Sega Muscles In on Nintendo : Electronics: Its new Genesis product helped the smaller video game maker grab a significant share of sales in the U.S. market last year.


A year ago, Nintendo was the virtually unchallenged king of the $3.5-billion American video game business.

And the Kyoto-based firm ruled its market with an iron fist: demanding high licensing fees, restricting the number of software companies allowed to develop games for Nintendo machines and barring them from developing software for rivals. Its actions sparked numerous lawsuits from retailers and game developers, who charged unfair trade practices.

Now the kingdom of Nintendo is under attack. Sega Enterprises, a Japanese arcade game maker, punched a big hole into Nintendo’s defenses last Christmas when its Genesis video game machine--packaged with a new hit game starring a zippy blue hedgehog called Sonic--trounced Nintendo’s latest offering, the Super Nintendo Entertainment System (NES).


Sega has also pushed ahead of Nintendo in a major new product area--a compact disc attachment to Genesis that enables it to play games with quality sound and film-like scenes starring real-life actors. The $299 Sega CD, which can also play regular audio CDs, will be shown at this week’s Consumer Electronics Show in Chicago.

In a major coup for Sega, Sony Electronic Publishing Corp. said last week that it had established a “broad alliance” with Sega under which Sony will develop software for the Sega CD and Genesis products from material held by its movie and music subsidiaries--the former Columbia Pictures and CBS Records. Sony says it is continuing talks with Nintendo toward developing a game machine that would run Nintendo software.

“The days of the dictatorship are over,” says Thomas Kalinske, president of Redwood, Calif.-based Sega of America. Kalinske spearheaded the attack on Nintendo last year with aggressive advertising and steep Genesis price cuts.

Nintendo is wounded, but it is fighting back. When Sega cut its game price by $20 to $129.95 earlier this month, Nintendo responded with a $30 price cut to $149.95. Nintendo has released impressive new games for its Super NES that have helped it regain some of the market share lost to Sega. And Nintendo is expected to announce at CES this week details of a CD game product it is developing with N. V. Philips that Nintendo maintains will be better and $100 cheaper than Sega’s CD.

Nintendo also remains a powerful player in the portable market with its popular hand-held Game Boy. Nintendo also leads Sega in American retail outlets--16,000 to 10,000.

But Nintendo’s reputation as the bully has come back to haunt it. Sega has gained software developers and retailers who were hostile to Nintendo and is expected to have erased Nintendo’s edge in those areas by the end of the year.


“Nintendo’s arrogance left an opening,” says Andy Eddy, executive editor of VideoGames & Computer Entertainment.

Few are mourning Nintendo’s fall. “Retailers feel better if there is more than one manufacturer; there is healthy competition,” says Emil Heidkamp, vice president for marketing at Konami, a Japanese firm that develops games exclusively for the Nintendo system and, thus, will see fewer sales as a result of Sega’s success.

Outgunning Nintendo has helped drive Sega’s earnings to $106 million in the fiscal year that ended March 31, up from just $58 million a year ago. Sales have doubled in the same period, reaching $1.6 billion this year.

Nintendo is still a far larger company. Its net income rose 26% to $670 million in the year that ended March 31 on sales of $4.3 billion. But Nintendo predicts that its profit will grow just 1% this year.

Ed Roth, vice president of toy services at NPD Group, a research organization, says the video game market didn’t grow in America in 1991 and is unlikely to show growth this year. That means that gains in Sega’s American sales will take away from Nintendo.

The war between Sega and Nintendo is a fight between two atypical Japanese companies. Nintendo, originally a maker of toys and playing cards, doesn’t have its own manufacturing capability. It subcontracts out nearly all its development and production. The formula has generated profit margins of 20% or more--four times higher than the average Japanese company.


Sega was started by an American businessman in Japan and was later bought by the conglomerate formerly known as Gulf+Western, and put under its Paramount Pictures division. Sega’s chief executive, Hayao Nakayama, was not a career employee but a jukebox importer who sold his business when he joined Sega in 1980. He arrived at a company that was falling behind in a rapidly changing game business. Sega had missed the electronics revolution and was overtaken first by Atari and then by Nintendo.

Nakayama engineered a management buyout in 1985. He broke with Japanese tradition by paying head hunters handsomely to hire away the best and brightest from Japan’s leading technology companies by promising them high salaries and generous research budgets.

While Sega and Nintendo slug it out, both companies may be overtaken by larger events. Giant consumer electronics companies, hungry for new products, are eager to get a chunk of the lucrative game business. Companies like Sony and Matsushita that own American film studios are also anxious to find game applications for their library of movies and for their special effects technology.

While the consumer electronics companies are currently allying themselves with the game makers--as in Sony’s deal with Sega--the consumer giants could be powerful competitors longer term.

“The technology has evolved in a way that is more favorable to traditional consumer electronics makers,” says Sean McGowan, an analyst at Gerard, Klaver Mattison.

Media companies could also become powerful players. San Mateo Software Games (SMSG), a joint venture of Electronics Arts, a major game developer, and Time Warner, is reportedly working with Matsushita and its MCA subsidiary on new game technology. Although the company won’t comment, David Baron, associate editor of Digital Media, an industry newsletter, thinks that SMSG is developing a system that would enable customers to play games distributed by cable television. Such a pay-per-view system could cut deeply into the game licensing revenues of both Sega and Nintendo. Sega and Nintendo would also suffer if a single new standard emerged for game machines. Some game developers hope to see Matsushita Electronic Industrial Co. push for a single new standard in the CD business, much as it did for video recorders through its affiliate, Japan Victor Co. (JVC).


“Matsushita is a terrific company with a lot of strengths this business needs,” says Bing Gordon, senior vice president at Electronic Arts. Gordon notes that a single standard would mean that Japanese consumer electronics companies could apply their low-cost production expertise to build cheaper game machines that would ultimately help expand the market.

Even Nakayama of Sega sees the consumer electronics companies as the long-term powers. “In five years, our key competitors will be the consumer electronics makers, not Nintendo,” he says.

To prepare itself to fight the next battle, Sega has worked with JVC to develop and manufacture its CD machine.

Most video game experts, however, say the high cost of CD machines means that it will be years before games stored on CDs become a major business. Meanwhile, the primary battle is still between Sega and Nintendo over sales of the consoles that run the more traditional game cartridges.

Ironically, the key beneficiary of the battle between Sega and Nintendo could be American game software producers. Many companies that were once forced to pay high licensing fees and to deal exclusively with Nintendo are now able to negotiate lower licensing fees and are selling their games to run on both the Sega and Nintendo machines.

And now that Sega has emerged as an attractive alternative, Nintendo is loosening its licensing requirements. “They have gotten significantly better,” says A. J. Redmer, executive director of research and development at Sphere Inc., which makes games for both Nintendo and Sega. “They have to--Nintendo doesn’t dominate like it used to.”


Electronic Arts has dramatically boosted its market share by producing games for both systems, something it couldn’t do under Nintendo’s past exclusive agreements.

U.S. Video Games Market Share

A year ago, Nintendo had a virtual monopoly on the U.S. video games market, but it is now struggling to maintain even a third of the market, primarily because of a strong challenge from rival video games maker Sega, but it has also lost market share to a number of other firms.


Nintendo: 30.1%

Sega: 31.2%

Source: Sega of America and independent toy market research firms.