Nintendo Could Be the Next Netflix

Though beloved, Nintendo has fallen on hard times. In 2012, the video-game maker reported its first ever annual loss as a public company.

The Wii was a sensation, leading the company to record heights. Yet, its successor -- the Wii U -- sits unsold on store shelves around the world.

Nintendo's June quarter saw the company move a remarkably low 160,000 Wii U's; it was the system's third quarter on the market. For comparison, that figure was 95% below the sales level of the original Wii in its third quarter on sale.

The chart below shows Nintendo's rise, and fall back to earth. All things considered, revenues are off 66% since its record-breaking fiscal 2009.

Source: S&P CapitalIQ

So, yeah, the company has seen better days.

Yet, Nintendo has plenty going for it. It can weather a downturn, possessing more than $10 billion in the bank. Most important is the company's history of popular franchises. Even if Wii U units aren't flying off the shelves, people still adore franchises like Mario and Zelda. The intellectual property and content that Nintendo owns is the gold standard in entertainment.

It's on this point that Nintendo could change its future. It could become the Netflix of video games.

Sony leads off CES with a bang
Last week, I was at CES in Las Vegas checking out the newest and greatest products from the tech world. The keynote speaker for the event was Sony's CEO, Kaz Hirai.

With Sony struggling in many key technology areas like smartphones, tablets, and even televisions, his keynote didn't have the same anticipation level that I saw around other well-known speakers throughout the week. Yet, when Hirai took the stage, he unveiled an intriguing product that was one of the best innovations across all of CES.

Sony's CEO described "PlayStation Now," a product that would allow video games to be streamed -- much like a Netflix movie -- into consumers' homes. Since all of the processing is done by remote servers (i.e., the cloud) rather than a powerful gaming system in your house, such a service could conceivably lead to even the most advanced video games played on everything from televisions, to tablets, to smartphones.

One service, across all devices.

My own limited experience with PlayStation Now was very positive. The demo unit I played in Sony's exhibit worked flawlessly. At least in my experience, the game played almost exactly as you'd expect, even though all the processing was being done by a remote server. Sure, the demo unit was in a staged environment within Sony's booth, but it was hard not to get excited about PlayStation Now.

Even in its early stages, Sony's new service felt like a home run product. It's an amazing technology demonstration for consumers of just how advanced cloud computing has become, and how it's benefiting our everyday lives.

However, there are still questions facing the technology.

Technical hurdles
The overall concept of streaming games is not just extremely challenging from a technology development standpoint, but requires users to have a fast Internet connection that some households still lack in America and other developed countries. After all, those far-off servers processing the game are sending back a ton of data as you play.

Sony recommends that users have a connection of at least 5 Mbps (megabits per second) when using PlayStation Now. To put that in perspective, the average American broadband connection was 8.7 Mbps in the second quarter of 2013. That's not a whole lot of bandwidth above Sony's recommendation, especially if other people in a household are streaming YouTube or other videos. Overall, about 72% of Americans have an Internet connection above 4 Mbps.

The difficulty getting streaming gaming to work consistently is high enough that Microsoft has declared streaming games from the cloud too "problematic" in its current stage to roll out to consumers. OnLive, a start-up that promised to stream games back in 2009, and quickly had analysts estimating its value at $1.8 billion, was forced to lay off all its employees and sell for under $5 million by 2012.

Yet, while Microsoft has publicly stated that streaming games from the cloud is too complicated, it's also reported they have prototypes of a service like PlayStation Now up and running. OnLive premiered nearly five years ago, ancient times in the fast-moving field of cloud computing. Its main competitor, Gaikai, was bought by Sony for $380 million, and formed the technology basis for PlayStation Now.

Cloud-based gaming has had to overcome hurdles, but now appears poised for its time in the spotlight.

Nintendo thanks you, Sony
With Sony preparing to launch PlayStation Now this year and Microsoft testing its own prototypes, the only question left is... what might Nintendo have up its sleeves?

Rather than being afraid of its competition, Nintendo should be sending Sony a "thank you" card. After all, by leading the charge to prove out the idea of cloud-based gaming, Sony might help unlock Nintendo's best asset: its massive catalogue of games created and owned by the company.

Because at the end of the day, when it comes to streaming services, having your own library of content is worth its weight in gold.

While Sony hasn't announced all the specifics around PlayStation Now, the company was very upfront about wanting to offer the service as a subscription product that's similar to Netflix. Pay a monthly fee; get access to its past library. That's an intriguing proposition that could change the whole business of video games.

Let's take a look at Netflix, the king of streaming entertainment in film and television. Its market value was $20 billion as of January 11. That's higher than Sony ($18 billion), and about dead even with Nintendo.

However, what's important to note is that Netflix has attained that giant market value while paying huge fees to license almost all its content from studios. Just a sliver of its content is owned and produced by the company.

Not only that, but every time Netflix wants to go into a new market, whether it be Canada, Latin America, or Sweden, it needs to renegotiate contracts to license content in each region. Head over the pond to London, and your movie selection on Netflix will be dramatically different.

A streaming service from Nintendo could stand alone only on games it has created and owns without licensing costly third-party content. While Netflix has spent years negotiating licensing to expand overseas, the only limitation on a global rollout of a Nintendo video game streaming service would be building out the infrastructure to support it.

From a content perspective, Nintendo's offering would be tremendous in breadth. The Wii U is Nintendo's sixth major at-home console, and the company can also lean on its mobile gaming catalogue that stretches back 25 years to the introduction of the first Game Boy. Look at a list of the top-selling games on recent systems from Nintendo (right here); you'll quickly note they're all published by the company. Along the way, Nintendo has not only nostalgic classics like Super Mario 3 that would translate very well to playing on smartphones, but also beloved games on recent systems like Super Smash Brothers.

Beyond games, Nintendo has a unique opportunity in that the technical challenges facing games streamed from the cloud could work to its benefit. Because so much of Nintendo's beloved game library is older titles, streaming those games would use up little bandwidth. Forget needing the 5 Mbps connections that would push most American households to the limit. Streaming games on Super Nintendo and NES would sip data when compared to games published in the past decade. The games are 20 years old; there are no complicated physics that remote servers need to process and return data on.

The key advantage is that users on smartphones and other mobile devices could actually use a Nintendo streaming service away from their Wi-Fi at home. With Americans -- and people from other countries -- facing tiered data plans, a half hour with PlayStation Now streaming an advanced PlayStation 3 game like God of War on LTE could easily blow through your data plan.

Nintendo's back catalogue that stretches three decades creates a game collection truly tailored for mobile devices that compares very favorably to what you could find in the App Store.

This is Logitech's PowerShell Controller. iOS7 created standardized support for controllers. One of the main challenges facing a streaming service would be how to handle varying game controls between different systems.

Does a streaming service make financial sense?
Conceptually, a Nintendo streaming service has all the makings of a winner with consumers. Yet, would it make business sense for the company?

From a cost side, total expenses likely would be reasonable. For example, NVIDIA offers a cloud-gaming service under its GRID technology. GRID was used by Amazon to help power a new service that streams apps from the cloud, which is a ringing endorsement of the technology. Whether or not Nintendo partnered with a company like NVIDIA to help build a streaming service, the main point is that technology needed to stream games could be achieved without copying Sony and paying $380 million to acquire technology.

As far as demand for the service, it seems to be there. The Game Boy Advance was released in 2001, a decade after Super Nintendo, but leaned heavily on selling ports of old Super Nintendo games like Super Mario World and The Legend of Zelda: A Link to the Past. The nostalgia of being able to play older Nintendo games on the go was a huge boon to the system, as more than 80 million Game Boy Advances were sold.

That nostalgia of past games continues to this day. The Wii came loaded with its Virtual Console, which allowed consumers to buy older games, and quickly became a hit. However, the unique value of streaming services is that they can create a surprising amount of revenue compared to digital sales of items such as movies or games.

Consider that, in 2013, sales of digital films soared 47% from the previous year to $1.19 billion. Yet, the U.S. film streaming market brought in $3.16 billion, making it almost three times as large as individually purchased digital films.

As far as how many people might be interested in a monthly Nintendo service, we could once again look at Netflix. The company closed out last quarter with 40.4 million subscribers. While the broader populace might associate video game playing with teens, the Entertainment Software Association notes that the average game player is 30 years old, and the average age of the most frequent game purchaser is 35 years old. Plus, close to 60 million (out of 115 million) American households own a dedicated video game system.

The video game playing segment might not be as large as the number of Americans who like films (68% of Americans went to the movie theater last year), but it's still remarkably large. Not only that, but they have money.

So, what if a fully built-out Nintendo streaming service managed to hook 20 million users? Let's look at a scenario where it had half the membership base of Netflix spread out across Japan, the United States, and Europe. If it was charging a modest $9.99 per month, that would be $2.4 billion per year. With Nintendo ringing up about $6.4 billion in sales in the past year, that would be a huge boost for the company.

A better experience for video games, in general
Whether or not Nintendo releases a streaming service, the bottom line is that cloud-based streaming looks like a compelling offering that will move the video game industry forward.

While the video game market is often framed in "console wars" between Microsoft, Sony, and Nintendo, moves like streaming could truly be a rising tide that lift all boats. For example, researcher Gartner estimates that mobile games will grow from $9.3 billion in sales in 2012 to $22 billion in 2015. Right now, that segment is dominated by "freemium" games like Candy Crush that are free to download, but attempt to wring out continuing small transactions from players.

Successful cloud-gaming services could possibly shift some of that mobile spend away from trends like freemium, and back toward large video game companies. In addition, this is far from a "winner take all" battle. There is room for streaming services from several gaming companies to succeed.

Or, these services could merely increase the size of the global entertainment pie that video games take up. Video games are still smaller than a $100 billion industry, while global entertainment spend is north of a trillion. Offer a better product with good economics for the industry, and video games could take consumer dollars away from other entertainment spend, like movies.

There are risks still facing video game streaming. We'll see how well PlayStation Now holds up when introduced to millions of gamers. Likewise, there's a chance that streaming services could cannibalize new-game sales, or Nintendo's mobile systems like the 3DS.

Distribution could also be tricky. Netflix is ubiquitous across consumer devices, which is a huge factor in its success. Could Nintendo manage to get apps for its service across smart TVs? With the Wii U fading, it would need to be aggressive in locking down distribution to ensure consumers could access its service from a variety of devices beyonds its own console. On top of that, there are still technology hurdles to overcome. For example, the unique controls of recent systems -- such as the Wii -- create a sort of complication that Sony doesn't face; all its systems use a similar controller.

Yet, at the end of the day, the benefits seem to far outweigh the risks. The video game industry looks set to take a major step forward into the streaming age. For both consumers and the company's shareholders, I hope Nintendo acts boldly.

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The article Nintendo Could Be the Next Netflix originally appeared on Fool.com.

Eric Bleeker, CFA owns shares of Nvidia. The Motley Fool recommends Amazon.com, Netflix, and Nvidia. The Motley Fool owns shares of Amazon.com, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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