In the mid-1970’s the father of commercially successful
video games, Nolan Bushnell was sitting on top of the world. A graduate of the
University of Utah, Bushnell had just sold the company he had built, Atari, named for the Japanese word for “check”
in the game of go, to Warner Communication for 28$ million. (Koerner, 1999) A
November 15, 1976 Business Week headline proclaimed that “Atari sells itself
to survive success.” (Atari sells, 1976) Indeed the small company was growing
so fast that manufactures could not produce the internal circuits fast enough, as Edger A. Sacks, the vice-president of GI’s
Microelectronics Group, explained “the trouble is that demand is 50% to 60% greater than anyone anticipated,”
and in turn Bushnell could no longer continue to create the additional funds needed to overwhelm the competition and appease
the demand. (Demand overwhelms, 1976)
In 1972 Bushnell had invented the first
commercially successful videogame, a simple ball and paddle game called, Pong. “To
be successful, I had to come up with a game people already knew how to play, something so simple that any drunk in a bar could
play.” Bushnell later recalled. (Koener, 1999) As such Pong was originally tested in a bar called Andy Capps in Sunnyvale, California. Two days later the owner of Andy Capps contacted Atari saying that the machine was
broken. Al Alcorn, an original employee of Atari was sent to repair the machine,
finding that the coin box, a milk cartoon with the top cut off, was overflowing with quarters which prohibited the machine
from working. The machine was soon fixed, Alcorn replaced the milk cartoon with
a casserole dish, and the quarters continued to flow in (Sheff, 1993; Demaria & Wilson, 2004).
With the initial success of Pong the
Atari Company was positioned to succeed. In 1977, Atari released what was to
be the first “successful video game console to use plug-in cartridges instead of having one or more games built in,”
the Atari Video Computer System or VCS, the machine's name was later changed to Atari 2600 using the unit's Atari part number,
CX2600. (Wikipedia, 2006) The VCS initially did poorly it’s first Christmas,
because of the many competitors that had decided to enter the lucrative video game market. Sheff
describes the market in his book, Game Over: How Nintendo zapped an American Industry,
captured your dollars, and enslaved your children, Atari was posed for a big year in 1978, but “so were National
Semiconductor, Fairchild, General Instruments, Coleco, Magnavox, and a dozen other companies.
The Christmas season came and went, and few consumers, perhaps because they were confused by all the choices, brought
video games home that year. Of all the entrants, only Atari and Coleco survived,
and Atari was in shambles.” (Sheff, 1993, p.143)
the end of 1979 the Atari VCS had sold around 6 million units. Still in did not become a common household fixture until 1980
when Warner Communication struck a deal with the Japanese game maker, Taito, making them the first videogame company to license
the arcade game Space Invaders for a home console. Consumers were soon rushing out to buy the system just to play the game.
(Demaria & Wilson, 2004) By 1981 over 5 million additional Atari VCS Consoles
were sold, entering almost 9% of all U.S.
households with a television set (The riches, 1981). The boom in sales of the
VCS earned Atari over 5 billion dollars over the next two years, marking the Golden Age of Atari (Lindorff, 1983).
Yet, on October 18, 1983 the New York
Times proclaimed that, “the boom is over for the once high- flying world of video games.” (New York Times, 1983) With Atari laying off about 600 people
in its first of many major personal reductions in February of 1983, millions of new video game cartridges being buried in
the New Mexican desert to reduce inventories, and video game cartridges dropping in price from 40$ to as low as 4$, the whole
video game industry was quickly headed for a massive meltdown (Sutton, Eisenhardt, & Jucker, 1986; Demaria & Wilson,
2004; Jim Morgan, 1984). What forces weakened this video game giant, producing
an almost instantaneous collapse from billions of dollars in revenues to the loss of millions? Poor management.
Early analyses of the video game market
stated that Atari was “creating another booming “razor blade” business.
Razor blade marketing strategies, which were first introduced into the toy industry in 1959 by Mattel with the Barbie
doll, is also called the "bait and hook model" or the "tied products model, and “refers to a family of practices in
which advertising and selling acts are coordinated so as to mislead, deceive, or defraud consumers. Typically, the initial
ad offers an especially tempting price on a certain model as “bait” to lure unsuspecting customers to the store,
whereupon the sales staff commences to “switch” the purchase to other units actually intended for sale, usually
at a higher price.” (Wilkie, Mela, & Gundlach, 1998, p. 275; Kinder,
1991) In the video game market razor blade marketing strategy “of focus[es]
on the development and sale of software that is compatible only with the company’s unique hardware.” (The riches,
1981, p. 98) Indeed in the beginning this did seem to be the case, Atari was
able to offer its VCS at a low price because the major profits were being made on each video game cartridge (game cartridges
could often be sold at almost 10 times the manufacturing price.)
Problems in this razor blade marketing
theory occurred because in 1982 Atari believed that no matter what anyone else did they could sell 60 million cartridges.
Even with weak creative output, E.T. the Extra Terrestrial was completed in five weeks and developed so poorly that some people
blame this game alone for the downfall of Atari, one executive was heard to boast, “I can put horsesh** in a cartridge
and sell a million of them.” (Cassidy, 2002; Demaria & Wilson, 2004,
p. 105) Atari even produced more Pac-Man cartridges than there were systems. One
Atari manager stated that they expected people to want a second copy for their ski house.” (Demaria & Wilson, 2004)
This ability to sale anything was virtually
true in both 1980 and 1981 but with the past success of Atari any company with the means were joining the video game market. As Fortune wrote in a 1982 article, Cashing in on the Cartridge Trade, “to line up at the receiving end of this
transfer of wealth takes fast thinking and money – but often astonishingly little of either.” (Brown, 1982, pg
125) In 1982 choices crammed the shelves; the 60 or 70 titles that were originally
supplied by five companies were joined by games from 16 new companies. (The real, 1982) An
analysis by Levy and Demaria states that there were “50 software companies when there should have been 5, every one
producing a couple of million carts – 60 million by Atari. Activision produced
probably 6-7 million and sold 80-85 percent. What you ended up with was over
200 percent of demand being produced, and half of it was still in warehouses or on shelves at the end of the year.”
(Demaria & Wilson, 2004, p. 105)
Competition also came from the many
home computers that were becoming less expensive than stand alone game machines. So
many companies began making machines that could play video games that in 1983 Atari share of the market slipped to 13% from
20% in 1981. (A Price, 1983) Home computers further cut into Atari’s profit
after, James J. Morgan, replaced Raymond Kassar, as Atari’s president. Morgan,
who was previously the vice president of Philip Morris, Inc, called for a 30-day freeze on all product development and introduction
in an effort to understand the market that he was dealing with. This freeze effectively
signaled the after Christmas introduction of the Atari 1400, an inexpensive home computer that Atari hoped would bring them
back into the market. (Jim Morgan, 1984)
With huge backlogs of software sitting
in warehouses and the loss of their market position Atari began to dump inventory; both literally in the New Mexican desert
and at financially at really low prices. Consumers stopped buying video game
consoles because of eroded consumer confidence and over saturation of the market which undoubtedly lead to confusion and the
lack of a clear leader. Atari could not build back their original position or
consumer confidence and they collapsed, taking the whole console video game industry with them. (Demaria & Wilson, 2004)
For the next two years toy distributors
in America avoided console video games
like the plague. While on the other side of the world a company that got its
start making playing cards was introducing its new video game console the Famicom, short for Family computer, to the Japanese
population. Nintendo, who had originally offered Atari the exclusive rights to
market a version of its Famicom console to an American audience, already held. (Herma, 2001)
In order to enter the American Market
Nintendo had to persuade the many retailers that had been burned by the downfall of Atari that their new console, the Nintendo
Entertainment System or NES, would attract consumers. This took drastic measures. Nintendo promised to personally stock each store while also setting up any displays
and windows. They further offered a ninety day grace period in which participating
store owners did not have to pay a dime for any Nintendo merchandise. After which
each store would only pay Nintendo for any merchandise that they had been able to sale, with the option to return any unsold
product free of charge. (Sheff, 1993). Store owners saw the offer as a no lose
situation and allowed Nintendo to set out their merchandise. “Nintendo
proceeded to unleash a $30 million television advertising campaign in the New York Area alone.
It was the most successful toy launch in US
history, resulting in sales of one million units the first year (1986).” (Shades, 1991, p. 10) By 1988 Nintendo held 90% of the market and their sales of video game cartridges alone had hit 2.3$ billion.
(The Nintendo, 1989; Potts 1987)
Nintendo, like Atari, used the “razor
marketing theory,” to sale their product. (Kinder, 1991, p.91) Yet, Nintendo had been able to learn from Atari’s
fall. Ron Judy, vice president of marketing at Nintendo, explained that Atari’s
business model failed because, “The quality [of games] was poor and the quantity was way too high…We felt the
main reason it collapsed was not that consumers disliked video games, but that they disliked the video games that were being
marketed.” (Potts, 1987)
Soon Nintendo controlled virtually all
of the video game market; any outside company interested in producing games had to play by Nintendo’s rules. Sales of Nintendo product also began accounting for a large
part of many toy retailers yearly earnings.
As Ed Logg, the inventor of the arcade classic Centipede, explained “toy stores couldn’t do anything because
all their business was from Nintendo. Nintendo made it quite clear that if [Toys
‘R’ US] carried [unlicensed
games] their allotment would get reduced. And at that time 50 percent of Toys ‘R’ Us’s profit came from
Nintendo.” (Tetris, 1999) Nintendo enforced a number of rules to insure
that the video game market remained profitable.
One method that Nintendo used to overcome
past weaknesses of the Atari business model was to introduce scarcity or in other words, “inventory control.” Peter Main, Executive Vice-President of Nintendo of America, Inc, stated that the
Atari wave had floundered in large part because of a flooded market. So Nintendo
used “Inventory Management,” or scarcity to whet the public’s appetite and maintain a sustained demand. In order to maintain a demand Nintendo would not fill all of the retailers’
orders, and it kept half or more of its library of games inactive. “In
1988 for instance, it sold 33 million cartridges, but market surveys showed it could have sold 45 million.” Main believed that retailers exaggerated demand and maintained that Nintendo
would rather have them pleading for more stock than have to worry about excess inventory (Sheff, 1993, pg 194).
Nintendo also controlled who could and
could not manufacture video games for their system to assure only quality games were in their library. Unlike the Atari 2600, which could be reverse engineered to learn the programming procedures, the NES was
created with a patented special electronic chip, called the “lockout chip”, which prevented all but those games
authorized by Nintendo from playing on the system. (Pisik, 1990) This chip enabled
Nintendo to decide what companies would have the rights to manufacture games for their NES. It
also created the need for all companies creating games for the NES to buy their cartridges directly from Nintendo (Rogers, 1989). Companies
that Nintendo granted a license to were also unable to produce versions of their Nintendo games for other consoles. (Palmer,
Logg explained the use of Nintendo’s
self-regulated scarcity and licenses in this way, “Nintendo the first year was jacking everyone around with “ROM
shortages.” Their contract was very one sided; you paid all the money up
front, assume all risk, they tell you how many [cartridges] you’re gonna get.” (Tetris, 1999) Another software CEO further explained, “We come up with an idea and submit it to Nintendo. Months later, they’ll say yea or nay.
If it’s a go, we spend months and money writing the program. We
then send in the final version. Again, they review it. If they decide they don’t like it, everything we have done is wasted. If
they decide it is only so-so, they will make only a few cartridges and we make no money.
We have no say. We are at their mercy. They can make or break any of us
overnight.” (Palmer, 1989, p. 20)
All of this success and a highly restricted
market were quickly making Nintendo enemies. Video game companies viewed Nintendo’s
selection process as unfair, and soon past giants in the video game market, such as Activision and Atari, were suing Nintendo
for vertical price fixing and intellectual rights. (Samuelson, 1990) Yet Atari’s
suit was only a preemptive strike.
Employees at Atari knew it was only
a matter of time before Nintendo counter-sued because Atari was developing a chip which they referred to as the Rabbit program. As Judge Fern M. Smith later stated “Atari developed its own program-the Rabbit
Program-to unlock the NES. The Rabbit program generates signals indistinguishable
from the [lock out chip] program…The Rabbit gave Atari access to NES owners without Nintendo’s strict license
conditions.” (Kent, 2001, p. 373) Nintendo soon countersued Atari for “patent infringement, breach of contract,
unfair competition, and tortuous interference with contract.” (Kent,
2001, p.373) These court battles would remain unresolved far into 1992.
By 1991 Nintendo no longer held such
a tight grip on the video game market. The Sega Genesis, a 16-bit console, was
superior to the Nintendo in speed and graphics and was marketed to an older demographic.
Nintendo failed to launch a 16-bit console to counteract the Genesis until the release of the 16-bit Super NES in 1991
but by that time Sega had been able to get its foot in the door. (Demaria & Wilson, 2004)
The age of the eight bit Nintendo was ending while video game console competition was introduced. It was the end of an era.
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