The story of Shenmue begins on November 29, 1986, in the perspective of the protagonist Ryo Hazuki returning home to his family dojo to witness his father, Iwao Hazuki, battling with a tall, ominous man dressed in a green silk Kung-Fu suit known as Lan Di. He demands Iwao hand over an item known as the "Dragon Mirror", though Iwao refuses to reveal where it is. Ryo intervenes in battle after his father is felled, but is injured by a blow from Lan Di. He then lifts Ryo from the ground and threatens to kill him with a final blow, which prompts Iwao to reveal its location underneath the cherry blossom tree.
After Lan Di's henchmen recover the mirror, he mentions a man called Sunming Zhao, who was allegedly killed by Iwao in a rural Chinese village. The two then engage in combat for the last time, as he wishes Iwao to die "as a warrior". Lan Di finishes the fight with a deadly blow, and he and his party then leave. Iwao dies shortly after in Ryo's arms, which fills Ryo with the desire for revenge above all else. He begins to instigate inquiries into the incident with the local people of his hometown, Sakuragaoka.