The Dreamcast and Saturn are anomalies, because they didn't have the right software mix. Why? Not enough western dev support ie. EA. The Genesis and PS2 both benefitted from launching before their eventual competitors (Nintendo, and Nintendo/MS respectively).
Personally, I think that MS has rightly determined the true bottleneck next generation and it isn't primarily hardware. Sure you need new and powerful hardware to deliver shorter load times and better/cleaner visuals, but art assets and code complexity will determine the quality of games for the most part.
If FFXII, MGS3 and GT4 are shipping in holiday of 2004, it's impossible for Sony to have FFXIII, MGS4 and GT5 before holiday of 2007. Two years for MS to bring out other games before Sony's heavy hitters is a long time. Exploiting the powerful and complicated PS3 hardware is going to take time.
By the time Sony gets the big guns out, Xenon will have been in production for two years and will be relatively cheap to manufacture compared to the PS3. MS can aim for 2009 for Xbox 3, shortening the lifecycle to 4 years, but with good enough software support that it doesn't matter to most consumers. ie. support the hardware with games for 5 years, but bring out new hardware every 4 years.
This is the ideal way to mess with Sony's inhouse hardware development strategy and their investments in the fab business. PS3 will only end up being out for 3 years before better hardware is on the market and if MS is successful in bleeding off marketshare, there is no way that Sony will be able to recoup its investment in foundries.
The strategy isn't without risks as many will soon point out: maybe no one will care about Xenon, maybe Sony brand power is so enormous that MS can't possibly do anything about it, maybe the Xenon software (Half-Life 2, Bioware RPG, Perfect Dark Zero, and Project Gotham Racing 3) available in the first 2 years won't be enough for consumers to go Xenon instead of waiting for Sony's big software hitters.
There are risks, but I think this strategy is the right one to take: shorten the life-cycle to 4 years, concentrate on software, reduce code complexity. Imagine the Gamecube with good 3rd party support, MS marketing, solid mature content, better branding, and a design that appeals to young adults and this is what MS is going for. Low-cost hardware with high-quality software, but is also out in a timely fashion (unlike Nintendo 1st party).
PSP is irrelevant to Xenon success.
Microsoft learned a lot from Sony this generation, but they also learned alot from Nintendo as well. If the Cube had a better case design, better 3rd party support, and didn't have the Nintendo kiddy image to contend with, it would probably have sold 30 million units by now. Good economical hardware can keep you competitive. Software and branding/mindshare are everything.
I think a myth that alot of people have bought into is that people passed on DC for superior PS2 hardware. I don't think this was a widespread phenonemon. My gaming friends all gave the DC a fair chance. They liked the price tag. They didn't care for the games. They thought Shenmue and Skies of Arcadia were goofy. They didn't get a PS2 right away either, but when they saw SSX, GTA3, and Baldur's Gate, they jumped right onboard the Sony bandwagon. The same friends didn't care about Xbox either, or that it was 3x more powerful than PS2, but when they saw Halo they had to have one.
Games. That's what it's all about. It's about 50% of the battle. 40% is marketing and branding. Technology is really only about 10% of the equation unless there are major deficiencies, and there won't be. Xenon games will look great and almost as good as PS3 games on 90% of the TVs that consumers own.
If Xenon has the games people want to play, they won't care about the lack of hard drive or Blu-Ray or any of those other intellectual excercises. MS is already in the process of selling everyone on "software is king" and de-emphasizing hardware. They know already that PS3 is going to be more powerful with more features. But they also know that it will always cost $100-$150 more to produce a PS3 than a Xenon unit if MS just sticks with DVD-9 and Sony includes a Blu-Ray drive. That's a pretty big advantage that a lot of people tend to ignore.