Listen to Episode

Read Episode Transcript

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 goes... He-he-he-he-he! Ho-ho-ho-ho! That is amazing! Wow, I had no idea you had that in you. I'm very impressed. Uh... See, have you been storing that up for this episode? Oh, wow! When Charles Martin and Moves on from this mortal coil, I think Nintendo knows who the replacement is gonna be. Ho-ho-ho-ho! Ha-ha-ha-ha! That is so good! I'm never gonna be able to lick it you the same. Good, that was the goal. Alright, let's do it. Let's go! Welcome to season 12, episode 3 of Acquired, 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 a hundred billion dollars 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 debt. That is the story we're going to tell today. We're not going to get to the switch. We're not going to get to the 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. 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 ESPN two channel the do's. Yes. So we're going to make it official. The LP show is now known as ACQ to it still has the same great expert interviews with founders and investors like VJ Rajee 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 ACQ to 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. You 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 slash LP. 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, 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 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 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 when Nintendo was founded, but in California in the 1970s with 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 carnie and he keeps referring to himself as a guardian or 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 electro mechanical games. So these are things like everything from you shoot the water gun to like 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 head games like this. They were something to do at bars. In fact, one of the leading companies that made these electro mechanical 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 our kids, he does something pretty unique. He goes to college at the University of Utah and majors in electrical engineering. This was a pretty special place in 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 at Cappemoll of Pixar, all of which have been protagonists of acquired episodes. 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 deck PDP1. 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 kind of like asteroid, not quite space invaders, per galaga or. 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. Nobody else who is playing space war in the entire world or using a PDP1 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 PDP1 cost over $100,000, which is over $1 million today. So like 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 heads 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 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 takes base 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 it'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 Davney and their business plan is they're going to do exactly this. They initially call the company Cisorgi, but it turns out that name is already taken by a candle maker in Mendocino, I think Dolan 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 Dolan, Rex's brain, it 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 and chess and go. They build a game called computer space that's based on space for 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. And 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 the co-workers from AmpEx, a guy named Al Alicorn, who's an amazing engineer. And the fifth theme that's going to come up a bunch in this episode is the mythical 10X, 100X engineer 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. Just on the raw costs, but on the assembly time, soldering takes time. And at this point, there's a 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 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 hundreds, maybe low thousands of devices when you're considering military communications equipment. Now with our Cades, 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 Al, and it just don't happen 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 television to cross America as we talked about it 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 ACQ 2 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 Magnovox 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 G Wiz 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 lying in and of its own, but they had created this machine in partnership with 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, Magnovox has no idea what they're doing with it here. And you can't blame them. There's no roadmap for this. And in what should have been assigned to them and certainly was assigned 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 Magnovox, they end up selling a couple hundred thousand units of this thing. The Magnovox Odyssey was invented to solve a problem that Magnovox 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. He brings this back to Atari and Alan 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 was 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 Caps tavern in Sunnyvale, California, and they convince the owner there to set up this pong machine as they start calling it at Andy Caps. 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 time is only to 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 of Atari start bringing on additional folks to build an 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. 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 Magnovacs 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 Woz 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 electro mechanical games companies like Sega and others get into the video game business. Atari is out there, obviously, the leader by the mid-delayed 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, you know, 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 sudden narrative violation. I thought this notion of eclipsing Hollywood and music was a recent phenomenon to show how much time people spend in games. What you're pointing out is that it was a different form factor and it was a physical location at our kids, but 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 in our kids 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. Yep. But again, it makes total sense. So this came out of our kids, carnivals. You don't need a story here. This is about competition in a public environment. Right. 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 Arcane games, you make the game. You work with a distributor like Midway or Bali or something like that. You get it into arcades and bars and the money comes in like 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.S. isn't going to buy your product for their stores if you only have ten 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 like 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. So what is 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 released 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 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 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 Calico 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 razor blades razor's model where I'm pretty sure Warner 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. And 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. Even 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 their 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 like fighting it out in court. By the way, the reason they name 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. So 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 that you made here. What if we Activision just pay you guys Atari like a Royal TV for every cartridge that we sell? You get 10, 20, 30 percent away. It doesn't even matter. We're all making so much money. Atari is like, oh, yeah, you mean you make the games, you sell them and we just get money. Okay, cool. And we have to take no capital risk on you developing that game. We just make money only if it works. 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. The parallels to like Web 3 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 rushed 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. And so the 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. Just 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 video game market, that home video game console market in 1982 by 1985 would be worth $100 million. A reduction of 32X in the market size because the entire category just went away. Just disappeared to put that differently. In 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. Just 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. In 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 game's business separately. And Colliko 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 ET Atari game, the cartridge burial happens. The New Mexico. Atari made so many of these ET games that they jointly developed with Universal. And in fact, Steven Spielberg himself was involved in approving the concept of, yes, let's turn ET 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. You 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 stopped buying. And so stores just stop buying upstream, specifically consoles. 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 placed in big orders anymore. And that's sort of how you have this whole Whipcrack 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 ET 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're like, literally took wrecking balls and they're like smashing the cartridges and they bury them in a landfill and they poor concrete on top. And people have gone and like 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 hulupe. 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. All 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 still make an 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 cost 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, you know, 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. And David, this is a great time to thank one of our very favorite companies, the first of this episode, pilot.com. And mention we are doing something different this season. As you know, pilot is already the largest startup focused accounting firm in America with over 1700 clients. They've scaled with companies that have grown 50X since becoming a customer of pilot. So we thought, okay, what can we do this season that would be helpful to listeners? And wasime Dahar, the CEO of pilot, had a great idea and we are going to flash over to him to join us for this episode's tip that he has for founders after starting three companies. Today, we see him, we're going to talk about your views on competition. Here's the thing about competitors. You're going to spend all of your time agonizing over who they are and exactly what they do and what changes they made on their website. And unfortunately, that is all time that's basically wasted. Your competitors are for the most part completely irrelevant. And anytime you spend thinking about them as time you're wasting, because it's time you're not focusing on what actually matters, which is building a product that's good that your customers love and that they're willing to pay you for. The reality is your actual competition is not Firm XYZ. It's actually the status quo. Supposedly, Visa's biggest competition. It's not MX, it's cash. And that's true with your company as well. The biggest competition is probably not the person who has a company that's like yours. It's probably people not adopting your thing at all. And if this were a podcast about incumbents and how to be a great incumbent versus other incumbents, then we could talk about getting baked off when you're completely mature product versus someone else's completely mature product. But if you're listening to this, you're probably building something new and interesting in a category that is still being established. Absolutely. And the other thing that's true is that it is rare for markets to truly be winner-take-all. So even if your competition exists, it's not like 100% of the market is going to go to them or 100% of the market is going to go to you. Two data points I think are really instructive here. Sales Force has something like 21% market share in CRM. And Sales Force is the obvious juggernaut in the space in only 21% market share. And then Amazon AWS, it's like 33% market share. So even if there is a dominant provider in your space, as long as the market is big, there's still lots of room for you to grow. And that's especially true if your perceived competition is a new startup because they're not going to be a juggernaut in the space, they're going to have 0.002% of the market. And you might have 0.001% of the market. That's really the dynamic we're talking about here. And by the way, this is a mistake that even seasoned entrepreneurs make. I wish I could tell you that at pilot, I'm blissfully unaware of where a competition is doing. Obviously, I'm looking at their website and stuff, but it's just like the way that you're actually going to win is by focusing on actually making the customer experience good. Our thanks to pilot. You can click the link in the show notes or go to pilot.com slash acquired and get 20% on finance, accounting and tax prep needs for your first six months. Our thank you to pilot. Thank you, pilot. 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 US 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 Fusageiro 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, who 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. Whoa. So Fusageiro was actually born Fusageiro Fukui, but he took on the Yamauchi family name to inherit this cement company. Now, similar to Nolan many, many years later in America, Fusageiro 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 of Nintendo is actually a multiple on-tondress. So the kanji characters, Nien Ten and Doe, can be interpreted as leave luck to heaven, which of course references luck in playing cards. Also maybe the entrepreneurial spirit of a new venture. But definitely plays on the fact that they're gambling company. Well that's what it's going to say. Perfectly 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 Fusageiro 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 till doing the research. You know how they did that? The rulers of Japan for this multiple hundred year period from the 1500s to the 1800s? No. They institute the death penalty for any foreigners who entered Japan and any Japanese who leave the country. Whoa. So like they meant 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. I think like cool. That's great. Interesting business, 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 in 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. But they're just like casinos in America when they play games with cards. They use 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 Fusagiro Yamayuchi 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, who 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 Yamayuchi. He becomes the, at this point, now third coming of the mythical Yamayuchi and the second president of actual Nintendo itself. Sekiro also. So doesn't have any male heir. So for the third time, the Yamayuchi 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, Shikanojo Inaba. Shikanojo also adopts the Yamayuchi name. He starts being groomed to take over the business. And then finally, in 1927, he and Kimi have a son, the first Yamayuchi son in three generations. And they name him Hiroshi Yamayuchi. 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. Shikanojo walks out on the family and abandons the business, the family, 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 Yamayuchi, the first actual Yamayuchi 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 and commands him to take over the family business to become the next Yamayuchi running Nintendo. Wow. And this is pretty young to take over the family business. He's 21 years old. This is 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, over 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 in the company. He fires every single manager in Nintendo. He 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 Yamaguchi 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. Okay. On this happens. So he roachy though, like you said, for the first time, he's 21 years old, like he's a young man. He doesn't want his life to be shackled by like what Nintendo and the Yamaguchi 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, nothing that makes them great. And Disney, 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 got to buy some of these. If these still exist somewhere on eBay, I got to go find some. Oh, I bet they do. Some of the documentaries I watched, there's, you know, 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 Yamaguchi, 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 and we're like, breeze and through history here. But we kind of have to. It's 100 years. From 1949 with Hiroshi taking over to 1959 when the Disney comes in, flash forward down in 1970. Yokoi comes up with this telescoping fake hand basically as a gag. And Hiroshi Yamuuchi 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 market 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. Like that's what we should do. So they 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 Rumba. So they're just coming up with crazy toys in the lab and bringing them to market. All these things and because they have this Disney sort of damnacles that they can hang over retailers heads, they know they're going to 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 Yamuuchi just has this sixth sense for products and for talent. He plexed him 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 or early 70s, Nintendo has become a toy company and a very profitable one at that. So Yamuuchi 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 got built. But then society lost interest in them and so there are all these empty bowling alleys. Yamuuchi 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 Goompei is building for toys to make indoor shooting ranges. Light gun shooting ranges like not laser tag more like play pigeon but like 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. And 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 Yamuuchi 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 electro mechanical games like Sega but once Pong becomes a thing and comes over to Japan and arcade video games they get into a two 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. 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. And who made the light gun for the Magnavox Odyssey? That is the most circuitous path to fighting 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 license the Odyssey from Magnavox 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 what 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 license the Odyssey. The next year in 1976, 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 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 for Nintendo. Oh, wow. This is like transformative for Nintendo. What year is this? 1976. Okay, so this is kind of before the success of the US-based home console rush. 100%. 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 6? Okay. These are not cartridge-based consoles yet. Oh. You're not selling programmable software for them. Huh. So, that sells another one 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 staker price than thalter hand and the other toys that they're selling. Right. The shooting gun ranges. That's a fad that goes the way the bowling alley into fans. So this is what Nintendo becomes kind of inadvertently. They become a Japanese video game business. It was a pseudo-importor 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. 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. There's like a one frame thing that happens. And I think that you can still see this 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 site, it sees the set of pixels that are lit on the one frame, then it knows it got to hit. If it doesn't detect those pixels, then it's a mess. No way. I always wondered how duck hunt works. I had no idea. Yeah. Pretty cool. That's amazing. So Nintendo, thanks to this relationship with Magnavox, isn't 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 Yamaguchi, even despite not being an engineer, is like, clearly this is the future. Yep, this piece of hardware not only is so much better than all this dedicated stuff that's like the Odyssey and what we've been doing that came before, but the business model implications of this, the Razer emboiled 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 Russian 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 Yamaguchi 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 swapable 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 razor's 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 Yamamoto says the constraint I'm going to relax here is time, which is what nobody else in the video game market is doing. So in 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 in the NES. Yup. Yamamoto 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&D two 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 of 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. Like it's portable, you can play it anywhere, you can play it on the go. It does really well for Nintendo. It's a 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. Yamuuchi 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. 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 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 OCrap button where they're like, 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 has 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. But grudgingly, the Yamaguchi 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 does not want him to do it. Minoru Arakawa. Yep. So before we get into what the fifth now cycle of the Yamaguchi family, I don't know if it's a cursor or a blessing, probably both. We have another of our favorite companies that we need to thank. Before we get into the real meat of the episode and sort of like how Mario and how the Famicom and how everything in Nintendo comes to be, it's a Vanta time. What a perfect place to talk about Vanta because what is Yamaguchi trying to do by setting up Nintendo of America, it's trying to enable revenue. What is Vanta do, they enable revenue. There's that Rosenthal transition. So most of you know about Vanta by now, they help companies of all sizes, scale security practices and automate compliance for all of the most important compliance standards across the industry. So SAK2, ISO 2701, HIPAA, GDPR, any other compliance standard that you may need to get certified in in order to sell to important customers. SAK2 automates up to 90% of the work required to achieve these standards like SAK2 and gets you audit ready in weeks instead of months. With Vanta, you can get up to 400 hours of your team's time back and 85% cost savings, especially if you're a startup. But if you're a company of any size, you should not have your own team checking all the boxes required for you to become SAK2 or any other compliant. You should use Vanta and get to enabling revenue with customers that you want to sell to way faster and for way, way, way less cost. Yeah, you can always tell those early stage B2B companies that like there's just not enough stuff on their website yet. There's not enough menus. There's not enough old badges at the bottom saying all the different ways in which they're compliant. You just kind of tell like this company is probably underpricing their product. They're probably selling to two small of customers. But once you see that footer full of badges, you're like, ah, these guys know how to find revenue. That's kind of a dying breed now because even seed stage companies now can become compliant and be able to sell to highly regulated industries like healthcare and hip-hide and everything. It's all because of Vanta. So listeners, go on over to vanta.com slash acquired to learn more and sign up. And for a limited time, if you use that link, new customers can get $1,000 off your Vanta implementation. Great deal. A great deal. You will be in great company, Vanta now has over 4,000 customers, which is crazy when we started working together like a year ago. I think it was less than 2,000. Yep. So impressive. Our thanks to Vanta. Thanks Vanta. 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 Jones and for it. And listeners, unless you're like Nintendo history, but you're like radar scope, but radar scope would be the ashes from which all of the phoenixes you know about rise. So Arakawa Yamaru-Chi'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. A whole ocean in the way is pretty nice. Well, this is before he met Yoko, his wife. Oh, OK. And he comes back to Japan. He meets Yoko at a Christmas ball while Yoko is 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's going to repeat itself here. Right. If I don't want to be involved with Nintendo, then this guy is 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 Yamaguchi 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 Yamaguchi 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. Yamaguchi says, I'll let you run things your way in America. Hmm. 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 recorded in America. And you've got to go build relationships there. So they've a mandate to set up Nintendo America in New York, which they do. And at first, 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 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. I think they were importing used Nintendo arcade games from Japan and like refurbishing them and then selling them into US bars and arcades. Like it was this very almost like 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 Alombs, Alstone 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 pretty good. Yeah. And there was pretty robust competition, of course, as we talked about in the American market. So Arachá was like, guys, why are these? Not selling. Ron and Al are like, they're not selling because the game suck. You need to call up Yamuuchi-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, Tito. Why don't you get the guys back in Japan to make something like Space Invaders and send it over to us? No, Minoru calls up, Yamuuchi, it's like, hey, can you send us something like Space Invaders? Yamuuchi doesn't really want to do it because he's like, like, you're supposed to be building relationships over there. Can't you just use our games? And Arachá was like, no, no, I really think this is going to sell. I'm going to place a really, really big order. I want you to send me 3,000 cabinets of a Space Invaders knockoff. I really know that this is going to work. Yep, we are your boots on the ground, 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, you know, a business partner yet, but I really think this is going to work. Yamuuchi says, okay, he directs the R&D3 team to come up with 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 3-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 mainly 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 manage to sell about 1000 of the 3000 cabinets. So they got 2000 radar scope cabinets sitting in a warehouse in New Jersey at the current headquarters of Nintendo of America collecting dust. So Mineru now needs to call up Yamaguchi again. It'd be like, you were right. Like, so about 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 of America is going to 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 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 is happened. Like, we're out of here. This is a pretty constrained problem too because you basically are saying, hey, create a different shooting game because when you only have the joystick and a couple buttons, basically every game at the time is, okay, use 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. Yamaichi 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 dumbass son in law over in America. I gotta give him something. Can you give me like a janitor or somebody to like make a game here? And Gunpei is like, I literally can't take any engineers and at the time only engineers made games. Like, 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 worked on the color TV game designs of the hardware and some of the user interface. Here's pretty tall. He's not an engineer, but he's been wanting to make a game and give you that guy. Yamaichi is 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 always 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 in these cabinets is called Donkey Kong. And Donkey Kong would itself go on turn hundreds of millions of dollars immediately in the North America alone. It totally saves Nintendo of America's skin. It earns $180 million the first year, another $100 million the second year in our kids. 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 ET. 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. Yes. Listeners, you might have thought that I was going for Italian plumber named Mario, but here we have Proto Mario, we have Jump Man, Jump Man, 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 of a sudden, 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 our kids. 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, 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 Yamamoto gives him the chance to make a game, he's like, finally, I can bring my genius to it. He's not a self-conceited man. I'm sure he didn't think about that way. But he has a very different vision for what a game can be. Here's what David Cheff who writes game over, which is a great book, writes about the conversation that Miyamoto and Yamamoto 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 him 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 Mick Beth. 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 jump man 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 girlfriend as revenge for not being treated well. Now it's important the gorilla does not want to hurt the girl. 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. 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. Climb 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 them 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 to 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. 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. 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 Wildcard. Team Wildcard. Arkau is totally freaking out back in New York. His wife has gone back to Japan, taken 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 and 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 moved the company to Seattle. They lease a warehouse space in Tacuela. For folks who don't know Seattle Real Estate, Tacuela is just south of the city, kind of by the airports. It's very like industrial. To great place for your video game warehouse. Great place for your video game warehouse. Exactly. A ship, the cabinets across the country by real road from New Jersey to Tacuela. 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 Radarscope with Donkey Kong. They plug them in. They all huddle around. They start playing. And they're like WTF. What is this? Worst career. It's super different. They weren't really told what to expect. They basically get these conversion kits that show up the 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 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. There'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 hire a couple kids and see Adolf to work in the warehouse. Move stuff around, get a chipped 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 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. It'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 in the warehouse is like really pleading with these guys like this is really good. And they're like, okay, well, let's take it to a couple bars around Seattle and just set it up and see what happens. And just like pong back of the day, this thing becomes a quarter magnet. Phillips's intuition was right. None of the senior guys, none of the older guys, Arkhalla, Stone and Judy, they didn't get it, but the kids did. And on the back of that, Phillips ends up becoming, Arkhalla'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. So they're casting a vow trying to decide what to name this character. And by the way, I should say I was shocked that Donkey Kong pre-dated 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 T'quilla either shows up or sends a letter. It's unclear. He goes 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. And this is how Super Mario gets his name. Amazing. Totally amazing. They named the girlfriend Pauline. I think it was either wife or girlfriend or one of the guys working at the company at Nintendo America at the time. Yes. 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. So one more thank you naming of a character is going to come up in just a second here. So the game sells like wildfire. Like we said, all the 2000 former radar scope machines fly out of the warehouse. They order more like they end up selling thousands and thousands of this. 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. There are any of ironies, Tido, the Japanese company that made space invaders. They call up Yamuuchi 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. Yamuuchi's kind of inclined to sell because memory 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 Arcada make the final call. Arcada says, nope, we're going to keep it. We're going to distribute it in-house in Nintendo America. Of course, that ends up being totally the right decision and kind of re-earns Yamuuchi'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 Shindberg who we talked about. That's Michael Ovitz. With Michael Ovitz over at MCA Universal. Of course he's 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 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. Arcawa is 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 America up with a great antitrust lawyer to fight off MCA, which is a crazy decision. Like they soon 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 Shineberg 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. Shineberg knew it. Yeah. That's the thing. And the judge slaps him across the face. 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 and a bunch of vectors too. They're like, wait, wait, once a gorilla one's an ape. And then the other argument that John Kirby finds what because John Kirby flies to Japan and starts interviewing a bunch of people at Nintendo to try and like mount the argument of like it. 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 universally. 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 universally goes to court. No. And so as I thank you, Nintendo goes to John Kirby a few years later and says, we've got this great game and development and we're going to name the protagonist after you and that is how Kirby got his name. Great. Smash character. Yes. Oh yeah, a lot of jumps. Okay, so we're at this point in time where Donkey Kong sold liking busters. They know they've got to hit on their hands. There's potential for these characters to really embrace their own storylines and they're 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 pop by game. They finally get the license. Got in the same van. 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 green pipes and that's how they became plumbers. I know when they came out 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're 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 amazing. What a Nintendo of Japan thing to do. I love it. Exactly. But yes, it's clear that Miyamoto's got the golden touch here. Yes. It's created this whole new discipline of game design where the same principles as engineering apply and Yamaguchi completely understands this. Just like you understood with Kumpai 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 Miyamoto's out 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, Yamaguchi 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. For 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 kernel, 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. Yamamoto 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 Yamamoto, 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. And they're 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 right. 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 Square and Enix in Japan with the Dragon Quest series and the Final Fantasy series here on Obu Satcheguchi who was the father of the Final Fantasy series would probably have a very different take on that. But he's equally a genius. Like there are these few people who are just the very best in the world at what they do and nobody else can match them. Yep. 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&D4. 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. And the way they do it that 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 Yamaguchi gave them would be to get the fanciest, fastest, most more is law enabled ahead of the curve process are 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, you know, 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. You know, we're in the 80s, even through to the 90s. Remember Intel's marketing and like 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 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 it had specialized circuitry both for doing the backgrounds of the games and for processing the sprites, which are the like 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 like 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. But in this subset of the computing market, it was Nintendo. I think you're right. I mean, I can't think of a counter example off the top of my head or where a counter example 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, disessetated by this constraint that Yamau Uchi put on the team of like, this has got a cell for less than a hundred 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 US as lateral thinking of seasoned technology that it's about inventiveness. I think the literal translation is withered technology. Withered technology. 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 and watch. Gunpei Yokoi's work on the game and 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, Moss 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 in 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 like 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 will 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, Nintendo titles, but then the third party titles too. Right. So interesting. 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 like 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 like be a Trojan horse into the home like 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. Retails for $14,800 yen, which is like $110, $120 at the time. But still way below any of the competitors on the market and way, 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. That's kind of like the famous Tylenol case. They recall every Famicom system in Japan. They don't just replace the one broken ship. They strip out the entire motherboard and replace every motherboard on every single unit to show people like we're really serious about quality. 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 3 million unit order with Riko, the Japanese semiconductor manufacturer. Riko manufacturer? Yeah. Oh my God. And Nintendo became by far their biggest customer. Huh. I used to have a Riko camera. That's right. So they did a deal with Riko 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 like 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 the US at the time in the 80s. And not just 90 million households. They're plenty other countries that have 90 million households. There are 90 million US households that mostly 100% of them have a television were used to playing arcade games. And new 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. Yamaruichi is 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, Arachala 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 Yamaguchi wanted to do it. I think Arachala did not. And I think Yamaguchi overruled Arachala 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 America, the distribution arm, we went through all this. You proved yourself with Donkey Kong even though I saved you, but I wanted to sell to Tito and you said that was wrong. I want to get this in the US 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, those are really dumb. Because he had already left Atari at this point and it was owned by Warner's. Yamaguchi goes to Atari and says, Nintendo America is not going to launch the Famicom. I want you to launch the Famicom now in the US. Wow. And they basically have a deal done. They negotiate it. This is going to be Atari, you know, under Warner's nose that they're hardware at the 2600 at this point. It's 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 Yamaguchi directs Arcawa 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 out. I'm sure Arcawa is like, I can't believe this is happening. Then the Atari folks fly out to Japan and meet with Yamaguchi. 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. But still like talk about history changing on a knife point. This would have been Atari's business. Yeah. Nintendo wouldn't have had the direct relationship with certainly not customers, but not even retailers. Retailers, it wouldn't have built the brand. All the IP were 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, the crash is already underway. And Atari and Warner's are keeping these negotiations going just keep Nintendo tied up. But they know that they can't actually follow through and like deliver on this partnership because in the second quarter of 1983, Atari reports a $283 million loss as part of Warner's earnings in 2Q 1983. And 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 a wouldn't have. You know, I think, I don't know 100% for sure, but I think I think I 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 let it from the beginning. And in a sense, Arakao is right. The fact that they didn't release what became the NES, the US version, which is a little bit of modified from the Japanese one for another two years. In one very key way, it's modified, which will get into in a sec. Two years later, it's a much better time to launch this system. Which is better. And in the interreveining 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're 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 a 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 US, which would be kind of seven to 10,000 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 six X, 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. Yep. Yeah, it's nuts. Totally nuts. Even more importantly though, building up to an eventual US launch, it's during those couple 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. You know what it is. The Legend of Zelda, which actually was the launch game for the Famicom Disk 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. Wow. 60 million copies. Duck Hunt sells 28 million copies. Later Super Mario Brothers 3 would sell 24 million copies. But mine 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. You know, 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, launch during those two years. Actually, Zelda might have been a little bit later, but like the billions and billions of dollars, like incredible. So when they're finally ready to launch in the US 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 just have check stocks and weather and I even think it did some of that in Japan by this point. It did, yeah. 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 launch in the US 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 US dollars for US 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 US. But like, they aren't doing a lot of product-specific work. Or business model or Yamaguchi definitely thought of Arkawa and Nintendo of America. Despite him being his son-in-law, I mean, because he was his son-in-law, just thought of them as like my American distribution network. Yes. But here's where things start to change. So Yamaguchi did know and had learned from the Atari third party licensing business model that we talked about with Activision and all that. That was an incredible cash flow stream and point of power. 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 were established companies, especially Namco. Like we're 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. Yamauji gets all this. The terms that he sets up for the initial licensees in Japan, Keiichi's copies the Atari business model. They pay Nintendo a 20% royalty on their revenues from the games. And that's it. 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 very Disney, very Apple and their family friendliness. And so this is so like, interthetical. Strict censorship, all of this stuff that we think of Nintendo today has been in the toy business for decades at this point. By the way, this sounds hard to do. You have to figure out how to manufacture the correct sized plastic and the correct motherboard with all the correct pin connectors. 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 like, 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. And 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 is 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. And so we'll also bring this to the Japanese market, but Nintendo 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 launch 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. Side loading is the worst thing ever. I watched Craig Federicki give a talk on stage in Lisbon two years ago, talking about how side loading 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 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 in a year or two, but like basically right. The Famicom was five years ahead of the competition and 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 just like, oh, the D.O.J. is never going to come for us. Which they didn't, I don't think. No, they didn't. I think they got in trouble for this. But somehow they escape in the U.S. 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, there's not going to prove it. No chips for you. Exactly. And then the third thing that they build into the Nintendo of America licensing program, are 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. The Sega would come out. Very important, very soon. Yeah. Dirty. Or clean. Nintendo would say clean. Yes, they would. We're 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 manage to get relationships with both F.A.O. 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 convince the retailers to carry them. And this is where the next set of innovations come from Nintendo of America. Partially, I think this was an 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 are us or the target or the Babages 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 Anselaer merchandise in their Mario Backpacks t-shirts, 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 like that they even sold that much. That'd be about $5 million in total sales. Again, like 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, like everybody was like, look, do we wish we sold more sure, but like this is actually a success. Yeah. So throughout 1986, they start rolling out more metros throughout the US. You take a kind of rolling thunder approach, which we're going to get 200 minutes also becomes the next innovation from Nintendo of America. Can you imagine this today if they rolled out the switch like 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 three 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 oversupply 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, Nintendo 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 mark down 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. It becomes this super hard to get. That's everything we talked about in the LVMH episode, this objective desire that is very difficult to get. They also take a page at a Disney's book and they keep most of their game catalog out of production most of the time. Yes. 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 Yamawuchi actually brings a lot of these innovations from Nintendo America back to Japan. So they alter the terms of the licensing agreements with third parties. They go even further into Japan and true Yamawuchi style. They 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 America still has their retail strategy, shall we say, but it blows through the roof. They sell seven 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 recognizable 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. And 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 in 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 unubated path, unubated path, firing on all cylinders. They do things just incredibly innovative things. They launch a 1-800-to-free line for game counselors. This 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 hard core. 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 tests. 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. I think this is crazy. They're 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 three, four hundred 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 and was 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, like, 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 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 flowing around, at one point in Nintendo America buys a bunch of properties in Hawaii and basically like creates their own internal like resort for Nintendo America employees that you could like book to go take your family to Hawaii and stay in the Nintendo on properties. And then we'll talk about this a little bit more next time. But they buy the Seattle Mariners. Can we talk about that? Like, yep. 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 the cool parent. So this is one half of the amazingly innovative direct relationship with customers that Nintendo of 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. So 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 like secrets that they divulge. But 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, exactly. Nintendo's had a marketing Peter main and then Gail Tilden who worked in the marketing 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 US, they send out the fun club newsletter for free once a quarter to everybody who registers. And then they realized 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 they, I think they eventually raised the cost of $20 a year. They get 6 million subscribers, so that's 120 million a year and high margin subscription revenue coming to Nintendo. Drop in the bucket. What it's way, way, way more valuable for though, not just the relationship with the customers, it's for selling games. 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 with the NFL did, which is building hype around your media properties and all around all of your intellectual property, you are going one level further as we just talked about with you were you actually have a direct relationship with the customer. I mean, 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 like contextualize some numbers. Remember how I said in 1989, Nintendo's sales were 10 times the market bottom. Yep. At that a billion dollars of revenue relative to the 100 million low point. Well two years later in 1990, Nintendo did almost three 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 media. Yeah, just incredible. I don't know if it first happened that year in 1990. It may have the only thing I read 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. What happens next is the fall from grace. 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. 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 were talking about how amazing the business model is but it is worth pointing out 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 consoles, actually three, including the virtual boy. There's a lot of 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. I 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'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 sides for you that are little branches off this tree of story. And I'm curious if you found them because one is like incredibly up your alley. But before we do that, we want to thank one of our favorite companies in the world, Tiny. Long time acquired friends and partners, Tiny, who have big, big, big news, they are going public. This is incredible. We're so happy for them. It's funny. Forever we've talked about how they're the Berkshire Hathaway of the internet, and they were missing a key ingredient, which was being a public company. Now they are truly going to be the Berkshire Hathaway of the internet. This is so cool. I've always thought one of the most amazing things about Berkshire Hathaway and one of the reasons I've been a shareholder for so long is basically you could get no fee, no carry access to invest in the best private equity firm of all time by buying Berkshire Hathaway stock. And now you can do the same thing with Tiny as the first and in our view, still the best internet private equity firm of all time. Tiny, if you don't already know by now, they are by far the best and leading holding company of profitable internet companies. Yeah. And the most important thing is we throw this word private equity around. They're not structured like a private equity firm. They don't have private equity backgrounds. I think everyone listening probably knows the story right now of Andrew starting a Metalab, a nice cash flowing business, which Metalab in its own right is a great business, be a great design firm. But just reinvesting the profits of one business that they founded and buying more and more businesses and that just results in a completely different structure to the business and cultural ethos than people who have only ever worked in PE raised PE funds have highly structured PE. It's just like Berkshire. I mean, it's the same thing for Warren and Charlie. They don't have a fund. They're not trying to get more assets under management to get management fees. Same thing for Tiny, they are taking the cash flow from their own businesses that they own and reinvesting them in a growing those businesses and be buying more to add to the platform. Yeah. So they really are the acquirer of choice. If you own a business that is on the internet, a software business that's doing 5 million or more on revenue and has call it 30 ish percent operating margins or the potential to quickly get there call it Nintendo ish operating margin. Yeah. They could be a great, great place to sell your business. So you can reach out at high at tiny.com. Just tell them that Ben and David sent you and you are an acquired listener and especially in this current environment where it may not make sense to stay a private company. It may not make sense to stay a venture backed company. You may want to clean up the cap table and just go operate the business, have some upside left for you, sell the majority of it to tiny. That could be a really great option right now. I'm huge congratulations to them for going public. What a milestone. By the time this episode comes out, I think it will be probably a couple of weeks away from happening. It's happening in April. But it's just great folks. We're so happy for them. Yep. Alright. Thanks, tiny. So David, my two sides. 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 were started in 1982 by Trip Hawkins and Izzy Gaming Company. So you're not talking about that. Yep. 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 exactly would have been. You're also not talking about Netscape, which started as obviously Mark Entryson 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. 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 years younger, we wouldn't be having this stage of the conversation. I already would be it. But I got to cry, Uncle. I'm going to keep giving you a hint because 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 for junior based. Wow. I can't believe I'm still playing on this. I'm hoping there's listeners like screaming into their air pods right now. Here's the question. 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 the Atari 2600 and it had an amazing amount of very prescient technology. The ability to temporarily download a game, cash it locally on device and keep track of high scores. It would work by connecting a telephone line and Game Line 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 in Stanford, the years 2012 to 2014, the AOL building in Palo Alto was still a central hub of things. So Star Dex, 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 1, David 0. Well, I have all the stats in front of me. I don't know if there's a me one. This is a game. You'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 when 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 its offer? I mean, you just read the books. No, this isn't fair. No, I actually got this. I'm sure it's in the book, but from research for this episode that I had completely forgotten. I do not know. When I looked at video of what you were talking about. What is it like SMB3DOS? No, no, no, it's related to it. Its ideas from the deep. Cool. So what happened was John Carmack, one of these geniuses that Yamuruchi was identified and talked 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 sides growing 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. It was a record software that enabled it and then they famously made a demo version of Super Mario Brothers 3 for the PC and showed it to Nintendo. We didn't talk about Super Mario Brothers 3, but like that is widely held to be the best Super Mario Brothers. One was the original. Two was too hard. Three was widely anticipated and then it came out and just was even better than everybody thought it could be. Yeah, three was amazing. 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 demo that Carmack coded up. It was lost. I think somebody found it on an old machine at some point in time recently. There's YouTube. You can go get video of watching it play. It's amazing. It's so incredible what Carmack did. The background of it, so they have the background of the desktop. They have it in a window playing on a PC. You still can't do unless you're running a Nintendo emulator on your computer. Maybe later. Yeah. I guess it was 3.1 maybe at that point in time. Windows 3.1. It was DOS based. Oh, it was DOS based. Well, there was whatever the GUI was that they had on top of it because they had a GUI to play. They gave him. So the background wallpaper of the GUI just said, I FD, I FD, I FD, I FD, I FD, and Rose across the screen. I'm like, what the hell is I FD? Then I figured out it was ideas from the deep. 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? Mario on PC. 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. They turn down the short term money to promote long term stability. But it 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. 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 economy 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, the 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. OK. 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 economy is 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. 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 fuse together. If Nintendo was acquiring the games, that 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 on to 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 for everybody now, but at the first for Nintendo's time in developing a superior hardware platform, that is a scale economy advantage. And then that directly links to the network economy of like 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 like 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 than the next episode, but an incredible self-inflicted wound that Nintendo is 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. I think that's something they've 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 economy's game where they can make the biggest best piece of hardware if they can get more people paying a subscription. Well, they can port their existing user base over to the... Yes. They first start doing it with the Wii, which not coincidentally is their big comeback. The Wii could play GameCube games, but we're getting ahead of ourselves. Definitely we are. But you're right. I think there's some scale economy, some network economy here, but we're both describing the same phenomenon. It's interesting. I remember back from my days at GSB at Stanford, one of my favorite professors, a professor named Susan Athe, who then later would join the Rover.com board with me and get the 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. Oh, 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. Video game, consoles, and software is the textbook classic definition of the two-sided network effects. I remember reading all about it in her class. It was like, oh, this is so cool. No question to me that both network effects and scale economies are huge sources of power for Nintendo here. Miyamoto definitely has process power. 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 be, he had such reverence for him. But all the Mario games, Mario 64, which was revolutionized the industry, the first true 3D game, Legend of Zelda, a link to the past on the Super Nintendo at 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 the producer now on the Zelda series and there are other directors below him, but like, it's all his process power. Yeah, 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 named their children Zelda totally. Totally. A lot of people who named 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 do they manage to pull this off? Because it's not for a core gaming audience. And it was once again to the point and 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 reinvisions and reenergizes 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, different games and Donkey Kong to though with the Famicom and the NES relative to especially the rest of the American video game industry right? 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, they'd be switching costs, but there weren't. And so that'll show up in the second 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. Like 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. Like today most households are going to choose between the PlayStation and the action Xbox, and it's interesting that Nintendo is a third alternative thing, but 100% switching costs. My God, I think Nintendo might have every single one of these powers of 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, and you're willing to pay more money to buy from a firm with branding power. Hmm, 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 banker insurance company where everybody is competing in a commoditized way, and so brand really matters. Two thoughts. Nintendo does have brand power, but I think it is the weakest of the seven that it has. That's just incredible. I think it has all seven. But the brand power I think is a smaller piece of the story and it's brand power around the seal of quality, and especially with parents and in this era, if I buy my kids an Nintendo system, I can be very sure that there's not going to be excessive of 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 Wars is actually more of a branding power for one versus the other of why you would pick since they're less differentiated, but Nintendo is 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. The coordinate 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. 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. 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 is story that's unfolding before you as an observer. It's like reading a book. Right. But in Mario, you know, there's not enough depth to Mario to say like, I'm observing Mario. You just are Mario. And that's like 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, you know, the hardcore story driven RPGs. Yeah. But Mario is also 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 an 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 like 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. It's so valuable. And in fact, Nintendo leaned into this. This is another sort of clever thing. They did not allow licensing of other characters. If you wanted to license an Nintendo character for a backpack or a lunch box 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. 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. I'm 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. Yeah. 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 the SNES and the Game Boy. And it's only ever their games on it. And the way that that has compounded out 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. Yeah. Well, with Pokemon too, we'll get in 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 or no. 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 like 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 with 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 great personal, incorporate 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% like that is what matters. And that's part of Yamamoto's true genius was as a complete outsider recognizing that like the Shigeru Miyamoto's, you know, the Gumpai Yokoi's are like the key to making all this work. Right. At the same time though, the reason it's not really ridiculous and doubly ridiculous because Peter Mayn coins it, he does everything besides make the games. And that is so important too. It really comes down like product and distribution both are really important. Well, also like the best CMO's 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 dichotomy and they are both so true. Nintendo has the best products, the best IP, the best game. Sometimes 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. And man, when you can marry both of those, that's when you get 95% global market share. This was my sort of final question and my the playbook themes that I had written down that I wanted to pose to you. What other businesses ever have had 95% 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 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 I think Apple and iOS, not of revenue, but of profits. Apple and iOS have something on the order of that of global market share of smartphone profits, smartphone profits. The other one that's like close, but I think is more around 85% to 90% 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. With the day they acquired Instagram. Yeah, that's true. And what's happened like during that hey day? 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 Microsoft's share of the operating system market. Yep. You know, that probably was something like 95% also. Or 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 three 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 hit-striven 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. A lot of it. I'm curious if your game, I think Baron Ball is stupid since we know the history from 1990 to 2023. Like, that's actually great. Oh, yeah. 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 Mark 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 $150 billion market but if 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 a $150 billion market. Totally. But it's a nice little hedge to be like, oh, I totally think Nintendo could address a $150 billion 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. Great. 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, 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 and Japan and inflation in the US 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 billionish category, which by today's standards, of course, seems quite small. And we're like 15 billion dollar companies are inconsequential and 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 70s, any revenue figure? Because we know that it was around three 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 three 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 three billion to a hundred 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 blacks want 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 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, you know, 1970 to 1990, complete masterclass in business strategy and execution. Yep. We're 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 the second episode. But I'm going to give them an A plus for 1970 to 1990. There you have it. There we are. Carvettes? Carvettes. 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 recommended. Oh, yeah, you've told me before that that was amazing. Really good. Have I recommended it on the show? Am I double car-bouting? I can't remember. I know you've told me about it. It's hard to separate like our conversations on the show and not on the show, you know? It's a great couples movie, but it's also a great sort of like indie film. Like 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 like independent film making. It is unbelievably VFX heavy. What 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 like a completely different take on VFX. It's not like Avatar 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 like 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. I think there will always be separate industries. But like the tools and the technology are converging. My car, vout 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. I went back and I listened to I think I do you or I have before had as a carve out his interview with Tim Veris a couple of years ago, which is so great. That got me on a kick of seeing what else is out there. 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 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 live here all like the real deep cut Michael Lewis stories. I thought I had listened 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 and runs mocks and stuff. It's the 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'd you 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 will give you the rest of your fifth hour back, fourth hour back, whatever it is. Thank you for coming on the journey with us. Our huge thanks to Pilot, Tiny and Vanta. You can click the link in the show notes to learn more. 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 the, 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, pulling you on, Dave 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 doose. 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 really made 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, got to update my script. Smart thoughtful people, talk about this episode, get some merch, acquired.fm slash store. Wow, we have like lots of things, Dave. I know. We're like a small media empire. The acquired Slack is like our version of Nintendo Power and the power line. There we go. We need to produce an Nintendo power. All right, I'm cutting this off. Listeners, thank you. We'll see you next time. Who got the truth?