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Soundwave on 23 August 2012
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The handheld market will look like this by the end of the generation IMO:

3DS - 80-85 million
Vita - 25 million

Down a lot from

DS - 150 million
PSP - 70 million

There's still a market for it. It's just a limited market, scaling back. I think the market was going to shrink anyway even without the smartphone factor, because the PSP really did not achieve its destiny of being the "cool" handheld that every 18-32 year old carried around like a gaming iPod. Handheld market is going to still have a place mostly because of younger kids. 

A lot of the people that bought into the hype of the PSP in its early years weren't coming back anyway, they tried it and the novelty of watered down PS2 games on the go didn't hold their attention once the 360/PS3 launched. So Sony at least was likely looking at a large scale regression anyway. For Nintendo the smartphones have probably forced them to retreat back to selling more to the Game Boy market (young boys) as their core demo. Adults if they want something like Brain Training, there are a milion $1 apps that basically do the same thing. 

It's not just about games. Smartphones has fundamentally changed people's lifestyle period. Before you were really limited in what you could do when you got outside the house. You couldn't watch a movie on your cell phone. You couldn't really browse the internet in a satisfying way. You couldn't check social media sites. You generally had to carry a seperate iPod or CD discman (lol) if you wanted to listen to music.

There are a million ways now that a cell phone is basically a mobile entertainment center, you can do all sorts of things with it on top of playing games that eat up any free time you'd have on the go. That's the problem. To the average grown adult, why should they spend $170-$250+ on a dedicated game player, when their cell phone/tablet eats up all their free time on the go as is? If they want to play video games, that's what their 50 inch screen and "real" game console is for.