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I have no idea why digital distribution would have an impact on consoles vs. other gaming platforms. Or was that quoted comment out of left field, with no relevance to the main topic?
The reasons that Sony isn't making money with the PS3 have nothing to do with the fundamental viability of consoles, but have more to do with a string of colossally inept decisions made by Sony over the entire life of the project.
Publishers aren't making money off it partly because development is too hard, and partly because the economics of the industry in general are bad. The difficulty with development may well possibly lead them to tell Sony to "pound sand", at least for a while, but that will be for contingent reasons having to do with PS3 design, not for fundamental reasons that will cause consoles to become permanently non-viable.
However, to be honest, I doubt it will work as advertised. It's great that they have some magic compression algorithm, but when you compute the bandwidth of the latest and greatest HD with the latest greatest compression, it just seems overwhelming for current networks, and with their ultra-thin-client approach, it seems like there will be no scope at all for local graphics processing.
Don't forget that once people move to 3dtv (which is actually easy to adapt to from a game perspective) it will probably take quite a while before onlive will have an adequate response in place.
I also think that sony therefore (deliberately) has the "longest" term strategy of the 3 consoles at the moment, which might play out pretty nice for them in the longer run.