Your concerns are justified. Dev costs are higher than expected, next gen install base is lower than expected, and the competition this coming holiday is greater than expected due to all the product that was due as early as last winter but has been delayed to Q3. I have small long positions in the sector that I write covered calls against almost every month, and the company I'm least bullish on is ERTS due to their high valuation and PS3 exposure. I'm most bullish on ATVI due to their lineup strength and Guitar Hero.
Halo 3 and GTA 4 should be a turning point, hopefully. Aside from Gears there hasn't been any truly compelling next gen exclusive games to encourage people to upgrade, and all the talk of price cuts makes people wait longer.
Also re ERTS, I do expect calendar 2008 to be excellent. With Spore, larger install base for sports, no Halo and GTA soaking up dollars, Warhammer Online.