Some people like to say that R-Type was on SMS and therefore that somehow ruins it as a pack-in and how the TurboGrafx-16 really needed an exclusive arcade port pack-in like Altered Beast...
-which was alson on SMS. 
Apples and oranges there. Altered Beast is a SEGA property and had brand exclusivity - it wasn't on any competing consoles (in the US). R-Type was previously released (in a pretty solid port, nonetheless) on an older, less powerful SEGA console. In addition, Altered Beast on the SMS is a severely handcuffed game - it is missing multiple levels, single-player only and a huge step down in graphics. If anything, having a far inferior version of Altered Beast on an older console only helped SEGA to tout the power of their new system. Looking at R-Type, many praise Compile's work in porting the game to the SMS - it's the complete game (which the PC Engine can't even claim, at least on a HuCard) and even adds in a bonus level not found in the arcade or the TG-16 port. There's no question the TG-16 version is graphically superior, but it's far less impressive of a jump than Altered Beast SMS to Genesis, and many would argue the SMS's FM sound is more appealing than the sound on the TG-16 version. In my opinion, even if R-Type were a far better game on the TG-16 (which it is not), launching with a game found on the competition's system (that's 5 years older than your current flagship) just cannot happen.
Ignoring the entire Altered Beast/R-Type port debate, shooters, especially at that time, were far more niche than platformers or action games. There's a higher barrier for entry, since those games are generally more difficult (and in R-Type's case, definitely) than your typical platformer or hack and slash game. Plop a kid in front of Keith Courage and s/he could do okay, but R-Type would be over in a matter of seconds. Even though it's an inferior game, Keith Courage would have more appeal to a broader audience than R-Type, which I'm sure weighed on NEC's decision.
The topic is about what pack-in the TurboGrafx-16 should have launched with. The PC Engine versions have nothing to do with this discussion, aside from the impact the game had for the PCE.
Most people in North America did not know that the Sega Master System even existed. The SMS also does not have FM sound. Altered Beast is a slow clunky game in any form. R-Type TG-16 is at least as much of an improvement over the SMS version and delivers much more of an arcade experience.
I rented a Genesis with Altered Beast at launch and got one by the end of the year. Altered Beast looked poor in color and shading and created the impression for me that the Genesis was like the NES and had weird unique color limitations. Altered Beast was a newer arcade, but was just gimmicky and not the kind of long lasting hit that R-Type was, nor was it as influential (or at all). R-Type has a major place in gaming hostory. Altered Beast is only remembered for being the initial pack-in of a console that eventually became successful, right around the time they dropped Altered Beast as the pack-in.
Shooters weren't niche until late in the 16-bit generation. When the Genesis and TG-16 launched, shooters were just considered normal games. R-Type is only really difficult for people used to loose games and refuse to pay attention. At the time, R-Type was easier than many NES games.
I'm one of the few people who appreciate Keith Courage and it was part of what converted me from Genesis as it had the things I had really wanted in next gen games that I wasn't getting on Genesis. I totally get why they picked it and think it's much better as a game and pack-in than Altered Beast. From a business perspective, R-Type makes the most sense as a pack-in from what was available. Altered Beast got tired quick. It didn't work out well for the consumer. It's impact was simply luring in people to buy the console. R-Type was at least as attractive. The fact that the end user would get more value out of it isn't as important.
The SMS was a distant second compared to the NES, but people still knew of it. Certainly SEGA as a brand through its successful arcade division had a lot more cache with US buyers at the time than NEC or Hudson, and if someone is buying a system other than an NES in 1989, they'd likely be informed enough to know what games are on the systems, since early adopters tend to be more savvy. Someone who knew what R-Type was would very likely know it was not an NEC exclusive.
Technically, yes, the US SMS could not play FM, but Japanese SMS's and MarkIII's (with the FM adapter) could play them, and even the US carts of R-Type do contain the FM tracks. I play the FM tracks on my US R-Type all the time on my SMS. I was more mentioning the FM music to support my claim that the SMS R-Type is no slouch and in ways just as impressive as the TG-16 version. If you've played both versions of Altered Beast and R-Type between the 8-bit and 16-bit consoles, there is no question that Altered Beast is a much bigger leap on the Genesis than R-Type was to the TG-16. The SMS version of Altered Beast isn't even close to the full game! There's virtually nothing missing from the SMS R-Type.
If you look at the best selling games of the previous generation, they are dominated by platformers or action games. Mario, Ghosts n' Goblins, Metroid, Castlevania, DuckTales, Teenage Mutant Ninja Turtles, Mega Man, Kirby's Adventure, Blaster Master, Commando, Adventure Island. You have to go a long ways down best-selling lists to find your Xeviouses, 1942s or Gradiuses.
From a business sense platformers or action games are perfect for a new console. They can be enjoyed by novice gamers and advanced gamers, and in Altered Beast's case, I'd argue that it getting tired quick is exactly what SEGA wanted. People would appreciate the arcade port and the power of the system, but quickly finish or grow tired with the game and look to buy a new one, increasing software sales. R-Type would have alienated younger gamers and would have kept hardcore gamers out of Toys R Us longer as they'd work their way through the game and its nuances.
