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They're missing one major point where they are - directly - competing with the Nintendo DS. Third party games.

The PSP is missing out on third party games because so far software sales on the system have been generally dismal. There have been a couple of major exceptions (monster hunter, I'm looking at you) but in comparison to the DS its clear why the third parties aren't flocking to make games for it.

It's the same problem the Wii has, but at least the Wii has expanding market-share to help alleviate the problem.