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 it goes.
Hee hee hee. Ho ho ho. That is amazing. Wow, I have no idea you had that in you.
I'm very impressed. See, I didn't store that up for this episode. Wow. When Charles Martin moves on for this mortal coil, I think Nintendo knows you the replacement is going to be.
Ho ho. That is so good. I'm never going to be able to look at you the same. Good.
That was the goal. All right. Let's do it. Let's go.
Who got the truth? Is it you? Is it you? Is it you?
Who got the truth? Now? Is it you? Is it you?
Is it you? City down? Say it straight? Another story on the way?
Who got the truth? Welcome to Season 12, episode three of Acquired, the podcast about great technology companies and the stories and play books behind them. I'm Ben Gilbert. I'm David Rosenvall.
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 has 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 dead.
That is the story we're going to tell today. Like we're not going to get to the switch. We're not going to get to the Wii. 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 Nintendo analyses to do. So consider this a part one and truly a story all to its own. Well, 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 a choir's ESPN 2 channel. The doos. Yes.
So we're going to make official. The LP show is now known as ACQ 2. It still has the same great expert interviews with founders and investors like Vijay Raji, 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 2 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. We 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. All right, listeners, now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture.
It used to be that you prove that you were secure once a year on audit or a static PDF, then everyone would not. And you're done. But in an AI first world, that doesn't hold up anymore. Yep.
Your risk surface changes every week now. A vendor turns on an AI feature or someone writes in a new model without telling it and your posture is different than it was last week, let alone at your last audit. Vanta's own research found that around 70% of companies have this quote, quote, shadow AI running with no security review at all. Right.
And that's where Vanta comes in. They're the leading agent trust platform, meaning they've built the thing that closes the gap. And the way that they close that gap is Vanta agent. Think of it as a GRC engineer.
That's governance risk and compliance, except that it's software and it doesn't sleep. It finds the issues, drafts, the fixes and cuts the time that you'd spend on vendor assessments in half. In half, which is exactly why more than 16,000 companies today run on Vanta. Companies like Ramp, cursor and Snowflake all stay audit ready and catch the risks that crop up between audits across every vendor, every AI tool, the whole environment.
And that's the real value. Trust has to be continuous now, which is why Vanta automates your security, your compliance and the work to earn and prove trust. We're huge fans of Vanta over here and literally hundreds of acquired listeners have become Vanta customers at their companies over the years. So you can get $1,000 off of Vanta at Vanta.com slash acquired.
That's V-A-N-T-A dot com slash acquired for $1,000 off and just tell them that Ben and David sent you. After you finish this episode, come discuss it with the other 14,000 smart, thoughtful, kind, curious members of the acquired community that acquired data from 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 the show is for informational 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 and I were texting about this is 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 happen 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 card and he gives 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 had games like that.
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 arcades, he does something pretty unique. He goes college at the University of Utah and majors in electrical engineering.
And this was a pretty special place and department to be in at that time. Other folks who came out of the University of Utah engineering school around this time, Alan K, Jim Clark of Silicon Graphics and Netscape at Katmall of Pixar. All of which have been protagonists of acquired episodes. I know, I know.
It is 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 PDP one. 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 Four. And it was a very, very early rudimentary kind of like asteroids, not quite space invaders. Or Galaga or it's funny how many early video games were space games because of space war. They were inspired by under the 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 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 PDP one 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 PDP one cost over $100,000, which is over a million dollars 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 are arcades or carnivals going to buy these things like no way. Totally.
I mean, it just literally never pays back when you're thinking about it was Nichols or quarters, but whenever 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 of the 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 Semicon Doctor, and now Intel at this point, Silicon has gotten cheap enough that maybe you could do this and basically take space 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'll get cheap enough to make this new business viable. Yeah.
So he packs up and leaves Ampex goes to start a company with fellow Ampex employee Ted Dabney and their business plans are going to do exactly this. They initially called the company Scissor G, but it turns out that name is already taken by a candle maker in Mendocino. I think Bill 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 Nolan Rax's brain 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 in chess and go. They build a game called computer space that's based on space where this is the first commercialized program to 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 OK. It's not really a profitable enterprise yet one because the amount of silicon required to run the game.
Remember this is coming from cutting edge scientific military use computers is still enough though. 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 piling a spaceship out in space and blasting enemies. That doesn't compete 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 Alcorn, who's an amazing engineer. One of the themes that's going to come up a bunch in this episode is the mythical 10x, 100x engineer or 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 a fewest number of chips. Because every chip that you put in there added a whole lot of cost to the build materials. Yep.
And not 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 it'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 haven't 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 kids, 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 wind. 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 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 so happens 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 televisions across America.
As we talked about 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'd 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 to 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 and one of the earliest acquired LP, now ACQ two 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 Magnavox 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 line in and of its own, but they had created this machine in partnership with a guy named Ralph Bair 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, Magnavox has no idea what they're doing with it here. And you can't blame it.
There's no roadmap for this. But in what should have been a sign to them and certainly was a sign 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 Magnavox. They end up selling a couple hundred thousand units of this thing. The Magnavox Odyssey was invented to solve a problem that Magnavox 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 pongable table tennis that you could play with the Odyssey on your computer. So he brings this back to Atari and 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 wasn't 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 Capps Tavern in Sunnyvale, California. They convince the owner there to set up this pong machine as they start calling it at Andy Capps. 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 it and pong it this point times only to play.
There's no way I hear 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, you'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 quite capital's very first investment. And it goes even deeper than that with the money. Nolan and the team in Atari start bringing on additional folks to build and engineer games that they can sell.
You know, this pond thing worked out pretty well. They hire a young kid named Steve Jobs. Amazing. To come in and design a one player solo version of pong that you can play, which ends up being called breakout.
That he does with his buddy, Steve Wozniak. This is like my favorite hidden Atari story is that freaking Steve Jobs was the designer and 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 Megabox 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 Wozniak started 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 to late 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 was it, did it dwarf the home console industry that the Odyssey started. It dorfed 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 a narrative violation.
I thought this notion of eclipsing Hollywood and music was a recent phenomenon to show how much time people spend in games. But what you're pointing out is that it was a different form factor and it was a physical location at arcades, but like that's basically always been true. Well, it was this ultimate hack to get distribution of this new technology and business into the mask and supermarket. People already went to bars and arcades 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. Yeah, but again, it makes total sense. This came out of arcades, 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 and only 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. Yeah.
So they start working on a programmable machine that can play versions of popular arcade heads 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 arcade games, you make a game, you work with a distributor like Midway or Bally or something like that, you get it into arcades and bars and the money comes in like the 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 Us isn't going to buy your product for their stores if you only have 10 of them. They're going to buy your product if you have at least a million of them. Yeah. So Silicon Valley has not evolved to the point 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, that ubiquitous 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. Wow.
Yeah. So everybody's coming into the market here. It quickly became a subcategory of toys in the American consumer psyche. The way that people thought to spend on this is, oh, my 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. Yeah. 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 model, where I'm pretty sure a Warner's 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.
I mean, you look at the incredible amount of firepower in the PlayStation's and Xbox's 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. Someone saw 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. What 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.
Atari ends up suing this new Activision. They're like, hey, you can't do this. They're fighting it out in court. By the way, the reason they name it Activision is so it comes before Atari in the phone book.
I'm pretty sure Accolade, they're a handful of A publishers at the time that all have the same idea. While they're fighting it out in court, which is just so funny, somebody must have taken a step back 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 royalty fee 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. Oh, and we have to take no capital risk on you developing that game. We just make money only if it works. Got it.
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. Got 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, quote unquote here. Like people were just shoveling any kind of software that they could. But 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. There 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. 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. The laws of 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, almost 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 at home video game console market in 1982 by 1985 would be worth $100 million, a reduction of 32 X in the market size, because the entire category just went away. Just disappeared. Let's put that differently. A 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. Because 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. And 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 through a piece Wall Street, they have to break up Atari and sell it off. They sell the console business and the games business separately. And Coleco and Mattel completely exit the video game business. The whole industry, the home video game industry is just decimated.
It's dead. This is when the famous ET Atari game, the cartridge burial happens in 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. The consumers just stop 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 placing big orders anymore. And that's sort of how you have this whole whip crack 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 like literally took wrecking balls and they're like smashing the cartridges and they buried them in a landfill and they pour 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, 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 hula hoop. Specifically, 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 sells. 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 fads, 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, I 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 the 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. Video 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're still making 80% gross margin on this stuff.
That's pretty incredible. And you can sell three, four, five, 10 of them a year, especially once you flash way forward to games today, there's zero marginal costs to make another copy of the game. There's zero distribution costs 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 non-human characters, spaceships and sort of ananimate 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 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. All right, listeners, now is a great time to thank our longtime friend of the show, ServiceNow.
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So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely at scale, go check out ServiceNow.com slash acquired and tell them that Ben and David send you. Okay, David, as we get into the 10-0 story here, there is one thing I think that's important listeners to know before we flashback 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 fusagiro Yamuchi, who was head of a cement company at the time in Kyoto, Yamuchi 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 mail errors to take over the company, which is how companies transitioned in Japan. And so what you did in that case was you adopted a mail error to take over the company. So fusagiro was actually born fusagiro Fuki, but he took on the Yamuchi family name to inherit this cement company.
Now, similar to Nolan many, many years later in America, fusagiro 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, names it Nintendo, and the name Nintendo is actually a multiple on contrast. So the kanji characters, Nien, Ten, and Do can be interpreted as Leave Luck to Heaven, which of course references Luck in playing cards.
It also may be the entrepreneurial spirit of a new venture. But definitely plays on the fact that they're gambling company. Well, that's what I was going to say specifically the character Ten at the time was a clear reference to the sort of mythical spirit, Tengu, which was the coded reference for gambling and casinos, which were very, very much legal at the time. Now, why did fusagiro 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 doing the research. Do you know how they did that, the rulers of Japan for this multiple hundred year period from the 1500s to the 1800s? No.
They instituted the death penalty for any foreigners who entered Japan and any Japanese who leave the country. So 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. 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 you got? Well, so the Yakuza operated gambling parlors and casinos all throughout the country.
And they're just like a casino's in America. When they play games with cards, they use a fresh pack of cards for every game because you won't have to eat it. This is an incredible business, one incredible customer for Nintendo. These gaming parlays 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 and 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 if we said, you know, Yamauji 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, had before him, which is when it comes time for him to retire, he doesn't have a mail air. So he arranges for his daughter to marry a promising local young man named Sekiro Knata.
And Sekiro also changes his name to Yamauji. He becomes the, at this point now, third coming of the mythical Yamauji and the second president of actual Nintendo itself. Sekiro also doesn't have any mailers. So for the third time, the Yamauji patriarch arranges to adopt an air to run the business in the future.
And specifically Sekiro arranges for his eldest daughter, Kimi, to marry another promising young local man, Shigenojo Inaba. She's also adopts the Yamauji name. He starts being groomed to take over the business. And then finally in 1927, he and Kimi have a son, the first Yamauji son in three generations.
And they name him Hiroshi Yamauji. 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. She can know Jo walks out on the family and abandons the business, the family, son, and leaves. Nobody knows exactly why this is kind of lost 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 Yamauji, the first actual Yamauji 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 West Ada 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 Yamauji running Nintendo. Wow. And this is pretty young to take over the family business. He's 21 years old because his father had walked out on him and the family.
There was this missing generation here. And then his grandfather, who he 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. We're gonna flash away for 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 gonna 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 is the writing was on the wall, happens in 1949. As soon as that happens, he institutes a massive perch. He fires not just anyone who is loyal to Sekiro in the company. He fires every single manager in Nintendo, 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 like no more institutional memory of a leader other than him in the entire organization. Yes. And there is no question who the new Yamauchi 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. So this happens. So he wrote it like he 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 Yamauchi 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 Company. 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 gonna 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 gotta buy some of these.
If these still exist somewhere on eBay, I gotta go find some. Oh, I bet they do. Some of the documentaries I watched there, you see the photos and video footage of them. So you can probably find them.
We gotta put these in the acquired museum. Wow, Nintendo branded Japanese Disney cards. So this is what Yamauchi, the 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 gonna 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 that'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 a extended grab. I know you did some research on this. This is awesome.
So this guy, Gunpei, Yokoi, in 1970 comes up with an idea. We're like, breeze in through history here, but we got half to it. It's 100 years. So, you know, we went 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 Yamauchi 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 Roomba.
And so they're just coming up with crazy toys in the lab and bringing them to market. All these, and he catches and because they have this Disney sort of damn clays that they can hang over retail, his 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 with Nintendo. And to your point about Yamauchi just has a sixth sense for products and for talent. He plucks 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. Ooh. So amazingly now by the late 60s early 70s, Nintendo has become a toy company and a very profitable one of that.
So Yamauchi 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 fat that had taken Japan by old in the late 60s? And so all these bowling alleys got built.
But then society lost interest in them. And they're all these empty bowling alleys. Yamauchi goes and buys up these bowling alleys. And he directs Goonpay 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 Goonpay is building for toys to make indoor shooting ranges, light gun shooting ranges, like not laser tag more like clay pigeons, 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.
But 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 Goonpay and Yamauchi 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 electromechanical games like Sega.
But once Pong becomes a thing and comes over to Japan and arcade video games, they get into it too. Nintendo starts making their own arcade video games to for Nintendo. These light gun ranges that they start building, they become pretty good at it. 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 international 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. Remember 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. Whoa. And who made the light gun for the Magnavox Odyssey?
Nintendo. 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 and then it 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 to 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 licensed 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 licensed 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.
Oh, wow. This is like transformative for Nintendo. And 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 6 games. I was like, why are they calling it the 6? Yeah, because remember, these are not cartridge-based consoles yet. You're not selling programmable software for them.