Shenmue begins on 29th November 1986, in the perspective of the protagonist Ryo Hazuki returning home to his family dojo to witness his father, Iwao Hazuki battling with a man dressed in Chinese attire named Lan Di. He demands Iwao to hand over an item known as the "Dragon Mirror". Ryo intervenes in battle after his father is felled, but is injured by a blow from Lan Di. As his father refuses to reveal the location of the mirror, Lan Di lifts Ryo from the ground and threatens to kill him with a final blow, which prompts Iwao to reveal its location underneath the blossom tree.
After Lan Di's henchmen recover the mirror, he asks Iwao if he knows of a man called "Sunming Zhao". Iwao expresses surprise and fear as he now remembers who Lan Di is, unbeknowist to Ryo. After Lan Di reveals that "Sunming Zhao" is the name of a man Iwao had supposedly murdered in a rural Chinese village called Meng Cun, the two engage in combat for the last time. Lan Di dodges Iwao's attacks and quickly kills him with a deadly blow of the Tiger Swallow Style (the same move is described in a mysterious scroll found in the very same room). As Ryo lies injured on the floor of the dojo, Lan Di and his men leave the Hazuki household and Iwao whispers in his dying breath one last message to Ryo: "I'm sorry for leaving you alone... Keep your friends, those you love, close to you". At this point, Iwao dies from an Internal hemorrhage from the strike and Ryo screams in horror as his fathers lies lifeless in his arms. After Ryo has partially recovered he feels that he must dutifully gain revenge for the murder of his father, and begins to instigate inquiries into the incident with the local people of his hometown.
Ryo's first clue is a car that some of his neighbours saw on the day of the murder. Though his leads are few and far between, Ryo slowly makes progress in his investigation by interviewing people all over Yokosuka. Just as he is about to run out of leads, a letter from a man named Yuanda Zhu suggests that he seek the aid of a certain Master Chen, who works at the harbour. Through Chen and his son Guizhang, Ryo learns that a local wharf gang known as the Mad Angels is connected to Lan Di's crime organization, the Chiyoumen. Ryo also learns that "the mirror" stolen by Lan Di is part of a set of two mirrors. After much investigation, he locates the second mirror underneath his father's dojo. This mirror is decorated with a phoenix.
Ryo takes a job on the waterfront in order to learn more about the Mad Angels gang, and eventually he causes them enough trouble that the gang kidnaps his friend (and principal love interest) Nozomi Harasaki. To rescue Nozomi, Ryo must first fight Guizhang, then team up with Guizhang to defeat all seventy members of the Mad Angels gang. Upon defeat, the gang's leader reveals to Ryo that Lan Di has left Japan for Hong Kong. With the aid of the Chen family as well as his family and friends, Ryo boards a boat to Hong Kong. Before the close of the first chapter (and subsequent end of the game itself), he is instructed by Master Chen to seek out the help of a master of the Chinese martial arts located in Wan Chai named Lishao Tao. Concluding the first chapter of Shenmue, Ryo boards a boat and travels to Hong Kong in pursuit of Lan Di.