One factor that I think a lot of people are overlooking is the collapse of one particular "genre" of handheld games: licensed games.
Looking back at the GBA, you'll find that other than Mario and Pokemon, licensed games made up a lot of the software lineup. Out of the 70 million-seller titles for the platform, about 23 were based on cartoons and recent movies, like Yu-Gi-Oh, The Incredibles, Finding Nemo, Dragon Ball Z, Spider-Man, etc. Finding Nemo was the 3rd best-selling non-Nintendo game on the platform, with almost 3 million sales.
Meanwhile, on the DS, licensed games were rarer, but still prominent. Big licensed names like Star Wars, Batman, Harry Potter, etc. were represented as LEGO games, and other licenses such as Hannah Montana, High School Musical, etc. stood on their own. About a quarter of the million-sellers on the DS were licensed games. The PSP had fairly few hit licensed games, but considering how it sold half as well, that's pretty much to be expected.
With the possible exception of Kingdom Hearts, NONE of the 25 million-sellers for the 3DS are licensed games.
What happened? Well, part of it was people finally getting smarter about these sorts of games, but not a large part. Many licensed games simply existed to help sell or thrive from a sucessful product, and were not meant to be great in of themselves. Thus, as the methods of delivering these games became cheaper via mobile device downloads, a large chunk of the handheld market was simply abandoned. In the process, this included most Western support for the dedicated handheld market, meaning that the 3DS and Vita mostly depend on one small region, Japan, for most of their games.
As for how this problem can be solved... I don't think it can. Licensed games were never the mainstay of the industry, and were arguably a simple inflationary process for what already exists. Without it, the numbers will be lower, but the core remains. On the downside, this will permanently weaken the handheld market to some extent, simply because it now relies mostly on Japanese support.
If we want to see the dedicated handheld market get reinvigorated, we need a new challenger to enter the ring. And they need to be a Western company. I say this because the Japanese market is not getting any bigger, and Western development is largely untapped. If some Western company were to deliver a new handheld that can attract support from new places, that would reinvigorate the industry.
For now though, the arrival of mobile devices has made dedicated handheld gaming a weaker domain. And until somebody new enters the domain, it will remain maybe half as large as it used to be.
