I'm not trying to argue about the specifics about what happened, but just in general terms, there was always going to be room for a competitor in a space that big, that was changing that rapidly. Imho.
I'm more flummoxed by the fact that a fundamentally social-native offering didn't disrupt the existing ecosystem, in the 2000 timeframe.
We had chat. We had basic web. Keyboards weren't that expensive, were they? Seems a killer feature for kids.
Not straight "the Web on your console", but something more like AOL, Prodigy, and the late 90s portals.
My only explanation is that the 3 big platform companies were still thinking in packaged software/games, sold retail, terms. Hence XBox Live, when it emerged, was essentially a way to get more value (multiplayer) out of the packaged software you bought.
I guess, in retrospect, Microsoft's fundamental synergy was "developers, developers, developers!" And realizing trading more powerful commodity PC hardware for decreased programming difficulty was a good deal. There were a large number of developers, or future developers, dissatisfied with catering to {insert Nintendo or Sony weird architecture hoops du jour}.