Given that the case against Japan is "historical popularity is in decline, and other markets offer more effective investment opportunities given rapid expansion", I'm not sure "historical popularity" is a case for Japan.
1) Is there a particular reason to believe that Microsoft will be less able to break into China at some future point due to a weak position in Japan? IE that investing now is crucial, because investing later when China is a viable market won't work, and investments elsewhere now can't pay dividends in China later.
2) Although I know Sony does good SEA business and Nintendo has emphasized its Korean operations in recent years, it's not clear to me that either would consider "Asia outside Japan" as a bigger market than even the minor European markets. It seems to me like EMEA investments are key to both Sony's firewall and Microsoft's upside growth more than SEA.
Correct, it's a poor fit for MS's current product line and MS's focus on the short term.
The current decline in the console market seems to be more a) a shift to handhelds, b) generational ennui, and c) poor position in the mid-00s to respond to an AAA market with two strong contenders and commodity engines; all of these are issues with trying to resurrect the 360 now, which we can all agree is a terrible idea, rather than indicators that Japanese software is permanently devalued.
The best argument for investing now is that the big-splash strategy has failed miserably for MS; Blue Dragon and Lost Odyssey floundered, and MS quite literally sank more money into N3's development than it grossed at retail. What did appear to work for MS's mindshare, for quite a long time, was a slow and extremely inexpensive drip of cultivating a niche fanbase and medium-dev familiarity with their tools.
If we assume that China will in large part follow Japanese software in the same way that Taiwan and HK do, and this is the core assumption that's my own experience and gut instinct, leaving the positive impression in the hypothetical launch buyer's mind that they're not going to be trading it in for $150 once they finish the launch titles will pay off in spades when the time does come to go big.
As for when that time will come? That's the big question, it's something that can't be pushed directly by any platformholder, and that's why it's on the back burner for everyone. The time for a major push is when the market opens up, and relying on the Chinese government in your business plans is lunacy. But that unpredictability is exactly why having a base to build from will be so vital.
MS exploited core mindshare in the US to break out with a strong 360 launch when the market suddenly expanded. Thanks to the 360's global strength they either have or had the potential to build similar mindshare in Japan in preparation for the huge expansion the SEA market will undergo, at costs that are a rounding error.
EMEA is certainly the market that will see multibillion-dollar returns on billion-dollar investments next gen, and it's where MS needs to seriously attack which forces Sony to seriously defend. But over the very long term, it will be matched-to-eclipsed by China's later maturation just as the US was the rising star of the past two gens but will likely be pipped by Europe this time or next.
Edit: And to address your edit, the impression that I get in my work marketing a Japanese multimedia property to the global market is that a) the mainland Chinese market is very responsive to Japanese trends, and b) it is possible to maintain core buzz on a very cost-effective level and stay far ahead of the competition that doesn't bother even when your attempts at bridging the Pacific on a mass-market level sink like the Titanic made out of lead.
