Complacency and conservatism.
Mega man developer Keiji Inafune himself remarked upon the decline of the Japanese video game industry a lot beginning in the 2000s and he took a lot of inspiration from Western video game companies who he looked up to, to try and focus Japanese towards doing more risky, innovative things, but that was not the Japanese way and eventually Keiji left Capcom out of dissatisfaction to form his own company.
Let’s be straightforward with the facts here: Western companies invented the video game industry. Atari kickstarted the industry with Pong, the world’s first arcade game. After that Japanese companies improved upon that with various arcade games in the 1970s. Many companies like Midway, Konami, Namco, Capcom and Taito got their start in the arcade industry.
Japanese companies took what Western companies built in the 70s and early 80s and evolved + refined it in the late 80s and 90s. This then set a period of Japanese innovation + dominance in the video game industry that lasted until the late 90s I would say.
(note I am talking home video game market – for the arcade market Japanese basically took over from Atari and dominated from the late 70s with Space Invaders, Pacman, Donkey Kong etc and never looked back)
Landmark RPGs like Final Fantasy, Phantasy Star and Dragon Quest were built on top of what earlier Western games like Ultima and Wizardry and Zork had started.
Japanese largely perfected the platformer genre with games like Super Marios Bros, Sonic, Mega Man, Castlevania, Metroid and Contra, taking Activision’s Pitfall as inspiration. Japanese also popularized the fighting game genre with Street Fighter II.
Legend of Zelda took what Atari’s Adventure built and heavily expanded the adventure genre.
So yeah I would say during the late 80s and early to mid 90s, Japanese dominated the home video game market, because their games truly expanded the video game industry.
But sometime during the mid 90s – Japanese management became more complacent, and started becoming focused with just churning out sequels to their well known franchises.
That’s why the late 90s and 00s what do you see from Japanese companies?
Another Resident Evil (which was built on top of what Alone in the Dark started). Another Sonic. Another Mega Man. Another Castlevania. Another Super Mario. Another Metal Gear Solid. Another Final Fantasy. Another Tekken. Pokemon and Shenmue were exceptions to the rule and were truly unique experiences, but for the most part, Japanese companies started resting on their laurels. The strict Japanese hierarchy prevented programmers and management from trying something truly unique and different. They were preoccupied with milking their existing franchises.
Meanwhile from Western companies from the mid 90s to 00s started coming out with new unique ways of developing games. Western developers created their own game engines, thought outside of the box and delivered some truly unique video gaming experiences.
Diablo. Warcraft. Starcraft. Goldeneye 007. Doom. Quake. Halo. Duke Nukem 3D. The Sims. Myst. Half-Life. Half-Life 2. Mass Effect. Fable. Elder Scrolls. Fallout. Command & Conquer. Sim City. Age of Empires. Civilization. GTA 3.
Need I go on?
Now you see the difference? Japanese companies more or less stuck to the same games and same genres while Western companies created games that ran the gamut from FPS to simulation to RTS to totally open world sandbox. And they were well executed. Japanese companies struggled with creating those kinds of games.
This is what Keiji Inafune saw when he went to the game shows in America.. he saw Japan create an endless stream of the same games over and over while Americans created genre defining games starting in the late 90s. That’s why he left to create his own company. But unfortunately that didn’t do so well (Mighty No 9 for those who have heard of it).
Right now I’d say Japan is only starting to learn from the West in the past few years. Games like Zelda – Breath of the Wild and some of the new Yakuza and Persona games proves that they are willing to explore with new more expansive games. And some of the indie games and visual novels they come out with are pretty cool
However, Western companies still have a foothold in the cinematic action genre (God of War, Call of Duty, Last of Us, Uncharted, Tomb Raider, Assassins Creed etc) – as well as providing truly unique experiences amongst indie developed games such as Into the Breach, Cuphead, Journey, and lots of roguelikes and metroidvania style games.
I’d say it still sort of holds true that Western companies still have the upper hand when it comes to truly diverse, big budget and unique experiences, while Japanese companies stick to what they do well (JRPGs, visual novels, horror, 2D platformers, fighters) – with Nintendo being the only japanese company usually that’s willing to experiment a little bit more with games like Splatoon, Fire Emblem, Pokemon and Animal Crossing.