In 1983, the North American video game console market crashed. Citing information from Wikipedia and its sources, I will look at modern parallels and how the game industry could reset again and possible reasons why it may need to.
The American video game console crash of 1983 was caused by a combination of factors. Although some were more important than others, all played a role in saturating, and then imploding, the video game industry.
Reason 1) Plethora of games and consoles
At the time of the US crash, there were numerous consoles on the market, including the Atari 2600, the Atari 5200, the Bally Astrocade, the ColecoVision, the Coleco Gemini (a 2600 clone), the Emerson Arcadia 2001, the Fairchild Channel F System II, the Magnavox Odyssey2, the Mattel Intellivision (and its just-released update with several peripherals, the Intellivision II), the Sears Tele-Games systems (which included both 2600 and Intellivision clones), the TandyvisioN (an Intellivision clone for Radio Shack), and the Vectrex.
Each one of these consoles had its own library of games, and many had large third-party libraries. Likewise, many of these same companies announced yet another generation of consoles for 1984, such as the Odyssey3, and Atari 7800.
Adding to the industry's woes was a glut of poor titles from hastily financed startup companies. These games, combined with weak high-profile Atari 2600 games, such as the video game version of the hit movie E.T. the Extra-Terrestrial and an infamous port of the popular arcade game Pac-Man, seriously damaged the reputation of the industry. Finally, Atari's market-leading 2600, now in its sixth year, was starting to approach saturation
We now have 17+ game consoles: Nintendo's Wii, Sony's Playstation 2 and 3, Microsoft's Xbox 360, Nintendo's DS Lite, DSi, DS XL, and upcoming 3DS, Sony's PSP and PSP Go, Microsoft's Zune HD, Apple's iPod, iPod Touch, iPhone, and iPad, the GamePark and Pandora devices, and the Android and Nokia phones. (more than in 1983 if you count all the models of the DS, iDevices, and Android/Nokia game-capable phones)
The industry is seeing a new sub-generation of systems with the slim relaunches of the PS3 and Xbox 360, and Apple and Nintendo's refreshes of their systems, and the uprising of tablet devices based on iOS and Android.
We again see the glut of poor quality titles on systems like the Wii, not only from those looking to make a quick buck by getting into the industry but also from veterans who don't want to change the way they make games. We also have seen some high profile titles not make their expected earnings or have critical failures such as Spore, Supreme Commander 2, Madworld, and others.
The PS2 has reached saturation to the point of not being supported anymore in the core videogame markets, even though some titles are still strong.
Reason 2) Competition from personal computers
Until the late 1970s, personal computers had primarily been sold in specialty computer stores at a cost of more than USD $1,000 ($3300 in 2009 dollars). However, by the early 1980s, many companies released PCs that could connect to a TV set and offered color graphics and improved sound. The first of these systems were the Atari 400 and 800, but many competing models vied for consumer attention. By 1982, the TI 99/4A and the Atari 400 were both at $349 USD ($800 in 2009 dollars), Radio Shack's Color Computer sold at $379 USD ($800 in 2009 dollars), and Commodore had just reduced the price of the Commodore VIC-20 to $199 USD and the Commodore 64 to $499 USD ($400 and $1100 in 2009 dollars).
Because these and other home computers generally had more memory available, and better graphic and sound capabilities than a console, they permitted more sophisticated games and could also be used for tasks such as word processing and home accounting. Also, their games were often much easier to copy, since they came on floppy disks or cassette tapes instead of ROM modules (though many of them continued to use ROM modules extensively). The use of a writable storage medium also allowed players to save games in progress, a feature useful for the increased complexity of computer games, and one not available on the consoles of the era.
In a strategy that directly affected its home computer arch-rival Atari, Commodore explicitly targeted video game players in its advertising by offering trade-ins toward the purchase of a Commodore 64 and suggesting that college-bound children would need to own computers, not video games.
The Windows PC, made by Microsoft (in a similar stance to Atari of 1983 w/ both PC and consoles on the market, though MS differs in that they do not provide the PC hardware) has become more and more commoditized to the point that most R&D at hardware companies is now focused on the hot mobile or cloud-server space. The Macintosh brand (now mostly known as Mac) has moved to a more compatible standpoint (using Intel chips) and is a desirable brand for gamers now with Valve's Steam and EA supporting it, not to mention casual and social games and indie game developers supporting it.
Computers still have more memory and capabilities than consoles, though copying has become an issue, which is solved to some extent however, through new business models and technologies like SteamWorks. Computers and consoles both strayed from cartridge based technology though we are seeing a resurgence of that in the forms of SD and SSD cartridge tech.
While NPD shows the PC digital distribution industry at close to parity with retail, the digital distributors dispute these results, and NPD acknowledges that they still don't cover some of the fastest growing areas like social games (which now have walls of prepaid cards at stores like Target and deals with companies like Target and General Mills to promote their products - which we haven't seen as much with regular games so far).
Reason 3) Loss of publishing control
Activision was co-founded by Atari programmers who left the company in 1979 because Atari did not allow credits to appear on the games and did not pay employees a royalty based on sales. At the time, Atari was owned by Warner Communications, and the developers felt that they should receive the same recognition that musicians, directors, and actors got from Warner's other divisions. After Activision went into business, Atari quickly sued to block sales of Activision's products, but never won a restraining order and ultimately lost the case in 1982. This court case legitimized third-party development, encouraging companies such as Quaker Oats (with their US Games division) to rush to open video-game divisions, hoping to impress both stockholders and consumers. Companies lured away each other's programmers or used reverse engineering to learn how to make games for proprietary systems. Atari even hired several programmers from Mattel's Intellivision development studio, prompting a lawsuit by Mattel against Atari that included charges of industrial espionage.
Despite the lessons learned by Atari in the loss of its programmers to Activision, Mattel continued to try to avoid crediting game designers. Rather than reveal the names of Intellivision game designers, Mattel instead required that a 1981 TV Guide interview with them change their names to protect their collective identities. ColecoVision designers worked in similar obscurity, feeding more departures to upstart competitors.
Unlike Nintendo, Sega, Sony, or Microsoft in later decades, the hardware manufacturers in this era lost exclusive control of their platforms' supply of games. With it, they also lost the ability to make sure that the toy stores were never overloaded with products. Activision, Atari and Mattel all had experienced programmers, but many of the new companies — rushing to join the market — did not have enough experience and talent to create the games. Titles such as Chase the Chuck Wagon (about dogs eating food, bankrolled by the dog food company Purina), Skeet Shoot, and Lost Luggage were examples of games that companies made in the hopes of taking advantage of the video-game boom. While heavily advertised and marketed, these games were perceived to be of poor quality and did not catch on as hoped, further damaging the industry. As a counterpoint, two of the most successful video game franchises were started in this period: Mario and Pac-Man.
While crediting is still an issue in the industry, a lot of developers forming new companies now are forming them because they've been fired or laid off from high-profile companies. A big example of this would be the Respawn Entertainment case. Another case, somewhat different, would be Brutal Legend.
The loss of publishing control in this time is different, with indies not necessarily wanting the big publishers involved, instead going through routes like Kickstarter.com or creating things like Indie-Fund.com - indies funded by indies.
Exclusive control is not such a problem now, but supply is. Several times we've seen critical shortages of systems like the Wii and iPhone.
As far as counterpoints go, we've seen the rise of Master Chief, Sackboy, the resurrection of Mario, and several hugely selling new franchises such as Wii Sports and Flight Control.
Reason 4) High-profile disasters
A core cause of the crash was two high-profile titles for the Atari 2600 that were disasters. In 1981, Atari attempted to take advantage of the craze following the arcade game Pac-Man by releasing a version for the Atari 2600. However, development was rushed so as to have the game out in time for the 1981 Christmas season. Although the game managed to sell well in terms of absolute numbers, Atari had grossly overestimated the number of sales it would generate. Critics and gamers universally panned the game as being nothing like the lively, colorful original. In the end, Atari only sold a little over half the number of cartridges it produced. Production cost overruns combined with the costs incurred with a big marketing campaign for the game resulted in huge losses for Atari.
The following year, Atari issued its widely advertised ET game. Once again, it manufactured millions of units in anticipation of a major hit. Concerned about making the holiday season, Atari again rushed the game to market quickly, after a mere six weeks of development time. The end result was a disaster and it is widely considered to be one of the worst video games ever. To clear their inventory, Atari eventually ended up burying the unsold copies in a landfill in New Mexico. Combined with the high costs for the movie license, ET became another financial disaster for Atari. Atari was sold two years later as the crash impacted the industry.
Besides the titles already cited (Spore, Supreme Commander 2, Madworld, etc), we could see any number of failures this holiday season. Kinect and Move are not truly on board with the hardcore demographic. A lot of big titles have already been released this year and people have a backlog due to economic distress. Blizzard may have messed up their fanbase with the Real ID fiasco. The remaining calendar year needs at least 8-20% more sales than are projected to make the same amount as last year, or the industry needs to accept that social and mobile games are important, perhaps even vital. While we don't have the dangers of production overruns especially with digital distribution and CDs and DVDs are commoditized compared to the costs of the old cartridges, sales numbers could still fall off the point on the charts that sales goals need to be at.
In addition, consoles are constantly being criticized for their high price points. The 3rd Atari console sold at a high price, much like the third Playstation is. The 3DO and Neo Geo also failed to see mass sales due to this. The only console that has survived a high price point so far is the iPad, one of the disruptive, non-traditional innovators.
The release of so many new games in 1982 flooded the market. Most stores had insufficient space to carry new games and consoles. As stores tried to return the surplus games to the new publishers, the publishers had neither new products nor cash to issue refunds to the retailers. Many publishers, including Games By Apollo and US Games, quickly folded. Unable to return the unsold games to defunct publishers after Christmas 1982, toy stores marked down the titles and placed them in discount bins and sale tables. By June 1983, the market for the more expensive games had shrunk dramatically and was replaced by a new market of rushed-to-market, low-budget games.
A massive industry shakeout resulted. Magnavox and Coleco abandoned the video game business entirely. Imagic withdrew its IPO the day before its stock was to go public; the company later collapsed. While the largest of the third-party cartridge makers, Activision, survived for several more years on personal-computer platforms (thanks to its then-legal ability to average its income and recover millions of dollars in past tax payments from the IRS), most of the smaller software development houses supporting the Atari 2600 closed.
Additionally, the toy retailers which controlled consumer access to games had concluded that video games were a fad. That fad, they assumed, had ended, and the shelf space would be reassigned to different products; as a result, many retailers ignored video games for several years. This was the most formidable barrier that confronted Nintendo, as it tried to market its Famicom system in the US. Retailers' opposition to video games was directly responsible for causing Nintendo's branding its product an "Entertainment System" rather than a "console", using terms such as "control deck" and "Game Pak", as well as producing a toy robot called R.O.B. to convince toy retailers to allow it in their stores.
The American video game crash had two long-lasting results. The first result was that dominance in the home console market shifted from the United States to Japan. When the video game market recovered by 1985, the leading player was Nintendo's NES, with a resurgent Atari battling Sega for the number-two spot. But Atari never truly recovered and could not match the success of its 2600 console. It finally stopped producing game systems in 1996 after the failure of the Atari Jaguar.
A second, highly visible result of the crash was the institution of measures to control third-party development of software. Using secrecy to combat industrial espionage had failed to stop rival companies from reverse engineering the Mattel and Atari systems and hiring away their trained game programmers. Nintendo, and all the manufacturers who followed, controlled game distribution by implementing licensing restrictions and a security lockout system. Would-be renegade publishers could not publish for each others' lines, as Atari, Coleco and Mattel had done, because in order for the cartridge to work in the console, the cartridge had to contain the appropriate key chip for the lock inside the console, and the publisher had to also acknowledge its license to Nintendo in the copyright notices. If no key chip was present or if the key chip did not match the lock inside the console, the game would not work.
Although Accolade achieved a technical victory in one court case against Sega, challenging this control, even it ultimately yielded and signed the Sega licensing agreement. Several publishers, notably Tengen (Atari), Color Dreams, and Camerica, challenged Nintendo's control system during the 8-bit era by producing unlicensed NES games. The concepts of such a control system remain in use on every major video game console produced today, even with fewer "cartridge-based" consoles on the market than in the 8/16-bit era. Replacing the security chips in most modern consoles are specially-encoded optical discs that cannot be copied by most users and can only be read by a particular console under normal circumstances.
Nintendo reserved a large part of NES game revenue for itself by limiting most third-party publishers to only five games per year on its systems (some companies tried to get around this by creating additional company labels like Konami's Ultra Games label). It also required all cartridges to be manufactured by Nintendo, and to be paid for in full before they were manufactured. Cartridges could not be returned to Nintendo, so publishers assumed all the risk. As a result, some publishers lost more money due to distress sales of remaining inventory at the end of the NES era than they ever earned in profits from sales of the games. Nintendo portrayed these measures as intended to protect the public against poor-quality games, and placed a golden seal of approval on all games released for the system. Most of the Nintendo platform-control measures were adopted by later manufacturers such as Sega, Sony, and Microsoft.
Effects on world gaming markets
In Europe, the early years of personal computing (1981–1985) were spearheaded by the very aggressive marketing of inexpensive home computers with the theme "Why buy your child a video game and distract them from school when you can buy them a home computer that will prepare them for university?" Marketing research for both the gaming and the home-computer industries tracked the change as millions of consumers shifted their intention to buy choices from game consoles to low-end computers that retailed for similar prices while still playing comparable games.
By 1982, computers such as the BBC Micro, Commodore 64 and Sinclair ZX Spectrum had launched in Europe and were selling extremely well there, dominating the European games market and growing throughout 1983 and 1984. The significantly lower price of computer games (some of which cost just 1% of the price of a computer, due to being stored on inexpensive cassette tapes or floppy disks rather than the ROM chips contained in the plastic cartridges of consoles) strengthened this domination and helped quickly create a mass computer games market. By the time of the 1983 North American crash, the European video game industry was mostly computer-based and most games were made by European publishers. This allowed the European market to thrive despite the crashing American market.
Immediate effects of the console game market crashing would likely be a lot of developer houses closing or moving their efforts to platforms which didn't crash (such as the mobile markets which are definitely booming, or back to PC/Mac/Linux - whether that be in the regular AAA or other disc-based format or server-requiring MMOs or completely server based browser or social games). We are already seeing mass movement to these new arenas.
Stores like Gamestop would probably fail in the aftermath of a console market failure, but this could actually be a good thing seeing how much publishers complain about used games and how these stores leech profits.
Japan is in no place to save us anymore, citing statements by high ranking pros at Square Enix, Capcom and others. Nintendo would probably stay around, but I would see Google and Apple taking places in the "big three" in the next 10 years. China produces most of the hardware even if the IP is technically owned by US or other companies, they have a massive knockoff market. Korea and Europe are in a better place to save the industry as it stands, though the change in business model would be drastic (more free to play titles). Companies like Zynga also will prosper or be acquired by other companies desperate to effect change, such as the current rumor of Disney buying Playdom.
Lastly, along with the trend of veterans starting their own indie studios vs making deals with the big guys when they lose their jobs, studios are offering more chances for users to generate their own content than ever before, with titles such as Alien Swarm, Starcraft 2, Little Big Planet, The Sims 3, Spore, Halo:Reach, and Elemental offering huge modding capabilities both on the PC and the console. Along with analysts recommending that developers charge for multiplayer in order to recoup huge development costs of titles like these, the developers and publishers may see resistance to purchases of new titles due to backlogs both from user generated content, long-tail multiplayer play, and economic fragility.
Gamers are obviously dissatisfied with games as they are, with the amount of games called "shovelware", the shunning of certain equipment produced, and the calls for boycotts or forum outrage with things like Real ID etc.
The industry is focusing too much on the forest (mass market) and not enough on the trees that planted the roots of the industry (hardcore market).
One way to fix this would be through a coop. Instead of paying $15/mo or $60 per purchase of a single game, players could pay a membership fee to be part of a coop where they actually get a say in development and can help develop if they want to. I don't expect the big corporations to accept this model... but it could work for the indies and innovators who will deliver the Marios, Pacmans, and Tetrises of 30 years from now... and the big company models will not survive that long. There will be a reset, a great reckoning. It's just unclear now when it will come.