I think part of the problem is that nobody is content with simply making a profit, but everyone wants monster profits. Thus perfectly profitable niche markets are being ignored in pursuit of "teh epix wins". I think the turn around point will be when the huge markets are simply split up so many ways again that developers will turn to niche markets to make a profit since things will be evening out.
The MMORPG thing is a factor, but not because "everyone is playing MMOs, noone is playing single player" most PC gamers do both. When chatting in MMORPGs you'll find that most people also play single player games on the PC, and a really popular PC game will lead to a lot of "OMG, shut up, focus on this game" when people start talking about their single player gaming in mass channels (like Trade in WoW).
What makes MMORPGs a factor is that with most game developers they figure if they are going to put a massive amount of resources and time into developing a game, they figure they might as well make it into an MMO rather than a single player game and hope they hit the "WoW Jackpot" somehow. It's developers aiming ignoring a smaller market for the most part rather than a bigger market actually killing it.
I'll also point out something a bit ironic: an increasing number of people seem to be interested in playing more than one game simultaneously. A lot of raiders and such seem to like playing portables in slow spots, and as odd as it might sound a game being able to multitask well with WoW has been a factor in some word-of mouth suggestions.
Honestly it's a bit surprising to me that we haven't seen any products directly targeted at this trend yet. I look back at things like the "Final Fantasy 8 Chocobo Game" (the real name eludes me) where you could raise a Chocobo in a pocket station game and use it back and forth with the main game, something that was never released in the US. As well as that Pokewalker thing which I think is kind of interesting (though with the death of my pokemon cartridge recently, I'm unlikely to try it anytime soon), and I think that a fortune could be made by someone who say came up with a portable side-game that could link to the PC and have an influance on a game like WoW, say letting you continue to grind/loot/powerlevel/etc... even when you have to go to Aunt Hilda's birthday, spend 2 hours waiting for repairs at a garage, babysitting an oblivious sick relative (sleeping in a hospital or whatever), doctors office waits, and all the other things that people use portables to kill time with. Heck, if someone simply came up with a sidegame online it could be interesting, with say some kind of benefits from playing a Roguelike in the backround or whatever so you can earn some kind of advancement while your guild spends 20 minutes going ultra-drama instead of getting around to the next pull (though thankfully this has not been an issue for me for a while).
Heck, even without any kind of direct game to game interface, simply having a multi-task friendly game that can be run alongside an MMO seems to be a benefit... yet ironically few companies even bother to consider easy multitasking (in any sense) an important design feature.
I guess what I'm saying is that all of the above ideas aside, the bottom line is that the industry just isn't willing to think creatively, or target a niche market for a moderate profit. Almost everyone spends all their effort trying to go toe to toe with WoW and fight for the MMO market without considering how they can work around the edges, or how to exploit markets that are going untapped due to everyone focusing on the big prize.
