Tech

Tim Culpan is a technology columnist for Bloomberg Gadfly. He previously covered technology for Bloomberg News.

An Italian plumber from the Mushroom Kingdom could be the key to Nintendo Co. continuing its three-year rebound.

At just 16 pixels tall, Mario has a heavy burden to bear. Thankfully, he has a whole stable of mates to help. And he'll need them.

Mario Mario (yes, Mario is also his surname) first appeared in 1981, in the Donkey Kong handheld game as a protagonist to the title character, a vengeful ape. While his overalls, cap and mustache have changed little since then, Mario's size and role have increased.

The late 2016 release of Super Mario Run for iOS heralded a new model for how Nintendo can leverage its cast of characters beyond the consoles that helped build the company over the past four decades. Pokemon Go -- the augmented reality hit of that year -- showed Nintendo the potential of smartphone games, yet it's only one of three shareholders in The Pokemon Company and wasn't that game's developer.

Pleasant Surprise
Nintendo has kept outpacing analyst expectations for operating income through calendar 2017
Source: Bloomberg

With Super Mario Run, Nintendo was on its own. The upside is that the Kyoto-based company could enjoy all of the spoils, helping feed a 426 percent boost in revenue at its smart-device content division for the six months to Sept. 30, 2017.

Ordinarily that would be a lot to crow about, but the release of Nintendo's convertible Switch console stole most of the thunder and helped total sales almost treble to 374 billion yen ($3.3 billion). As a result, the smart-device content division merely doubled its share to account for 4.8 percent of six-month revenue versus the 14 percent it would have been had the dedicated video-game division stayed flat from the year prior.

With the ubiquity of smartphones and the reduction in couch-based viewing, Nintendo knows it will need to rely less on the one-two punch of hardware meets software in coming years. Switch -- which converts between handheld and console modes -- has been far more popular than anyone expected, but it would be a mistake to point to that success as proof of the console segment's invincibility.

Momentum
Nintendo's shares have had some great quarters, though it's unlikely we'll see a repeat of September 2016 amid Pokemon Go excitement and the lead up to Switch's unveiling
Source: Bloomberg

In releasing Super Mario Run, as well as Fire Emblem Heroes and Animal Crossing: Pocket Camp, Nintendo has shown it doesn't plan to fall into such a trap. The company will show how deep into its deck of stars it's willing to dive if a rumored mobile incarnation of its Zelda franchise comes to pass, as the WSJ reported back in May.

But to prove its non-console business is a long-term winner, a few things are needed. The first is obvious: Nintendo needs to grow revenue from its smartphone games well beyond the 17.9 billion yen it posted in first six months of 2017.

Onward and Upward
After a bumper holiday-shopping quarter, the pressure will be on for Nintendo to drive sales into the new year
Source: Bloomberg

Pokemon Go was a big success, but it's a Niantic Inc. title. This means that Nintendo not only has to share the revenue, but it doesn't have full control over the franchise. Super Mario Run, on the other hand, was a moderate success but sales may have been hobbled by the pay-once model instead of the usual in-app tokens approach. Animal Crossing looks set to be an earnings dud because there's little gameplay incentive to pay for items. Taken together, though, these three serve as a fantastic experiment on how best to make money.

It's also clear that Nintendo isn't sitting still. A Wall Street Journal report last month that said Nintendo is in talks with GungHo Online Entertainment Inc. for smartphone games development sent shares of the Japanese publisher up as much as 18 percent on the day, and those of competitor DeNA Co. down as much as 6.3 percent. That was tacit acknowledgement that games companies want to be in bed with Nintendo.

Yet, making great smartphone games isn't enough. The other thing Nintendo needs is better overseas traction.

Smart-device content (which includes royalty revenues) is the only one of Nintendo's three revenue categories where Japan is the largest contributor. That's a concern because it might indicate that Pokemon Go, Super Mario Run and even Animal Crossing don't travel well beyond the domestic market. Even if those games garner huge downloads offshore, data so far suggest that international markets haven't delivered actual revenue to the extent that the company's core games division has.

Failure to Launch
Japan is the largest source of revenue for Nintendo's fast-growing smart devices (mobile games) division
Source: Nintendo, Bloomberg Gadfly calculations
Note: Data is for six months ended Sept. 30, 2017 in yen.

One step to boost exposure is to expand franchising, like Nintendo's deal in November with Kellogg Co. to "take fans on a breakfast odyssey that will continue long after the cereal box is empty." That not only builds royalty revenue, but gets Mario's face in front of American kids every morning.

The other is to embrace non-Nintendo gaming systems, as it did in a deal with Nvidia Corp. to release titles on the U.S. chipmaker's Shield platform. This was a bold move, but helped get Mario into China where the market potential hasn't been fully tapped and the company's titles are largely unavailable. Like the Super Mario cereal deal, this China-only tie up helps bring in money, as well as build top of mind.

There's every chance that non-console revenue will be a major part of Nintendo's future, but it's a brave new world for the Japanese technology company. That's why, when it comes time to choose a smartphone game, Nintendo wants consumers to be glad there's always a friendly plumber at hand.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tim Culpan in Taipei at tculpan1@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net