I could be wrong but I believe that Microsoft ensured that they would lose their lead when they didn't cut the price of the XBox 360 last year ...
The Red-Ring of Death is a massive problem for the XBox 360 but was (somewhat) predicted from the time Microsoft entered into the console wars. As a software company, Microsoft built a reputation for releasing flawed software, ignoring problems until they grew into massive PR-Nightmares and then patching the software (while often introducing new flaws which were ignored). Fanboys and Linux supporters often mentioned this when they were commenting on the XBox and claimed that Microsoft would have a large failure rate and suggested the internet connection and hard-drive were really there to patch anything they could.
These problems never showed up with the XBox mainly because the XBox was primarily conventional hardware that was readily available; the ammount of engineering that Microsoft would have done to produce the XBox was minimal. The XBox 360 was a far larger engineering problem for Microsoft and it could be argued that the built in culture at Microsoft prevented them from realizing it was a problem and acting appropriately.
