That didn't stop MS from releasing 360.
They released 360 because as Laa Yosh said, they decided the fundamental hardware royalty model Xbox was based on doomed it to be a money pit forever (they should have known this BEFORE the gen, of course).
Currently I dont see ANY next gen hardware on the horizon for a long time. Sony is trying to amortize PS3 over who knows how long, and MS by all intents and purposes appears to be aiming at Natal as their "next gen console" for the forseeable future as well. Natal doesn't even debut until fall 2010.
Personally, I'm afraid. The longer we wait for next gen, the fewer process shrinks are left, the more shrinks we use up. We are already on 65/45. 32 and 22nm are about all the sure bets left then. Maybe there is another after 22, maybe.
So basically, I dont see a way to cut silicon costs in post-PS360 hardware, so I think they might have to pull way back on power. They may be designing Xbox3/PS4 on the last die shrink, no further shrinks will be possible for the life of those systems. Which is pretty drastic.
Whereas if you debuted a new system right now, youd probably do it on 65nm. You'd be able to cut it's costs in steps all the way down to 22. In 2013, you may start at 22, or 32 at least. There will be nowhere to go down.