LogFAQs > #969958180

How did it work?
Each Genesis game starts with a header, imaginate it being a digital identification that the console have to access before starting the game. When the Sonic & Knuckles cartridge feels that a cartridge is inserted, it will check if it is a Sonic 3 or a Sonic 2 cartridge. If it is Sonic 3, it will merge it with the data on the cartridge and create Sonic 3 & Knuckles.
If it is Sonic 2, it will say "run this game, but when the game is looking for player data, use Knuckles data instead".
So why didnt it work with Sonic 1?
It did, but it screwed up the graphics because they couldnt find a working color palette.
Back then, memory was expensive as hell. So to save space, and money, graphics was stored different. This is how some Super Mario Bros graphics are stored
https://gamefaqs.gamespot.com/a/user_image/8/8/6/AAA_aCAAD9Y-.jpg
Small tiny pieces that can be reused with different colors (Mario vs Luigi, cloud vs bush, etc). So instead of saving graphics for two characters, it stores one and references to what color in the color palette you want to use.
This is the Nes color palette
https://gamefaqs.gamespot.com/a/user_image/8/8/7/AAA_aCAAD9Y_.png
56 colors to pick from. Each game got access to smaller color palettes with fewer colors, basically you got 13 colors for the background and 12 for sprites, so a whooping 25 colors on screen at the same time!
The Genesis had a bigger palette and more colors on screen.
But Sonic 1 used the palette in such way so they couldnt add Knuckles colors without it messing up some color somewhere in the game.
From a technical point of view, they could have rewritten all the graphics coloring from scratch to fit with Knuckles colors, but that would require so much extra data stored on the Sonic & Knuckles cartridge so it wouldnt be worth the extra cost.