The answer to the question is relatively straightforward in that it ties explicitly to the diminishing of the Americans as the dominant cultural force in the industry. The more complex question was how that fell apart, but I'll answer the initial question as thoroughly as I can.

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Of course America had a head start in video games, but Japan was close behind. Within the coin-op field - where video games first reached the public - Japan had actually become very relevant in the creation of games during the 1960s. They produced a large number of what were called "Audio Visual" games, electro-mechanical machines with complex mechanisms which could emulate more advanced sights and sounds than what you would see on a pinball machine for instance. These include Indy 500 (cloned as Speedway by Chicago Coin), Periscope, and Missile.

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While the technology of these games were not in themselves beyond the reach of American companies, Japan demonstrated their aptitude for visceral excitement. Both Tomohiro Nishikado at Taito and Kazunori Sawano at Namco who were the main game designers at their companies in the early 70s relate that their aim was not to aim towards realism. Instead what they strove for was an authenticity that served towards intense gameplay. Compare American games like Wild Cycle and Whirly Bird which are in the same general vein. They focus on simulation above "gaminess".

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However, while the Japanese were perfectly up to speed on electro-mechanical design, they had a stumbling block with video games because they were solid state. Only by the recommendation of a supervisor had Nishikado begun looking into solid state electronics, and he by far pushed the bar above anybody else. What he and many Japanese creators aimed for though was using the technology to achieve an artistic style which was more broadly appealing, rather than looking to put the most objects on the screen at once.

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For example, compare Western Gun (1975) to Death Race (1976). The cowboys in Western Gun are more distinct, but their world isn't extremely dynamic. The monsters (and yes, they are actually monsters) in Death Race are numerous but they have the barest enough information to detail their movement. This was a divergence which became very meaningful when you were talking about Japanese games having a toehold with a younger audience. That which was immediately appealing had more resonance than that which was strictly realistic.

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It did take until Space Invaders (1978) until Japan really regained it's relevance in the West as a cultural force in the games industry. At this same time, the three big Japanese coin-op companies (Namco, Sega, Taito) were looking at setting up their own manufacturing. Sega would by Gremlin Industries, Taito would set up their own manufacturing after the success of Space Invaders, and Namco would remain solely a licensor of their games to other companies. Of course the biggest thing from the latter would be Pac-Man (1980), and this is where things really shifted into high gear.

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Pac-Man encapsulated the aim of the Japanese artistic ambition. The kawaii style employed by it was also the first incredibly distinctive use of color in games. The gameplay had no realistic analogs whatsoever and the character was just so appealing. Only in Japan would a character like that have been made, and it absolutely opened the eyes of American game players to new types of games. In the 1981-1982 period, even though the volume of Japanese games was less than American games, they were approaching half the overall sales of machines. Donkey Kong (1981), Frogger (1981), Pole Position (1982), and Burger Time (1982) were all huge hits that defined that era of the arcade. In the home many of the ports were also popular, but as of yet the Japanese weren't really personally involved.

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And then, something happened. That something was that the games oversaturated their presence in the United States. There were too many, and it started to become the case that individual games were popular for only a few months before they stopped taking in any money. The cycle which had kept the industry thriving was utterly destroyed and there was a huge Crash. This wasn't the same issue as the home market crash at the same time, the economics here were entirely different, but every single one of the major arcade companies started having trouble which included companies that had been importing Japanese product.

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While generally Japanese companies do more of their sales business in Japan, right in 1983 there was a big new issue. A law was passed in Japan amid moral panic around arcades distracting young people which restricted operating hours of the local Game Centers in the country. They had originally been running 24 hours a day and could retain continuous profit during that time. Now, they were going to be losing a massive amount of business and these smaller manufacturers needed to break into the American market where there was more room for them.

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Over the following period of about 1983-1986, the smaller Japanese companies established partnerships with American companies to produce their games in kit form. I.E, these thousands of Pac-Mans, Donkey Kongs, Defenders, and other games could be retrofitted into a new game selling a board to the operator. These allowed companies like Data East, Konami, SNK, and Capcom to get their games into the American market during a time when the larger companies across the board were largely in the shadows and most of the smaller US companies had gone under. This allowed them to be well placed when another new development hit.

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Nintendo's Famicom system was brought to the US as the NES in 1985. While initially the company had not planned to support third parties, they were quick to recognize the value of having hot arcade properties when Namco released Xevious for them in 1984. After that they actively sought companies like Irem to port games like Kung-Fu (1985) to their system.

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I'm sure you may know this peripherally, but the market Nintendo stepped into was decimated by the collapse of Atari from 1982-1984. Home video games were absolutely dead. The channels were flooded, the response was ineffective, and a lack of cohesive forces to drive the market in a new direction had left the American home industry fallow. It was a wasteland, and Nintendo felt that they could rebuild by studying the mistakes of overproduction that Atari had wrought. They were right about it too.