I think the nail in the coffin for HD was the fact that the Xbox HD player was a costly add on for the system, rather than being incorporated from the get go.
I think Microsoft is gearing itself more toward the downloadable movie market than a specific player type, hence why they didn't include it in their system. For example, Xbox Live's Video Marketplace is currently offering Pirates of the Caribbean: At World's End in HD. Disney has an exclusive deal to put all its movies out on Blu-Ray disc, but on-demand, downloadable video is a completely different animal and has different deals.
I think this was a smart move. If (or more probably when) HD-DVD sinks like a stone, Microsoft won't really be affected as they can almost instantaneously switch gears, as their console will be able to access both formats, which is totally a win-win for the consumer and the house that Bill Gates built.
