I've heard this argument since the NES days. People wondered exactly how much better graphics could get with the SNES and Genesis. We all know how that worked out...
Anyway, we'll see some scaling back of bleeding edge hardware, but mainly for the reason that it costs Sony and MS too much to design and manufacture the hardware, forcing losses for the first year or two. Nintendo proved that isn't necessary and MS/Sony will follow suit next generation. Probably not to the extent of the underpowered Wii, but it won't be a HUGE leap in hardware tech.
On the software side, we'll see companies like Epic and id really flourish in the coming years. Their engines will become more and more of a staple to other developers who can't afford to spend two years and $5m on an engine alone. Over time, I expect the middleware providers to become more and more important as we see developers rely on them for texture packages, graphics engines, physics engines, sound packages, etc. Basically, to stem enormous developing costs, we'll see more devs rely on a "plug-and-develop" strategy to games where most of the back-end stuff is provided to them by someone else and they work on story, characters, and upper-end gameplay.
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