Blu-ray, or a similar high-capacity disc if Blu-ray is replaced, is almost essential for Microsoft next generation.
Games are only going to get bigger and bigger. Some games have already strained the 4.7GB DVD limit and have had to be on multiple discs. As kowenicki said, Blu-ray players are cheap, and blu-ray drives are cheap as well. It would be a very, very small cost tacked on to the system production cost, and in any case, ALL discs are cheap. The difference between the price of Blu-ray and DVD films is because the studios take more money for Blu-ray films. That's why PS3 games don't cost more than 360 games.
Digital distribution is brilliant, yes, from the point of view of somebody with high-speed fibre-optic internet. In most of the world, access to high-speed internet is limited, and even in parts of the USA, broadband is unavailable. Until high-speed internet is universal, physical media isn't going anywhere.
(Former) Lead Moderator and (Eternal) VGC Detective 
