Why Did PS4 Sell Less Than PS3 in Japan?

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It's the result of Sony competing with Nintendo and being unable to win. You only need to consider how third party support has moved over the course of the past 20 years.

With the PS1 and PS2, Sony held the lion share of notably third party games that registered in the software charts. The steep rise in development costs for the PS3 did a lot of damage to Sony's home console business, but this was mitigated for the overall PS business by third parties choosing the PSP instead of the Wii. But what shouldn't be ignored during this generation is that the DS could expand on what the GBA had received. This was followed up by Nintendo being very aggressive during the next generation when the 3DS went right after the PSP market, including the most efficient third party deal that was ever made in video game history: Nintendo secured Monster Hunter exclusively for Nintendo systems for the duration of a generation. This stripped Sony's handheld business of its lifeblood, because MH was central to the PSP's extended prosperous lifespan in Japan; MH had also risen to become the biggest third party IP in the Japanese market, leaving both Dragon Quest and Final Fantasy behind it.

Sony's handheld business declined from 20 million systems sold to only 6m. At the same time, the PS4 was on pace to outsell the PS3 for a long time, but during the latter half of its lifecycle the wheels began to fall off. This coincides with the rise of Nintendo Switch which broke up a lot of exclusivity that PS previously enjoyed. By 2020 there weren't many third party IPs left that were kept off Nintendo.

A common narrative that has been used by PS fans is that Sony and Nintendo don't compete with each other because AAA third party games usually skip the Nintendo platform. But this argument doesn't hold up for the Japanese market because most AAA titles don't sell much in Japan while at the same time most third party titles below the AAA level are nowadays multiplatform and available on both PS and Nintendo. When the argument is that Sony and Nintendo don't compete when games aren't available on both platforms, then this same argument must mean that Sony and Nintendo do compete with each other when games are available on both platforms.

The PS5 is following the same path of PS's terminal decline in Japan. Here's how Sony's hardware sales look over the course of five generations:

PS1: 20m
PS2: 23m
PS3 and PSP: 31m
PS4 and PSV: 16m
PS5: 8-9m (projected figure)

The addition of a handheld lifted PS to its greatest height, but the fall has been steep with two consecutive declines of around 50% each. How will the PS6 fare when Switch 2 is making further inroads? We might be looking at lifetime sales of around 5m, because remaining holdouts like Square-Enix have already announced to go for a broader multiplatform strategy than before.

There are two other explanations that are being pitched regularly. The first one, that Japanese gamers are less interested in home console gaming, is bogus. As a hybrid console, Switch can be played just fine on TVs because it didn't surrender any home console features; the breakdown of how Switch SKUs have sold over the years also shows us that the much cheaper handheld-only Lite isn't exactly popular, finishing in third place among three SKUs. If we look at only the timeframe since Japanese gamers have a choice, so since September 2019 when the Lite launched, we have shipments of ~12m for the original Switch, ~10m for the OLED and ~7m for the Lite. The bottom line is that the portability of Switch doesn't mean that gaming on TVs has ceased to be in high demand in Japan.

The second explanation, that the PC platform has become more popular in Japan, makes sense. The same logic as for the more elaborate Sony vs. Nintendo explanation above applies here: More games have gone multiplatform than was previously the case. But this is merely a smaller piece of the overall puzzle because consoles are still way more popular than PCs in Japan.