In the early 1980s, the American video game industry entered its second generation and was making money hand over fist. Arcades popped up across the country, the Atari 2600 dominated competitors in the home market, and Pac-Man Fever (no relation to the same-named trope) held America in its iron grip.
But in 1983, something went terribly wrong. Dozens of game manufacturers and console producers went out of business. Production of new games stalled out. The American console market as a whole dried up for two years and when it returned, Japanese companies dominated as old American stalwarts tried to play catch-up.
So, what happened? The story of The Great Video Game Crash of 1983 truly begins with the downfall of Atari, a company forever linked to the Crash:
- Atari refused to give game designers authorial credit or royalty for their work. That led to a culture of dissent where many of its programmers started their own companies to make games for the 2600 (of which the most successful is Activision). Atari lost its legal attempts to prevent the use of its cartridge format, which allowed the most creative people in the industry to directly compete with Atari's own efforts.
- Atari's business strategy—sell its consoles as cheaply as possible while relying on game sales for its profit margin—made the situation worse. The strategy worked when Atari had a home-market monopoly on Space Invaders and Asteroids, but when competing companies produced either better or cheaper-yet-comparable work, Atari's profits suffered.
- The company produced a number of overhyped but underdone games in late 1982, including the home port of Pac-Man and the adaptation of blockbuster film E.T. the Extra-Terrestrial. Those two games, both Christmas Rushed, soon earned a reputation as two of the worst games ever made. Atari also overproduced copies of these two (and many others) in the hopes that they would become system-sellers. While initial sales were brisk - indeed, record-breaking in the case of Pac-Man - word quickly spread of their poor quality, and the sheer volume in which the cartridges were produced negated positive sales figures. Stores either returned the unsellable products in droves or relegated them to clearance sections. The situation was so bad Atari ultimately took millions of dollars' worth of worthless cartridges (together with defective consoles and accessories) and buried them all in a landfill in Alamogordo, New Mexico.
- Further compounding the company's problems was the launch of the Atari 5200, released in November 1982. Intended to be the successor of the 2600, its lack of native backward compatibility and its notoriously finicky and fragile analog joysticks helped to doom the 5200. Although a 2600 adapter was eventually released, it was only compatible with later revisions of the 5200 console, so early adopters were still out of luck.
- December 7, 1982 is the closest thing the gaming industry has for a "Black Tuesday": during a shareholder meeting, Atari projected a 10-15% profit increase—way below the 50% people predicted Atari would announce. The stock of Warner Communications (Atari's parent company) dropped 33% on the next day, and a mini-scandal erupted when people discovered that the president of Atari had sold 5,000 shares of the company only a half-hour before he made that fateful announcementnote .
- Though not a video game console, the Atari 1200XL computer was an even bigger flop than the 5200, due to the desire to rush it out and retire the expensive-to-build 800. Due to all the changes made to the architecture, including unimplemented features and missing connections, the 1200XL had serious compatibility issues with the 400/800 library, and was still more expensive than what the 800 was going for at the time of the 1200XL's launch. The scramble to fix the problems and relaunch the XL line, combined with Commodore's aggressive pricing on their computers, only further deepened the hole Atari was in.
With its customer base eroded by inferior technology and their profits consumed by wildly optimistic production runs, Atari racked up nearly half a billion dollars' worth of losses by the end of 1983 (roughly $1.4B going by the 2012 value). Of course, if it had just been Atari suffering, there wouldn't have been a real crash, but its competitors were also facing hard times:
- A glut of companies attempting to cash in on Atari's success gave consumers too many choices which meant no one system could succeed in the long term because very few consumers would buy more than one. The glut of home systems included (amongst others) the Bally Astrocade, Colecovision, Coleco Gemini, Emerson Arcadia 2001, Magnavox Odyssey and Odyssey², Mattel Intellivision, Vectrex, Sears Tele-Games note , and Fairchild Channel F-System II. Many of these featured indistinguishable libraries in part because Atari, Coleco, and Mattel released games for each other's consoles. (The current trope image shows the exact problem left to consumers looking to determine just what system to buy.) Consumers largely waited to see which console dominated and by the time everyone figured out that nobody would, companies had started going out of business.
- A similar problem occurred with software development. Companies could produce games for these systems without much cost; since they figured all video games would sell regardless of quality, poor titles from dozens of hastily-created upstarts flooded the market. Non-video game companies (like Quaker Oats) produced thinly-disguised commercials for their products, such as Chase the Chuck Wagon (Purina) and The Kool-Aid Man. As the Crash started, these companies died off first.
- As console makers and game developers went out of business, retailers had to deal with their own problem: a stockroom full of unsold products that they couldn't return. Stores offered massive discounts on this hardware in an attempt to salvage something from the Crash, which caused the market for higher-priced new games to shrink in the face of large amounts of budget-priced crap. Speaking of crap...
- Consumers had no real way to discern good games from bad ones. The Internet existed as a military and academic research project at this time; and video game magazines didn't really appear on newsstands, so most buyers had only screenshots and box text to tell them anything at all about the game. Since these almost always lied to get people to buy the game, consumers soon felt once-bitten twice-shy. A few stores had demo stations set up for potential consumers, but those didn't really help since they would never warn against bad or buggy games instore.
- The personal computer market made its first competitively-priced entry into American society. PCs had software libraries which catered to the early gaming crowd, but their educational and office software gave them the edge. Certain computers (such as the Commodore 64) ended up priced and marketed to compete with game consoles. Commodore and other companies marketed these machines to Education Mamas who were worried their kids would be shut out of good colleges and the job market if they weren't "computer literate."
- Home computers were rapidly outstripping the second-generation consoles in the field of memory capacity, making it possible for game programmers to write larger programs. Features had to be cut out of Montezuma's Revenge and Fort Apocalypse just so that the code and graphics could fit on 16KB cartridges. It was rapidly becoming obvious that the PC could handle games that couldn't feasibly fit on the available consoles. Was the PC destined for the next generation of gaming? This was the birth of the PC Gamer, who began to enjoy larger, more graphically advanced games - for a price.
- While not a true contributor to the crash, much media had painted video games as a fad and played up all the company bankruptcies as proof of the industry's inevitable demise.
The Crash killed the American home console market for two years: video game sales dropped from $3B in 1982 ($7.23B in 2017 dollars) to as low as $100M ($241M in 2017 dollars) in 1985 (a dropoff of 97%), which caused a majority of game companies to go out of business.
When the market returned to prominence in 1985, it largely rode on the success of the Nintendo Entertainment System, at which point the console's native Japan overtook America as a leader in the video game industry, which meant the Crash never came close to killing video games as a medium (think of the Crash as a condensed version of the type of American business hubris that led to the financial meltdowns of 1929 and 2008).
The home gaming market suffered a huge blow from the temporary death of the dedicated console, but the growing PC base (especially the Commodore 64) provided a viable replacement for game production by the small number of companies left alive. While the American arcade scene began its slow descent into obscurity, arcade games still stood near the height of their popularity. Minor arcade classics like Paperboy, Punch-Out!!, Space Ace, Karate Champ, and Gauntlet saw release during this period and many of them would end up ported to home consoles (with varying degrees of success) after that market's revival.
Outside North America, though, the Crash made little impact. In Europe, eight-bit home microcomputers (predominantly the Sinclair ZX Spectrum and the C64) already dominated the gaming market. An outrageous number of one-person coders wrote and released games for the far cheaper tape-distribution system, which helped those machines flourish and become the backbone of Europe's gaming industry for the next decade (this is also why the NES and Master System took a lot longer to catch on in the UK than they might have). These "bedroom coders" received status labels ranging from "cult hero" (Jeff Minter, Matthew Smith et al) to "legend" (Bell and Braben, the Oliver Twins) from their fans but that didn't prevent a number of talented developers from making enough stupid decisions to snatch defeat from the jaws of victory (Imagine Software see here for info, with a big example of an Orwellian Editor as a bonus). Even with the missteps, the European gaming industry remained solid. (Nevertheless, a similar crash due to market saturation affected the home computer hardware market in the UK in 1984, causing a lot of the less popular machines like the Dragon 32 and Jupiter Ace to disappear entirely and causing Sinclair and Acorn to be taken over by Amstrad and Olivetti respectively).
The Crash had little discernible effect on the Japanese market, either. Though the home of a massive arcade base that grew out of Pachinko parlors and Mahjong dens, Japan didn't adopt home gaming consoles at first; people deemed American imports as curiosities at best. The massive discounts at which Japan forced people to sell computer technology after the Crash provided the perfect storm for domestic development and the release of the Famicom console, the MSX computer and the SG-1000 in 1983 didn't hurt, either. The Famicom and the MSX systems dominated the Japanese gaming industry for the rest of the decade, though the latter would soon fall to increased PC competition. (Near the start of 1983, Atari had entered into the early stages of negotiating rights for the Famicom's US release. The Crash eventually ended those plans, and it later came out that Atari never had the capital to buy the Famicon for the US. They were just hoping to tie up Nintendo with red tape for as long as possible.)
Nintendo exported the Famicom two years later as the "Nintendo Entertainment System" and achieved near-monopoly status because of the American console market's weakened state. Nintendo's "Seal of Quality" system and a cartridge design that no one could manufacture without Nintendo's approval provided a degree of protection against the low-quality shovelware that plagued the Atari. To assuage concerns of American shopkeepers burned by the Crash, Nintendo designed the NES with a front-loading cartridge slot to make it look more like a VCR and bundled its largest NES set with the Robotic Operating Buddy (R.O.B.) and Zapper light gun peripherals (which looked much more like conventional toys). The former only worked with two games, and the latter didn't fare much better in the long run, but they both looked cool for the time, which was more important.
Toy stores saw through the plan, but success in test markets and a brilliant advertising strategy landed the NES space on store shelves across the country. Nintendo also had the perfect game to bundle with the NES for its 1985 American debut: a fat Italian plumber, best known for antagonizing a giant ape, ventures across a land overrun by turtles and walking mushrooms in order to save a princess from the grasp of a dragon-turtle villain.