Digital-only Switch 2 doesn't seem likely, here's why

Reports indicate that Nintendo could be preparing two versions of its next-gen Switch system: One model would support GameCards, and the other would be a digital-only system. But the dual-SKU approach doesn't align with Nintendo's historical financials.

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There's been lots of new Switch 2 rumors floating around, including discussions of potential DLSS-enabled performance capabilities of the next-gen Switch that enables 4K visuals to plans for a simultaneous launch of two model variants. Reports indicate that Nintendo could be readying a digital-only Switch 2 model that does not feature a cartridge slot for existing Switch GameCards, not unlike Sony's PlayStation 5 Digital Edition or Microsoft's Xbox Series S. There's just one issue with this report: Nintendo's own financials don't entirely support the hypothesis.

While PlayStation and Xbox make most of their software revenues from digital sources (the bulk of digital revenues for PlayStation and Xbox are typically from free-to-play microtransaction-driven games), Nintendo is different. While Nintendo has a commanding presence in the Big 3, with the Switch selling more units than its competitors, it doesn't exactly play by the same rules.

For one, the Switch was sold at a profit when it released. This gave Nintendo an upper hand against its competitors and allowed the company to keep its profit margins higher (It's worth noting, however, that Nintendo's revenues have been lower than Xbox for the past two years).

This means that Nintendo doesn't have to subsidize costs of its video games hardware and make up for these losses via software. This technically gives the company more flexibility, among other things, to prepare more games for the Switch's lifecycle. And Nintendo has capitalized on this quite well, having released a bevy of must-have first-party exclusive games for the Switch.

Let's take a closer look at game sales. Unlike PlayStation and Xbox, Nintendo makes most of its game software sales revenue from physical games. Physical game sales revenues have beaten digital every year since the Switch's launch, but digital is catching up very quickly. In FY18, physical games made up 83% of game sales revenues; by FY23, that shrank to 52%. Despite digital's growth, it's still lower than physical.

The numbers make it clear that Nintendo still very much depends on physical game sales.

Perhaps the most substantial anomalous behavior that Nintendo exhibits is regarding first-party games. Unlike Xbox and especially PlayStation, Nintendo makes most of its software sales revenues from first-party games (from 85% in FY18 to 79% in FY23). A digital-only Switch 2 would impact Nintendo's first-party sales the most.

An all-digital Switch 2 would cut Nintendo off from a potential revenue source for its own first-party games, which is counter-intuitive to its core business model. We shouldn't expect Nintendo to compromise the integrity of its game sales in this regard, especially when it comes to first-party game sales in retail stores. Nintendo typically is very thoughtful and persistent in how its brand is represented in physical stores, and its video game content is at the core of its business.

Percentage of Nintendo's first-party game sales on a quarterly basis (left), digital vs physical sales revenues on a quarterly basis (right).

Now, this isn't to say that Nintendo isn't trying to emphasize digital sales and capture more of that market.

Nintendo very much wants to pull in more digital revenue, but the company's approach is two-fold: First, there's the digital game availability on the eShop, and second, the Nintendo Switch Online subscription offers a steady stream of consistent earnings over a period of time. It also helps that Switch Online is comparatively the cheapest multi-game subscription on the market.

The reality is that a digital-only Switch 2 would significantly disrupt Nintendo's business model to a degree that isn't really necessary for the company. Nintendo has thrived in recent years due to its consistent ability to maintain its current multi-access business model aligned with unique hardware, and we should expect this to continue moving forward due to, in no small part, the volatility of the video games market as a whole.

Our prediction is that Nintendo will release a single Switch 2 model at a premium price that's either profitable on day one for Nintendo, or projected to be profitable within a half-year of sales. Later down the line, when digital overtakes physical on a more meaningful level, it's possible that Nintendo could roll out some sort of digital-only Switch 2 Lite model...but even then this seems like a risky bet.