Japan traded 20m selling home consoles for 30m selling handheld consoles. ;)

Demographics where 25% of their population is retired, 40% will be retired by 2050, an economy that has been in the tanks since the early 1990s, and working age gamers who prefer hand-helds because consoles are viewed as for kids of otaku (Japanese social rejects who disregard the image of a working man/woman who thinks first of family, then self second).

Total HW sales for each generation (millions) console/handheld/combined

5th - 32.93/38.77/71.70 (PS1,N64,SegaSaturn,GameBoy,WonderSwan,PocketStation)

6th - 30.39/18.96/49.35 (PS2,Gamecube,Xbox,Dreamcast,GBA,Neogeo pocket)

7th - 18.54/48.40/66.94 (PS3,Wii,Xbox360,DS,PSP)

Source: VGChartz and Wikipedia

Japan doing fine. This gen not even finished yet. Maybe because others country gaming market growing at fast rate make Japan market looks smaller than 1990's era. Others factor could be decreasing in population, aging population, lost decade effect, limited space and popularity of handheld.

The 5th generation is a bit misleading. The gameboy sold 30m handhelds 2 generations behind the 5th. 

I would blame this on third parties splitting up between three home consoles.   Whether it was developers being unsure of whether to support ps3 or Wii or being paid to support 360, franchises that traditionally found strong success on a single platform were suddenly splitting their fanbases up between multiple platforms.   Looking at JRPGs in particular, the genre has been spread pretty evenly across all three platforms, with some individual franchises actually being stretched across all three platforms (Tales, for example).

This lead to confusion among consumers, as well as a probable want to not buy more than their usual 1-2 consoles, so they mostly stuck with handhelds.

Of course, I'm sure the increase in support for handhelds by Square Enix alongside the Monster Hunter phenomenon have also played a part here.  I'd say that and developers being too quick to jump into bed with Microsoft were probably the most pivotal factors overall.  I mean, there was a good bit of time there where almost all the major games were either on handhelds or on Xbox.

I wouldn't exactly say developers and publishers were hesitant to support PS3, at least not categorically in the same sense that they were (and still are) with Wii... the two are hardly comparable, PS3 had huge hitters like FFXIII, Versus, MH3, DMC4, RE5, MGS4, VF5, Gundam Musou, etc, etc announced for it (usually exclusively) before it was even on shelves. Wii had... a few spinoffs and the 4th RE4 port.

I'd also say it's unfair to put the onus of console declines on 360 and what support Microsoft managed to attract there... the gameplan for most Japanese studios seemed to be they'd take Microsoft's incentives and lay the groundwork on 360 in terms of HD development pipeline (staffing, engines, tools, etc) then move on to PS3 when it was finally ready to take over the world.  Unfortunately (for them) that didn't pan out, and due to market conditions the move to PS3 became an additional venture rather than an exclusionary one, so 360 support continued (albeit mostly for foreign markets).  Wii meanwhile was breaking records in sales, and 3rd parties only threw it a few experiments, more spinoffs and eventually whatever big names Nintendo could incentivize first hand (MH3, SW3, DQX, etc).  The only chance the Japanese industry had this gen with repeating the PS2's success in the living room was really with Wii, and they largely blew it in favor shifting to handhelds (smart!) and/or sticking to their HD guns (dumb!).

As far as the handhelds themselves, 3rd parties largely followed the markets there rather than leading them imo.  Nintendo, Pokemon and Capcom (with Monster Hunter) respectively pretty much drove that single handedly. If anything, I'd say the relative failure of the HD consoles in Japan is proof that 3rd parties by large (MH being the big exception) have proven pretty ineffectual at building markets... their success is more at sustaining them, which is what they did with DS/PSP and didn't do with Wii.

I don't know but I find it sad.

Anyway the iPhone is killing the handhelds so hooray! Handhelds need to die.

They steal amazing games that could be on consoles.