I think the entire problem was with customer loyalty. There's only one things that makes a company #1 for the long haul, and that's loyal customers.
And sega of japan shunned its customers big time when it cancelled support for all prior systems (sms, genesis, cd, 32x, game gear) to put all support on the Saturn. Everyone had just spent all their hard-earned money on segas latest consoles just to be told sorry, we're canning them. Um, wanna buy a saturn? No.
That was the point when I quit console gaming and went PC full-time until 2002 when I rediscovered old games on the used market. I was so pissed at sega for dumping support for my segacd and 32x. And of course I was upset when they were still alive that we'd only get like 1 new game every 6 months.
It's my belief that if sega of japan hadn't tried to backstab sega of america, the 3rd parties wouldn't have dumped cd&32x to wait for the saturn, and we could have still had 3rd party software coming out to keep the systems alive. Without the constant influx of 3rd party software, a system can't survive. Consumers have the view the system as alive by constantly seeing new titles.
And when segacd was creating titles, they forgot to testdriver them first and threw out too many craptastic duds which fuelled its demise.
With 3rd party support, lots of new games, the genesis/cd/32x machine would have done great. It had both things that were needed: backwards compatibility (= large install base and large software base), and 32-bit power (despite the fact that few games were made to take even close to its advantage, the 32x+CD combo was capable of saturn-quality games.
So, basically, the 32x-CD should have replaced the saturn. And then the customer base still would have been loyal when the new dreamcast came out. And the dreamcast should have had the cartridge port like the saturn did, BUT actually support genesis & 32x cartridges for backwards compatibility, and also played CD games.
And this time when the dreamcast came out, all the loyal sega fans hadn't been scorned and jumped ship to Sony, so they would have fared much better in the competition. Dreamcast had superior graphics and games and would have easily won.
Also, there's one problem with consoles that noone has yet tackled, and that's import games. Since sms and nintendo and continuing through the ps2 we've passed over great import titles, and the ones we imported we f'd up royal by removing the story/cutscenes, replacing sprites and names completely, etc. If someone would just step up and start porting games the right way, they would gain a huge loyal following of fans who want to see unmolested imported games. Like the people who want to watch Star Wars on DVD the way it was meant to be - the way it was in the theaters 20 years go.