Tag Archives: Financial Analysis

Profiting from Inkling

One of the most talked about characters for Smash 4 DLC are the Inklings from Splatoon. Even before the game’s release, fans were begging and pleading for their inclusion. After Splatoon’s launch, the game’s Miiverse is filled with comments and images asking for the characters to be playable.

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The Great amiibo Shortage

Amiibo Shortage

Wired wrote an interesting article a while back about an amiibo bubble. The article cites a few reasons for why they believe this is the case: retailers having to carry too much stock, replacing amiibo with new lines (or waves), and the perspective from consumers that the newest amiibo will be gone. What this has done is lured in resellers trying to make a quick buck by buying up the already limited stock and reselling them on Ebay for an exorbitant mark-up. As I write this, Rosalina amiibo are selling for 40 dollars on Ebay. So, I want to explore this issue a bit more using some economic theories, the events that led to the burst of the Beanie Baby bubble, and how Nintendo can address this issue before it kills the goose that laid the golden egg.

Amiibo Success Story

Nintendo has reported that consumers have purchased 3.5 million amiibo figures in a few short weeks.  Furthermore, the attach rate is nearly two figures per copy of Super Smash Bros for Wii U. It’s clear the initial response to amiibo has been warm. Nintendo president, Satoru Iwata, has discussed his plans to expand Nintendo’s business, on top of development. In describing his plan, he stated “we intend to simultaneously challenge ourselves with new endeavors which include our plan to take advantage of smart devices, more aggressive use of Nintendo’s character IP and our new QOL improvement platform business.” amiibo seems to be but one way for Nintendo to expand their IPs. With Nintendo promoting toys of Nintendo characters, it’s no surprise they decided to launch amiibo with the Super Smash Bros. series. This is one of the first times fans can get toys of Nintendo characters, from famous characters like Mario and Pikachu to more obscure ones like Captain Falcon and Marth.

Shortage

I’m sure you are all aware of Supply and Demand, the most recognizable theory of Economics. Essentially, the price we are willing to pay is both a function of demand (how much we want) and supply (how much is available). The price for a good or service will be where supply and demand meet, which we call equilibrium. This is all well and good, in theory. Sometimes, it doesn’t always work out like that. What if how much we want, given a certain price, is more that what the market has to offer. That’s when we have a shortage. Think of a hurricane; everyone is trying to get supplies all at once. There is a lot of demand for extra food, water, and other essentials. But since the current supply can not handle the demand of consumers, we have a shortage.

A graphical representation of a shortage.  The gap between the demand curve and the supply curve is what causes a shortage

And that is what is going on with the amiibo right now. We want more than what the market has available. However, this has also caused the price of amiibo on the secondary market to skyrocket.  The exorberant prices are the market’s way to have demand match supply.  With price increasing to $40, the quantity demanded falls and supply and demand reaches equilibrium.

So what caused the shortage in the first place?  On one hand, demand for amiibo was far greater than what Nintendo anticipated.  This would make sense given the high attach rate and sales of amiibo sales so far.  However, the issue may be due to a lack of supply.  The port strikes in California have halted the shipment of goods from Asia, including amiibo.  Furthermore, the high demand was not anticipated by Nintendo.  Satoru Iwata stated, “Some figures are sold out and are being sold at online auctions at premium prices – something which none of us had predicted.”  Overall, it appears the issue is a lack of supply.  This is reflected by Satoru Iwata who stated

The Beanie Baby Bubble

A group of collectors swarming a store in 2000.

The Beanie Baby is one of the most successful plush toys ever. In 1997, 64 percent of households owned at least one Beanie Baby.  However, Beanie Babies eventually went from huge success to just another fad.  Even the rarest Beanie Baby, once going for hundreds of dollars, was later sold in dollar stores and flea markets.  What happened?

Beanie Baby collecting became a huge part of the craze with consumers paying out the wazoo for Beanie Babies. The collector craze first started when Lovely the Sheep was discontinued due to issues with the company’s Chinese supplier. However, instead of being forward with the issue, Beanie Baby creator Ty Warner said Lovely was “retired.”  This move caused consumers to be delighted by the fact that the toy they purchased may be worth far more than what they paid. This started a practice of retiring Beanie Babies and turned Beanie Babies into less of a toy and more of an investment.  Soon, everyone was buying Beanie Babies in hope of reselling them and netting a tidy profit.

What had happened is Beanie Babies were becoming less of a toy and more of an item to collect and resell for profits. Hopeful collectors invested thousands on Beanie Babies in hopes of making a nice return on their investment.  Although there were a handful of success stories, many lost their shirts on trying to flip Beanie Babies. In the end, the retiring and creation of new Beanie Babies created too much supply than consumers could handle.  Eventually, the once rare Beanie Babies were cheap and easy to find. In every economic bubble, asset prices inflate until they become too much for the market to bear. The greater fool theory sets in and assets are sold to some other fool, hoping to create a greater profit than the first.  Beanie Babies declined because they were no longer toys. When the market becomes only other collectors trying to make a quick buck, it becomes unsustainable.  No longer is there a base of consumers who purchase the toy based on their inherent value and not their value to turn a profit.

Avoiding the Bubble

The amiibo are going the way of the Beanie Baby.  Even before Wave 4 is released, it is almost impossible to find the newest amiibo.  Even before its release, the Jigglypuff amiibo has become scarce with online pre-orders selling out near instantaneously.  Its has already become well understood among consumers that your favorite amiibo will likely not be available.  Nintendo will need to rope in the amiibo craze before the bubble burst.

But how?  The first thing Nintendo needs to do is control supply.  Nintendo’s retirement practice has been a result of trying to sell toys for each of the 50+ characters in Smash.  Rather than having a huge stock of less known characters and taking up a large amount of shelf space.  However, this has led to the collection craze of amiibo as consumers know some amiibo will no longer be available.  As stated above, increasing the supply of amiibo will bring the shortage of select amiibo into equilibrium.  However, simply resupplying stores with the rarer amiibo may only be a temporary fix.  There still remains the issue of why Nintendo retired certain amiibo.  Stores can’t large stocks of amiibo that may only sell to a small amount of consumers.

As the Wired article suggest, Nintendo should begin selling amiibo online through an amiibo store website.  This will allow Nintendo to control the supply of amiibo and circumvent the issue of retail space.  Furthermore, Nintendo could utilize Just-in-time inventory, where new amiibo are made to match customers orders with toys not staying in the warehouses for long, if at all.  This will reduce the risk of over supplying rare amiibo characters like Ness and Ike.

The other thing Nintendo must do is make sure the amiibo are valued as accessories, and not as investments.  Nintendo appears to be doing this, as many of their games shown off in the new Nintendo Direct have amiibo support.  By making sure the amiibo have value in the game, the company can ensure that consumers will keep purchasing amiibo for the game and not just to resell.  However, on the other hand, Nintendo appears to be going down the same path, as they have made a Gold Mario amiibo which has no practical purpose in-game besides being gold.  Furthermore, rumor is Nintendo will also be releasing a Silver Mario amiibo as well.

So far, amiibo have been a success and have helped Nintendo escape the financial black hole they have been in for the last few years.  amiibo have potential to be a sustainable source of income for the company.  However, they have to recognize the issue at hand.  It doesn’t seem like they do as their solution is to simply restock some rare amiibo and tell customers to “stay tune.”  The current trend of amiibo is mirroring the rise and fall of the Beanie Babies and it doesn’t seem to be changing anytime soon. If Nintendo wants to keep the amiibo success going, they need to address the issues before it gets out of hand.  If not, it won’t be long until that $40 amiibo becomes $3 sitting along side Gamestop’s other Pre-owned accessories.

Thoughts? Comments? Questions?  Feel free to write all of that in the comments below.  Hope you enjoyed the article.  

DLC Econ 102: Opportunity Cost and Character Selection

Authors Note: This article was written before Roy and Ryu’s files were found in the 3DS version.  For now, I am assuming this is a rumor until Nintendo officially announces the characters as DLC.  I will address those characters when the characters are officially announced.

In DLC Econ 101, I talked a bit about how Diminishing Marginal Utility presents a limiting factor for DLC. For the second part, I want to focus on opportunity cost and how it relates to character choice, namely third party character and veteran characters. With the recent ballot, many fans are looking towards third party characters, like Rayman and Shovel Knight, to be added to the new Smash Bros game. However, much like how Diminishing Marginal Utility limits the number of characters, the opportunity cost of each character may dictate who gets added and who does.

But first, what is opportunity cost? Investopedia defines opportunity cost as “The cost of an alternative that must be forgone in order to pursue a certain action.” In other words, you give up something by do another action. For instance, if you decide to go to a movie instead of working, your opportunity cost will be the money you could have made working. Essentially, opportunity cost is the cost of what you gave up. Time and resources are finite, so you will have to make choices of what you can and cannot do with the alternative coming at a cost.

Because Sakurai and his team can only make so many characters, there is a huge opportunity cost with making any character because any character made is foregoing making, and selling, another. Much like the example of the movies and work, the team has to make a conscious choice on which characters they will include as adding any character is another character forgone.

Opportunity cost can be calculated, but for this article, I’ll talk about it in more general terms.

Third Party Characters

Each character has a distinct cost associated with their inclusion. Third party characters, in particular, as very high compared to other characters. But why? For all third party characters, Nintendo will have to share the revenue with the owner of the IP. Although the company would receive advertising for their character at Nintendo’s expense, they won’t let Nintendo profit from using their IPs for nothing. Very likely, the companies will require Nintendo to pay them for using the character. This means that Nintendo’s revenue will be reduced when developing another company’s character as DLC and, as such, will forego profit by developing this character and increase their risk.

To illustrate this, at $4 per character, revenue from selling 1 million characters would be $4 million dollars. But let’s say they produce a third party character instead, and the other company requires $1 per character sold. This means for 1 million characters sold, Nintendo only gets $3 million in profits. This represents a 25 percent loss in revenue, and our opportunity cost (the cost of an alternative), would be $1 million dollars. In order to make the same $4 million dollars, Nintendo would have to sell an additional 333,333 characters, which represents a 33 percent increase in sales that would be needed to make the same profit. While this may not seem like much, let’s compare this to the total number of potential buyers. With the 3DS version selling 6.19 million units, Nintendo will have to sell the character to 16.16 percent of Smash fans for the first scenario verses a 21.53 percent in the second scenario. And if we say revenue is split 50-50, then Nintendo would need to sell twice as many characters to make the same profit. All the while, Nintendo will likely be at risk for all of the development cost.

In order to justify these characters inclusion, the third party characters will need to sell substantially more than a Nintendo character. In the example above, the character would have to 33 percent more than a Nintendo character. In the Mega Poll, Rayman was the most voted newcomer, above King K Rool, with 1,329 votes to King K Rool’s 1,125. Rayman received 18 percent more votes than King K Rool. If we assume that Rayman will sell 18 percent more than King K Rool, then in order to make the same profit, Ubisoft can ask for no more than 61 cents on Rayman. Otherwise, Nintendo would be better off adding King K Rool to the game over Rayman. Furthermore, the vast majority of the responses to the poll were from English speakers. In Japan, Rayman only got 3 votes. As I mentioned in a previous article, roughly one third of all sales for Super Smash Brothers for Wii U/3DS were from Japan. This means any character that is not well known worldwide, like Rayman, would have a greater opportunity cost. Many fans may note characters like Banjo and Kazooie who are known in Japan and cite Phil Spencer, the head of Microsoft Xbox divisions, willingness to work with Nintendo. However, remember that Nintendo would have to sell more characters and the revenue is contingent upon what Microsoft wants. As a large public company, they may demand more of Nintendo to the point where it would still be more feasible to use a Nintendo character given the limit time and resources.

This analysis does not take into affect other cost, such as legal cost and production time. A lot of things can happen and with such a thin margin for profits, it may make even negotiations unfeasible. For example, the developers may be left sit on their hands to being working on the character until an agreement has been reached, and if negotiations fall flat, this could be wasted time which could have been used instead to make a Nintendo character. In the end, adding any third party character is a gamble in many different ways.

Veterans

Another class of characters that is unique are the veterans fighters, characters who were in a previous Smash Brothers game. Unlike the third party characters, these characters have a lower opportunity cost that that of new characters. This is because these characters are easier to develop and may even generate more revenue.

Unlike new characters, like K. Rool, the veteran characters already appeared in a Smash Brothers game. This means these characters are cheaper to develop for two distinct reasons. First, these characters have already been made which reduces development cost. Melee is a very old game, and, as a result, Mewtwo had to be recreated from scratch. Second, the character has already been conceptualized. This means that a character can go right into the programing/modeling stage as how the character will fight has already been decided. Furthermore, it will be easier to balance these characters as they were already in a Smash Brothers game and their abilities and properties can be judged against the prior game.

Moreover, these characters are, in some instances, more popular than new characters. In the Mega Poll, the most popular characters were veteran characters, with Ice Climbers getting the most votes of any character. Furthermore, on many fan polls, these characters generally placed higher than others, usually in the top 10. As such, it appears consumers would be more willing to purchase a veteran character rather than a new one. This has been well understood in consumer research as consumers tend to buy familiar products, for reasons such as consumers hearing of it, their parents using it, and it has been around for a long time.

Closing

To close, let’s compare the opportunity cost of each type of character. As I mentioned above, the lower the opportunity cost, that is, the cost of a foregone alternative, the better. Based solely on this, we can assume Nintendo will include characters with the lowest opportunity cost. As I discussed above, the highest opportunity cost will be third party characters as they require a greater deal of negotiation and the IP owner may require Nintendo to pay a percentage of sales. Next would be a new Nintendo character, which has a lower opportunity cost as Nintendo is the IP owner and negotiations to use the character will be much easier. A veteran would have the lowest opportunity cost as the character has already been included in a Smash Brothers game which mean the character is more familiar to fans and would be cheaper to make and design.

So, from highest to lowest, here is the opportunity cost for each type of character

  • Third party character
  • New Nintendo Character
  • Veteran character

In regards to Snake, we can assume he would have a lower opportunity cost than other third party characters as he was a character in Super Smash Brothers Brawl. Furthermore, the negotiations would likely go smoother as Nintendo worked with the character in the past. However, other veterans will have lower opportunity cost.

Nintendo appears to take to heart these facts I mentioned above. So far, Mewtwo and Lucas are the only DLC characters to be included. It may be that Nintendo will produce more veterans as DLC characters and focus more on New Nintendo characters rather than third party characters, if at all.

Agree? Disagree? Let me know in the comments. Please feel free to field any questions there as well. Thanks for reading!! 

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DLC Econ 101: DLC and Diminishing Marginal Utility

With Nintendo adding DLC to the newest Smash Brothers game, I wanted to take some time and look at the economics behind this. This is the first in a series of article to explore DLC for Smash Bros and how economic theories affect the company’s decisions.

With DLC in Smash, a deep-seated dream of an ever expanding roster may now be realized, and fans will be clamoring for every character under the sun. It may seem like Sakurai could make millions of characters, and fans are so feverish that Nintendo could profit from these millions of characters. Regardless of what we may believe, Sakurai will be limited on the number of characters he can make. On one hand, there just isn’t enough time in the day to make that number of characters. Even still, if Sakurai could fulfill every hope and dream, the greatest limiting factor to making characters is the Law of Diminishing Marginal Utility

What then, is the Law of Diminishing Utility? Investopedia defines it as “A law of economics stating that as a person increases consumption of a product – while keeping consumption of other products constant – there is a decline in the marginal utility that person derives from consuming each additional unit of that product.” In other words, the more you consume, the less you like it the second time. The best example is food. Say you are eating Ice Cream. Like any self respecting human, you love ice cream. The first one you have really satisfies you, which we refer to as “utility.” You like it so much, you have another. This time, you didn’t like it as much, but it’s still good. So you have another, and another. As you keep eating ice cream, you don’t like it as much. Eventually, it makes you sick, which we refer to as negative utility.

So how does this relate to DLC? Naturally, with each DLC character that is added, marginal utility (the satisfaction from each additional unit) declines. That is, we get less and less enjoyment for each new addition, and, from Nintendo’s standpoint, spend less and less money. Even though fans were excited for Lucas’s inclusion, it may not have been as exciting as Mewtwo’s inclusion. The benefit we derive from DLC declines as more content is added. If Nintendo abuses DLC, consumers could reach a point of “negative utility,” where we resent the DLC and even become hostile towards it.

So the questions remains, how much DLC does Nintendo make? Marginal Utility is hard to estimate. It is almost impossible to quantify because marginal utility is unique from person to person. This is where the ballot comes in. The ballot is actually a sneaky way to get consumers to willingly give Nintendo this information. The more unique responses Nintendo gets from the ballot, the more DLC they can produce. If Nintendo gets a significant amount of responses, this means consumers are warm to DLC and marginal utility, that is, the utility for each additional character, is low. Each additional character Nintendo adds diminishes utility no matter what. Since fans tell Nintendo exactly who they want, they can determine which characters to focus their limited resources on.

Even with this data, it may be hard to determine when Nintendo should stop or keep going. As I mentioned in my predictions, I expect Nintendo will do at least 4 additional characters. Based on reactions from fans to Lucas and Mewtwo, it seems that fans are very open to DLC characters and marginal utility will decline at a slower rate. In the end, we’ll have to wait and see how much additional content Nintendo will make and how much fans are willing to purchase it. In the end, there are multiple reasons why Nintendo will or wont produce DLC characters. Economics is still a good start.

Please leave any comments or questions in the comments. I will be doing more on DLC in the near future.

 

A Global Perspective on DLC

The other day, PushDustin posted some translations of the Smash Bros thread on Japanese site 2ch, which was linked to reddit.  As the thread went on, the discussion cropped up on why it would be an issue to include some characters that were unknown in Japan when at the same time characters like Marth and Roy were completely unknown in the west when they came over in Super Smash Brothers Melee.  So it begs the question:

How can Marth and other Fire Emblems characters be added while Western characters can’t?

To understand this, we need to look at the nature of how the DLC and the main game sells.  Nintendo is a corporation and its ultimate goal is to make a profit. Both the full game and the DLC produce income in the same manner: the customer pays the company and they get the content in return. However, they are still very different in how how the content entices the consumer.  To illustrate, let’s assume that the only reason anyone buys anything related to Smash is for the characters. In the full game, you’re buying the whole roster of characters. This includes favorites like Little Mac and Mega Man and some you may not particularly want. Many players may have first learned about Shulk in Smash, but consumers weren’t buying the game solely for Shulk. This is also why the inclusion of Dark Pit, a generally disliked character, didn’t stop anyone from purchasing the game. In contrast, with DLC, you are buying a single character at a time. The sale of that DLC is dependent on you wanting to play as that character as opposed to the full game where you want to play with the roster of characters. As such, the strength of the individual character is what gets that content to sell.

It is this distinction that makes it difficult adding characters that are not well known in a specific region. For example, consider Shovel Knight. As of this writing, his game has not been released in Japan. So if Japanese fans do not know him, they are less likely to purchase the DLC. As of year-end 2014, the 3DS version sold 6.19 million units, of which 2.42 million units, or 39 percent, are from Japan. Selling a character who is unknown in a specific region posses a significant risk as the company restricts sales in a particular region. If Shovel Knight sold to every consumers outside of Japan, at $4 a character, total sales would be $15.08 million. However, Nintendo could generate the same revenue by selling to 60 percent of Japanese fans and 61 percent to fans outside of Japan, resulting in revenues of $5.9 million and $9.2 million, respectively. A lot of consumers will not purchase DLC due to a lack of knowledge, or they are uninterested in DLC, so being able to spread the sales over a larger consumers base can make a significant difference, even if the subject character will sell incredibly well in one region. As the old saying goes, don’t put all your eggs into one basket.

Regardless, some consumers may purchase a character even if they have no idea who the character is.  This may be because they want more characters or they will find the character interesting.  Likewise, consumers may purchase the full game for more than just characters. But the fact remains that the primary driver in someone purchasing DLC is if they like the character. This is also why Nintendo released a ballot for which character consumers wanted in Smash right after the company announced their plans for DLC. Will this completely bar the inclusion of characters like Shovel Knight? Perhaps not. But it is something to consider.

I’ll be talking more about some of the economic behind DLC soon and I’ll touch back on these topics.  Either way, please feel free to tell me what you think about this in the comments.