PS3 will be backward compatible with PS2. Sony made sure that from the PS1 , which most of us have games for, we would easily buy a PS2 NOT just because of the new games that were coming but we could play our old games as well. They are doing the same with PS3 allowing PS2 games the same way. They will phase out production of PS1 games completely when the PS3 hits.
PS1 HOT SELLER then...
PS2 plays HOT SELLER PS1 and new PS2 GAMES making PS2 the new HOT SELLER
PS3 plays PS2's (the current HOT SELLER) games and new PS3 games....and the beat goes on
PS3 doesn't even need to be the best technically or graphicly (and probably won't be) and it will still outsell Xbox 2 and Gamecube 2 combined (PS3 does have to have a very noticeable improvement over PS2). It will in turn (even if the system is harder to program for) make a developer/publisher want to tap that higher installed base of users (more profit) and games for that system (more times than not, exclusively).
This proves that being first and having excellent marketing can win over superior ttechnical advancements by competitors. Microsoft and definitely Nintendo will need a next generation system that unequivicly blows PS3 out of the water to really 'crack the Sony wall'.
They might also ETCH IN STONE these MUST HAVES to have a chance to compete:
DVD or new Blu-Ray disc compatibility (learn Nintendo)
TIVO style recording
play recordable DVDs if not record itself (Blu-Ray's format is already recordable in hi-def)
maybe come with a game, mem card, or free online time
is lower costing than PS3
Failure to do this will insure Sony's dominance for at least 3 more years and definitely put Nintendo in the 'software only' market.