After the failure of the Atari 5200, Atari figured the third time's a charm and even after the nosedive the industry took at the end of 1983, Atari revealed the 7800 to the world.
The 7800 fixed many of the problems that the 5200 had - the most obvious being the controllers. Not satisfied with four "player" objects and four "missiles", they bumped up the sprite capabilities to unlimited. Increasing this number past a certain amount, of course, would take its toll on the 6502-based CPU. Atari also made the system backwards-compatible with the still-popular 2600.
For every step Atari took forward with the system, however, they took two steps back. Either as a cost-cutting measure or a way to ensure 2600 compatibility, the 7800 was limited to the sound capabilities of the 2600. The POKEY soundchip was one of the staples of the Atari 8-bit computer line and one of the few things the 5200 got right. Atari must have felt that music in games was a ridiculous notion, but the designers did make it so a POKEY could be added into a cartridge assembly in case tunes were needed. Only two games, Ballblazer and Commando, made use of this option.
Anyway, in 1984 the system was test-marketed for a very short time in California. Soon after, Tramiels (of Commodore fame) took over Atari and shelved the system in a warehouse and promptly forgot about it. Until ...
Come on, you know the story. It was 1986, Nintendo single-handedly revived the home video game industry in the United States. Atari then remembered all the new-in-box 7800 consoles they shelved away and re-emerged as a competitor to Nintendo.
We all know how that went, but why?
When Americans first discovered Super Mario Bros., they learned that they could go on an adventure through varied worlds and there was an actual goal to achieve. "Saving the princess" evolved from a revolutionary new concept to a rite of passage. The Legend of Zelda took this to a new extreme, giving the player the option of turning off the console and continuing their quest at a later time. The games also had catchy themes and music, something of a swan compared to the 7800's bleats of a dying elephant.
The 7800's release suffered largely from a marketing department that could not comprehend the innovation these new games from Japan afforded. To them, gamers wanted to do the same thing over and over again for the high score. They ordered the release of the same titles that brought them a fortune less than a decade ago - Pac-Man, Asteroids, Donkey Kong, Robotron, Dig Dug, Pole Position ... they seemed to refuse to believe that gamers have long since moved on. Surprisingly, they didn't try to drop Blockout and Space Invaders on the consumer again. It took almost four years for Atari to release a side-scrolling adventure on the same level as SMB, known as Junkyard Dog. This game arrived right before the 7800 breathed its last.
Also, the games looked absolutely primitive compared to what was on the Sega Master System and the NES. The 7800 suffered from the same fat pixel mode that was on its way out the door. Also, in 1986, over in Japan, NEC was putting its finishing touches on designing the system that would usher in the 16-bit revolution, the PC-Engine. Back to games.