By coming up with tons of crap that in the end no one really wants.

It's that simple.

Sony is getting kicked around for a few reasons in my opinion:

A) Complicated cell processor

The added cost of the cell added to the complicated programing required to utilize it meant that developers are not taking advantage of its power. Therefore, it's wasted power that adds an additional cost to the console.

B) Inferior online network

The PSN lacks the ease, features, usability, and aesthetic appeal of that XBOX LIVE incorporates. Add that to the fact that it was launched years after LIVE (therefore, smaller loyal community) and the continued push-back of HOME upgrade. It's a free service that can't beat a $50+ a year pay service.

C) Blu-ray

Sony's strategy in winning the console war was directly tied to winning the high-def format war. With the success of the Wii and 360, this generation has already proven that people don't think a high-def player in their console is a priority. the average gamer buys their console to play games first, and anything else second.

On top of this, 3rd party developers are not taking advantage of the Blu-ray disc space. Especially considering a large portion of them are dual-releases for the 360 & PS3. If they are making a game

I don't think so. The reason why Wii dominates now it is its appeal. The reason why Wii dominated at the beginning of this generation was its price. When PS3 cost 599$ (ridicously amount) and X360 399$ with much smaller brand name people went to buy Wii which was far most cheapest console. With price point 249$ PS3 would have with its huge brand name sold more consoles and with that all developers would have continued at same path as they did with PS2.

"My only assumption is that they assumed the loyal PS2 fanbase would all naturally upgrade to the PS3, which thus far has not happened on a mass scale."

Well, Comrade, some people say that "assumption is the mother of all fuck-ups".

Ehm, so now it has appeal, but not at the beginning?

Really the main appeal of wii has stayed the same for the 2 years it's on the market. It's Wii Sports and Motion Controls. If you don't see that I don't have a clue how you explain the recordbreaking sales.

Really, price is definitely a part of the equation, but not the most important one. Wii kills the 360, despit it being more expensive now. PS2 completely obliterated the Gamecube at a much higher price. People won't buy a console of $250 (which is for most people still a significant amount of money) because it's the cheapest. They pay $250 because they think it's worth it and they want it.

I agree except for the PS2. I think B/C has been ready via emulation for quite some time, and that Sony has been depending on the PS2 to keep the game division afloat until costs to make the PS3 drop low enough for it to break even or turn a profit. IMHO B/C will return via a firmware upgrade after the funeral of the PS2. Then Sony thinks those people who are still buying PS2's (and until very recently there were more of them than the ones buying PS3's) will be ready to move to the PS3. This might work, but a $200 360 might interfere with that strategy. And if sony goes $299 the 360 and Wii might finish them with another price drop.

Sony is in a BAD place.

 That's very true, the GC didn't sell at $99 with the complete console history of The Legend of Zelda (including Ocarina of Time) included. And if the Wii is GC 1.5 (and I'm not saying it is, just quoting the trolls), then why has it sold for $250? It was always the mass appeal of the controller and immersive experiences it provides, like Wii Sports. Price is always a factor, never the only factor.

To put that in perspective, the Gamecube did not sell when it was the same price as an Eye Toy. And GC only sold 22 million consoles while sony's Eye Toy Accessory sold almost 11 million units for the PS2 alone. The experience generates the sales.

In PS3 vs 360, the experience is similar, so price did/does play a factor. To gamers and developers. And to gamers and developers interested in HD experience, online play is definitely a factor, and in this area 360 wins hands down. 

Though i think the price is a factor, at least against the XBOX, in order for sony to have taken first place they needed like the OP said, the everybody software that the Wii has.

By now i think we already know as far as the whole console war goes, price dose not mean much nor does the technical ability, look at NPD the weakest and second most expensive system has out sold all competitors combined and then some.

A valid lesson needs to be learned from this Generations by the industry

1) a game console should never be expensive (anything over $300)
2) a games console should have games for everyone, not just a selction of people
3) media capabilities should not be the selling factor of a console, but just a bonus

@BornFirst: I would add one more lesson for the industry:

4- Do not assume you can engage Microsoft in a cash-throwing war.

This one may not seem important, but it shapes the next generation in that Sony will have to change their strategy, and it will decrease the number of potential newcomers (probably to zero).

Nintendo is only succeeding because their strategy doesn't rely on having 3rd party exclusives and having a price advantage. Otherwise MS would have "killed" them too.

PS: This assumption may not have been explicitly in the minds of Sony's execs, but it was certainly implicit in their strategy.

Okay, that's great, but don't just tell me I am wrong, tell me why I am wrong.  Don't be scared buddy, I won't get mad at you.  Everybody has the right to an opinion ;)