I disagree, in my playthroughs, I've found that Cloud and Aerith are the only characters with significant stats changes (Aerith is a mage, and Cloud is just plain broken) hell even the official strategy guide doesn't hide the fact that the characters are all basically the same.
As for the Limit Breaks adding individuality, I agree and disagree. I'll agree their Level 1 and 2 limit breaks are different and unique and makes choosing your party important. Once they reach level 3 almost all the limit breaks devolve into "different animation, same affect: damage" The only difference being the amount of times the attack hits. Strategy and individuality disappears at this point. I'm not saying previous or even later games don't have these issues but lets be honest here. You basically have Cloud, Aerith, and everyone else. Though at least the game does have some distinctions.
I disagree, I've never found overloading specific materia on a character to have serious penalties. The only time I ever saw a drastic change was when I gave Vincent almost every Summon Materia I owned. Their was a change in HP and MP but I never noticed any further affects.
You also forget about Master Materia which offers only benefits. All magic on Barret with no consequences. In comparison to your earlier example; sure you can remove the materia and Barret doesn't have them anymore whereas Sabin retains it but lets be serious here... Who uses Sabin as a mage? Hell, I would argue restricting him to magic is a handicap for the player.
Also, one factor that we seem to have overlooked concerning the lack of difficulty in VII comes from Ultimate weapons and the Enemy Skill materia. I know Blue magic has always been a hit or miss... oh I can't even say that lets face it, they've been nerfing it ever since VII. Blue Magic is flat out broken in V,VI, and VII. The thing I've noticed about VII's though, is that in all my games I end up using Enemy Skill materia exclusively and stop using magic all together.
The four elemental spells are easily as strong as their level 3 counterparts and easier to acquire, they cost slightly less. In my current file I just got Time and Barrier materia and I haven't touched them. Why would I neglect such powerful materia? Cause I have Mighty Guard which casts Haste, Shell, and Protect on my whole party in one round. Saving me anywhere from two to four slots. The thing makes magic materia obsolete imo. It also makes the game a joke cause the spells are overpowered as hell.
As for Ultimate weapons, its hard to argue against a weapon being overpowered when it allows your character to do max damage every time. Yes they have rules and allow no Materia growth but Enemy skill materia fixes that problem and who spams summons anyway? Hell once you get mug and 4x cut, you don't need to bother with leveling command materia. As for rules, I've found they are not only easy to maintain but are flexible enough not to bother. Cloud has to lose a third of his health before you start noticing a difference in damage.
A lot of FFs are guilty of being broken, VI basically gives you two of the most broken characters in the game right off the bat. As stated by others, quite a few games allow your party to decimate a group of enemies right off the bat with little consequences (looks at VI) but only a few FFs allow you the chance to have a single character take a boss out in the first round. VI, VII, VIII, and X are all guilty of this gaming sin.
My problem with the battle system overall in VII is that its really cool in the beginning where you are quite restricted. Yet due to overpowered materia, Limit Breaks, and equipment, the whole system falls apart. It offers strategy but the game lacks challenge to ever need to use it as well as overpowered abilities and options that makes forming intricate strategies a waste of time. In order to make the battle system shine, you have to severely restrict your party, at which point I feel that the game designer has failed in his duties.
Now that this topic has gotten more interesting, I may need to post a more thorough discussion on how I feel about VII especially since I reached a revelation about it while playing it a few days ago.







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