BREA — Already reeling from its inability to sell its video games through major retailers, a small local company said Tuesday that a recent decision by the Nintendo Co. could pose an even greater threat to its success.

Color Dreams, a Brea firm that develops games that work on the popular Nintendo system but are not licensed by the Japanese company, said competition will intensify as a result of Nintendo's decision to permit the U.S. companies that design its games to also manufacture them. The move is expected to clear the way for a flood of new video games on the market, perhaps driving down prices.

"We're looking for cutthroat competition," said Eddy Lin, Color Dreams marketing director. "The only good things happening are we're exporting some games to Japan and overseas to the Third World and Europe."

Nintendo of America, the U.S. arm of the Japanese parent, controls an estimated 80% of the American video game market. To ensure that only licensed video games are played on its system, the company implants a computer lockout chip in each game cartridge. Before play can begin, the chip must send a key signal to another chip in the Nintendo Entertainment System machine.

Competitors charge that the practice of prohibiting other firms from developing games for the Nintendo system amounts to unfair competition. They say the practice allows Nintendo to preserve artificially high prices for its games, which typically sell for about $50 each.

Nintendo has maintained that unlicensed games contain software flaws that could cause malfunctions and frustrate players. The company said it has assurances that the 53 U.S. firms that design its games can manufacture them without flaws.

Nintendo's manufacturing decision has not placated competitor Atari Games Corp. of Milpitas, Calif. In a statement Tuesday, Atari Games said that "while Nintendo's move to loosen its manufacturing restrictions may appear to ease its stranglehold on the video game industry, in reality it does no such thing."

Calling Nintendo's move "a sham," Atari Games Senior Vice President Dennis Wood said Nintendo's continued use of lockout chips gives it "total control over the titles and quantities of the games that are available to consumers." Atari Games and Nintendo have sued each other over the issue.

Color Dreams' games circumvent the Nintendo lockout chips and can therefore operate on the Nintendo system. The company will not say exactly how it is able to do this.