I have Xbox Live. I've downloaded content for several games, ripped a few of my favourite albums for playback in game and never been forced to clear a save file from the device in the whole time I've had it. I wouldn't be suprised to find I've got less than a Gig of stuff saved on the box - and next generation I won't even need to have my soundtracks on the actual console (that'll be a *choice*). I'll opt for a HDD, whether it's a pack in or peripheral, but many, many users (probably most) would never see a real benefit over using memory cards.
Next-gen is a bit different. Downloadable content will be much more pervasive, lots more movies, music, vg downlods available. Also there's downloadable demos (which is a killer feature BTW). I believe that I will get much more use out of the HDD next-gen than current gen, MS should just keep it standard with the hardware. Its a nice bullet point against the PS3 IMO.