Sega is the only controller maker to use Hall Effect sensors. These tiny black boxes sense the proximity of the magnets in the pad inputs and vary their voltage throughput accordingly, then the controller's chip converts this voltage to a signal the console can work with. It's a simple and functional design, with fewer mechanically linked parts to wear out or break down.
The nipple is basically an inverted bowl with a magnet attached to it. As the bowl is tilted in any direction the magnet moves closer to one sensor at the same time it moves farther from another. The nipple spring assembly is clipped to the PCB, but has no electrical or mechanical contacts to the sensors. A spring returns it to center, the same way the spring in an arcade joystick does.
Despite its large size Sega's nipple actually has less travel from one side to another than the 3D sticks used in the N64, Playstation or Xbox pads.
Like the N64, it has no particular preference for the up/down/left/right compass points. Where the Playstation and Xbox use two sensors, one for vertical and one for horizontal movements, each with its own return-to-centre spring, the Saturn 3D pad has a single spring for all directions. Without this twin mechanism design the nipple moves with the same ease in any direction.
The Saturn 3D pad also uses hall-effect sensors in the analogue triggers. A single magnet attached to the swinging end of the analogue trigger arm moves past two sensors mounted on a vertical sub-PCB.
The Dreamcast uses the same mechanisms, though it replaces the nipple with a more traditional analogue mushroom stick.