I don't remember the specifics, maybe prices declined by fixed amounts but not fast enough. But BOM would decrease anyway because memory, DVD and HDD, etc. would have all become cheaper. There are models of Xbox that have hard drives larger than 8GB, for example, because drive sizes expanded to the point that 8GB drives were more expensive than larger ones. They were partitioned to only have 8GB accessible, though.
Edit - Found an article
about the case. It was settled in arbitration. Microsoft was ordering shipments of chips from nVidia, but nVidia wanted prices to stay the same. No financial details were listed when they settled, but MS was not happy about the deal and not only chose ATi for 360, they also licensed the chip design and handled the fabrication contracts. I think part of the problem was that nVidia really had control over Xbox in a way MS didn't care for. If nVidia shipped them less chips, they couldn't do anything about it. The deal with ATi allowed them for shop around fabs for a better deal or have multiple fabs if demand required it.