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Squilliam said:

They staked a console release but they anticipated a much lower release price ($199) and much lower sales. They had confidence enough to release a new console based on the technology but not enough to go without hedging their bets. This wasn't the first time they hedged their bets, they released the N64 with only a single analogue stick when the industry finally settled on two and they didn't move to make any adjustment either after the PS1 obsorbed their innovations.

The pre-release period where developer confidence set the tone of the whole course of the lifecycle of the Wii would have been completely different had they actually bothered to release new hardware. Before the release of the Wii the developers essentially voted no-confidence and moved on to larger projects on other platforms. The only developers who developed for the Wii essentially were given no other choice whereas the developers with some market power decided against the Wii, hence the fact that the Wii was supported by the least capable developers plus Nintendo. Whilst new hardware would have cost more money, hindsight more than suggests that a $299 price point was supportable given the price so many were willing to pay for access to the unavailable hardware.

We don't know how much the Wii would have sold at 299$. You only know what it sold like at 199$. The pricepoint was true to Nintendo targetting a new crowd of gamers that wasn't accustomed to spending big bucks on the entertainment diet it offered.

Reggie said at e3 2004, as quoted this in the article:

"We are serious about expanding what we do," he began.

"We understand that we're not going to run our company just for hardcore gamers. There are gamers out there who are not as knowledgeable as you, gamers who aren't your age, gamers who don't have your tastes. It's my job, it's Nintendo's job, to satisfy all the gamers."

Thirty minutes later into the press conference, and two-and-a-half years after Tom Quinn flew out of Kyoto with a signed contract in hand, company president Satoru Iwata announced a new home console was in development. It was called Project Revolution.

"Nintendo DS is not the only change in our future," Iwata said.

"The definition of a new machine must be different. Nintendo is working on its next gaming system, and that system will create a gaming revolution. The time when horsepower alone made the difference is over."

I think, in favor of your perspective, rather what actually took Nintendo by surprise is how successful they were in the market as a whole, and the failure of the PS3, which in turn left a door of opportunity to also conquer the core market. I think also the core market's attachment to top-grade graphics (devs and gamers alike) also came as a surprise to them.

I agree with noname that they believed the Wiimote alone was the key to the Wii's success, not the concept of HW power. They believed in it alone. That's pretty intense.