Yeah, it's the "Selling Two Cokes" Theory -- that making two products that are the same is cannibalizing the market. Now, to an extent it can be true (the way WotC unintentionally broke its market into Planescapers, Birthrighters, Realmsers, etc.) but for the majority of it, gamers are rabid completists, and they'll play multiple kinds of systems. Ryan Dancey thinks differently, but I don't think TSR competed with itself -- it spent so much time overproducing product lines that it couldn't justify the demand in terms of sales. I don't think it cannibalized itself so much as it couldn't justify its resources spent in terms of sales.
I both agree and disagree. It is hard to imagine to many gamers, even completionists, would have purchased all those books if all the books were of a single setting they liked. That is especially true because you really run out of ideas. Just FR alone was clearly running out of ideas. They had sourcebooks and adventures seemingly covering everything, and you saw many of them in every sale bin of every gaming store because so few people wanted them. If you had hundreds of books for a single setting, then you would really wear out your audience.
Having a diversity of settings really helps. You could have an "undead adventure" for every setting. You could have sourcebooks to talk about elves for each setting. And each one could still be a pretty useful book. Also, you draw people in that like one thing but not the other. Some people really liked Dark Sun but hated the Realms. Another might be all about Planescape but hate Dragonlance.
The problem, in the end, was profit. We've heard tons of stories about how some products lost money on each and every sale (for example, the awesome Dark Sun flip-books). No amount of sales made profit (they just reduced loss). And having so much depth for each setting meant only the really extreme completionists owned everything. I'm about as big a Dark Sun fan as there is, and I didn't own everything from AD&D until 4E came out, which drove me to buy the last two sourcebooks and last minis I had not owned.
And, the problem is overwhelming the buyer. Many of us in those days just
had to write something off. If you had a budget (I was bouncing checks four times a year in college and scraping the change cup to buy groceries), you just couldn't own everything. So, despite understanding it was awesome, I entirely wrote off Planescape, Dragonlance, most FR, Birthright, and probably a few others. I focused on Greyhawk and Dark Sun and Spelljammer. Once I made a decision on a setting I stuck too it, because I perceived it as too expensive to even dip my toe in. That's where two cokes can really divide up the audience. And it can really hurt if most people are saying no to Birthright, but you have a few strong fans that are screaming murder if they don't get a new sourcebook that no one else wants. It does have many parallels to edition wars... after all, we used to meet on Usenet and rage about this setting vs that setting (Greyhawk vs FR, etc.) endlessly.
While I think there is room for some more depth, I don't think it is much more than we saw with 4E. It was interesting to see in the recent Chris Perkins poll that the number of "do not own" responses was higher for each release over time almost without exception. Few people (and these are largely DMs given the column) did not own MM, but the number climbs steadily with each book. Which is an incredible shame, because MV and MV:NV are fantastic books. Similarly, Mordenkainen's is their finest magic item book and the later settings books (such as Neverwinter) are their best. It is a classic problem, where sales decline for an edition over time, regardless of quality. The same is true within a setting.
I think 4E actually did a really good job with keeping setting short and sweet. Dark Sun had a really well done sourcebook and creature book, plus one (relatively poor) adventure. But, they had two preview convention experiences, a free RPG day adventure (still available for free download), a gameday adventure, an Encounters season, an organized play program taking you from 3rd to 10th with limited free download availability, and monthly (sometimes more) content through DDI (including monsters, adventures, etc.). The end result is really very robust if you are a fan, but takes up almost no headspace if you aren't.
We gamers as a rule are NOT going to say, "OH, well, I can't buy new supplements for AD&D, so I'll buy the newest D&D instead." We just go off and make our own stuff.
Yes and no. Most gamers don't own more than a few books, even if they play weekly. I have friends that love to play that own 2-5 books. That is a problem for either model. It sure doesn't work for a multiple settings model, and it doesn't work for the limited model either. And I know many DMs (particularly new ones) that just won't create their own stuff. Even many very well-known DMs that really know the game (Sly Flourish is an example) prefer to start with a pre-purchased adventure and make minor changes. Combine it with a budget for real problems under any multiple setting scenario.
The answer? I think it is a bit of everything. I think multiple settings are a good way to get gamers interested in something new. For example, Gamma World (a relatively radical change) was welcomed by many and seemed to be for WotC an unexpected success. And they seemed to smartly not go deep on it (I would argue they did one release too many, and they only had 3). But, it also seems like it makes sense to publish depth for a setting in non-traditional ways. It can be a way to validate a subscription to something like DDI, or to interest you in something that is actually setting-neutral but speaks to fans of a setting or something system-specific that speaks to everyone (Dungeon Tiles are a great example, such as the Dark Sun ones). There are ways to create depth without creating an audience split.
I think it can be carried further. They could be selling a lot of the organized play content once it "retires". I have only to look at the incredible prices organized play material fetches on E-Bay to see how there is a small but lucrative market in these hard-to-find materials. I don't think it translates to mass sales (placing Encounters in stores would just make them another un-purchased adventure), but I do think they could be the ones selling a small number of copies for a high value for those that are completionists or big fans. An "App Store" would make all of this much easier to manage.