Sunday, 22 August 2010

Console-shaped Bottles: The difference between Coca-Cola and Nintendo

Cola pouring onto transparent Xbox

When we think Coca-Cola, we think about a single pervasive product quaffed all over the world. However, the drink has traditionally been brought to market by two independent businesses: the Coca-Cola syrup maker, and the Coca-Cola bottler. The history and the rationale for this structure is fascinating, and makes for an interesting comparison with the videogames industry.

A mere 3 years after the magic Coca-Cola recipe was invented in 1886, the decision was made to sell the exclusive bottling rights to independent entrepreneurs. This allowed The Coca-Cola Company to concentrate on making their famous brew, and to sell it to their bottling rights-holders for distribution. The margins on the bottling business are considerably lower than those in the syrup business, and operating the factories and distribution networks to get Coca-Cola to retail is a capital intensive pursuit. It made sense for The Coca-Cola Company to put their resources to better use by sticking to their margin-rich business, marketing their product and expanding into new territories.

The model was tested again in 1986 when owners of two of the key Coca-Cola bottling companies in North America made it clear that they were going to sell their operations. The Coca-Cola Company could not risk their route to market falling into hostile hands, and had to raise an enormous amount of money through financing to buy the asset-heavy bottlers. Rather than merging with the low-margin businesses, they stuck to their plan and spun them off with the IPO of the bottling company Coca-Cola Enterprises Inc.

How does Coca-Cola's approach to distribution compare with the approach taken by videogame companies like Nintendo, Sony and Microsoft? We can draw parallels between the products: games consoles being the "bottles" from which the game "mix" is drunk. However, I think there are some fundamental differences that have prevented the decoupling of manufacturing and distribution in the videogame industry.

To drink a Coke you need to simply buy one in a shop and then put it to your lips. However to play a videogame, you must buy two products: the game itself, and a games console on which to play it. This would be analogous to buying the Coke bottle separately from the Cola. It's clear that there are two distinct distribution channels in the games industry: games distribution and console distribution.

The Coca-Cola Company wanted nothing to do with the distribution of either bottles or the liquid inside of them. Videogame platform holders like Nintendo have far more involvement in getting their consoles to retail; the equivalent of the bottle business. Like all major platform holders, Nintendo designs, manufactures, and sells their consoles. Coca-Cola spun off its retail distribution due to the low-margins, and I think this is where the differing approaches can be explained.

Making a bottle is a mature process, with little opportunity to imbue a simple product with added value. Bottles are sold business-to-business, where their perceived value is very efficiently correlated to their raw production value. Games consoles are considerably more complex than bottles, and are sold directly to consumers as a product in their own right. This represents a far better opportunity to yield higher margins than the bottle industry. The average consumer is unable to calculate the production value of a complex combination of electronics, and the manufacturer can reinvent the console each generation as a new product, with its own unique selling points. Nintendo's Wii is a great example of this, its components costing a fraction of its retail price. The innovation of using a motion interface provided a unique experience, which inflated its perceived value on the high street. Nintendo is involved in making consoles because the margins are good.

However, when comparing games to syrup in the Coca-Cola model, we can see that the apporach to distribution is far more similar than with consoles and bottles. Independent agents take games to market themselves, much like the distribution of Coke. Although, there is a difference in the way that we consume Coke and games that subtly changes the business model.

The combination of ingredients in Coke is static. We drink Coke because we like the taste, and we don't want that to change. Conversely, the "syrup" in the videogames industry is dynamic, as people don't want to play the same game over and over again. Each new game must have its own individual recipe, so there's no secret formula for Nintendo to sell to developers to be reconstituted. Instead, they make developers pay to release games for their consoles by ensuring that only licenced code will run on them. The bottle has a lock on it, and you can pay to get the key. This offers the console manufacturer a second revenue stream that is as operationally cheap, even more so than the sale of syrup.

The experience offered by a game is a combination of its software and the hardware on which it's running. Whether you drink Coke out of a can or bottle makes little difference, but the value of a game is inextricably linked with the interface experience provided by a console. The Nintendo Wii has shown that this console generation, people are far more interested in gesticulating than viewing high resolution graphics. Incorporating their interface into your design can move software.

The sales of games and consoles are synergistic, as to play a game you need the platform to run it on. Nintendo makes money when you buy both, so securing a desirable game library for their platform is key. Ensuring the features of a console are suitably unique to drive the creation of exclusive experiences has been the traditional approach. As with all the major manufacturers, Nintendo also have world class in-house game developers to create their consoles' killer apps.

It appears as though Coca-Cola and Nintendo have little in common, and that spinning off the distribution of their hardware is a bad fit for the gaming giants. However, we are entering interesting and disruptive times for the videogames industry, which will complicate things further.

Technology is driving games off of discs and down broadband connections. Games delivered straight to a consumer's home are far more convenient for them, but don't think that this is why the big platform holders are clamoring to get into the digital distribution business. A 15% royalty rate is not uncommon for the disc-based business, but 30% is considered aggressive in the digital realm. Nintendo, Microsoft and Sony's cut just got doubled. There is the consideration of the cost of hosting and transmitting these digital assets, but it still represents a significant bump for platform holders.

The temptation of those margins is bringing other players to the table, armed with innovative new approaches to the hardware aspect of the business. OnLive and Gaikai are proposing to move the computational power running your games from under your television, to remote servers that will simply transmit a video stream to your web-browser or TV. It's yet to to be seen whether the technology has made this a viable, cost-effective model, or whether gamers are willing to forego the focussed design of a company's unique hardware vision. However, it's clear to see that these upstarts are presenting a significant threat to the traditional business model of Nintendo, Microsoft and Sony. We already see developers creating multi-platform releases for the Xbox 360 and Playstation 3, rather than addressing the differences in their features more directly with separate games. OnLive and Gaikai could quickly gain parity if the experience offered is indistinguishable, and if the cost to the consumer is less, then they could become preferred.

If the hardware business is generalised by cloud computing providers, and the experiences available are no longer exclusive to any platform, then where does that leave the big three? Microsoft has the most experience in the cloud services business, but Nintendo and Sony are nowhere. They are not positioned for a disruption of this magnitude. Like the Hanging Gardens of Babylon, their walled-gardens may also become mere legends.

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