military use computers, is still enough that it costs too much to make these machines. It's not really economically viable yet. It has another more important problem though,

which is that consumers in America aren't really ready for space games. They haven't yet made the leap to we're going to live in fantasy worlds and we could pretend we're piloting a spaceship out in space and blasting enemies. That doesn't compete yet with audiences. Right. It's escapism at its finest. And now we take it for granted that whenever you play a video game, you're entering some escapist fantasy. But that was a brand new novel idea. So they get this feedback, Nolan and Ted, and they think, all right, well, one, we need to make this technology simpler so that it's more affordable and cost effective. So they hire one of their coworkers from Ampex, a guy named Al

Alcorn, who's an amazing engineer. One of the themes that's going to come up a bunch in this episode is the mythical 10x, 100x engineer or game designer, somebody who can do things that other people can't. And specifically, what was really valued in Silicon Valley and technology engineering at this time was the ability to design systems with the highest amount of functionality with the fewest number of chips, because every chip that you put in there added a whole lot of cost to the bill of materials. Yep. And not just on the raw costs, but on the assembly time. Soldering takes time. And at this point, there's very little software involved in these games. You're mostly

hard coding the functionality onto the motherboard itself, depending on what chips you put in. Yeah. To put a finer point on that, I don't think there's any software involved. Like I think everything is hard coded in these chips at this point in time. Right. This is managing to create games using just electrical engineering. Right. And something I hadn't even thought about till now, all of the applications of silicon to this point in time, they were mostly for military use cases, somewhat for industrial and commercial use cases. But the end products, like the physical devices that were being produced by all these companies, were not meant to be distributed in large numbers to

consumers. If you're making systems for the government, you're not making a high number of machines. Right. We were in the like hundreds, maybe low thousands of devices when you're considering military communications equipment. Now with arcades, you're into the thousands and potentially tens of thousands, which is a huge leap. So all this kind of value engineering, you can see why it's super, super important. So huge win. They bring Al Alcorn over. He is the engineer that can make this happen. And to get him started, Nolan decides that he's going to give Al,

because Al's never made a game before, he's going to give him like a training project to get started. And he's thinking about what sort of like small toy game could I give out? And it just so happens that Nolan had recently been to a demonstration by the consumer electronics company Magnavox. And Magnavox, which at this point in time, they were one of the companies riding the wave of televisions across America, as we talked about in the NFL and plenty of other episodes. They were looking for ways to market their televisions as superior to other manufacturers out there like RCA or what have you. And they had come up with this little device that plugged into their televisions called the Odyssey. And they called this thing a closed circuit electronic playground. What it actually was, was the very first home video game console.

They just didn't think about it that way. This just goes to show, too, a lot of the times before a category is created, you don't know how to describe the job to be done of the very first product in the category. And so you come up with some really esoteric name like that. And it's only when five other competitors come in after you does the category sort of get a name like video game consoles or home video games. And I think this came up way back when we interviewed Vlad from Webflow on one of the earliest acquired LP, now ACQ2 episodes. He brought up the fact that he's like, oh, people started calling us no code. And he was like, we've been going for five years. We had

no idea we were a no code company, but now apparently that's a thing. And that's exactly what happened with the Magnavox Odyssey. Yeah. It's even more extreme than that. Not only did they not know what to call it, they had no idea what this market was. They thought this thing was a gee whiz device that they could have their sales reps in their stores around the country demonstrate to consumers to help them sell TVs. That's all that they thought about. They didn't think that this would be a market or a product line in and of its own, but they had created this machine in a partnership with a guy named Ralph Baer, who really created it. They licensed it from him, and he's known as the father of home video games. So they had game cards that you would plug into the Odyssey, and depending on

which game cards you had plugged in, you could play different games. We'll see as we go along here, but it wouldn't be for several more years until that idea would come back and people would realize, oh, hey, there's actually value to selling not dedicated hardware into the home of like this console only plays this game, but you want interchangeable software here. So this Odyssey, like we said, Magnavox has no idea what they're doing with it here. And you can't blame them. There's no roadmap for this. But in what should have been a sign to them and certainly was a sign to Nolan, even though they were not marketing this as a standalone device or anything like that,

it becomes a pretty big success anyway, despite Magnavox. They end up selling a couple hundred thousand units of this thing. The Magnavox Odyssey was invented to solve a problem that Magnavox had. And what they sort of failed to realize is that it had a tremendous job to be done for consumers, where they sort of accidentally fell backwards into a gold mine, but did not feel around enough to sort of grab the gold. Yes. Nolan, though, when he sees a demonstration of this, probably the most compelling game on the

Odyssey was called table tennis. And it was like a very, very rudimentary approximation of either tennis or ping pong, you know, table tennis that you could play with the Odyssey on your computer. So he brings this back to Atari and to Al and says, make something like this as your test project here. Al, of course, does, does it brilliantly. And they start playing around with it at the office and they're like, dang, this thing's kind of fun. And wasn't it like a proof of concept game? It was basically a demo to show off the potential of what they could do as Atari. And they didn't realize in creating Pong right there on the spot, they invented a mega hit as the proof of concept. Yes, that was the thing. So famously,

they take the first cabinet to Andy Capps Tavern in Sunnyvale, California, and they convince the owner there to set up this Pong machine as they start calling it at Andy Capps. And it just becomes like a quarter vacuum, like a magnet. Literally all of the pieces of coin in customers' pockets just get sucked right into Pong. It's incredibly compelling. And the thing that makes it so accessible to just average people who are going to the bar is it's relatable. You don't have to make the leap that you're a pilot of a spaceship out in space. Everybody knows what table tennis is. You know how to play this game.

You know what you're doing. And that gets you in to try it. And once you start playing this thing and you get engrossed in it, and Pong at this point in time is only two player. There's no AI here. You have to play against somebody else you get the competitive factor going especially in a bar and they're like oh we got something good here yep so they start producing these cabinets selling them to bars and arcades around the country it's going really well. So well that a certain newly minted venture capitalist comes and seeks out Nolan and Atari, the legendary Don Valentine. When you say newly minted, you know, it's funny in today's terms, he'd be like an emerging

manager. I think he had raised, what, $5 million fund. And this is effectively like Sequoia fund one looking to make its first investment yes and atari becomes sequoia capital's very first investment and it goes even deeper than that with the money nolan and the team at atari start bringing on additional folks to build and engineer games that they can sell. You know, this Pong thing worked out pretty well. They hire a young kid named Steve Jobs. Amazing. To come in and design a one-player,

a solo version of Pong that you can play, which ends up being called Breakout, that he does with his buddy Steve Wozniak. This is like my favorite hidden Atari story, is that freaking Steve Jobs was the designer and the creator with Steve Wozniak of Breakout. So just like that, not one, not two, but three industries are born. You've got the home video game console business with Magnavox and the Odyssey that Atari copied with Pong. You've got the arcade video game business that Atari is really

entering here and starts to take off faster than anything. And then you've got the personal home computer business that Steve and Waz start with Apple. And it all comes out of this one moment, which is incredible. So unlike today with games or any type of software, there's no app store out there. Turns out that distribution is a critical element to building a technology company. So the arcade business with Atari starts to really take off. Companies, both existing electromechanical games companies like Sega and others get into the video game business. Atari's out there, obviously the leader. By the mid to late 70s, the top arcade games out there were making billions of dollars in annual revenue. Like Space Invaders, which was launched by the Japanese company Taito in 1978, it does $2 billion in

annual revenue in the US alone. Whoa, what year is this? This is in 1978. I don't think I realized how big the arcade market got before there were even video game consoles in the home. I've done all this research and I did not realize how big the arcade market was. Yeah, this industry, not only did it dwarf the home console industry that the Odyssey started? It dwarfed the personal computer industry. This was the main application of silicon for the 1970s for consumer markets. By the end of the 70s, the total video game arcade market is $5 billion a year, which is already by then, you said in the intro, today video games are bigger than movies and music. It was already bigger than movies and music by the end of the 70s. Huh, that's a narrative violation. I thought this notion of eclipsing Hollywood and music was a recent phenomenon to show how much time people spend in games. But what you're pointing out is that it was a different form factor and it was a physical location at arcades. But like that's basically always been true.

Well, it was this ultimate hack to get distribution of this new technology and business into the mass consumer market. People already went to bars and arcades and this was a better product of what they already did. So the industry just took off like wildfire. The fascinating thing about this pre-home console era is that there's basically no intellectual property yet because there's no stories yet. These video games are so basic with Pong, with Breakout. It feels silly to compare it to Hollywood because there's not real franchises and characters and stories and anything you can repurpose. You're not going to figure out how to make Pong into a movie or a TV show. There's nothing there.

Right. You could, but it would probably be pretty bad. Right. It's a false comparison at this point in history. Yeah. But again, it makes total sense. This came out of arcades, carnivals. You don't need a story here.

This is about competition in a public environment. So as Atari really starts to take off through the early and mid-70s, Nolan decides that, hey, they should probably get into the home video game business too. Moore's Law keeps happening. We can now create what used to take a whole cabinet into a small box that you plug into your TV that's purchasable by a consumer rather than costing tens or hundreds of thousands of dollars. It's finally happening. Yep.

So they start working on a programmable machine that can play versions of popular arcade hits at the time. And they codename it the VCS, the Video Computer System. Now, as they start working on this, he and the board of Atari realize this is going to be a very different business with different dynamics than the arcade business. And the first and most visceral thing they realize is this is very capital intensive. It takes a lot of firepower to bring a home console to market in the right way. With arcade games, you make the game, you work with a distributor like Midway or Bally or something like that, you get it into arcades and bars and the money comes in. The cash flow cycle is very quick.

And you make one of the machines and like a thousand people can play it. The way to address a thousand consumers is make a machine and let them flock to the bar to drop quarters in. Yeah. But in the consumer market, things are very different. You need to get machines into retail and then you need to get retailers and marketers behind what you're doing and build demand amongst consumers for people to have a reason to go to the store and buy your thing and bring it home. And you need to build a hundred, a thousand times more machines to address that same set of consumers in their home. Right. Toys R Us isn't going to buy your product for their stores if you only have 10 of them. They're going to buy your product if you have at least a million of them.

Yep. So Silicon Valley has not evolved to the point yet where there are big growth funds out there that could come in and give Atari a couple hundred million dollars to build up this inventory. So they decide the right thing to do is sell the company. They end up selling it to Warner Brothers in 1976 for $28 million. And this becomes one of the greatest acquisitions of all time for a very brief period. But during that brief period, the payback on Warner Brothers' $28 million investment is pretty incredible. Yeah, that ubiquitous Atari 2600 system that everybody sort of has a fond memory for and recognizes pretty instantly, basically all the value of that accrued to Warner Brothers, not the founders and investors in Atari, the

independent company. Yes. So they acquired the company in 1976. 1977, they release the VCS, which gets renamed as the 2600. It's a smash hit. It sells a million units in the first year and then sales double every single year for the next three years. It's so huge that by 1980, just like three years after the 2600 launches, the Atari division of Warner Brothers does $415 million in revenue, which is one third of all of the revenue that Warner Brothers does. Basically, Warner Brothers, the publicly traded Hollywood studio, becomes a video game company for a couple of years. That's insane. I had no idea it was that

meaningful to Warner. This is the thing that has just gotten lost to history is that the video game industry took off like almost nothing we've ever even seen to this day. Right. I mean, we're building up to this impending crash here, but boy, those first five years were incredible. Yeah, it is a total gold rush. So much so that Atari is not the only ones making money here. Lots of other toy companies, other media companies decide, hey, they want to get in on this home console video game business too. So Mattel enters the market. A toy company called Coleco enters the market, which actually had its roots in the leather business.

It's the Connecticut Leather Company. Oh, wow. Yeah. So everybody's coming into market here. And it quickly became a subcategory of toys in the sort of American consumer psyche. The way that people thought to spend on this is, oh, my eight to 18 year old son needs a toy and it's a big birthday or something. So I'm going to get him a really nice toy, which is going to be one of these video game things. Yep. And specifically the magic to this and why these became so popular as toys and what informs the whole business model for decades to come, is the swappable game cartridges. So if you buy an Atari 2600, you're not just buying a toy for this year or this birthday or this holiday, you're buying toys for the next several years to come.

And this is like a full lean-in on the Razer Blade's Razors model, where I'm pretty sure Warner's wasn't actually generating gross margin on the atari 2600s they were selling they would make all the money on the games which has been true even in the modern gaming era i mean you look at the incredible amount of firepower in the playstations and xboxes of the last 10 years those things sell for the very cheapest they possibly can in order to get an install base so that they can make money on the games. That's what was happening with Atari here too. Totally. Everybody's figuring this out all at once. So much so that a few engineers at Atari

after the acquisition, they start to realize this and they think, man, all the money, all the profits are in the software here. What if we leave Atari and we set up a new company that's just going to make games? We're not going to make hardware. We're going to make games for the 2600. So they leave. They actually don't set up a deal with Atari, these guys. They start publishing their own games. They make the cartridges. They sell them on the market themselves. Because Atari didn't require you to do a deal with them. Nobody was thinking about third-party developers yet. These guys who left, they knew how to do it because they were Atari employees. So the company they start is a little company called Activision,

which is now in the process of being acquired by Microsoft for just about $80 billion, just as a third-party publisher. So Atari ends up suing this new Activision. They're like, hey, you can't do this. They're fighting it out in court. And by the way, the reason they name it Activision is so it comes before Atari in the phone book. I'm pretty sure Accolade, there were a handful of A publishers at the time that all had the same idea. Yep. While they're fighting it out in court, which is just so funny,

somebody must have taken a step back at some point and realized, hey, wait a minute. What are we fighting about? There is so much money to be made here. What if we, Activision, just pay you guys, Atari, like a royalty fee for every cartridge that we sell? You get 10, 20, 30% of what it doesn't even matter. We're all making so much money. Atari's like, oh yeah, you mean you make the games, you sell them, and we just get money? Okay, cool. Oh, and we have to take no capital risk on you developing that game. We just make money only if it works. Got it. Got it. Yes, please. Yes, please. Indeed. And obviously, that works out very, very well for all involved. For a time for Atari. Yes, for a time. So you've got this rush of competition coming in for the video game consoles. Yes. And the problem was it worked too well. Got the parallels to like Web3 and crypto here just all over this episode. But there was so much money to be made. Everybody rushed in with a game. Game, quote unquote, here.

Like people were just shoveling any kind of software that they could. Both the first parties like Atari, like Mattel, and third parties like Activision. They were just trying to get games into stores because people, parents, would buy them without knowing what they were. And like it didn't matter if they were crap. It was just a license to print money. And it wasn't just the games. Once people realized the power of this royalty model, they wanted to come out with systems too.

And so you had 15 different companies rush to market in the US with consoles. And so suddenly these toy stores got flooded both with games and consoles. And as you would imagine, there's intense concentration in the consoles that got selected. There's a real ecosystem effect and network effects that need to be developed for these things to work. And so for a console to be successful, you need a bunch of people buying the console and once you have a reason for people to develop for your thing then suddenly you actually get the good games not all the shovelware crap that's hitting the shelves and so you kind of needed the market to suss out hey can we consolidate down to just a few game devices a few consoles because otherwise nobody knows what to buy, nobody

knows what to develop for, and it's just a big mess and the whole thing's going to be a failure as a category. Yep. The problem was it was so overcrowded and so overfunded, just like things in recent history here in 2023, that didn't happen. Nobody could figure out what was the crap. There was just too much out there. Right. The laws of economic physics were broken. And instead of free market dynamics playing out, there was just tons of incentive to just go make more stuff and get it out there, even if it may or may not work. Yep. So remember I said by 1980, the arcade video game business was a $5 billion annual industry in the United States. By the end

of 1982, just two years later, the home video game business is a $3.2 billion industry. Almost as big and combined, you've got a $10 billion industry that just sprung up overnight. Incredible. And just to paint where we're going here that 3.2 billion dollar video game market that home video game console market in 1982 by 1985 would be worth 100 million dollars a reduction of 32x in the market size because the entire category just went away. Just disappeared. To put that differently, a 97% drop in market size within two years. So everybody who came into this industry, the third-party independent software game developers,

the hardware guys, Atari, Warner Brothers, Mattel, they just lose their shirts. Because remember, this is still the 1980s. Software has real cogs to it. These are physical packaged goods. These are cartridges and systems with silicon and chips in them. And supply chains and labor. There's billions of dollars of inventory tied up in these companies, in all these systems and games that all of a sudden now is sitting on shelves and can't sell. So all these companies have huge losses. Warner Brothers, publicly traded Warner Brothers company, has to report massive losses, so much so that to appease Wall Street, they have to break up Atari and sell it off. They sell the console business and the games business separately.

And Coleco and Mattel completely exit the video game business. The whole industry, the home video game industry is just decimated. It gets dead. This is when the famous E.T. Atari game, the cartridge burial happens in New Mexico. Atari made so many of these E.T. games that they jointly developed with Universal. And in fact, Steven Spielberg himself was involved in approving the concept of, yes, let's turn E.T. into a game. The game was so poorly made and the actual game

mechanics were so not fun, much like basically every other game at the time, because you're trying to figure out what console to make it for. make it for like five consoles you're rushing to market with this and 16 other games at the same time eventually the quality of every single thing that's hitting the market is so low because all the incentives were to just get crap out there that consumers just stop buying and so stores just stop buying upstream specifically consoles they. They kind of stop buying games, but they really stop buying consoles except for the one or two or three that are the leading consoles. But even then, they're not placing big orders anymore. And that's sort of how you have this whole whip crack effect all the way back upstream to the game makers and the newfound

publishers, these third party developers, that the whole thing kind of collapses. The interesting thing with E.T. is, to your point, they didn't want people discovering the buried games and then reselling them for cheap and compounding the problem even worse. So they literally took wrecking balls and they're smashing the cartridges and they bury them in a landfill and they pour concrete on top. And people have gone and excavated this and looked, and this is a real thing that they had to bury all this inventory. Point is, it was brutal. Now, like you said, Ben, this was the way this industry went to market was as part of the toy industry. So this is actually not anything new for the

toy industry. Toys are so cyclical. They're fads. And so the mental model that everybody here in America has for what just happened is, oh, the home video game console was like the hula hoop. Specifically, you know, I mentioned Coleco, which entered the industry. When they get out of the video game industry, the next thing they do is cabbage patch kids dolls. This is just how the toy industry works. You move on to the next thing, you make as much money out of it as you can before the fad, the kids move on and the generation changes. It's fad based and it's super seasonal. Basically like Q3, Q4 matters and you're not

selling anything Q3, Q1. It's like just the rush up to Christmas. And so everyone's sort of viewing it as, oh, 1982's Christmas toy was the video game console. And oh, yeah, it didn't really pan out that people would want those in more future years, but I'm sure we'll find something else. So here's this opportunity of a lifetime sitting right there in plain sight for anybody who has the foresight to actually realize this, which is the video game industry, specifically the home video game industry, is not like toys. There actually was incredible product market fit and demand for good games out there. There's a reason why kids wanted this stuff. And the business model of a home video game system

is one of the best of all time. We talk on this show about how the software business model is the best business model of all time. And the media business model is the second best business model of all time. Video games are software that is media. It doesn't get any better than that. You sell a console, whatever, you lose money on the console, who cares? You sell games into homes across america and across the world at 50 bucks a pop that even with all the manufacturing costs you're still making 80 gross margin on this stuff that's pretty incredible and you can sell three four five ten of them a year especially once you flash way forward to games today there's zero marginal cost

to make another copy of the game. There's zero distribution costs because you just ship bits over the internet. And to your point on top, it's media that is software. It's also IP. We're about to tell the Nintendo story here as we transition to Nintendo and how they really find story and characters in an industry that just had non-human characters, spaceships, and sort of inanimate objects. You have a whole new level on top which is the durability of ip franchises that is about to come into view for the first time so you're right unbelievable business model to produce these games and if you can be sort of the platform maker and get all of the platform network effects that accrue when you are the game console manufacturer.

God, you put those two things together. That is a pretty great combo. So enter Nintendo. All right, listeners, our next sponsor is a new friend of the show, Huntress. Huntress is one of the fastest growing and most loved cybersecurity companies today. It's purpose built for small to mid-sized businesses and provides enterprise grade security with the technology, services, and expertise needed to protect you. They offer a revolutionary approach to manage cybersecurity that isn't only about tech, it's about real people providing real defense around the clock. So how does it work? Well, you probably already know this,

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by customers in the G2 rankings as the industry leader in endpoint detection and response for the eighth consecutive season and the industry leader in managed detection and response again this summer. Yep. So if you want cutting-edge cybersecurity solutions backed by a 24-7 team of experts who monitor, investigate, and respond to threats with unmatched precision, head on over to huntress.com slash acquired or click the link in the show notes. Our huge thanks to Huntress. Okay, David, as we get into the Nintendo story here, there is one thing I think that's important listeners to know before we flash back and tell Nintendo from day one, which is the U.S. video game market is decimated. But in Japan, for home game consoles that were just starting to really

find their footing around 1983, they kind of resisted the urge to import all of these American consoles that were flying off shelves. And so in Japan, you had a completely different dynamic, which was there were only a few consoles but they were selling quite well and they didn't have a ton of competition so there actually was a moment in the japanese market to look around and observe when we make high quality games people totally want to buy them and pay for them and knowing that might give us an advantage in entering other markets too. Totally. So Nintendo, we go back to 1889, a hundred years earlier in Kyoto, Japan, when one Fusajiro Yamauchi, who was the head of a cement company at the time in Kyoto. Yamauchi was actually not his

original family name. He had become the head of the cement company because he had worked in it. And the person who ran and owned the cement company was ready to retire. He didn't have any male heirs to take over the company, which is how companies transitioned in Japan. And so what you did in that case was you adopted a male heir to take over the company. So Fusajiro was actually born Fusajiro Fuki, but he took on the Yamauchi family name to inherit this cement company. Now, similar to Nolan, many, many years later in America, Fusajiro was looking around for interesting new technologies and how he might apply it to a market that he knew had universal appeal, which was playing games and specifically playing games for money. He saw that there was

an opportunity to get out of the cement business, the boring cement business, and enter the playing card business. So he sets up a new company. He names it Nintendo. And the name Nintendo is actually a multiple entendre. So the kanji characters nin, ten, and do can be interpreted as leave luck to heaven, which of course references luck in playing cards. It also may be the entrepreneurial spirit of a new venture but definitely plays on the fact that they're a gambling company well that's what i was going to say specifically the character ten at the time was a clear reference to the sort of mythical spirit tengu which was a coded reference for gambling and casinos, which were very, very, very much still illegal at the time. Now, why did Fusajiro see the opportunity here? Playing cards and card games had originally entered Japan from the West in the 1500s, but then they'd been banned for hundreds of years

when Japan's rulers followed a strict isolationist policy and basically kicked all Western influence out of the country. I think I knew this, but I had forgotten until doing the research. Do you know how they did that? The rulers of Japan for this multiple hundred year period from the 1500s to the 1800s? They institute the death penalty

for any foreigners who enter Japan and any Japanese who leave the country. Whoa. So like they meant it it all Western influence out of Japan. This goes on for hundreds of years. Wait, if you entered the country, it was just so illegal that they would kill you. Yes. Oh my God. Yeah. I feel like I missed this part of world history. Yeah. But human nature is human nature. And even despite this very strict effort to eliminate Western influence from Japanese society, the allure of playing games and gambling for money is too strong to resist. And so during that time, the playing card system developed a kind of substitute parallel track in Japan

called, instead of the Western deck, the Hanafuda cards. And instead of four suits, these cards had four seasons. And instead of 13 numbers and faces on the cards, they had 12 months of the year, but used for basically the same purpose, which is games of gambling. So by the late 1880s, after the Meiji Restoration, the government had finally removed the official ban on playing cards. So Hanafuda cards existed for hundreds of years, but even they were like underground. Finally, now you could legally produce these things and so that's why yamaguchi starts nintendo so nintendo becomes quite successful in this new industry so successful in fact that they become the largest playing card manufacturer in japan you think like cool that's great interesting

business you know playing cards fun games i can see maybe how that leads to uh you know, playing cards, fun games. I can see maybe how that leads to, you know, what Nintendo becomes. If you think about it a little more, though, playing cards are now legal in Japan. Gambling is not, though. And what is the main use of playing cards? Well, it's gambling. Who are the primary customers for playing cards? It's not households. Okay, so anybody who's operating an illegal casino, basically. It's organized crime. It's the Yakuza in japan the japanese mafia whoa i had heard whispers that there was some yakuza involvement in nintendo's history but i didn't find anything about it what do you got well so the yakuza operated gambling parlors and casinos all throughout the country. And they're just like casinos in America.

When they play games with cards, they use a fresh pack of cards for every game because you don't want to have cheating. This is an incredible business. What an incredible customer for Nintendo. These gaming parlors run by the Yakuza who need thousands and thousands of packs of cards. Wow. Very, very successful business and a quite interesting distribution capability that Nintendo builds up over these 50 plus years that they're just a playing cards company.

Wow. So on this show, we talk a lot about value chain and where power accrues in a value chain and how you get power as a company. It doesn't feel like you want your biggest customer to be the Yakuza, and it doesn't feel like you want them controlling your destiny. Maybe, maybe not. I mean, if you can navigate that successfully, you can really develop quite a lot of power within a market. It's so interesting because in the US, the early arcade games industry was sort of the same way. It was also a mafia thing. We talked about this with Nolan. Yeah. And that is 100% the roots of Nintendo. So Fusajiro

Yamauchi runs this business for a number of decades quite successfully. He ends up having the same problem that his adopted father, the original cement entrepreneur, had before him, which is when it comes time for him to retire, he doesn't have a male heir. So he arranges for his daughter to marry a promising local young man named Sekiro Kaneda. And Sekiro also changes his name to Yamauchi. He becomes the, at this point now, third coming of the mythical Yamauchi and the second president of actual Nintendo itself. Sekiro also doesn't have any male heirs. So for the third time, the Yamauchi patriarch arranges to adopt an heir to run the business in the future. And specifically, Sekiro arranges for his eldest daughter, Kimi, to marry another promising young local man, Shikinojo Inaba. Shikinojo also adopts the

Yamauchi name. He starts being groomed to take over the business. And then finally, in 1927, he and Kimi have a son, the first Yamauchi son in three generations. And they name him Hiroshi Yamauchi. Unfortunately, here's where things start to go pretty terribly wrong for Nintendo. And what year are we in? We're in 1932. So this is before the war. Hiroshi is five years old. Shikinojo walks out on the family and abandons the business, the family, the son, and leaves.

Nobody knows exactly why. This is kind of lost to history. But I got to imagine between all the pressure, the family, the business, the Yakuza connections. There's a lot going on here. His mother, Kimi, also kind of never recovers from this incident. She basically also leaves the family. So Hiroshi Yamauchi, the first actual Yamauchi born in generations, is pretty much orphaned at this point. His grandparents, Sekiro and his wife, adopt him, but they're not parenting him. Not to mention that World War II happens when he's an early teenager. The life that he grows up in is quite, quite, quite difficult. Finally, when he's 18,

the war is over. He makes what I assume must have maybe been like a deal with his family and his grandfather. He escapes Kyoto and goes to Tokyo to study law at Waseda University. But in exchange for being able to do that, the family and his grandfather arranges a marriage for him as well to the daughter of a formerly high-ranking samurai family. And then pretty much right after this happens, a couple years later in 1948, Sekiro suddenly has a massive stroke and is completely incapacitated. This is Hiroshi's grandfather. This is Hiroshi's grandfather and can no longer run the business. And so he summons Hiroshi back from Tokyo, from law school to Kyoto Kyoto and commands him to take over the family business to become the next Yamauchi running Nintendo. Wow. And this is pretty young to take

over the family business. He's 21 years old. Because his father had walked out on him and the family, there was this missing generation here. And then his grandfather, who has this very complicated relationship with, has this sudden stroke. And all of a sudden, Hiroshi has to come back and take over the business. Now, listeners, the crazy thing is you might be thinking, wow, so this guy probably has no idea how to run this business. It's unlikely that it would be successful. Interestingly, he develops into a leader who has an unbelievable eye, this killer taste. We're going to flash way forward, like what games are fun and what games are not fun by not even playing them, like observing them for like a half hour. And he's like, this is going to be a winner. It's amazing that out of basically no training and

no real apprenticeship in the business turns into this oracle of fun. He comes back to Kyoto. He takes over the family business. He waits until Sekiro finally dies, which the writing was on the wall, happens in 1949. As soon as that happens, he institutes a massive purge. He fires not just anyone who is loyal to Sekiro and the company, he fires every single manager in Nintendo, just decapitates everybody. He doesn't literally burn the company to the ground, but he just about burns the company to the ground. So there's basically no more institutional memory of a leader other than him in the entire organization. Yes. And there is no question who the new Yamauchi

is going forward and who is in charge here. Wow. Yeah. Totally crazy. And so we're in what, 1950-ish when he takes over? 1948, 1949 is when this happens. So Hiroshi though, like you said, for the first time, he's 21 years old. He's a young man. He doesn't want his life to be shackled by what Nintendo and the Yamauchi family has always been historically. So he's looking around for ways to make Nintendo his own. And finally in 1959, the perfect opportunity arises. The Walt Disney Company is looking to enter Japan. It's crazy that Disney comes into this story, especially because there's so many parallels between Nintendo's identity as a business and the thing that makes them great and Disney. It's crazy that what lands on his doorstep

is Walt Disney calling. Also given. It's crazy that what lands on his doorstep is Walt Disney calling. Also given what Nintendo's business is, what we just spent 20 minutes describing. Disney's like, oh yeah, these are the guys we're going to work with in Japan. Right. Oh yeah. We're a family-friendly brand that has to protect our brand safety above all else. How about these guys that do business with the mob? But the reason they do it is the way that they want to enter Japan is with playing cards. So Nintendo licenses Walt Disney characters and puts them on playing cards and they sell playing cards to kids in Japan. I gotta buy some of these. If these still exist somewhere on eBay, I gotta go find some. Oh, I bet they do. Some of the documentaries I watched, there's photos and video footage of them.

So you can probably find them somewhere. We got to put these in the acquired museum. Wow. Nintendo branded Japanese Disney cards. So this is what Yamauchi, the, I guess, fourth at this point in time, Hiroshi is looking for. This is the opportunity. Not only does this open up a new market and a new distribution channel, the kids market, the toys market, the legitimate retail for Nintendo,

there's just an incredible opportunity to draft off the Disney brand. So they start with playing cards. Then they start licensing from Disney other kids' toys to sell in Japan. And then they go to the retailers and they say, hey, you like carrying these Disney toys? If you're going to carry the Disney toys, you need to carry some Nintendo-branded toys along with them. It is amazing. It's this story that we tell over and over and over again on Acquired where you acquire something, some asset that then gives you a leg up in a different part of your business. And now it's a self-fulfilling prophecy where that other part of your business is made better. And so by having a scarce commodity,

Disney branded cards, they get power over the distributors. So now you actually have a reason to be in stores. And now that you're in stores, it doesn't matter how you got there. You have that channel, you have those relationships. And especially if you can hold them captive and say, you have to distribute our stuff with Disney stuff, then it's a pretty good bargaining position. So during the 1960s, Nintendo transforms itself into a Japanese toy company. They are making things like the Ultra Hand, which is like an extended grabber. I know you did some research on this. This is awesome. So this guy Gunpei Yokoi in 1970 comes up with an idea. We're like breezing through history here, but we kind of have to. It's 100 years. So,

you know, we went from 1949 with Hiroshi taking over to 1959 when the Disney comes in. Flash forward down to 1970. Yokoi comes up with this telescoping fake hand, basically as a gag. And Hiroshi Yamauchi looks at it and he goes, that looks like a winner. Because this guy, he's just so good at identifying things that consumers are going to love. And so they mark it as the Ultra Hand. I mean, truly, he made it as like a gag around the office. They sell 1.2 million products of this Ultra Hand. Of course, then they're all looking around. They're like, oh, we should become a novelty toy company all out. That's what we should do. So come up with i think the 10 billion barrel maze they have a love tester device that they market they have a remote control vacuum like

30 years before roomba and so they're just coming up with crazy toys in the lab and bring it into market all these zany gadgets and because they have this disney sort of damocles that they can hang over retailers heads they know they're gonna get the retailers to carry all this stuff. It's amazing. So you mentioned Gunpei Yokoi. He was a tech on the playing card assembly line, maintaining the machines within Nintendo. And to your point about Yamauchi, he just has this sixth sense for products and for talent.

He plucks them off the assembly line and says, you are now the chief designer, the chief engineer for Nintendo. That's crazy. Gunpei would go on to design the Game Boy and the Virtual Boy. He would run the Metroid series, and he would be the first boss and mentor of one Shigeru Miyamoto. So amazingly now, by the late 60s, early 70s, Nintendo has become a toy company and a very profitable one at that. So Yamauchi starts investing in a whole bunch of other stuff. And one of the things he invests in is failed bowling alleys. What? Bowling was this incredible fad that had taken Japan by hold in the late 60s. And so all these bowling alleys. What? Bowling was this incredible fad that had taken Japan by hold in the late 60s. And so all these bowling alleys got built, but then society lost interest in them. And so there are all these empty bowling alleys. Yamauchi goes and buys up these bowling alleys

and he directs Gunpei to say like, hey, come up with some gadgets that we can put in here and we can attract people to these bowling alleys. And they decide that they can use some of the technology that Gunpei is building for toys to make indoor shooting ranges. Light gun shooting ranges. Not laser tag, more like clay pigeons, but simulating shooting ranges indoor in these former bowling alleys. They do this. This goes pretty well. This becomes another big thing. So this is kind of random.

Nintendo getting into indoor light gun shooting ranges. But actually this becomes the critical thing that pushes them into the video game market for a bunch of reasons. One, this gets Nintendo into the arcade business. Because what else do you put in bowling alleys and indoor shooting ranges but arcade machines? So Gunpei and Yamauchi and the rest of the company start making their own arcade games that they can put into their shooting ranges and bowling alleys. At first, these are electromechanical games like Sega, but once Pong becomes a thing and comes over to Japan and arcade video games, they get into it too. And Nintendo starts making their own arcade video games. Two for Nintendo, these light gun

ranges that they start building, they become pretty good at this and they decide that they can export the technology to North America and Europe. So this is actually the first product that Nintendo starts exporting out of Japan is this technology. And they do it using trading companies to start. So they're not setting up their own distribution internationally yet, but they start building relationships with American companies. And three, and this is kind of just unbelievable here. The light gun business gets them into a relationship with Magnavox.

Remember Magnavox from the beginning of the episode? Oh yeah, the Odyssey. Specifically for the launch of the Odyssey in America. So the Odyssey came with a bunch of peripherals for use in the games on the console. One of the peripherals was a light gun. Whoa. And who made the light gun for the Magnavox Odyssey? Nintendo. That is the most circuitous path to finding their way into American home video consoles, but it makes sense. Right. You cannot script this any better.

Nintendo, who single-handedly in a minute comes in and dominates not just the American, but the worldwide market for home video game consoles and builds this incredible juggernaut around the world. They were right there, part of the very first home video game console launched in America by Magnavox. Wow. But in a way that sort of lets them observe this market without having to push their chips in on this market. Well, let's take the story from there. So they build this relationship with Magnavox. They see that the Odyssey, despite Magnavox is having no idea how to market this thing is succeeding despite itself in America. They're like,

well, we're in the toy business in Japan. This thing might actually do decently here in Japan. So they licensed the Odyssey from Magnavox and Nintendo rebrands and starts distributing the Magnavox Odyssey And Nintendo rebrands and starts distributing the Magnavox Odyssey through its toy retailer channels in Japan. Oh, I had no idea that before the NES, they had their own Japanese distribution of a home video console. This, all from these crazy light gun ranges, this is gets nintendo into the video game business so they start selling the

odyssey in japan and then pretty quickly they actually just license a bunch of the tech from magnavox and start making their own modified consoles so in 1975 is when they licensed the odyssey the next year in, they take a bunch of that tech and they make their own Nintendo home video game console. The very first one that they make, the Color TV Game 6. And it's just kind of a Odyssey knockoff, just more localized for Japan and maybe a little better tech. But the same thing, it only plays a couple of simplistic games, one of which is table tennis. It becomes a huge hit, just like the Odyssey. That Color TV Game 6 sells a million units in Japan. This is transformative for Nintendo. And what year is this? 1976.

Okay. So this is kind of before the success of the US-s based home console rush a hundred percent nintendo is very early to the market just in their own unique way isolated to japan but they're learning everything along the way the next year they follow the color tv game 6 up with a new model the color tv game 15 plays 15 games instead of six games i was like why are they calling it the six okay yeah because remember these are not cartridge based consoles yet oh Oh, you're not selling programmable software for them. Huh? So that sells another 1 million units. And together, these consoles, like I said, totally transform the company. They're making much better margins on these things. They can sell them for a higher sticker price than the ultra hand and the other toys that they're selling.

Right. The shooting gun ranges. That's a fad that goes the way of the bowling alley in Japan. So this is what Nintendo becomes kind of inadvertently. They become a Japanese video game business. It was a pseudo importer reseller. Yep. That's crazy. By the way, do you know how the light gun works and why that was such a leap forward? No. So this was a very clever invention by Nintendo's engineers. You could imagine that the way a light gun, the most intuitive way for it to work would be, well, you take a regular gun that shoots bullets out of it, and instead you make it shoot some kind of laser out of it but what that would require is for the tv the target to have a detector on it which you really don't want to have to force that constraint that sounds really hard especially when you're trying to work with a lot of different tvs ironic that later nintendo would force that constraint with the wii right right isn't that

funny so they flipped it on its head they figured out that actually what we should be doing is we should make the gun the detector and we should specialize what's coming on the screen. Oh, that's super cool. in the early Duck Hunt games. But basically the screen flashes one frame where only the target is lit up and the gun is the detector. And if in the gun's sight, it sees the set of pixels that are lit on the one frame, then it knows it got a hit. And if it doesn't detect those pixels,

then it's a miss. No way. I always wondered how Duck Hunt worked. I had no idea. Yeah, pretty cool. That's amazing. So Nintendo, thanks to this relationship with Magnavox, is in this incredibly privileged position in this new industry. They have a bird's eye view into the American home video game industry, and they're

learning all the lessons from what's happening there. They're also pioneering and establishing themselves as the leader in the Japanese video game industry. So they're in a great spot through all of this. They see come 1977 when Atari and Warner Brothers releases the VCS 2600 in America, the Yamauchi, even despite not being an engineer, is like, clearly this is the future. This piece of hardware not only is so much better than all this dedicated stuff that's like the Odyssey and like what we've been doing that came before, but the business model implications of this, the razor and blades model, the interchangeable cartridges, selling software. We got to get into this game. But they also see things are crazy over in America. Everybody's rushing into this industry. Yeah, they got to be very judicious

here. It's a very attractive market to enter, but they have to figure out a way to differentiate and not make all the same exact mistakes that everyone else is making and rush in with crap products that eventually people are going to stop buying. They have to figure out how to sell something interesting, durable, and unique. So Yamauchi makes an incredibly foresighted decision here. He says, we Nintendo need to build a programmable home video game console like the Atari 2600. But whereas Atari and all these other American companies, they're rushing their consoles to market. This is if not shoddy hardware, like the development cycles for these consoles are like maybe a year, a year and a half. We have the luxury here in Japan because there's not direct competition.

Let's take our time and let's make something really amazing. Yep. Not to mention that by taking a long cycle development time, they actually get the benefit of Moore's law. They get to come out with something a few years later that is much, much better. Exactly.

So he starts a project in the late 70s within Nintendo to develop their first programmable ROM cartridge, swappable software, home video game console. But he's willing to take a very long view and he instructs the team, I want this device that we produce to be at least one year ahead of any competitors on the market anywhere in the world. And I want us to be able to sell this thing for the equivalent of $75. And on top of that, I want us to be unit economic positive on these machines. I want every game system that we sell to be profitable for us. And this is completely contrary to the rest of the industry who's like, oh yeah, this is a razors

and blades thing. We're happy to subsidize so that we can sell more games. He's like, we're going to do it all on hard mode and we're just going to take years to do it. Because this is 77 when he's saying this, the NES won't debut in the US until 1985. And not in Japan until 1983. So it kind of reminds me of the old saying, you can have high quality, you can have cheap and good prices, and you can have something done quickly, but you can only choose two out of three. And so Yamauchi says the constraint I'm going to relax here is time, which is what nobody else in the video game market is doing. So it's 1977. What are they going to do in the meantime?

Well, R&D is super heads down and secretive on building what becomes the Famicom and the NES. Yep. Yamauchi splits Nintendo's R&D teams from one singular team that's working on all of their video game business into multiple teams and he takes the new team the r&d2 team and he dedicates them to this home console project and says you have years you don't have unlimited budget you have a lot of constraints but make this thing amazing the original r&d team the r&d one team he says you guys keep working on the line of tech that we already have the dedicated home consoles and let's explore some other ways to use this technology to make money that leads to the game and watch business which is this total dead end in

video games and technology but was insanely profitable for nintendo for a couple years i played one dedicated game per machine. It actually comes from the calculator industry is where they take this tech. It becomes the spiritual forerunner of the Game Boy, but this type of product is particularly suited to the Japanese and broader Asian markets. It's portable. You can play it anywhere. You can play it on the go. It does really well for Nintendo. Much lower price point. Much lower price point. They sell millions of these things in the late 70s and early 80s in Japan, which keeps financing the other R&D team. Yep. Also, they haven't forgotten about the arcade

side of the business too. Yamauchi spins up a third R&D team just to focus on making arcade titles because he also knows that software is going to be really important for this eventual home console. Yep. They're basically saying we want to learn what games are great. And once we have a stable of those great games, then we can unleash them on whatever our next generation console ends up being. But for now, we kind of need to like create a bunch of games in the arcades, in cabinets, so we can know what the hits are going to be. And I will say, to know what the hits are going to be,

basically none of them were at first. So I imagine there was like a year at Nintendo over in Japan where they're hitting the oh crap button, where they're like, uh, we may not have any good games to put on this thing fortunately the console wasn't ready yet there's one more piece of the puzzle though and that's that he needs to get a foothold in the american market so that they can get distribution relationships

there and actually be able to enter it and ideally in his mind to be their own distributor nintendo is really obsessed especially at this point in history with not getting commoditized and not having to fork over 50 to this middleman and then another 50 to that middleman it's like no no we need to get directly to customers right they've been using trading companies to export the light gun tech and other things they want to set up their own distribution begrudgingly the yamauchi family cycle is going to repeat itself as much as hiroshi hates it he knows the perfect person to set up nintendo of america his son-in-law who does not want to work in nintendo who definitely doesn't want to do it and whose wife hiroshi's daughter absolutely definitely doesn't want to do it. And whose wife, Hiroshi's daughter,

absolutely does not want him to do it. Minoru Arakawa. We want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts. So frameworks like SOC 2, ISO 27001, GDPR, and HIPAA compliance and monitoring, Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple. Yep, Vanta is the perfect example of the quote that we talk about all the time here on Acquired, Jeff Bezos, his idea that a company should only focus on what actually makes your beer taste better, i.e. spend your time and resources only on what's actually going to move the needle for your product

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vanta.com acquired acquired. All right. We're heading into the 80s. It's going to be Nintendo's decade. Over there, they have a four-pronged strategy. Bring me to Radar Scope, David. I'm jonesing for it. And listeners, unless you're like Nintendo history buffs,

you're like Radar Scope, but Radar Scope would be the ashes from which all of the phoenixes you know about rise. So Arakawa, Yamauchi's chosen son-in-law, begrudgingly, who he sends over to set up Nintendo of America, unlike other son-in-laws in the Nintendo family history has a bit of a different background. So he's also from a very prominent, high society, well-respected family in Kyoto. But he left Japan and went to America for his education.

He went to MIT where he was educated as an engineer and he fell in love with America. And he may have fallen in love with the distance from his father-in-law too. The whole ocean in the way is pretty nice. Well, this is before he met Yoko, his wife. Oh, okay. When he comes back to Japan, he meets Yoko at a Christmas ball while Yoko's in college. And Yoko wants nothing to do, just like Hiroshi before her, wants nothing to do with Nintendo, nothing to do with her father, nothing to do with the family business. And she's kind of taken by Arakawa in part because he loves America.

He's so different. Like there's no way that history is going to repeat itself here. Right. If I don't want to be involved with Nintendo, then this guy's probably that ticket. He's my ticket. So they get married and they move to Vancouver in Canada, where Arakawa becomes a very successful real estate developer. Yoko loves it there. They come back home to Kyoto to visit family and Yamauchi makes his pitch. So Arakawa's intrigued, but he's got a successful business

of his own, right? And he loves his wife. His marriage is very important to him. And he knows that if he accepts here, he's going to be in a real tough spot. But Yamauchi says, hey, I'm not asking here. You kind of need to do this. And there's a little negotiation. I think they strike an economic deal that makes it very much worth Arakawa's time. And Arakawa's strong belief is I have to be in America and do it my own way rather than me sort of starting to take over the company in Japan. This is part of the deal that convinces both Yoko and Minoru to do this. Yamauchi says, I'll let you run things your way in America. Big concession.

But I know you live in Vancouver. I want you to move to New York City because New York City is where the toy industry is headquartered in America and you got to go build relationships there. So they have a mandate to set up Nintendo America in New York, which they do. And at first, you know, there's no console yet. They're not ready to enter the home video game market, but they've got these arcade machines. And so the way that they're going to build up Nintendo of America is through the arcade business. They do the obvious first thing that makes sense. They hire the guys who had been running the trading company that was importing Nintendo's arcade machines in the past. And I think they were importing used Nintendo arcade games from Japan and refurbishing them

and then selling them into US barsS. bars and arcades. It was this very almost gray market way to acquire Nintendo's cabinets. That was run by two young guys at the time who were from Seattle, University of Washington alums, Al Stone and Ron Judy. That becomes the initial Seattle link for Nintendo of America. So they hire Stone and Judy to sell Nintendo's arcade games that they're producing back in Japan. And to no one's surprise, they don't sell very well. The games just weren't very good. Yeah. And there was pretty robust competition, of course, as we talked about in the American market. So Arakawa was like, guys, why are these not selling?

Ron and Al are like, they're not selling because the games suck. You need to call up Yamauchi-san and be like, hey, send us some better product. They say, you know what is selling here? We're now in 1978, 1979 in America. What is selling is Space Invaders. That's made by a Japanese arcade company, Taito. Why don't you get the guys back in Japan to make something like Space Invaders and send it over to us? So Minoru calls up Yamauchi and is like, hey, can you send us something like Space Invaders? Yamauchi doesn't really want to do it because he's like look you're just supposed to

be building relationships over there can't you just use our games and uh arcao is like no no i really think this is gonna sell i'm gonna place a really really big order i want you to send me 3 000 cabinets of a space invaders knockoff like i really know that this is gonna work yep we are your boots on the ground we We know this market. It has to work. Yep. I'm putting my reputation with you on the line. I know you don't know me that well as a business partner yet, but I really think this is going to work. Yamauchi says, okay. He directs the R&D3 team to come up with a Space Invaders knockoff, which they do. They make Radar Scope. It's innovative. It has a different perspective. It's not the top- a Space Invaders knockoff, which they do. They make Radar Scope. It's innovative.

It has a different perspective. It's not the top-down Space Invaders. It's got like a three-quarters view quasi-3D twist on the Space Invaders mechanic. They start producing them in Japan. Unfortunately, to make the games from scratch, build them in Japan, and then ship them over to New York, which takes a long time on the water to ship them. It takes four months. During this time, the American space invaders mania peaks and starts to die off. And this is pretty much the last time that Nintendo will pursue the strategy of something is hot. Every single success that Nintendo has from here on out is from their own discovery of something fun, from being inventive, and from taking risk. And that means it will come with failures too.

But from this point forward, they never try the fast follow clone copy thing again. Totally. So when the cabinets show up, Nintendo of America can't sell them. And they've got all this capital tied up in this inventory. They only managed to sell

about 1,000 of the 3,000 cabinets. So they got 2,000 Radar Scope cabinets sitting in a warehouse in New Jersey at the current headquarters of Nintendo of America collecting dust. So Minoru now needs to call up Yamauchi again. And be like, you were right. Be like, so about, you know, when I kind of put my neck on the line with these

radar scope cabinets, I was wrong. You can only imagine how this conversation went. And he's like, we got to do something like we can't you know nintendo america is gonna go bankrupt with all this inventory and these cabinets just sitting here can you get somebody to reprogram some new chips that we can insert into these cabinets and just try and move this inventory right so radar scope is this game that has i think one joystick and maybe two buttons and like can somebody come up with a game that has, I think, one joystick and maybe two buttons. And like, can somebody come up with a game that leverages that and like most of the same chips that are on the motherboard and leverage basically the assets we've got to create a new game out of this thing? Yep. And things are so bad.

Yoko at this point is so pissed. She takes the kids and basically moves back to Japan. She's like, I can't believe this has happened. Like, we're out of here. that to sort of move the gun to where you're going to shoot it and then press shoot and then maybe you have a different button and so you're giving a pretty prescriptive order and you're giving a pretty narrow set of things you could turn this into yep and less so yamauchi is so pissed he can't take anybody off the console project those are his best engineers who could maybe pull some rabbit out of the hat here. He goes to Gunpei and he's like, my dumb ass son-in-law over in America. I got to give him something. Can you give me like a janitor or somebody to like make a game here? And Gunpei's like, I literally can't take any engineers. And at the time, only engineers made games. There was no game designer role. It was just the engineers who made the games. I can't give you engineers. We do have this young kid

who I brought onto the team, who is our design guy. He's here to help with the hardware design. He'd worked on the color TV game designs of the hardware and some of the user interface. He's pretty talented. He's not an engineer, but he's been wanting to make a game. I can give you that guy. Yamaguchi's like, fine, whatever. And importantly, this isn't the B team. This is the unknown. Right. This is literally like the janitor. Right. And that guy's name is Shigeru Miyamoto. And this is how he comes to make his first video game. Yes. And if you don't know that name,

which I suspect 90% of you don't. Oh, I suspect 90% of people do know that name. That's the thing. I'm really curious if people are like, this is Miyamoto? Or if people are like, what the hell are you talking about? And I think like,

for those of you who know your Nintendo history, David just said, and this is how God is discovered. But for those of you who don't, this is how God is discovered. The tablets come down from the mount. Moses brings them down. Miyamoto, Moses. Well, the game that young Shigeru Miyamoto makes to replace the Radar Scope software on these cabinets. It's called Donkey Kong. And Donkey Kong would itself go on to earn hundreds of millions of dollars immediately in North America alone. It totally saves Nintendo of America's skin, earns $180 million the first year, another $100 million the second year in arcades. It becomes such an incredible franchise

and IP, which we'll get into in a second, that just this game, the original Donkey Kong, has grossed over $5 billion alone in the decades since on all the platforms it's been released. David, the year that it was released in 1982, it made more money than any film release that year, except for E.T. Even more importantly, though, I'm so curious what percentage of our audience already knows this and what percentage doesn't. The playable character that the game Donkey Kong is actually named after the villain. The playable character in this game is this very small, big-headed, wearing a hat, sort of innocent, nameless carpenter?

Yes. Listeners, you might have thought that I was going for Italian plumber named Mario, but here we have proto-Mario. We have Jumpman. Jumpman the carpenter. So what's going on here? Like I said, up until this point, everywhere in America, in Japan, the only people who made games were engineers. And Miyamoto has this incredible quote about this. He says, until Donkey Kong, programmers and engineers were responsible for game design. These were the days when engineers were even drawing the pictures and composing the music themselves.

They were pretty terrible, weren't they? And specifically, like we've been talking about all episode, there was no story. The whole point of making the game was to make it technically competent and something competitive that would have enjoyable gameplay for mostly to suck up quarters in arcades. It's also a freaking miracle that they work at all. You think about the very early technology involved to like layer on more hard things on top of make this thing work, like make it make people enter a flow state when they're playing it and make it repeatable over and over again and add story. Like, no, no, no, no, no, no. Arrange the chips in a way that it works and doesn't break quickly. Right. Miyamoto, on the other hand, he's not an engineer. He's a designer and he thinks games can be an art form. So when Yamauchi gives him the chance to make a game,

he's like, finally, I can bring my genius to bear. He's not a self-conceited man. I'm sure he didn't think of it that way, but he has a very different vision for what a game can be. Here's what David Sheff who writes Game Over, which is a great book, writes about the conversation that Miyamoto and Yamauchi have when he gets assigned to make the game. Miyamoto boldly told the Nintendo chairman that he would enjoy creating a game. However, he said, the shoot-em-up and tennis-like games that were in the arcades at the time were unimaginative, simply uninteresting to many people. He had always wondered why video games

were not treated more like books or movies. Why couldn't they draw on the great stories? Some of his favorite legends, fairy tales and fiction, King Kong, Jason and the Argonauts, even Macbeth. And this is exactly what Miyamoto does. He makes the first narrative-driven video game. Now, it's a super simple narrative and a very thin character. I mean, this notion of Jumpman running around at the bottom, trying to save this nameless princess from an ape that's throwing barrels like it's not a lot of story it's his girlfriend oh really yeah originally it was not a princess well so here's the story that miyamoto comes up with for the video game a regular every man jump man has a pet gorilla who he keeps in his house. He's not very nice to this pet gorilla.

He doesn't treat him very well. So one day the gorilla escapes and kidnaps our protagonist's girlfriend as revenge for not being treated well. Now, it's important. The gorilla does not want to hurt the girl. Oh, that's right. Her name is just like lady, right?

Yeah. Like they don't even name her. She was Pauline in the American version. Okay, yeah. The gorilla, this is important, does not want to hurt the girlfriend. He actually likes her quite a bit. He just wants to stick it to the protagonist. So he runs with the girlfriend into a skyscraper construction site, climbs up to the top of this half-constructed skyscraper and starts throwing barrels and construction equipment down at the protagonist as he tries to chase him up and your

goal as the player is to reach the top of the construction site defeat the gorilla and save the girlfriend which is incredibly simplistic today but nothing like this had ever existed before. And so like wonderfully innocent and kind of convoluted too. Like everything about that, you're like, what? That worked? That was the best story you could come up with?

Yep. But despite its kind of wackiness and simplicity, it's a classic three-act story. There's a beginning, dramatic tension is introduced, there's a middle and a struggle, and there's an end and a victory and a story. Totally. There's a beginning, dramatic tension is introduced, there's a middle and a struggle, and there's an end and a victory and a resolution.

Yep. It's also worth saying Miyamoto came up with all this within the constraints of what Radar Scope's hardware was. Right. So he managed to figure out a way to retrofit this hardware

to create a non-shooting game and come up with a completely new game mechanic of climbing these ladders and avoiding the barrels using the same controls originally intended for Radar Scope. So while Miyamoto, like you said, not even the B team or the C team, just the unknown team is working on this game back in Japan. Team Wild Card. Team Wild Card. Arakawa is totally freaking out back in New York. His wife has gone back to Japan, taking their kids. He's like, all right, I don't know if this is going to pan out here,

but I know one thing. If we're going to save both the business for Nintendo in America and my marriage, we got to leave New York. We got to go to the West Coast of America because the shipping times, that's what the fatal mistake that we made with Radar Scope is we placed this huge order with a four-month lag time. We couldn't get any feedback. We couldn't get any test machines into the market. I assume they had to go through the Panama Canal. I assume so, right? You can't just put all this stuff on an airplane and send it there. So he says, we got to leave New York for business reasons. We loved being in Vancouver. We don't like New York. We can't move to Vancouver because we got to be in the United States for what we're trying to do here. But we can move to Seattle. Yep. Nice and close to Japan. Easy shipping times.

Easy drive to Vancouver. Yoko can hang out with all our old friends back there. This will be great. And Microsoft was seven, eight years old at this point. And so, you know, there's starting to be some tech talent. There's the former Boeing engineers. Absolutely. And it's even more perfect. Our distribution guys who we hired and brought in-house, they're from Seattle. It's perfect. We need to move there. So while all this is going on back in Japan, they move the company to Seattle. They lease a warehouse space in Tukwila. For folks who don't know Seattle real estate, Tukwila is just south of the city, kind of by the airport.

It's very industrial. It's a great place for your video game warehouse. Great place for your video game warehouse. Exactly. They ship the cabinets across the country by railroad from new jersey to tequila they're all hanging out there yoko and the kids come back they're like okay great and then the roms show up with the replacement game for radar scope with donkey kong they plug them in they all huddle around they start playing and they're like wtf what is this we're screwed it's super different they weren't really told what to expect they

basically get these conversion kits you know that show up via freight over the ocean that's got instructions of here's all the ways to replace all the components with these other components here's the way to load the new music on in fact there were rumors that this was going to be some like really great recognizable ip to help with sales that nintendo actually had some pre-existing relationship with the owners of the popeye ip yes they were working on a Popeye license with King Features. Yes, this wasn't going to be like Jumpman and Lady and Donkey Kong. It's a nonsensical name for a gorilla. Right. This was going to be Popeye and that was going to be Olive Oil instead of Lady. And that was going to be Brutus, the kidnapping character. That would sell well to an American audience.

And this thing arrives with these brand new characters that no one's ever heard of. And they're like, crap, we are totally screwed. So Stone and Judy threatened to quit. They're like, well, this is not going to go anywhere. But they've got this kid. They've got to hired a couple of kids in Seattle to work in the warehouse, you know, move stuff around, get it shipped out. And there's this one kid named howard phillips working there who's just a total arcade nut loves video games he plays it in the warehouse and he's like guys this is the greatest game i've ever played this is a work of genius and the game mechanics are a work of genius even though at first blush you're like this is not the type of

thing that is selling well once you start playing, you're like, this is not the type of thing that is selling well. Once you start playing it, you're like, oh, everything about it is thoughtful. It doesn't get boring right away. The music is continuous and recognizable without getting repetitive. There's random variables. So you can't just beat it the exact same way every single time. If you memorize all the right things to press. It actually has a lot of art to it, exactly what Miyamoto set out to do. Yep. And not only does it have that narrative and art, it's exactly what you're describing. This thing is really fun. If you pick up and play it, you can intuit really quickly how it works, how to play it, and you can just start having fun. There's a maxim in the video game industry that a great game is easy to play,

but hard to master. And that is exactly what this is. Yep. So Phillips at the warehouse is like, really pleased. He's like, guys, like this is really good. And they're like, okay, well, let's take it to a couple of bars around Seattle and just set it up and see what happens. And just like Pong back at the day, this thing becomes a quarter magnet. Phillips's intuition was right. None of the senior guys, none of the older guys, Arakawa, Stone and Judy, they didn't get it, but the kids did. And on the back of that, Phillips ends up becoming Arakawa's kind of most trusted advisor about games. And he becomes Nintendo's game master. He becomes a hero in Nintendo power, all of this, like a national celebrity. It's incredible. The Nintendo of America management

though does decide one thing. They're like, we get okay that there's this narrative revolution here with this game. I don't think it's going to work here if we call the protagonist Jumpman. We need to give him a little more of an identity than that. And so they're casting about trying to decide what to name this character. And by the way, I should say I was shocked that Donkey Kong predated Mario. His name is not on the cover art in the very first game he appears in. Of course, he doesn't have a name, but yeah. So the legend goes that as they're debating this, the landlord of their warehouse in Tequila either shows up or sends a letter.

It's unclear. Shows up because they were way behind on rent because this freaking company didn't make any money. Demands the rent because they're late. And the way I know he shows up is because he starts jumping around and ranting and raving and waving his arms in the air. And he's like super animated and they can see him there.

And he's got this big bushy mustache. He's this Italian guy named Mario Segale. And this is how Super Mario gets his name. Amazing. Totally amazing. They named the girlfriend Pauline. I think it was the either wife or girlfriend of one of the guys working at the company

at Nintendo of America at the time. Yeah, so they named her Pauline because the warehouse manager who was taking a lot of the heat from Mario Segale and directing it away from the Nintendo guys and sort of like taking the hits for them, his wife was named Paulie. So they named the character Pauline after her as a thank you to him. Nice. Nintendo has a history of doing this with their characters. Well, one more thank you naming of a character is going to come up in just a second here. So the game sounds like wildfire. Like we said, all the 2000, you know, former radar scope machines fly out of the warehouse. They order more like they end up selling thousands and thousands of this. It it expands the tam of who

plays video games too that's the other thing it's like it's not just for boys anymore it's not just teenage boys anymore or people in bars irony of ironies taido the japanese company that made space invaders they call up yamauchi and they're like hey we're like the really good japanese arcade game manufacturer now you've made this hit arcade game Can we buy the rights to it from you to distribute it for Nintendo around the world? We'll pay you a ton of money for it. Yamauchi is kind of inclined to sell because remember, he doesn't really care about the arcade business. He really just wants to set up Nintendo of America to get the distribution arm for the console that's coming. But he lets Arakawa make the final call. Arakawa says, nope, we're going to keep it.

We're going to distribute it in-house at Nintendo America. Of course, that ends up being totally the right decision and kind of re-earns Yamauchi's trust from him. It's like a multi-billion dollar correct decision. Multi-billion dollar correct decision. The other hilarious thing that happens is MCA Universal and the legendary Sid Sheinberg, who we talked about- With Michael Ovitz. With Michael Ovitz over at MCA Universal, of course sees what's going on with Donkey Kong.

And he's like, I'm going to make some money on this. He's like, wait, wait, wait, wait, wait. Big gorilla thing all the way at the top of a building named Kong. That sounds like King Kong, which, wait, wait, wait, big gorilla thing all the way at the top of a building named Kong. That sounds like King Kong, which I think I own the rights to. This is my circus and this is my monkey. I think we talked about this with Michael, but this is where it comes out in the court case. Sid would refer to the legal arm of MCA Universal and their legal suit activities as a profit center for the company. God. He filed suit against Nintendo America for infringing on his King Kong trademark. Nintendo led by Seattle lawyer Howard Lincoln,

who would go on to succeed Arkawa as the president of Nintendo America. And I think Howard Lincoln was the personal lawyer first of the two guys who ran the import distribution business. That's right. So Lincoln sets Nintendo of America up with a great antitrust lawyer to fight off MCA, which is a crazy decision. They should have just settled with MCA. Right? Tiny companies that are not doing well getting sued by very dominant global entities like MCA Universal. You roll over. Yep.

Lincoln sets up Nintendo with a great antitrust lawyer, John Kirby, and he and Lincoln together team up and they fight off Sid Sheinberg and MCA Universal and they end up winning in court the case. And it hinges on, they discover that Universal doesn't actually have the trademark for King Kong. Because it was public domain. Exactly. And they knew it too. Sheinberg knew it. Yeah, that's the thing. And the judge slaps him across the face. He's like, you guys knew you were in the wrong here. You've been suing this company and all their partners just to try to be extractive, even though you know

you don't have a case. I can't believe you followed up with this. This is where the profit center language comes out. Yep. They're wrong on a bunch of vectors too. They're like, wait, wait, wait. One's a gorilla, one's an ape. And then the other argument that John Kirby finds, because Johnby flies to japan and starts interviewing a bunch of people at nintendo to try and like mount the argument of like they didn't know of course they didn't reference king kong ip and he's in japan and he's looking around and he's like wait in japan they use kong to describe big monkeys generally that's like a word that's commonly used and so he uses that too. He's like, this thing was invented very quickly by this small team in Japan using common parlance. And so the judge just serves MCA Universal. He's

like, you guys are dicks and you knew it and you were wrong and you owe all their legal fees. Amazing. Which is not normally what happens when MCA Universal goes to court. No. And so as a thank you nintendo goes to john kirby a few years later and says we've got this great game in development and we're going to name the protagonist after you and that is how kirby got his name uh great smash character yes oh yeah a lot of jumps okay so we're at this point in time where donkey kong sold like gangbusters they know they've got a hit on their hands there's potential for these characters to really embrace their own storylines and there's strong incentive by nintendo the parent company in japan to really flesh this all

out because they've got the Famicom nearing release. And so they're trying to figure out, is this thing that Miyamoto came up with on a lark? Can he keep doing it? Should we turn the keys over to him creatively and say, hey, see if there's a there there for this to be like the centerpiece of our launch of our console? Which they do. So Miyamoto makes a couple more games. He makes the sequel, Donkey Kong Jr.

That also does really well. He makes an actual Popeye game. They finally get the license, kind of in the same vein. That's a footnote in history. And then in 1983, he makes the first dedicated Mario game, Mario Brothers, as an arcade game. Super Mario Brothers, right? Well, no, they're different games. Mario Brothers was an arcade game that Miyamoto made, and that's what introduced Luigi.

And you had two plumbers. This is what canonically made them plumbers. The setting was underground, and they had green pipes, and that's how they became plumbers. Side note, when they came out with this game, the Mario Brothers, people were like, oh, wait, the Mario Brothers. So Mario is the last name and Nintendo confirmed it. And so they were like, wait, so that guy's name is Luigi Mario. And that guy's name is Mario Mario. And Nintendo was like, correct. And I think they've maybe changed their stance on that over time. But what a Nintendo of Japan thing to do.

I love it. But yes, it's clear that Miyamoto's got the golden touch here. Yes. And has created this whole new discipline of game design where the same principles as engineering apply. And Yamauchi completely understands this,

just like he understood with Gunpeia yokoi that there are these certain engineers out there who are so talented and so creative that they can do things and enable things with technology that nobody else can do the same dynamics apply to game designers that there are very few shigeru miyamotos there. And the value of what they make is worth many, many multiples of what every other game designer out there makes. Yep. So after Miyamoto proves that he wasn't just a flash in the pan, Yamauchi creates a fourth R&D division within Nintendo, puts Miyamoto in charge, and the sole purpose of this new R&D4 unit, which would later become

the legendary entertainment analysis and development group within Nintendo, the sole goal is to make games and to make the very best games in the world. And their manifesto really ends up becoming fun first. And that sounds obvious, but in a way, they're sort of zigging where everyone else is zagging, where a lot of other game designers at this point in history are starting from a place of, we need to make a game that's in this category, or other people have made this game and it is successful, or games that are great today involve this set of things that everybody thinks you need for a game and what the team that miyamoto is leading is saying we are on a quest to be inspired and find fun and then we will build exactly the right

window dressing around that fun that real, that core mechanic that we love, and no more. We don't need to do any of the other stuff on top of that. If it's fun, and if it continues to be fun, and it's super replayable, then our mission is accomplished. And it is a very, very, very different approach to how other people were designing games. Yes, exactly. Yamauchi has this great quote about Miyamoto and the Nintendo philosophy of what makes for a great game designer. He says, an ordinary man cannot develop good games no matter how hard he tries. A handful of people in this world can develop games that everybody wants.

Those are the people we want at Nintendo. It's just so wild that Yamauchi, he's never played a game in his life. And that is actually true. We haven't really harped on this yet, but like this guy led Nintendo through its heyday, invented the modern Nintendo, found the talent to design and market all these games and never played any of them. Yes. But he totally intuitively grasped all these principles that would just come to define not just the video game industry but all technology industries yeah amazing and

that's funny that quote is less about fun and what defines fun and their philosophy on building and more about like most people don't have what it takes and miyamoto has what it takes and we've got Miyamoto, so good luck. Well, it's true. I mean, I think fun and that brand of fun is the Miyamoto and Nintendo style of game design. There are other brands of game design. I mean, folks like over at Square and Enix in Japan with the Dragon Quest series and the Final Fantasy series. Hironobu Sachiguchi, who was the father of the Final Fantasy series, would probably have a very different take on that, but he's equally a genius. There are these few people who are just the very best in the world at what they do and nobody else can match them. So we're now in 1983 and all the pieces are coming together. Nintendo's got the games. They've got the IP. They've got the creative genius in Miyamoto running R&D 4. They've got the distribution network that they've always had in Japan. And now they've got it set up in North America as well. And the technology is just about ready. So the R&D2 team

has accomplished something nobody else can or would for years in the industry. Yep. They've created a home video game console that is not just a year, many years ahead of the competition and will sell for cheaper and profitably. There's so many of these unbelievable moments in the Nintendo story. The way they do it, it takes them years to come up with, is they realize that the brute force way of accomplishing the year plus ahead of the competition directive that Yamauchi gave them would be to get the fanciest, fastest, most Moore's law enabled ahead of the curve processor out there. But that would kill the bill of materials. That would make it way too expensive. Yep. So they come up with this incredible innovation. They realize,

okay, we're constrained on cost. We can only use cheap, off-the-shelf, at this point, dated technology for the CPU of this machine. And up until now, the CPU was everything. The CPU was the brain of the computer. We're in the 80s, even through to the 90s. Remember Intel's marketing and the PC industry and the CPU was so important. What the Nintendo team realizes, because even though this is a programmable console, we're doing specialized applications for gaming. This doesn't have to be a machine that can also do your spreadsheets. We can pair a cheap CPU with a secondary processing unit within the machine that they dub the PPU, the picture processing unit.

And I think maybe I'm wrong and this is why nobody talks about this. Or maybe like we've stumbled onto something like incredible in history that just everybody overlooked. I think this might be the first example of a dedicated GPU in a piece of hardware. Oh, interesting. I wonder if that's right. A programmable GPU. So let's unpack this a little bit. The Atari 2600 had a CPU that did most of the work. And then it also did have another chip that interfaced with the television. And Atari called this the TIA, the television interface adapter. But there was no memory on this TIA chip. It was literally just there to like draw the graphics that the CPU was outputting to put on the television screen. The PPU that Nintendo designs and develops

is its own programmable chip that sits next to the CPU within the NES. And it has eight bytes of memory. And it's dedicated to processing the graphics that get output on the television. So that has specialized circuitry, both for doing the backgrounds of the games and for processing the sprites, which are the characters, the movable items on the screen. Wow. And I think this was the first example of a machine and an architecture in history where the workload was split up like this, because it was a decade later when NVIDIA came around and invented the GPU. Which is farcical. Of course they didn't. But now it would be until that time when people would think about using this architecture in computers, in PCs. Right. But in this subset of the computing market, it was Nintendo. I think you're right. I mean,

I can't think of a counterexample off the top of my head or where a counterexample would even exist. Right. That's what I thought about too. I'm like, I can't think of anything else. And again, like it is technically true that the Atari and other consoles had chips that handled the graphics output from the CPU, but they weren't programmable. They didn't have onboard memory and they weren't doing any of the processing of the graphics. The PPU at the NES is actually doing a lot of work and it all came about as this desiccated by this constraint that yamauchi put on the team of like this has got to sell for less than 100 bucks super clever i mean the famous thing that nintendo also went on to do, and I'm very curious if you know sort of how this came to be, is that their games are optimized for fun, not to show off the hardware. And so they're always able to do what translates very poorly to the U.S. as lateral thinking of seasoned technology, that it's about inventiveness.

I think the literal translation is withered technology. Withered technology. You know, it's not about using the state-of-the-art chips. It's not about using the most expensive hardware. It's about how clever and inventive and fun can you be with it. It sounds like the first example of cost savings was around this PPU. Well, it actually was the Game & Watch. Gunpei Yokoi's work on the Game & Watch, which he's the author of this philosophy within Nintendo. And that's what led him to that. He's like, oh, we'll take this calculator technology and apply it to games. And we can use this kind of lateral technology to

make something fun while keeping the cost down. But it's the same thought here. I mean, the CPU that they end up using in the NES is a slightly customized, but basically off the shelf MOS technology 6502, which by this point in time is like a very standard off the shelf CPU used in thousands of applications around the world. It's like how the switch processor is like a circa 2014 Android phone chip. And a crappy one at that huh okay so they already were fully embracing the idea that we actually don't need the most expensive hardware to create the most fun experiences yeah and in this case it was really interesting in that the nes had graphical capability literally years beyond any of its competitors but it did it with cheaper technology

and that was the amazing innovation and that enabled a bunch of things most importantly at the outset for the famicom and nes it meant that this new console would be able to have totally 100% accurate ports of arcade games. When arcade games would come to other home consoles like the Atari 2600, they had to be dumbed down a little bit because the hardware couldn't handle it. When you're making an arcade cabinet, you can have dedicated customized chips and systems and circuit boards for that game, which allow you to do better graphics, more fancier stuff. Right. That if you're then trying to bring it to something like the 2600,

you're going to have to make a bunch of compromises. The NES was able to have the best ports of Donkey Kong, Mario Brothers, the Nintendo titles, but then the third-party titles too. Right. So interesting. I mean, it makes a lot of sense with the way that cartridges work too, because unlike CDs, where, you know, in the modern era, you're reading a game off of some media, loading it into memory, and then executing it on the hardware of the actual platform of the console. In the cartridge era, the circuitry was in the console. And so everything kind of like loads instantly because you are literally playing the game

on the hardware within the cartridge. And it's this perfect marriage of the circuitry in the cartridge and the circuitry in the console itself that creates exactly enough resources to play that game and nothing more. Yep. The wild innovation technology-wise that comes out of Nintendo in this time is just incredible. They do stuff like later in the Famicom and NES's life cycle, I think with Super Mario 3, the NES is kind of like old in the tooth. The Genesis is out at this point and the graphics aren't industry leading like they used to be they start putting computing chips on the cartridges to help the console

because it like marries together in the same system when the cartridge is in the console they do some similar stuff with zelda okay so take us to 1983 take us to launching the famicom in japan so on july 15th 1983 after years of work, Nintendo finally launches the Famicom, the family computer, Famicom for short, in Japan. Because they had broader ambitions than gaming. Right. They had zany stuff. They thought like, oh, this is so powerful. What we can do with these two chips? We're going to give it a keyboard. We're going to be a Trojan horse into the home. All the stuff that Sony would do sort of stupidly later. Nintendo originally wanted to do that. They ended up cutting all of it to save costs. They still don't get the machine under $100 in Japan. It retails for 14,800 yen, which is like 110,

120 bucks at the time, but still way below any of the competitors on the market and way, way, better. The first shipments in Japan immediately sell out. They sell 500,000 units when they launch. Then there's actually, they have to do a recall. There's a fault in the motherboard because it's such a complex system and they hadn't worked out all the kinks when they launched it. It's kind of like the famous Tylenol case. They do a nationwide recall. They recall every Famicom system in Japan. And they don't just replace the one broken chip. They strip out the entire motherboard and replace every motherboard on every single unit to show people like we're

really serious about quality. Yep. And so starting from the summer of 1983 in Japan, right as the video game industry is dying in America, this rocket ship of Nintendo and the Famicom just takes off in Japan. They sell, over the next two years, every single unit they can make. They had placed a three million unit order with Ricoh, the Japanese semiconductor manufacturer. Ricoh manufactured them? Oh my god. And Nintendo became by far their biggest customer. Huh.

I used to have a Ricoh camera. That's right. So they did a deal with Ricoh to manufacture the CPU and PPU tandem system together. And the only way they could get the price down far enough to hit the price point they wanted at retail was to place a 3 million unit order up front, which was like crazy at the time. It was 3 million units over two years. They couldn't make them fast enough. They sold out the whole thing. It was incredible. God, Nintendo got so lucky that the Japanese market wasn't saturated the same way that the

US market was. They launched into the very best conditions in Japan they could of, frankly, not a lot of competitive consoles at that moment. Yep. So over the next few years, the Famicom would go on to sell almost 20 million units in Japan. In Japan in the 80s, there were only 38 million households. So they get an almost 50% penetration into the Japanese market. Whoa. Isn't that wild? Wow.

That is crazy. It just becomes this enormous juggernaut in Japan. But meanwhile, of course, the big kahuna market is the US. There's 90 million households in thes at the time in the 80s and not just 90 million households there are plenty of other countries that have 90 million households there are 90 million u.s households that mostly 100 of them have a television were used to playing arcade games knew about the home video game market from everything that had just happened. Has the highest GDP per capita in the world. And could afford to buy a console, especially a relatively cheap console like the NES.

You know, not 100%, but 70%, 80% of the US market could afford this. Yep. Wow, that's crazy. So by 1983, like everything's all set up ready to go in america yamauchi's like all right let's go and like you got to be wondering like should we pull the trigger this is like a crazy moment to decide like yes let's launch let's flash back two hours before the nintendo story and remember the state that the United States was in. They just went from $3.2 billion, being the home gaming market size,

to $100 million. And they're burying games in concrete, in landfills, and smashing them up, and throwing away consoles. And this is 1983. So it's the exact same moment in Japan that somebody, I don't know exactly who and exactly what the story is, but somebody is deciding to pull the trigger and say, take the Famicom

and make an American version of it. Yes. So Arakawa is like, I hear you. I don't think this is the right time. So that's the crazy thing. This is the thing that I think I couldn't tell between reading stories from the US perspective, stories from the Japanese perspective. Do you have a sense of how that dynamic went? I read so many versions of this. So a lot of this is my speculation. I can't 100% say for

sure that this is exactly what happened, but this is kind of how I imagine based on everything I read. I think Yamauchi wanted to do it. I think Arakawa did not. And I think Yamauchi overruled Arakawa and said, fine, if you're not going to do it, we're going to partner with somebody who will. Even though you set up everything to be in-house with nintendo set up this whole nintendo of america this distribution arm we went through all this you proved yourself with donkey kong even though i saved you but i wanted to sell to taido and you said that was wrong i want to get this in the u.s so badly i'm going to go around you nintendo goes to Atari. Remember this? We talked about this with

Nolan Bushnell and he was like, yeah, I wasn't involved. That was really dumb because he had already left Atari at this point and it was owned by Warners. Yamauchi goes to Atari and says, Nintendo of America is not going to launch the Famicom. I want you to launch the Famicom now in the US. And they basically have a deal done. They negotiate it. This is going to be Atari, you know, underwarners knows that their hardware, the 2600 at this point is like dead.

It can't compete with the NES. They also know the market is totally going sideways. So they're like, sure, you know, worst case scenario, we can just sit on a competitor and tie up Nintendo and not launch this. Best case scenario, this is the Atari Nintendo Entertainment System. Wow. So what happened? They basically have a deal done. They are all set to sign it at the Summer CES conference in June of 1983. So Yamauchi directs Arakawa and Howard Lincoln to go down to LA and meet with Atari and Warner Brothers, start the initial negotiations. They do that. It goes well and I'm sure Arakawa's like,

I can't believe this is happening. Then the Atari folks fly out to Japan and meet with Yamauchi. They get a deal basically agreed to in principle where Atari is going to distribute the Famicom, not just in North America, but everywhere in the world, except for Japan. And they're going to pay Nintendo a per unit royalty fee, Nintendo would still get to sell the game cartridges. So it actually wouldn't have been like a terrible deal because all the money and all the profits are in the game cartridges. Right. But still, like talk about history changing on a knife point.

This would have been Atari's business. Yeah. And Nintendo wouldn't have had the direct relationship with certainly not customers, but not even retailers. Retailers. It wouldn't have built the brand. You know, all the IP. We're going to get into all the amazing stuff

that really Nintendo of America drives. Oh, it would have been an Atari-branded Famicom? Yep. Whoa. So they're all set to sign this at the June CES show in Chicago in 1983. So summer 1983. But by this point in time time the crash is already underway and atari and warners are keeping these negotiations going just to keep nintendo tied up but they know that they can't

actually follow through and like oh deliver on this partnership because in the second quarter of 1983 atari reports a 283 million dollar loss as part of Warner's earnings in QQ 1983. In the third quarter, so after CES, that goes up to a $536 million quarterly loss at the Atari division. A year before, I think like we said at the top of the episode, Atari had been half of Warner Brothers' entire revenue and 60% of its operating income. And now it's reporting a $536 million quarterly loss. So like the other shoe's about to drop. They have no power.

They can't do anything at this point. It's just a charade. So this probably would have happened. This definitely would have happened if the timing were different. Wow. But well, maybe it would have, maybe it wouldn't have, you know, I think, I don't know a hundred percent for sure, but I think Arakawa was like, yo, the reason I don't want to launch now is like, now is not the time to launch this in America.

I can see what's going to happen here. So maybe it wouldn't have, like, if things were different, maybe he and Nintendo of America would have led it from the beginning. And in a sense, Arakawa was right. The fact that they didn't release what became the NES, the US version, which is a little bit modified from the Japanese one for another two years. In one very key way, it's modified, which we'll get into in a sec. Two years later is a much better time to launch this system. Much better. And in the intervening two years, all the revenue and profits that Nintendo of Japan, Nintendo Co Ltd, the parent company was making allowed the whole company to be in a much better position to whether the investment they were going to have to make to reeducate the American market

when they do launch. And just to put some numbers on that for the first couple of years of the Famicom in Japan, not only are they selling every piece of hardware that they can make, every console that they sell has what comes to be known in the industry as an attach rate, the number of games that are sold with it, going up to like 11 or 12 games per console, not per year, but for the life of the console. And I couldn't actually find what the retail price of famicom cartridges were in japan at that time but let's assume they were comparable to the u.s which would be kind of seven to ten thousand yen kind of like half ish of the price of the console if you're selling 12 games at half the price of the console, you're making another 6x the console revenue

at like 80% gross margins. God, that's crazy. It's just a cash flow spigot. And that attach rate is high even relative to like the big consoles today. Like I think PlayStation and Xbox, it's different with the subscription stuff today, but target like a seven or eight game attach rate. What did you say? 11 game attach rate? 11 to 12. Yeah. Yeah. It's nuts. Totally nuts. Even more importantly, though, building up to an eventual US launch, it's during those couple of years from 1983 to 1985 that Miyamoto and R&D4 start churning out an existing library of just amazing games. So Duck Hunt, Super Mario Brothers, which is the first Mario game like we know it today. Absolute smash hit side scroller platformer. Yes. You know what it is. The Legend of Zelda, which actually was the launch game for the Famicom

disc system in Japan, which is, we won't get into it here, but The Legend of Zelda was the best thing to come out of it. Let's put it that way. So Super Mario Brothers for a long time was the top selling video game in history. Over the lifetime of that title, it sold over 60 million copies, obviously across multiple platforms, not just the NES. Of just Super Mario Brothers 1. Super Mario Brothers 1, 60 million copies. Duck Hunt sells 28 million copies. Later Super Mario Brothers 3 would sell 24 million copies. Keep in mind, listeners, there are 90 million households in the US. Right. So these individual games, this is the point we were making earlier that Yamamuchi understood. They're making billions, billions of dollars per game. That takes Miyamoto and a small

team at this point in time, somewhere between six months and a year to make these games. Well, there are some games that take four or five years. Right, right, right. But even in just those two years, from 1983 to 1985, Duck Hunt Super Mario Brothers Legend of Zelda launched during those two years. Actually, Zelda might have been a little bit later, but that's billions and billions of dollars like incredible so when they're finally ready to launch in the u.s in 1985 they've got so much firepower to bring to bear here yeah so they do a few things differently when they're developing the nes they take away the word computer which is sort of an important nod to, you know, we wanted this thing

to do all sorts of stuff to have check stocks and weather. And I even think it did some of that in Japan by this point. I think they did have the ability to connect to your phone line in sort of like a pre-internet way and get some of these services, but they launched in the U S and they're like, this is an entertainment system. Congratulations, you've just bought the very best way in the world to play video games. And for the US version, the NES also had removable controllers. They were hardwired in on the Famicom in Japan. And in the US, an important difference, the cartridges had a lockout chip. Ah, yes, the critical difference. That brings up the next pillar of the unbelievable Nintendo business model that we need to talk about. Third-party licensing.

And this is probably like a place to talk generally about the role of Nintendo of America versus the Japanese parent company. Because to this point, what we've basically talked about for Nintendo of America is they were a distributor. They were a regulatory arm. They had to pay payroll, and they had to do that in U.S. dollars for U.S. employees. And also they set up the distribution network and had some opinions on a go-no-go decision

of whether to launch in the U.S. But they aren't doing a lot of product-specific work. Or business model. Yeah. Yamauchi definitely thought of Arakawa and Nintendo of America, despite him being his son-in-law. Or maybe because he was his son-in-law, just thought of them as my American distribution network. Yes. but here's where things start to change so yamauchi did know and had learned from the atari third-party licensing business model that we talked about with activision and all that that that was an incredible cash flow stream and point of power you know he knew that even he wasn't going to be able to get all of the elite game

designers in the world to come work for Miyamoto and Nintendo, but he did know that he could get all of the elite game designers in the world to publish on the Famicom. So he sets up third-party licensing in Japan. The first two licensees are Namco, the Japanese arcade game company that made Pac-Man and Hudson. The first games that those companies, they were established companies, especially Namco, like were big existing companies, video game companies in Japan before publishing on the Famicom. It transforms their business when they publish their first titles as third-party licensees with Nintendo. Konami, which is another Japanese game developer that listeners might recognize, once they start publishing in Japan

on the Famicom, their revenue goes from $10 million a year to $300 million a year. This is how powerful what they built is. All right. So this is how consumers want to play video games. So if you make a video game, you should probably figure out a way to go to market on this. This is the power of a platform and a network effect in the video game console business. Yamauchi gets all this. The terms that he sets up for the initial licensees in Japan, Keech's copies the Atari business model. They pay Nintendo a a 20 royalty on their revenues from the games and that's it i mean great cash flow stream for nintendo wonderful all that but they could be doing so much more and indeed the next set of licensees in japan nintendo ups the cut to 30

that they take and says oh by the way only we can manufacture the cartridges you got to buy the cartridges from us you can't make them yourself too and we're going to make a profit on that too so like good which at this point is just contractual it's not a technical limitation yes exactly and there's also no legal structure that they've set up in Japan that prevents anyone else from sort of unofficially making and publishing games for Nintendo. And so a gray market emerges of developers who say, we're going to make Famicom games, but not work with Nintendo and sell them ourselves. And famously, one specific company from Taiwan called Hacker International starts making both pornographic games and gambling games. Super ironic given Nintendo's origins.

And Nintendo, meanwhile, has drifted like very Disney, very Apple and their family friendliness. And so this is so like antithetical. Strict censorship, like all of this stuff that we think of Nintendo today has, you know, they've been in the toy business for decades at this point. By the way, this sounds hard to do. Like you have to figure out how to manufacture the like correct sized plastic and the correct motherboard with all the correct pin connectors. Like if you don't have a factory set up to make Famicom cartridges, creating that sounds really hard. But the economic incentive to do so is worth it. This market is so big. So companies like Hacker International are making tons of money selling

their own cartridges directly and not paying a dime to Nintendo. And meanwhile, they've got this brand problem that's emerged and all this stuff. And if they're not careful, even though the Famicom is so advanced and so superior, you're not going to end up with the same thing as happened in America in 1983 with a video game crash, but you're going to have some of the same problems if you don't control the ecosystem of publishing around your platform. So Nintendo of America, when it comes time to launch what would become the NES in the US, they come up with maybe the most genius inversion of all time. One, they say we should engineer a lockout chip that you were referring to into the hardware and the software. It's actually unclear to me if that

idea came from Japan or from America, but the Japanese engineers implemented it. And this is a specific chip in the console that needs to handshake with specific chips in the cartridges for the new systems in America that will lock out any not official Nintendo approved cartridges from playing in the console. I don't know if it's actually how it works, but it's effectively a Nintendo signed cryptographic thing. So it's like, unless you actually go through Nintendo to make sure you get the specific chip with the specific cryptography and put it in the cartridge, it's not going to run on them. Yep, totally. And actually, later versions of the Famicom in Japan would also include a lockout chip on them. Yep, totally. And actually, later versions of the Famicom in Japan would also include a lockout chip on them. So they try and retroactively also bring this to the Japanese

market. But Nintendo of America is like, obviously, a lot of people in the ecosystem are going to hate this. What if we market it, though, to consumers, as this is a good thing. We know that you consumers got burned by the glut of mediocre software in the last video game bubble. We, Nintendo, are on your side. We're going to make sure that doesn't happen here. This is our seal of quality. The Nintendo seal of quality that we are promising to you, our customers, that only the very best, highest quality software and hardware peripherals are going to come out for your system.

This is absolute genius. And this is the exact thing that Apple steals from. This is the exact party line. This is the exact strategy. When they launched the App Store, to this day, this is the exact reason that they have to justify it. Oh my gosh, for privacy, for security, this is for the benefit of our users. Sideloading is the worst thing ever. I watched Craig Federici give a talk on stage in Lisbon two years ago, talking about how sideloading or external app stores would be the worst possible thing. And Apple generates tens of billions of dollars a year from the 30% of everything that

runs through their app store. And they stole it all from Nintendo of America. It is to the number the same thing that Nintendo was getting with that 30%. So, so, so good. And they don't, Nintendo of America doesn't stop there. They're so audacious with what they do, but they could get away with it because nobody cared in America. It was a dead industry. And also they had a great device. Like again, the iPhone parallel here, Steve Jobs always said, this is five years ahead of the competition. I think that ended up being around it maybe a year or two, but like basically right. The Famicom was five years ahead of the competition in consoles. So they go and they have the very best device on the market that everyone wants. You aggregate all the users. You could do whatever the hell you want to your developers. Oh my gosh. And they just make money six ways from Sunday on this. So it continues the legal

innovations of Nintendo of America here. And really, I think Howard Lincoln is behind a lot of this. They say, we're going to go further. Any third party that makes games for the NES in America, we're going to limit the number of games that you can make per year. We're only going to allow you to release a maximum of five games per year on the platform. They're just like flagrant here. They're just like, oh, the DOJ is never going to come for us. Which they didn't, I don't think. No, they did in Europe. I think they got in trouble for this, but somehow they escape in the US. There is truth to the promise that Nintendo is making to consumers. If you do this, it does mean that anybody who publishes for the NES can't just offload a ton of crap on the system.

They have to pick their five best games and that's all they can do any year. And Nintendo is going to just like if they feel like someone's game is crap, they're not going to prove it. Yep. No chips for you. Exactly. And then the third thing that they build into the Nintendo American licensing program, your games that you publish on the NES have to be exclusive to the NES for at least two years, which doesn't matter right now because there's no viable competition, but will become very important very soon.

Yeah. Dirty. Or clean. Nintendo would say clean. Yes, they would. We are keeping our platform clean so nintendo of america and nintendo japan finally align that they're going to launch in north america for the 1985 holiday season and they're going to launch in a test market to start the new york city metro market super important because this is the epicenter of the toy industry. So they managed to get relationships with both FAO Schwartz and Toys R Us, and Toys R Us would

become huge. Of course, it's already national at this point, the biggest toy chain in America. It's based in New Jersey. So it's very strategic to launch in New York. They convinced the retailers to carry them. And this is where the next set of innovations come from Nintendo of America. Partially, I think this was necessity because the retailers, even though they know this is an incredible product, they're skeptical. Like it's not obvious that this is going to work. The consumers are way, way, way down on home video games at this point, even still in 1985. Nintendo says, we will come merchandise this within your stores for you. We'll make it so easy for you to do this test with us. You don't have to take your staff off of other things. If you

can give us space in your stores. How very Louis Vuitton. Yeah, exactly. This is, I think, the first store within a store in America. Literally, they come in and they set up the Nintendo displays and they do everything. Eventually, this would evolve and become the world of Nintendo. That is the way that, you know, if you were a kid or parents in the 80s and 90s and you bought Nintendo products in a toy store, you bought them at the World of Nintendo store within the Toys R Us or the Target or the Babbage's or whatever. And all of that, that experience was controlled by Nintendo of America. Fascinating. And of course, they could put all sorts of other ancillary merchandise in there. Mario backpacks, t-shirts, you know, blah, blah, blah, what have you. God

knows did they put Mario on backpacks and t-shirts. Oh boy, did they ever. So they managed to sell 50,000 units during the Christmas season in New York, which is not a grand slam success by any means, but that they even sold that much, that'd be about $5 million in total sales. Again, not a lot, but given that the whole industry had shrunk to $100 million in sales, that they could sell $5 million in one metro market in one holiday season. To take 5% of the US's market share just in that one holiday season, that one metro, not bad. Not bad. It's funny, when you said 50,000, I was like, so it flopped when it launched. But actually,

when you think about it relative to how terrible the market was. No, everybody was like, look, do we wish we sold more? Sure. But this is actually a success. Yeah. So throughout 1986, they start rolling out more metros throughout the U.S. They take a kind of rolling thunder approach, which we're going to get to in a minute, also becomes the next innovation from Nintendo of America. Can you imagine this today if they rolled out the Switch city by city? Right? So antiquated. So antiquated, but so brilliant, which we'll get into in a sec. They sell a million units throughout all of 1986. So like, okay, we're now like in real business. 1987, it's officially

available nationwide. They sell 3 million units in 1987 and 10 million game packs. So like at this point, they're already basically coming close to parity with Japan, which is incredible given that the whole industry was dead two years ago in america yep but the strategy and how they roll out to retail is brilliant remember it was over supply that killed the market before and you're trying to bring a market back from the dead like what will kill a market is when you have supply and demand out of whack where there's way more supply than demand even though there's just a trickle of demand for video games at this point in america n of America leans into it. And they say to retailers after that first New York City test launch, we only have a very small amount of product available. They ration the

product. I think they fill 50% of every order. And this is an unofficial, never written down anywhere for fear of the DOJ, but like an unofficial policy of Nintendo America for years and years and years. Retailers only get half their orders. Wow. And it works like a charm. All of a sudden, the NES and a video game console goes from being like on the markdown collecting dust in a bin somewhere to the hot thing. You better show up at 6 a.m. to get it on the shelf. You got to stand in line like it becomes this super hard to get. It's everything we talked about in the LVMH episode. This object of desire that is very difficult to get.

They also take a page out of Disney's book and they keep most of their game catalog out of production most of the time. And so it's also hard to get a game unless it's new or one of the few that they've brought back into production. Yep. So Yamauchi actually brings a lot of these innovations from Nintendo of America back to Japan. So they alter the terms of the licensing agreements with third parties. They go even further in Japan in true Yamauchi style. They can only make three games a year in Japan instead of five games in the US. They add the exclusivity clause. Like we said, they changed the hardware on future Famicom models to add a lockout chip. They have so much control over every player in the ecosystem.

It's so Disney-like. And then finally in 1988, Nintendo of America still has their retail strategy, shall we say, but it blows through the roof. They sell 7 million NES units in 1988, which is way more than Japan, and 33 million game packs in America in 1988. So that's just

in America, a billion dollars in console revenue and another one and a half billion dollars in software revenue. A billion dollars in console revenue in 1988 is 10 times the entire market size for home video game consoles four years before. 1989 and 1990, they sell about another 10 million units of the hardware each year, such that by the end of 1990, one third of American households, 30 million American households have an NES. And in the annual Q ratings in America, which aren't as much of a thing anymore, but I had to be reminded of it. It's the measure of recognizability of celebrities and brands in America. In 1990, Mario has a higher

Q rating among American kids than Mickey Mouse. Whoa. Isn't that wild? That is wild. And this is where they just start running away with it. In 1990, this is when they have 95% of the video game market, right? In the US. Yes. This is like the peak. This is Nintendo at the peak of their power. The Sega Genesis, the Mega Drive in Japan had launched in 1988 in Japan and 89 in America. But it's a flop at first.

It takes them a couple of years to figure out the marketing and how to compete against Nintendo. So Nintendo is just- An unabated path. Unabated path, firing on all cylinders. They do things, just these incredibly innovative things. They launch a 1-800 toll-free line for game counselors. This is incredible. Do you know my personal story with this? No. is incredible do you know my personal story with this no so my wife's mom worked in redmond in the correspondence department for nintendo and they had two groups one is the game counselors and this is like super hardcore like you take a test there's a great netflix documentary that

describes it called high score and it interviews it's got footage of a bunch of people in the game counselor group right after they take their test and like they are on the phone talking people through levels and kids are calling up and yeah my mother-in-law worked in the correspondence department the letters letters and so she was saying that they would get hundreds and hundreds of letters they would answer every single one and they were almost always like to illustrate and validate the point that like this was a little boy thing for a long time and teenage boy thing she's like basically all the letters are from little kids mostly little boys and they're just like asking for help and like thanking nintendo for making great games and it's just this unbelievably heartwarming

thing but it also gave nintendo such a direct relationship with customers they eventually do make the phone line i think it's the nintendo power line paid but in the beginning it's free think this is crazy they are offering game counseling advice, like help with games. For free. For free. This is an 11-star experience. Not only are we going to sell you the most powerful hardware on the market by years for a really cheap price, we are then going to give you a toll-free number that you can call for free, and we will help you play the games. Because they wanted to answer every single one. So they had 80 people regularly on staff, but during the holiday season, it would be like 300 single one. So they had 80 people regularly on staff.

But during the holiday season, it would be like 300, 400 people that they would staff up to to handle all the calls. Yeah. This also tells you about the margins that they were making on the software. I asked my mother-in-law about it last night as I was getting ready for the episode. And she said it was like a pretty amazing place to work because, as you can imagine, I don't think her logic was because it was so profitable but the fact that it was so profitable and it was such a like central part of the country's zeitgeist trickles into the culture where like everyone's doing well everyone's having

fun at work the work itself is fun it's such a like family safe clean brand that like there's only like upside to every interaction that you're having so it's such a like family safe, clean brand that like there's only like upside to every interaction that you're having. So it's funny, right? Like this is a subsidiary of a Japanese company. So it's not like anybody working there has equity in what's happening. Right. And in fact, they were all paid at or below market. But as one example of the money floating around, at one point, Nintendo of America buys a bunch of properties in hawaii and basically like creates their own internal like resort for nintendo of america employees that you could like book to go take your family to hawaii and stay in the nintendo own properties and then we'll talk about this a little bit more next time but um they buy the seattle mariners can we talk about that like yeah uh this is a very profitable enterprise pretty amazing perks to get to work there you

end up with free game systems and free games and like you are a cool parent so this is one half of the amazingly innovative direct relationship with customers that nintendo America comes up with. The other half is Nintendo Power. And it's crazy. I mean, like doing the research for this, there are issues of Nintendo Power that sell on eBay today for thousands of dollars. The amount of brand affinity that this creates. Well, I used to buy so much of next episode is going to be about Pokemon, but I used to buy Nintendo Power for the maps of the Pokemon levels to be able to like show you where you need to go walk to unlock something and where different Pokemon are found. And the idea that like you're taking a pretty small screen. I mean, in my case, it was the Game Boy Color.

But back in the Famicom days, it was, you know, still a pretty small snapshot of the world on the screen. And to be able to lay it out in a magazine format to really show you the whole thing, it helps you understand how to play the game so much better. And of course, there's editorial. And of course, there's secrets that they divulge. I think this thing built up a pretty significant readership. Six million circulation. Crazy, right? So here's what they do. Everybody who mails in the warranty card for an NES automatically gets added to the Nintendo Fun Club fan club.

So they're getting all the addresses and names of every single one of their customers directly. Nintendo's head of marketing, Peter Main, and then Gail Tilden, who worked in the marketing department department came up with all this stuff and gail ended up running nintendo power so for the first kind of year of the nes in the u.s they send out the fun club newsletter for free once a quarter to everybody who registers and then they realize like what this could be so much more so gail starts an actual magazine, Nintendo Power, they send in the next mailing to everybody, they say, hey, you can subscribe for $15 a year to a monthly magazine. They instantly get a million and a half subscriptions. It's the fastest magazine to reach a million subscription circulation in the US in history and becomes one of the largest magazines in the country. Wow.

And so all this is amazing. So I think they eventually raised the cost to $20 a year. They get 6 million subscribers. So that's 120 million a year in high margin subscription revenue coming to Nintendo, dropping the bucket. What it's way, way, way more valuable for though, not just the relationship with the customers, it's for selling games. Oh, amazing. So the game previews, they use Nintendo power to just juice all of the Nintendo first party and some third party games. They control the entire ecosystem now, like the marketing channel to the customers, the retail experience within the stores, the hardware, the software, everything. It's one of the greatest businesses that's created of all time.

The Nintendo Power Strategy reminds me so much of the NFL with NFL Films and the NFL Print Division. Absolutely. Not only are you doing what the NFL did, which is building hype around your media properties and around all of your intellectual property, you are going one level further, as we just talked about, where you actually have a direct relationship with the customer. They built a 6 million plus CRM of people who bought Nintendo that they otherwise wouldn't have had their contact information, but now they have a new way to market stuff to them. Yeah, it's just this incredible story.

So here's the craziest thing that I was trying to contextualize some numbers. Remember how I said in 1989, Nintendo's sales were 10 times the market bottom? Yep. That a billion dollars of revenue relative to the 100 million low point. Well, two years later in 1990, Nintendo did almost 3 billion in revenue, which was the entire industry market size at its peak before the fall. Nintendo's revenue alone in 1990 is the same as the entire industry in 1983 at the height of the mania. Yeah, just incredible. I don't know if it first happened that year in 1990.

It may have. The only thing I read and that I know for sure is that by 1992, Nintendo's profits, so not their revenue, but their profits, surpassed all of the major movie studios and television networks combined. Isn't that wild? It's so insane. So the NES, and I think it's probably about time to start tying a bow on the NES story here,

would eventually sell 62 million consoles worldwide. I think we should save the Super Nintendo, Game Boy, and the whole battle with Sega as the beginning for part two. What do you think? Yes, that was my intention all along. There's plenty of analysis to do just on part one here. This is the perfect place to leave it because here we are by the end of the NES Famicom generation. Nintendo has revived, rescued this industry from death's door, built one of the most impressive monopolies of all time in business anywhere in the world, and a global monopoly too, they can basically do no wrong. And what happens next is the fall from grace. And I think that's going to be the perfect

place to start the next episode is how they fall and then how they come back. Yep. Agree. It's also worth pointing out a little bit at this point. So for fiscal 89, just to put some numbers around this, they did 1.84 billion in revenue and 217 million in earnings. So they're doing 12% ish net income margin which is like good but not as good as big tech companies today we're talking about how amazing the business model is but like it is worth pointing out like just how much r&d they had just how hard it was to manufacture a lot of this physical stuff at this point in 89 they were heads down on two future generations of console actually three including the virtual boy so there's a lot of like real expense in the business even though they're blowing the doors off sales i think that's true i think that net income was

probably suppressed and artificially low perhaps in part because of all the cash sloshing around that they were using but also all the international entities believe, I don't have the stat at my fingertips, but I believe operating margins were more in the 30-ish percent range. Okay. So still not like tech companies today, but good. Right. So spitting off hundreds of millions of dollars in cash is nice. Yes. There are a lot of ways that you can find tax-efficient ways to hide those hundreds of millions of dollars. That's a lot of ways that you can find tax-efficient ways to hide those hundreds of

millions of dollars. That's a good point. Before we get to analysis, I have two very fun asides for you that are little branches off this tree of story. And I'm curious if you found them, because one is incredibly up your alley. This is my favorite part of every episode, when you try and stump me. I think so too. So we talked about 1983 being a really crazy year for gaming. There was a company started in 1983 that was supposed to be a gaming company that became very large that was not a gaming company. Do you know what that is? Well, obviously it's not Slack because that happened later.

Obviously it's not Slack. Let's see. Electronic Arts was started in 1982 by Trip Hawkins and is a gaming company, so you're not talking about that. Yep. And it might be more fair to call it a game distribution company than a game developer again it didn't really happen so it's hard to say what it exactly would have been you're also not talking about netscape which started as obviously mark andreason and jim clark of silicon graphics and university of utah fame which started with the initial business plan of building software for the n64 but you're getting much warmer okay okay 1983 the original company name was control video corporation

it's probably not helpful oh wait i know this this is the problem when you become a parent is like your mental acuity. Just like if I were a couple of years younger, I, we wouldn't be having this stage of the conversation. I already would be, but I got it. I got to cry, uncle. I'm going to keep giving you hints. Cause like, you're going to get this. It's like the Netscape story in every single way. They wanted to develop a way to internet connect a game console and instead became something like Netscape. Have we covered it on the show? We have extremely early on. And we did not paint it in a great light.

And it is not Silicon Valley based. It's East Coast, Virginia based. Wow. I can't believe I'm still blanking on this. I'm hoping there's listeners like screaming into their airpods right now it is the question is how much of this are we going to cut in post-production it is aol oh my goodness so it started as control video corporation in 1983 there was one product an online game service called game line for for the Atari 2600. And it had

an amazing amount of very prescient technology, the ability to temporarily download a game, cache it locally on device, and keep track of high scores. It would work by connecting a telephone line, and GameLine would eventually go through some corporate restructuring and eventually emerge six years later as America Online. Wow. I can't believe I missed that. Here's a crazy total aside. When I was in business school at Stanford, the years 2012 to 2014, the AOL building in Palo Alto was still a central hub of things.

So, Stardex, the Stanford incubator that I was part of when I was there, was actually based out of the AOL building at that point in time. Isn't that wild? Even at that point in time, AOL still had its tendrils in Silicon Valley. Wow. Okay. I've got another one and I'm just going to start telling the story score so far ben one david zero well i don't know i have all the stats in front of me i don't know if there's me one no this is a this is a game we're doing the nintendo episode we got to keep score all right so hit your buzzer when you have a guess okay so in 1990 right where we ended our story a small game developer approaches nintendo to show off that they had ported the first

level of Super Mario Brothers 3. Come on, that's too easy. Carmack and Romero. This is a crazy story. Do you know what Id's first name was before they shortened it to Id Software? I mean, you just read the book, so this isn't fair. No, I actually got this. I'm sure it's in the book, but from research for this episode actually got this i'm sure it's in the book but from research for this episode that i had completely forgotten uh i do not know when i looked at video of what you were talking about what is it like smb3 dos no no it's related to it it's ideas from the deep oh cool so what happened was john carmack one of these geniuses that Yamaguchi was identified in talking about, had engineered, and I understand this so much better now having done the NES episode. This is why what Carmack

did at id was so incredible. He had developed in software a way for generic PCs to do side scrolling graphics like the NES. This was incredible because the reason the NES could do this was because of the picture processing unit, the PPU that we talked all about. Regular PCs only had a CPU. They couldn't do this. Carmack wrote software that enabled it, and then they famously made a demo version

of Super Mario Bros. 3 for the PC and showed it to Nintendo. And we didn't talk about Super Mario Bros. 3, but that is widely held to be the best Super Mario Brothers. One was the original, two was too hard, three was like widely anticipated, and then it came out and just was like even better than everybody thought it could be. Yeah, three was amazing. But so you can find video, we'll link to it in the show notes. You can find video that came out decades after the fact of the actual id demo that carmack coded up like it was lost i think somebody found it on an old machine at some point in time recently and so

there's like youtube like you can go get video of watching it play it's amazing it's so incredible what carmack did but the background of it so they have the background of the desktop they have it in a window playing on a pc huh which you still can't do unless you're running a nintendo emulator on your computer an emulator yeah yeah i guess it was 3.1 maybe at that point in time um windows 3.1 uh it was dos based oh it was dos base yes well there was whatever the gui was that they had on top of it because they'd have a gui to play okay that. So the background wallpaper of the GUI just said, IFD, IFD, IFD, IFD, and rose across the screen. I'm like, what the hell is IFD? And then I figured out it was Ideas from the Deep. Oh, that's awesome. So here's how the story goes. So he invents in an unbelievably genius way on this architecture, a way to do the side-scrolling

Mario thing. and they approach nintendo and he's like look at this market opportunity i've discovered for you can we be the developer of nintendo's entry onto the pc you know mario on pc and nintendo thinks about it and they say no because we only want mario to be available on the nes to promote console sales which of course is the right decision of course so they turn down the short-term NES to promote console sales, which of course is the right decision. Of course. So they turned down the short-term money to promote long-term stability. But id would then go on to rip Mario out of that PC side-scroller and turn that into Commander Keen. So Carmack and Romero would then of course go on to create Wolfenstein 3D, Doom, Quake.

There is some alternate world where Nintendo could have said yes, and those could have been Nintendo games. The alternate worlds in this episode are wild. Like the Atari NES, Doom by Nintendo. The internet being AOL on Atari devices. Right. We're not going to talk about it on this episode, but Netscape being an N64 information super highway-based technology platform. It's crazy. All right. Well, let's get into analysis here. Let's do it. Should we start with powers as usual?

Yeah, let's do it. So for folks who are new to the show, as always, we run each company we analyze through Hamilton Helmer's wonderful seven powers framework, where he identifies seven ways by which a company can earn persistent differential profit margins versus its competitors in any given industry, AKA have power in its industry. The seven powers are counter positioning, scale economies, switching costs, network economies, process power, branding, and cornered resources. All right, let's get into it for Nintendo. Well said. Far and above number one, in my opinion, is scale economies. We have done all but name it. Not network economies. Well, it's a good question.

Keep going with scale economies. I mean, I agree. The reason scale economies jump to mind is we just keep talking about it on this episode without naming it. And when we talk about things like Nintendo produced the most desirable console, which all the consumers bought, which then meant that Nintendo had power over its developers, that is a pure play scale economy that a game was worth way more on Nintendo for the NES's distribution than it was worth anywhere else. And so if you're a developer, it almost doesn't matter how bad the terms are with Nintendo. You have to build for Nintendo because there's more money there because it's amortized across so many different users of

the platform that it's just always worth it. Okay, so I totally agree with you. I think this is the number one source of power. Isn't this network economies, though? A two-sided network effect, the more users you have on your install base, the more attractive you are to developers, the more and better 10x, 100x developers you have developing for your platform, the more likely you are to attract more users? It's a good question. I mean, I think the scale economies when you define it is that you can make a fixed cost investment that is more valuable to you than it is your competitors, because you can spread that cost across more customers that can sort of pay it back in a bigger way. And so because you have more customers to spread it across, that fixed cost investment is more valuable to you, Nintendo,

than it would be to your nearest competitor. Like the fact that Netflix can pay more for content because they have more people watching. I think this might actually be a special case of both network and scale economies where it's both as a fused together. If Nintendo was acquiring the games, then it would be pure play scale economies, but they're not. They're convincing developers to build on their system. Yes, but there is a strong component of scale economies here too. I think you're onto something that these are linked because it's all about the hardware R&D cycle. Because you have to invest an enormous fixed cost of both money and, you know, for everybody now, but at the first for Nintendo's time in developing a superior hardware because you can have that scale economy advantage on the hardware platform, then you can get the network economy effect going of consumers and developers. Yeah. Interestingly enough, Nintendo historically hasn't done a great job of leveraging

a large install base to advantage them with the next platform. We'll talk about this next episode, but their success in the N64 did not carry through to the next generation with GameCube. They were sort of starting from zero again. It started even before then. And these were like, this is, we'll talk about this a lot more in the next episode, but an incredible self-inflicted wound that Nintendo as part of killing their dominance, they didn't have backward compatibility at every early generation.

The Super Nintendo was not backwards compatible with the NES. The N64 was not backwards compatible with the Super Nintendo. The GameCube was not backwards compatible with the N64. They completely whiffed on this really important lesson. And so console R&D is actually not a scale economy because you don't have the benefit of all the people that bought your old console to amortize the cost of your new console across because you don't know how many people are going to buy the new console. And so I think that's something they've sort of woken up to with the Switch, again, foreshadowing

here. But to the extent where the next big console that Nintendo comes out with is a Switch and is super Switch compatible, then they actually start entering the scale economies game where they can make the biggest, best piece of hardware if they can get more people paying a sort of subscription. Well, that they can port their existing user base over to the... Yes. They first are doing it with the Wii, which not coincidentally is their big comeback, that we could play GameCube games. We're getting ahead of ourselves.

Definitely we are. But you're right. I think there's sort of some scale economy, some network economy here, but we're both describing the same phenomenon. You know, it's interesting. I remember back from my days at GSB at Stanford, one of my favorite professors, a professor named Susan Athey, who then later would join the rover.com board with me and I get to re-intersect with her there. A wonderful, wonderful person, incredibly smart. She was,

in addition to being a professor at GSB, the chief economist at Microsoft. And a lot of her work was on Xbox and the video game industry. That'd be such a hard spreadsheet to make to figure out. Oh, totally. Her academic specialty is network effects. Everything she did was network effects. And video game consoles and software is the textbook classic definition of the two-sided network effects. And I remember reading all about it in her class. Like, I was like, oh, this is so cool. Yeah, so no question to me that both network effects and scale economies are huge sources of power

for Nintendo here. Miyamoto definitely has process power. Yep, and he's a cornered resource for Nintendo. There's something that happens in his group where they come out with an unbelievably creative game concept that I'm sure at first, much like Pixar movies, I'm sure the first cut isn't super fun, but they have a way of turning it into fun and weeding out things that aren't fun.

That is absolutely process power because I bet it would be really hard for him to write it down. Totally. And I'm sure a lot of people listening to this know by heart all of the games that Miyamoto has made. But for folks who don't, we mentioned a couple, but he is the Beatles of video games solely. He's probably the best game designer to ever live. No doubt about it. And in fact, there's this amazing story of, I think it was in the 90s, when Paul McCartney was touring in Japan. He's contacted Nintendo. He wanted to meet Shigeru Miyamoto. He had such reverence for him. But all the Mario games, Mario 64, which revolutionized the industry, the first true 3D game, Legend of Zelda, A Link to the Past on the Super Nintendo, The Ocarina of Time on N64, Breath of the Wild now for Switch.

Did he design Breath of the Wild? Well, so he's the head of Nintendo's game. So he's the producer. He's like the producer. He's the producer now on the Zelda series. And there are other directors below him. But like, it's all his process power. By the way, a new Breath of the Wild, or what do they call it? Tears of the Kingdom comes out next month. Which is, I have a confession to make.

I've never been the biggest Zelda fan. Like, I like them. I play them. And I thought Breath of the Wild was great. It's just not my total, like, style. But, I mean, there are people who name their children Zelda. Totally. Like, a lot of people who name their children Zelda after the video game.

And you and I both talked to some games industry people preparing for this episode. And from real core gamer type people, it's amazing how much reverence they have for Breath of the Wild, where like everyone just looks at it like, wow, how did they manage to pull this off? Because it's not for a core gaming audience.

And it was once again, to the point of process power, it was a similar situation at a smaller scale where open world games were dead. They'd been totally overdone, oversaturated. The market was sick of them. And here along comes Nintendo and Miyamoto and completely re-envisions and re-energizes the genre. Yep. So back to the powers. Is there counter-positioning in the way that Nintendo created cabinet games or maybe in the general concept of we're not about the fastest and newest? Absolutely. I think there's plenty of counter-positioning

all throughout Nintendo history. And I think there's several examples here in this chapter of the story or these chapters of the story. One with narrative driven games and Donkey Kong. Two though with the Famicom and the NES relative to especially the rest of the American video game industry. It's like we're about a small number of high quality games, not a large number of crappy games. Yep.

Again, this will show up in the next episode, not this one, but switching costs. 100%. If Nintendo had a viable competitor in the late 80s, there'd be switching costs, but there weren't. And so that'll show up in the Sega battle of once you pick a side, you're sort of dug into that side, at least for the next six, seven years.

And for the majority of the market in both America and Japan, families are only going to buy one console system that they're going to buy all their games on. There is a subset of the market that is going to buy both the Super Nintendo and the Sega Genesis, but that's a small subset. Today, most households are going to choose between the PlayStation and the Xbox. And it's interesting that Nintendo is a third alternative thing. But yeah, 100% switching costs. My god, I think Nintendo might have every single one of these powers. I'm looking at this. I don't think they have branding. Well, they do now with

their IP. I don't know that that's branding, though. The definition of branding is if you receive two identical objects, you're willing to pay more money to buy from a firm with branding power. Great point. And IP is a cornered resource, not branding. The reason you buy something from Nintendo is all sorts of reasons, but not because it says Nintendo. Like their nearest competitor doesn't have any of the same features

and capabilities that they have. It doesn't have the games. It doesn't have the same form factor. In the later years, it's like your friends don't have it, so you can't play online. Like there's lots of differentiation. It's not like a bank or insurance company where everybody's competing in a commoditized way, and so brand really matters.

Two thoughts. I think Nintendo does have brand power, but I think it is the weakest of the seven that it has. It's just incredible. I think it has all seven. But the brand power, I think, is a smaller piece of the story and its brand power around the seal of quality and especially with parents. And in this era, if I buy my kids a Nintendo system, I can be very sure that there's not going to be excessive blood and guts. There's not going to be sexual content. There's not going to be profanity.

I think that's definitely branding because the Genesis brands against that. Yeah, that's true. They counter position there. I guess the reason I bring it up is because it never actually comes down to branding because there are so few competitors that they differentiate in all sorts of ways that they don't actually need to rely on branding. You could argue maybe in the modern era, the Xbox versus PlayStation war is actually more of a branding power for one versus the other of why you would pick since they're less differentiated. But Nintendo's wildly differentiated in the IP that is on their platforms and nowhere else. I mean, at a minimum, I think they score super strong on six out of seven powers during this era. Yeah. The cornered resource being the IP, process power we talked about with Miyamoto,

network economies and scale economies probably being chief among these, switching costs for sure, counter-positioning, yes. Like, wow, have we ever covered a company like this? I don't think so. I don't think so either. And it reflects in what happened. Like they had 95% global market share in this enormous industry. Yeah, and perfect timing.

All right, playbook. We've talked about a lot of these, so I don't want to just revisit some. I want to bring up some that I think are kind of new. So Mario as a character, and I pulled this out of the Super Mario book from going deep on that franchise, is so perfect because he's so universal.

It's story-driven, but there's not that much personality. So anybody can sort of see themselves in Mario. Whereas if you're playing more of a core game and you're like, or even an RPG of any sort. Oh, RPGs. Yeah, absolutely. Your experience, a story that's unfolding before you as an observer. It's like reading a book. Right. But in Mario, there's not enough depth to Mario to say, I'm observing Mario. You just are Mario. And that's the perfect casual gaming character to just massively expand the gaming audience beyond teenage boys and make it the most accessible ever. Yep. Completely agree. It's also interesting to note though, during this era too, and again, just to how powerful Nintendo was as a platform, they also had all of the great opposite kinds of games, the Dragon Quest, the Final Fantasies,

the hardcore story-driven RPGs. Yeah. Mario is also fun fun every time you don't get sick of the music the levels were easy to play but hard to master most of the levels only had small tweaks between that stage and the next stage but somehow it still felt fresh and new every time especially in this era where like a lot of the competitors games you'd quickly tire of them like you could play mario for 150 hours and it would still feel fresh and new every time and that's a extremely difficult thing that is why miyamoto is such a genius yep he does this genius thing of incredible world building especially starting with super mario brothers of like you're in the mushroom kingdom and like it's this incredible fantasy world but it's story driven, not narrative

driven. So like you can create your own narrative within the world. Right. You know, it's funny that the Popeye IP stuff didn't work out because like it was their first choice to use Popeye IP, but by not getting it, they ended up creating this unbelievably valuable franchise with Mario. And I pulled some numbers. You mentioned 385 million Super Mario games were sold cumulatively. And so that gets beat by Tetris, Pokemon, Call of Duty, and GTA in terms of total franchise copies sold ever. But Mario, if you sort of pop up a level and include Mario Kart and Mario Party, that's 826 million copies of Mario games sold, which definitely makes it the best-selling franchise of all time. Yeah. Wow. sort of clever thing they did not allow licensing of other characters if you wanted to license a nintendo character for a backpack or a lunchbox or one of the other 10 000 things people have

licensed nintendo ip for for the longest time they would only grant you a mario license because they wanted to build a mascot they wanted to build so much IP and brand value into the Mario character that he became Mickey Mouse. Ah, interesting. So they concentrated the effort as opposed to having Kirby licenses or Link licenses or Zelda licenses. Right. It's interesting what that allowed them to do because it made Mario more than a plumber. It made it so that when Mario appears in other games, it doesn't feel strange because Mario just means Nintendo. It doesn't mean side-scrolling plumber character, which was another clever creative decision where he's just like, oh, he's the Nintendo mascot. And sure, he's got a game of his own, but he shows up in all these places. And it keeps going back to like, it's important for him to not have that

much character depth because it makes it so that he can be super universal as the mascot. Yep. Great point. There's one more in this train of thought, and this will be, I think, a big theme of the next episode. But the fact that Nintendo platforms are first and foremost for Nintendo IP, and they love making high margin revenue on other developers. And they're going to

say no to a lot of developers because they're inappropriate for the platform or they don't deem it a good game or whatever other finicky belief that they have that it's not Nintendo in some way. But unlike other platforms where they have a launch title and sort of a mascot for the platform that's just like to juice the initial sales of the platform so that they get a network effect and then they can really make money from the third party developers. Nintendo has such good owned IP that I think they would be delighted just making the NES and SNES and the Game Boy and it's only ever their games on it. And the way that that has compounded over all these years is that they own some of the most

differentiated IP in the entire world, and basically the only globally recognizable video game IP in the entire world. And in second place is Pokemon, and they own a third of that. I think it was probably accidental at first, but then once they realized the value of what they had, they were super protective of it. Yep. Well, and with Pokemon too, we'll again talk about this more next time, but they only own a third of the IP,

but they own Pokemon only being on Nintendo platforms, to your point. Correct, yeah. It's very Bernard Arnault. It's control more so than economics. All right, what do you got? The one big playbook theme that I want to talk about, Peter Mayne, who we mentioned, was Nintendo of America's VP of Marketing. And he, along with Gail Tilden and others,

were really responsible for the core of the innovation that came from the American side of the business. He codified what ultimately became the company's sort of unofficial slogan, besides like, do everything to be a monopoly without using the word monopoly. But we'll put that aside for a minute. The phrase he comes up with is, the name of the game is the game. And I think this is like such a key to understanding Nintendo and so applicable elsewhere. And specifically, I think like all like such a key to understanding Nintendo and so applicable elsewhere. And specifically, I think like all great personal and corporate encapsulations, it's both 100% true and 100% ridiculous and not true. And so what he means and what Nintendo means by it is that the quality of the games that we make and that others make for the platform is the name of the game.

That is all that matters. The quality of the product, the quality of the games, if we make and make available exclusively the very best games out there on our platform, we will win. And that's 100% true. That is what matters. And that's part of Yamauchi's true genius was as a complete outsider, recognizing that the Shigeru Miyamoto's, the Gunpei Yokoi's are the key to making all this work. At the same time, though, the reason it's utterly ridiculous and doubly ridiculous because Peter Main coins it, he does everything besides make the games. And that is so important too. Like it really comes down to like product and distribution. Both are really important. Well, also like the best CMOs party line is our product is just so amazing. It sells itself. That's exactly what you hear there.

But I think Nintendo is such a perfect case study of this, of like this dichomy, and they're both so true. Nintendo has the best products, the best IP, the best games. They also, especially in this era, had the best distribution channels, the best relationships with their customers, the best control over their ecosystem. The best strategy, generally. The best strategy, right. And man, when you can marry both of those, that's when you get 95% global market share or maybe the interesting one might be like what business is today because this isn't like a narrowly scoped market this 95 represents global video games you know it's not like uh browser market share on ios devices or something like that it's like global video games the only one that immediately comes to mind is um i think apple and ios not of revenue but of profits apple and ios have something you know on the order of that of global market share of smartphone profits smartphone profits

yep the other one that's like close but i think is more around 85 to 90 percent is search, US-based search engine usage. I mean, I guess at a certain point, Facebook had something like that of social networking across all of their family of products. The day before Instagram launched. The day they acquired Instagram. Yeah, that's true. And WhatsApp, like during that heyday. And the most interesting thing is like,

all the examples we're naming are under heavy regulatory review and pressure and another one that i was going to raise is uh microsoft's share of the operating system market yep you know that probably was something like 95 also or um microsoft office too and every single one of these have gone under significant DOJ concerns and Nintendo never seemed to. And is it like people viewed this as a toy market that was like not terribly important to our economy? I mean, it is a much smaller market. In 1990, they were only doing $3 billion in revenue. It's not like these companies that are doing

$100 billion in revenue. I think there's this really weird dynamic with Nintendo, which is why I'm so happy we're doing this episode, that it's just kind of overlooked and underappreciated as a business story. Yes. Partially for the reasons you're saying, partially because it's a Japanese company. And so there's this like weird bicultural thing. And the belief that it's so hits driven makes people think like, oh, well, it's probably whatever market share they've accumulated surely isn't durable. Yep.

But yeah, like, and even there's such great books, as we said at the top of the episode out there, and work and documentaries on Nintendo, but there are ones from a business perspective, but they're not like, nobody's covering Nintendo like people are covering Apple. No, everyone's covering Nintendo for the nostalgia of the character development and the fan service. Right. And yet the business story is just as good.

Yeah. All right. I, even though we killed it, want to do grading on this episode. I'm curious if your game, I think Baron Ball is stupid since we know the history from 1990 to 2023. So like, let's actually grade. Oh man, that would be really interesting to do if we could go back in time and not know what happened next. But obviously, we can't do that. That's true. Would we think that like Nintendo was going to take over the world and expand beyond gaming? Probably. Would we think that gaming would go from a $3 billion market to a 120, 150, whatever it is, billion dollar market now, that would have been a tough prediction to make. I bet we would think what Jim Clark and Marc Andreessen thought, which

is that Nintendo is going to become the computer. The window to the internet. Yeah. And we would not at all have predicted that just gaming itself was the thing and would become a $150 billion market. We would have said it'd be a billion dollar market but something else right oh that's a good point because it's you're out on a limb if you try to make the prediction in 1990 that gaming becomes 150 billion dollar market totally but it's a nice little hedge to be like oh i totally think nintendo could address 150 billion dollar opportunity but it'll be a bunch of stuff. It's almost like all the people in 2016 when asked about crypto, they were like,

oh, I'm not so sure about Bitcoin, but I think the blockchain is going to be a fundamental technology. It's like, it's the way to hedge. And you're like, well, I don't know exactly what the AI use cases are yet, but I'm sure it's going to be huge.

Yep. Okay, that was kind of a fun like... What would have happened otherwise? Yeah. Okay, but grading. Gr a fun like... What would have happened otherwise. Yeah. Okay, but grading. Grading. So I suppose the interesting thing is to take it from a shareholder perspective

in call it the late 60s, early 70s through 1990. Let's just say the 20 year span from 70 to 90. Yep. You know, how do you feel about nintendo relative to being a shareholder of anything else and it was hard especially because of all the exchange rates and the changing inflation in japan and inflation in the u.s and all these decades that have happened since then but it seems like the market cap in 1990 of nintendo is in the like 15 billion ish category, which by today's standards, of course, seems quite small. And we're like $15 billion companies are inconsequential

when stacked up against big tech. Right. But was huge back then, especially because there was all this weirdness of having to buy a Japanese listed company and whatnot. And like, most of the global capital markets are not based in Japan. Right. But one question I did have is in your notes, do you have any in the seventies, any revenue figure? Cause we know that it was around 3 billion in 1990. I do not. I got to imagine it was inconsequential compared to what it would become. Yeah. So the framing is it rounds to zero and then 20 years later it goes to 3 billion in revenue, 15 billion in market cap. From a market addressability perspective, it's interesting that what happened is they had literal perfect timing to enter a market that would become a hundred plus billion dollar market and they went in and they captured 95%

of it. So like what I should be saying to you is this is an A plus, no question. They couldn't be positioned any better and they couldn't have executed it any better. Oh, and they own the customer relationships and they own all the IP and they have immaculate control over the whole thing. But I was thinking about it and the reason I don't think it is an a plus is because of the fall that will happen at the beginning of the next episode which is like they kind of blew a lead where they were up by 10 runs in the bottom of the ninth and maybe the technology wasn't available at the time to have further lock-in but it does feel like if the gaming industry was going to grow from $3 billion to $100 plus billion over 30 years, it's kind of amazing that Nintendo didn't manage to surf on top of that wave, but kind of ended up getting clobbered by it two or three more times before

figuring out how to really find their place there. Yeah. And I think had some really unforced, you know, own goal errors there along the way. Like Nintendo very much could have embraced backward compatibility on each of their console cycles. Nintendo very much could have embraced the CD format, you know, and failed spectacularly at both of those. Yeah. So I guess I'm an A and I would be an A plus, but for the fact that we do know the future and we do know that they weren't as positioned as well as the numbers would state. I think that's why it's hard to be an investor and specifically hard to be a public company investor because the numbers can tell you one story, but then there are

either execution problems in the form of unforced errors or black swan events or the world sort of changes in ways that you absolutely could not have predicted by just looking at numbers. Yep. It's so hard. I mean, I'm absolutely inclined to agree with you, given that we know what happens next. On the other hand, if you purely scope it to this period of time, like these guys executed 10 out of 10 during the 1970 to 1990. Complete masterclass in business strategy and execution. Yep. Like we were saying earlier, we've never covered a company that scored so high on so many of the powers.

Yeah. All right. Give me your grade, David. I hear your argument. I love it. That's the reason we're doing it in the second episode. But I'm going to give them an A plus for 1970 to 1990. There you have it.

There we are. Carve outs. Carve outs. By the time this episode comes out, the Oscars will have happened. So you will know if this already is best picture or not. But even if it is not, everything, everywhere, all at once was exceptional. And I highly recommend it. Oh yeah.

You've told me before that that was amazing. Really good. Have I recommended it on the show? Am I double carve outing? I can't remember. I know you've told me about it. It's hard to separate our conversations on the show and not on the show. It's a great couples movie, but it's also a great indie film. It's a feel-good movie to watch together. I also recommend watching it alone because I think it's just a great piece of independent filmmaking. It is unbelievably VFX heavy, which you don't expect from the first 20 minutes. You're going to start watching this movie and be like, what do you mean that this is unbelievably VFX heavy? But it was done by a four-person team, and it's a completely different take on VFX. It's not like Avatar

of the Way of Water, let's go spend $250 million to create a film. I think it's like a $25 million total budget where it's almost like, let's show off how amazing After Effects and other state-of-the-art software that can run on your computer have gotten. Did they use Unreal Engine to do some of it? I imagine. I'm not sure. I'm not sure. I got to watch more YouTube videos like behind the scenes. Which is funny, right? Like we spent a lot of time on this episode.

Of course, the natural comparison is video games versus music and movies. But like, it's all converging. Yeah. Well, but there is a key difference with video games, which you pointed out earlier, which is like, it is a different part of your brain in terms of, am I experiencing the media? Is it coming at me passively or do I have to be active in the media? Oh yeah, totally agree. I think there will always be separate industries, but like the tools and the technology are converging. My carve out slash outs are two related ones. Michael Lewis interviews. For whatever reason, I got like

on a kick of listening to Michael Lewis. And I just love Michael Lewis so much. And I went back and I listened to I think either you or I have before had as a carve out his interview with Tim Ferris a couple years ago, which is so great. That got me on a kick of seeing what else is out there. You know, he definitely has his, like everybody does his quiver of stories that he pulls out. So you listen to a few and you're like, okay, I've heard you talk about this like 16 times, but I found one that I'm so glad I did deep cut on YouTube. It's a three hour interview on C-SPAN on book TV. I think it's even on C-SPAN too. I have no idea why Michael did this, but, uh, it was from a couple of years ago and it's by far

the longest one out there. And like, he goes like three clicks deeper on everything. It was just fascinating to hear all like the real deep cut Michael Lewis stories. I thought I had listened to all of his interviews, so I can't wait to listen. I've got YouTube premium, which is amazing. So I've been listening to it in podcast form, like without the video while I go on runs and walks and stuff. It's the only way to live. Only way to live. Oh, I can't believe I went so many years without YouTube premium. Yeah. What is it? 10 bucks a month. It's a pretty easy 10 bucks a month. I mean, literally you're valuing your time. If you don't pay for YouTube premium and you watch any amount of YouTube, you're saying that like my time on all these ads is worth like zero.

Yeah. I mean, if they were better ads, I'd be more inclined to pay attention. Right. It's not like these are like high quality brand, you know, acquired style, like, you know, ads where you want to hear about YouTube ads or YouTube ads. It's like, oh, Sprite. I guess I should drink Sprite. Huh? Never mind that I haven't drank a sugar soda in 15 years, but sure.

Show me another Sprite ad. Right. All right. Anyway, listeners, we'll give you the rest of your fifth hour back, fourth hour back, whatever it is. Thank you for coming on the journey with us. You can join the revamped, reinvigorated, acquired LP program and become a limited partner. Oh, since we're at the end of the episode, I thought about doing this earlier, but I thought,

let's just get right into Nintendo. But now that we're at the end, I can say the inspiration for how we've revamped the acquired LP program, where one of the core things we want to do is involve LPs in the audience and helping us choose topics that we cover on the show was inspired by my favorite video game podcast, which does this. Yeah. The great folks over at resonant arc, they are a video game book club podcast. So they play video games like a book club and they choose a game to cover and their Patreon. The key benefit of being their Patreon is you can vote on the next game that they cover. And I was like, that's brilliant. We should do that on acquired. It is brilliant. So LPs, I would say maybe like a week after this episode comes out,

keep an eye out for an email polling you on, David and I have a short list of the next episode that we will do. We're curious to hear your feedback. We'll put a free forum field in there too. And also we're starting back up with the Zoom calls. So if you want to hang out with David and I on Zoom for an hour, keep an eye out for an email on that too. If you are an LP, acquired.fm slash LP to join. Go check out ACQ2. We have the deuce.

Seriously, like the best content that we've had on that feed in a long time coming up. I've been really pumped with the last few episodes and chock full of it even more. So search ACQ2 in the podcast player of your choice.

No space. I don't know, we may change in the podcast player of your choice. No space. I don't know, we may change that. But as of right now, no space, just like ESPN2, our muse. And yeah, we're pumped to launch that. Join the Slack. Almost 15,000 folks strong. We just passed 15,000.

15,000 then. Yeah. Gotta update my script. Smart, thoughtful people. Talk about this episode. Get some merch. Acquired.fm slash store. Wow, you have like lots of things, David.

I know. We're like a small media empire. The acquired Slack is like our version of Nintendo Power and Powerline. There we go. We need to produce a Nintendo Power. All right, I'm cutting this off. Listeners, thank you. We'll see you next time.

We'll see you next time. Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? We'll see you next time.