The Japanese were using their cellphones to watch TV, navigate with GPS, download music, make movies, pay bills, and check their emails years before American consumers were doing the same. Japan also had touchscreen phones eight years earlier than iPhone — the Pioneer J-PE01. And yet it is no surprise that Apple’s iPhone was the best-selling phone in Japan last year. After over a decade of trouncing any foreign handset looks and talent-wise, Japan’s legendary keitai are being given the heave-ho in favor of foreign models.

Take NEC, once one of the world’s biggest IT and telecoms firms. Its fortunes have been typical of the other seven Japanese handset makers. After two years of losses and a stock value that has fallen over 90% in a decade, it is selling off its mobile phone sales unit and cutting 10,000 mobile related jobs. Analysts say the firm can’t compete anymore with Apple (AAPL) and Korea’s Samsung.

What happened? Japanese mobile phone guru Nobuyuki Hayashi believes there are three main reasons Japan has fallen out of love with its own handset makers. First, he says, you have to understand what a colossal and unexpected hit the iPhone was with Japanese women. “The iPhone has been very strong among women from very early on. The original round plastic iPhone 3G series soon become a fashion item for Japanese women who also enjoyed the huge variation of cases and ease of decoration. Then there is the brand loyalty of Japanese women.”

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Japan had phones just as good-looking as the iPhone. The once popular Infobar candy bar phone even won international design prizes. But the craze for the iPhone, despite lacking all the bells and whistles Japanese telecoms executives thought were indispensable (e-wallet, TV, etc) proved overwhelming.

According to IDC Japan, the iPhone was the No. 1 best-seller for 2012 in both handsets and smartphones. Quite a feat for a phone that the country’s ketai-watchers and industry leaders said would fail at the start. Apple now has 15% market share putting it ahead of Japan’s Sharp and Fujitsu, which both enjoy 14% of the market according to IDC. Japan’s top mobile provider, NTT Docomo (DCM), which does not carry the iPhone, hit back by promoting mostly foreign-made smartphones like Samsung’s Galaxy.

But this won’t help the attempts to defeat Apple according to Mr. Hayashi who says that the way the phone industry operates here leads to an inferior product. “The phone operators produce almost each and every mobile phones sold in Japan. Even the phones by Nokia (NOK) or Samsung are modified to match the special requirement by the operators to include features that operators believe are important such as e-wallet, One-Seg TV receiver and wide range of special services by the operators,” he says.

“iPhone still is about the only phone in Japan which is sold unmodified (i.e. just the way the manufacturer has it produced).”

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He adds that such tinkering makes the phones — based on Android (GOOG) — too feature-heavy, too complicated, and unstable battery drainers.

Thirdly, he suggests that the software that Japanese add to foreign phones and that is found in domestic-bred devices is no match for Apple’s or an unadulterated Samsung. “As Steve Jobs once said, Japanese manufacturers’ biggest mistake is they didn’t realize how important software technology has become. Most of the executives at Japanese consumer electronics manufacturers were hardware engineers, and they don’t get the importance of software or how software business works.” he says.

There is, however, a silver lining for Japanese electronic companies making parts for Japan’s and the globe’s smartphones. Japan Inc. may have failed to produce a phone to set the world on fire, but Japanese electronics makers still produce roughly 50% of parts for all our smartphones and that includes Apple’s iPhone. “Japan’s phone makers have less market share here than five years ago, it’s true, but the value of sales here is offset (by many times) compared to the volumes of components they provide to every single maker shipping globally over that same period of time,” points out Japan mobile market consultant Lars Cosh-Ishii at Mobiyko.

“And it’s not just hardware. Nobody seems to mention the IP aspect of Japan Inc.’s contribution to wireless industry. Its critical patents for 3G enable billions of handsets around the world to connect to the network.” His message is as the cradle of the modern mobile, Japanese innovation might still engender a phone that pushes all the right buttons and astounds the world once more.