There's been a lot of hype about the Nintendo Wii - how it's finding itself in sports clubs and retirement homes, how everyone from young kids to old grandmothers are buying Wii consoles. Some have even talked about Nintendo's "Blue Ocean" strategy breaking all the conventional rules in the video game market.

In fact, however, there really is nothing new about either Nintendo's market strategy or the market dynamics of the Nintendo Wii. The success of the Wii isn't about a "new economy" in the video game market - it's really about excellent execution by Nintendo. The irony is that Microsoft demonstrated very clearly that it understands the economics of technology adoption; but it was out-maneuvered by Nintendo and the Wii.

Technology Adoption

Technology adoption - including everything from video cassette formats to video disc formats to video game consoles, follows a well-established market adoption pattern. In general, the people who purchase technologies fall roughly into a standard bell-shaped distribution with innovators and early adopters at the "leading edge" of that curve, and late adopters and laggards at the trailing edge. The vast majority of people fall into the middle of the bell curve.

(source: US Congress, Office of Technology Assessment)

If a technology is adopted by a large enough portion of the relevant market, the bell-shaped adoption curve will result in an s-shaped saturation curve; slow adoption in the beginning with innovators and early adopters, then very fast growth as the majority of the market adopts the new technology, then a slow growth plateau as the last few people who don't have the technology finally get one.

(source: Everett Rogers' Diffusion of Innovations Theory)

The key: If a technology is adopted by a LARGE ENOUGH portion of the RELEVANT market. After all, some technologies fail: Betamax v. VHS, laserdisc v. dvd, and Sega Dreamcast v. Playstation 2. (Does anyone even remember those failed technologies?)

So what makes some technologies succeed where others fail? A simple economic principle known as the network effect, commonly called the bandwagon effect. Many technologies actually become more valuable as more people adopt them. A technology like the telephone is a classic example. If only 1 person in the world has a telephone, it's pretty useless. If 10,000 people have telephones, it becomes a little more useful. And if 10,000,000 people have telephones, it becomes quite useful, and even more people will want to get one. If you can get enough people to adopt your technology, the network effect will drive the market to saturation.

Economics of Gaming Consoles

That's why Microsoft was so eager to be the first console on the market - they understood that every XBox360 sold to an early adopter in the first year would increase the value of the entire XBox360 platform, and decrease the value to that early adopter of getting a PS3 or Wii the following year. Microsoft's intent was to use the year's head start to build up adoption levels, to leverage the network effect, to bring more 3rd party developers on board, and to muscle out Sony and Nintendo.

It's a good strategy, and it seemed to have the right support among 3rd party developers. It should have worked, given the economics of technology adoption and the power of the network effect. So what happened with the Nintendo Wii?

Remember that the key to a successful technology is to get it adopted by a large enough portion of the RELEVANT market. Nintendo decided to redefine the relevant market. Then, they constrained their technical decisions to keep the system at a low price point and bundled their best software (Wii Sports) in order to drive adoption more quickly.

It worked. Sales of the Nintendo Wii will soon surpass sales of the XBox360, and Nintendo will be in the driver's seat, using the economic engine of the network effect to drive market adoption to saturation. Furthermore, the cumulative adoption of the Wii will potentially be even larger than the PS2, simply because the relevant market is larger.

Casual Games, Bad Games, Failed Console?

What about the theory that 3rd party developers will throw cheap games at the Wii, saving their best development efforts for the advanced technologies of the XBox360 and PS3? Certainly, 3rd party software is important in the console market, and is a significant reason why Nintendo was not successful with the GameCube.

Still, from an economic perspective, it's mainly about quantity rather than quality. Consider the iPod. There is certainly no lack of poor quality iPod accessories on the market today, but the sheer volume of available iPod accessories means that (1) more stores (including non-traditional outlets for electronics) will stock iPod accessories, and (2) more people will buy iPods because of the variety and availability of accessories.

And if the best games for the Wii continue to be 1st party Nintendo games, then Nintendo will reap even more profit. And ultimately, the business of gaming is profit; everyone, even a hardcore 3rd party developer, wants a share of that profit.

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