Nintendo and digital sales: Better late than never?

October 22, 2012: 5:00 AM ET

Nintendo has been trying to nose its way into the profitable digital format business. Will the traditional gaming firm be able to make the jump?

By Chip Lebovitz

FORTUNE –The gem of the video game industry these days is digital format sales -- games you can directly download from the web. After all, downloading is convenient and eliminates packaging and shipping costs that hurt profit margins. But if there's money to be made at the digital profit trough, Nintendo has been fasting.

In the past couple of months, however, Nintendo has been trying to nose its way into the profitable digital format business, which drives around $400 million in sales industry-wide every month.

In August, Nintendo released its first big budget title, New Super Mario Bros. 2,for the handheld 3DS system in both packaged and digital formats. Building on the Mario momentum, the video game maker announced plans this month to release a whole slew of games in its online store, the Nintendo eShop, in time for the holidays.

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This eShop ramp up comes at a time when the online video game market has reached new competitive heights. There are over nine major competitors in this space, ranging from traditional console competitor Microsoft's (MSFT) Xbox Live Arcade to video game developer EA Games' (EA) Origin. Nintendo is pushing the boundaries of what it means to be fashionably late to the digital format, while established industry leader Valve's Steam is reaping the benefits of its almost-awkwardly early arrival. Launched in 2003, Steam, a download service for desktops and Sony Playstation 3, has dominated the business ever since. Its estimated market share ranges from 50-70%.

Nintendo's eShop debuted in June 2011, and the shop's in-store catalog, which is just one third the size of Steam's, shows its youth. The shop also has yet to have a major impact on Nintendo's overall revenues. Wedbush Securities analyst Michael Pachter estimates that eShop sales will comprise about 5% of New Super Mario Bros. 2's total sales.

"People are not accustomed to going online to do anything with Nintendo. It's an afterthought since the company launched it," he says, "I don't think it'll flop, but I don't think you're going to get immediate positive results because people have to learn that there is something there."

Nintendo believes that the eShop has a strong foundation. According to the company's executive vice president of sales Scott Moffitt, the average 3DS owner's attach rate -- the number of additional purchases for each gaming system it sells -- is 4.7, which is comparable to Nintendo's competitors. Xbox Live Arcade's attach rate in 2006, two years after its debut, was between 6 and 7.

The eShop's rate should only increase in the coming months. According to Moffitt, Nintendo is set to release the majority of its future internally developed games in the same fashion as New Super Mario Bros. 2, bringing company policy up to speed with the competition.

Nintendo's position in the online market business is also entwined with its future. The company's near-term outlook rests in large part on its next generation console, the Wii U, which is set to hit stores in mid-November and will have eShop connectivity. "Nintendo is very late to this game, and they can't move fast enough," says Gartner analyst Brian Blau. "I don't think that their users are probably going to complain that much as long as they have connectivity."

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At the same time, Nintendo seems set on continuing to offer its traditional Wii console. The company announced on October 15 that it would drop the price of the original Wii to $130 from $150.

Meanwhile, Nintendo had better keep an eye on Google (GOOG) and Apple (AAPL). Smartphones, tablets, and handheld devices like the iPod touch are now all mobile gaming platforms, and while Nintendo's Moffitt doesn't think those other products directly compete with the 3DS, analysts view Apple's App Store and Google Play as some of Nintendo's chief rivals in the fight for the mobile gamers' time and money.

In fact, Google Play, a relatively late entry to the app store world (Google combined its music store with the Android Market in 2012 and launched Google Play.), is within striking distance of its Apple counterpart in terms of number of available apps. Nintendo can only hope the eShop experiences similar growth.

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